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That global imbalance has already unwound unexpectedly, prompted by the US sub-prime defaults, losses and write-downs in financial institutions and by weak US macroeconomic data. Although most economists believe that the slowdown will likely be quite lengthy, their views about its depth have become less negative since April.

Currently, many think that aggressive rate cuts by the US Federal Reserve, liquidity injec-tions into financial institutions and Washington's fiscal stimulus package through tax rebates should stimulate the US econom-ic recovery in the second half of 2008.

Initially, some market-watchers also expected severe knock-on effects from the US to Europe, Japan and emerging markets.

In actuality, 2008 first-quarter GDP numbers did not show as sharp slowdowns in these economies as expected owing to continued investment and strong exports to emerging markets.

Indeed, emerging-market economies have shown remark-able resilience in maintaining the momentum of domestic demand and export diversification to non-US markets, supported by domestic fiscal policies to count-er negative external shocks.

Even the Mexican econo-my, which has close trade and labour ties with the US, has con-tinued to grow quite favourably on account of the above factors.

International financial markets have remained fragile as down-side risks on global economic growth still appear significant.

No one wants to bet on when the slump in the US housing market will bottom out. A tightening of rules for evaluating credit risk has crept from the mortgage sector to the consumer and corporate sectors in the US and Europe. Moreover, there is now concur-rent risk of infla-tion accelerating in line with food, oil and other commodity prices as demand for them, espe-cially from China and India, con-tinues to strengthen. Across the world, monetary authorities now need to delicately weigh risks to growth against inflation.

For the Fed, focusing on both inflation and employment, the challenge on setting US monetary policy will become more difficult if inflationary pressures rise amidst fragile economic condi-tions. In the euro-zone, with infla-tion above the target rate eight months in a row, assessing the spillover from the US economic slowdown for the rest of 2008 is crucial.

Similarly, emerging-market economies, which are absorbing more food and energy through increased consumer expenditure, must also thoroughly assess the robustness of their economies in view of the fragility of the world economy and financial markets.

Under the current circum-stances where surging prices of food, oil and other commodities are mostly not driven by tempo-rary factors, a decision to change monetary policy earlier rather than later may be a wise and con-ventional policy option to arrest a possible rise in inflation.

Clearly, effective coordination of fiscal policy to maintain growth of domestic demand is vital. Countries will, however, have varying degrees of flexibility avail-able for fiscal stimulus as part of the right fiscal-monetary policy mix without compromising medi-um-term fiscal-policy discipline. At this difficult time, keeping pub-lic debt low and sustainable will prove greatly beneficial for ensur-ing this much-needed flexibility.