updated 1/28/2009 12:11:22 PM ET 2009-01-28T17:11:22

The world economy will essentially come to a halt this year as more than $2 trillion of bad assets clog the financial system, the International Monetary Fund said Wednesday.

The global economy will grow by only 0.5 percent this year, the IMF said. That would be the slowest pace since World War II and is a sharp reduction from the IMF's projection of 2.2 percent growth in November.

The IMF also raised its estimate of the total losses for banks and other financial services companies stemming from bad loans in the United States to $2.2 trillion, from $1.4 trillion in October.

The ongoing financial crisis is restricting credit for companies and consumers, and is the primary reason the global economy is in dire straits, the IMF said in two reports.

"A sustained economic recovery will not be possible until the financial sector's functionality is restored and credit makers are unclogged," the IMF said.

Governments should take several steps to address the crisis, including injecting capital into "viable institutions" and "carving out bad assets" from banks, according to the IMF.

Despite efforts such as last year's $700 billion financial rescue program in the U.S. and similar steps overseas, "risks to financial stability have intensified since October," the IMF said.

The U.S. economy will shrink by 1.6 percent this year, according to the IMF's updated World Economic Outlook. That's a sharper decline than the 0.7 percent dip forecast in November.

The 16 European nations that use the euro currency will see their economies shrink by 2 percent this year, while Japan's economy will contract by 2.6 percent, according to the new IMF forecast.

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