Committee for a Responsible Federal Budget

Iceland Ash Blanket Settles Over World Economy

Apr 22, 2010 | Economics

Airline traffic may not be the only thing slowed by Iceland’s volcanic eruptions. The slow-moving, fragile economic recovery may take a hit as well. While a just-released report from the International Monetary Fund predicts stronger worldwide growth than previously predicted, the projections were made before the volcano erupted.

The big question now is: Did the volcano blowing its stack cause enough damage to cool optimism about a recovery?

The Wall Street Journal noted from the IMF report that, “the real rebound is occurring in emerging and developing countries, which are expected to continue to accelerate at a 6.3% pace this year and 6.5% next year."  It added,

The global economic recovery is taking off faster than expected, but the International Monetary Fund warned Wednesday that many advanced economies could be left behind if they don't address the lingering financial-sector weakness and growing concerns about public debt.

The IMF is increasingly optimistic about the world economic outlook for this year, lifting its forecast to 4.2% from the 3.9% projection given in January, the fund said in its latest World Economic Outlook. But global growth isn't expected to pick up much next year, with its estimate unchanged at 4.3%.

However, The IMF warned that accumulated and growing federal debt continues to be a threat in advanced economies in particular, whose growth isn’t projected to grow as fast as less-developed economies.

Now, it is feared that the airline and tourist industries will suffer from the recent disruptions, and there are also fears that commerce in general may have been dealt a severe, if short term, blow. A Washington Post story included this graphic displaying how the closure of much of Europe’s airspace is rippling through the economies of various countries. Car parts, fresh fruits and vegetables, and even diamonds have been unable to reach their destinations form points across the world. Some fear the travel disruptions alone could slash as much as one to two percent off GDP.

While the sky is falling scenario may not play out, especially if all the flight restrictions are able to be lifted and remain so, the problem with many nations’ economies is that fighting the global recession has left them without any budget flexibility to deal with additional problems, such as the volcano's impact. Many U.S. states set aside specific funds, often called rainy day funds, to deal with unexpected crises. But countries, in general, have no such practice. Greece, because of its problems with unsustainable debt, has set up a “solidarity account” to which people can donate money to help pay down its debt. But this came only after it was pretty much too late.

Perhaps nations need to begin budgeting for disasters by setting aside a portion of their budgets for emergencies. That would be a pretty big change for most countries. An important first for mitigating against future emergencies is for countries to immediately begin implementing plans to get their fiscal houses in order. Lessons from around the world show that planning early for getting a country’s fiscal house in order can help reduce the pain of changes forced upon you by unforeseen events. Let’s hope countries can learn from the impact –realized or not – of the volcano on the world’s fragile economies.