One year after the global financial crisis erupted, the world economy again stands on a crucial turning point. There have been clear signs since July that the global recovery is gathering strength. However, caution should prevail: Are these strong signs of a long-term sustained recovery, or it is just a short-term rebound from the bottom up caused by the stimulus plans?

The world economy is undergoing a stage of transition, swaying between rebound and recovery, government and market, outside stimulus and internal growth. Next year will be critical for the world economy, and could be full of uncertainties and challenges to test the wisdom of governments. We have seen the dawn of hope, but the task is still arduous.

Recently, signs of rebound were visible in leading economic indicators in the United States, the European Union, Japan and other main economies, signaling the intertwining of the robust world economy. The global growth estimates by the international institutions, such as the International Monetary Fund (IMF) and the Organization for Economic Co-operation and Development have gradually turned optimistic by improving their growth outlook for the global GDP.

Take the monthly IMF report. Its March report predicted the global economy will contract by 1.7 percent this year; in the April report, it was down 1.4 percent this year and up 2.5 percent for the next; the September report, down by 1.3 percent for 2009 and up 3.9 percent for next.

However, great risks, looming behind the initial growth, remind us to be cautious to the continuity, complication and twists of a further recovery. We are facing three problems: how to effectively achieve a mechanism that will drive growth forward; how to readjust financial policies; and whether expectations of inflation will be realized.

If these problems can be addressed, the year 2010 will give birth to a new round of global economic growth. Once they are badly dealt with, we cannot rule out the coming of the second world recession.

The first problem refers to how to achieve an effective replacement of the growth driving force. The imperative task of each government is to cultivate domestic demand, seek successors for government investment and reduce the potential fluctuation caused by policy adjustments in the future.

The current situation does not seem optimistic. First, the spillover effect of policies has dissipated. Large-scale fiscal stimulus plans and eased up monetary policies from governments around the world have reeled in the sharp global downturn. The impact of the economic stimulus will diminish by the middle of 2010.

Second, the sign of transforming the economic growth driving force from government stimulus to private demand and investment is not distinct. Sustainable economic recovery needs the rejuvenation of private demand, including consumption and investment.

Third, there are no new engines of growth in major developed economies. Before the crisis, consumption, the housing market and eased credit boosted the US economy but now none of them have any momentum. Without new emerging economic forces, the actual growth rate will be lower than the potential rate for a long time.

The second problem is whether the governments should change their loose monetary policy. According to statistics, the increasing budget deficit in major developed countries may weaken the effect of the stimulus measures and curb the recovery. Furthermore, as the source of global liquidity, the quick expansion of the US Federal Reserve balance sheet and the soaring of greenbacks printed have expanded the gap between "the real economy" and "the virtual economy." It will be the sternest test for governments of different countries to maintain the hard-earned recovery and at the same time avoid the potential of an overall stagflation against the background of increasingly unbalanced government revenue and expenditure and the amounting pressure of stagflation.

The third problem is whether the inflationary expectation will turn into real inflation. At the initial period of recovery, the rise in prices is restrained by the overcapacity and surplus product supply, so there is no risk of inflation. But base money, money multiplier and money circulation velocity will all blow up in the short-term, when people become optimistic to the economic performance. The outcome is the re-emergence of the contradiction in the supply and demand previously covered by the financial crisis. If the inflationary expectations become reality, the fragile recovery will receive a heavy blow.

The author is an economics researcher with the State Information Center.

(China Daily 09/26/2009 page4)