Prospects for North America and Japan
Ashworth, Paul, Dury, Karen, Pain, Nigel, National Institute Economic Review
Over the past nine months economic activity in the United States has slowed abruptly. Several indicators suggest that the economy has come close to outright recession. Whilst some slowdown in activity had long been expected, the speed and depth of the transformation has come as a surprise. The quarterly rate of growth of GDP has slowed from an average 1 1/2 per cent during the latter half of 1999 and the first half of last year to just 1/4 per cent in the fourth quarter of 2000 and the first quarter of this year. It appears likely that output has at best continued to rise at a similar rate in recent months. The industrial sector is clearly in recession, with production in May some 4 per cent below the cyclical peak attained in September last year, and employment fell in the second quarter of this year. Corporate sector expenditure has begun to decline, but household sector expenditure has proved surprisingly resilient in the year to date.
Although business and consumer confidence both picked up a little in June and the rate of decline in the industrial sector appears to be moderating, there are presently few grounds for expecting an imminent rapid rebound in the rate of economic growth. This was reflected in the decision of the Federal Reserve to reduce the Federal Funds rate by a further 25 basis points at the end of June. The most likely picture remains one in which there is little or no growth until the latter half of this year followed by a gradual pick-up in activity as the impact of easier monetary conditions begins to be felt. We expect to see GDP growth of 1.7 per cent this year and 2.3 per cent in 2002. Growth through this year to the fourth quarter is expected to be 1 1/2 per cent. There remain clear downside risks that a more prolonged slowdown could yet occur. Our forecast suggests that the imbalances that currently exist in the economy will moderate this year, but will not be eliminated completely, and the rate of growth of househ old sector and external demand are both likely to weaken in the coming months.
Private sector final demand declined by 0.2 per cent in the first quarter of this year. The recent pattern of demand is unusual compared to that seen at the onset of the 1982 and 1990 recessions, in that the slowdown in expenditure has been led by the corporate sector. But there are several factors, notably weaker equity prices and rising unemployment, which suggest that household sector demand is likely to weaken as well. Monetary policy has been eased aggressively since the start of this year, with the Federal Funds rate having been reduced by 2 3/4 percentage points. We expect it to remain at 3 3/4 per cent until clearer signs of the sustainable recovery begin to appear. Prompt action of this kind should help to equilibrate private sector confidence and ease potential pressures on financial institutions, and the effects on the level of activity should, given normal circumstances, begin to emerge by the end of this year.
Fiscal policy is also helping to support activity at the present time, with a rise of 1 1/4 per cent in final government expenditure in the first quarter more than offsetting the drop in private sector demand. The recently agreed package of tax reforms worth $1.35 trillion over the next decade may also help to support activity, although the effects are likely to be modest because of the upward pressure on long-term interest rates that it has had. Long-term government bond rates have risen by around 40 basis points since April, although they remain below the average levels prevailing in 1999 and 2000.
The continued strength of the dollar, with the real effective exchange rate at its highest level since 1986, is also likely to restrain the speed at which output recovers, although it will also have the welcome effect of dampening any remaining inflationary pressures. There is thus scope for the Federal Reserve to reduce interest rates further should the need arise. …