The world economy will grow by 3 per cent this year, and by 3.8 per cent in 2014. Growth has picked up slightly in advanced economies, while it has slowed in key emerging market economies. Despite the clear improvements in some major economies, the risks to global growth are mostly on the downside.

Growth is picking up among the advanced economies, supported by monetary policies which remain accommodative. The strong upturn in Japan has been sustained, and growth has returned to the Euro Area, albeit very unevenly, partly as result of a slowing of fiscal consolidation. Monetary policy has remained broadly unchanged in the past three months. In the US, the Federal Reserve's decision against any early reduction in the rate of 'QE3' asset purchases has moderated the global rise in longer-term interest rates. It now seems unlikely that the Fed will begin tapering asset purchases until at least early 2014. However, US fiscal policy has been a substantial drag on the economy, both directly and through the confidence impacts of the current political impasse. In the Euro Area, there seems clear scope for a further reduction in official interest rates.

By contrast, some key emerging market economies are slowing. Although growth in China appears to have stabilised and Brazil has continued its recovery, India and Russia have slowed further. In both cases there has been little scope for expansionary policy because of inflationary pressures, financial imbalances and fragile market confidence. A number of emerging market countries, including Indonesia, South Africa and Turkey as well as Brazil and India, experienced large-scale financial outflows between June and early September.

Despite the clear improvements in some major economies, major downside risks remain:

– Financial markets are likely to remain volatile in anticipation of the eventual end of the period of near-zero short-term interest rates and unconventional monetary policy in many major economies. A normalisation of monetary policies will be a necessary feature of a successful economic recovery but raises market risks.

– The political brinkmanship in the US over the direction of fiscal policy, which has become the norm in recent years, also increases the potential for instability.

– In the Euro Area, the continued concentration of the burden of adjustment on the deficit countries and the incompleteness of the institutional framework for the monetary union mean that adjustment fatigue could, at some point, reverse the fitful progress to date.

– In financial services, the continuing lack of coordination between the US and Europe on rules governing cross-border banking runs the risk of balkanisation of financial services. While sounder cross-border banking is essential, financial protectionism would be an unnecessary constraint on growth.

– Finally, this year's slowdown in some key emerging market economies, including China, and the indications of supply-side constraints in many cases, suggest the possibility of a more prolonged growth slowdown in these economies than we are assuming.

More than five years after the collapse of Lehmans precipitated a global financial crisis and then a deep recession, we may be gradually exiting a long period of economic stagnation that has afflicted most advanced economies. But we are far from out of the woods, and policymakers will need to be particularly careful to avoid, through economic or political misjudgements, reversing what is still a weak and fragile global recovery.

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