The Canadian Press

One of the world’s pre-eminent economic organizations is warning governments they risk a second recession next year if they withdraw stimulus too quickly.

The alert from the International Monetary Fund comes as most governments and central bankers are putting in place plans to end the massive spending and historically low interest rates put in late 2008.

The IMF says the recovery is well underway, but it is artificial in the sense that it is underpinned by government spending, not business activity.

“For the moment, the recovery is very much based on (government) policy decisions and policy actions,” said IMF chief economist Olivier Blanchard in a an interview.

“Right now it’s OK, but a year down the line, it will be a big question.”

IMF managing director Dominique Strauss-Kahn was blunter in a statement posted on the organization’s website, warning that countries could fall back into recession next year “if anti-crisis measures are withdrawn too soon.”

The risk is believed to be highest for the U.S. and Europe, but even in Canada, the Harper government has signalled it wants the next budget to lay out a blueprint for restraint once the upcoming fiscal year’s stimulus runs out.

In its quarterly report last week, the Bank of Canada said it expects the contribution of government spending to growth in domestic demand, having peaked at 2% at the end of 2009, to actually turn negative in 2011.

The Liberals are urging the government not to reverse course on stimulating the economy, at least until growth in jobs returns.

Canada’s unemployment rate appears to have stabilized at around 8.5%, judging from the last few months of data, but critic John McCallum says the official number underestimates the problem.

“If you factor in reduced hours, people who give up and leave the workforce, people who lose their jobs and are classified as self-employed, it’s worse that the official statistics tell us.”

McCallum said the party will outline specific proposals to boost employment in the next week or two in advance of the March 4 budget, but would give no details. In the past, the party has called on improving employment insurance benefits for laid off workers.

The IMF’s warnings come in an otherwise up-beat report that substantially upgrades the strength of the global recovery from the previous forecast in October.

Now the IMF expects Canada’s economy to grow 2.6% this year, a half-point more than it believed a few months ago, although still three-tenths below the Bank of Canada’s expectations.

And for the first time, the IMF projects that the U.S. economy will outperform Canada’s this year, advancing 2.7%, while the world also gets a sizable upgrade to 3.9% growth.

But what happens next year, when interest rates begin to rise and most governments stop pumping money into the system and start fixating on their ballooning deficits has the IMF worried.

TD Bank chief economist Don Drummond also believes public policy now constitutes the biggest risk factor for the recovery.

“Governments are supposed to be the calming influences on the economy but they are actually the key points of risk going ahead,” he said.

“We really don’t know when and how forcefully governments are going to shift to restraint, and we have absolutely no idea what and when regulatory reform for (global) financial institutions will show up.”

The fragility of the recovery was borne out recently when commodity markets went into a spiral over China’s announcement it was imposing new restrictions on lending.

And the White House proposals to punish the banks with new taxes and regulations, while imposing a freeze on discretionary government spending, also raised fears in the market.

The Bank of Montreal’s chief economist Sherry Cooper advised governments, particularly Washington, to “don’t rock the boat” while the economy remains wobbly.

“Now more than ever, the biggest risk to sustained recovery is the political response to the fallout of the financial crisis and its impact on consumer and business sentiment,” she wrote in a report.

The IMF calls on countries to take an individualized approach to unwinding stimulus based on local circumstances.