Academic journal article National Institute Economic Review

The World Economy

Academic journal article National Institute Economic Review

The World Economy

Article excerpt

parties and political fragmentation may be irreversible. Electoral and constitutional reforms were already being discussed in a joint parliamentary commission, with the aim of creating a more efficient political system, but the process will be accelerated by the constitutional court's ruling which has approved ten referendums, two of which concern the abolition of proportional representation in favour of a first-past-the-post system.

Growing confidence in the Italian economy after the turmoil in the foreign exchange markets has enabled the monetary authorities to cut both the Lombard and the discount rate, Turbulence has continued in European foreign exchange markets over the last three months. The realignment of European exchange rates in September was not particularly conducive to promoting economic stability, and subsequent realignments have produced more strain. We had argued for some time before Black Wednesday that European exchange rates were not near their fundamentals. We have often said that such a realignment might be beneficial.(1) Any realignment involves some loss of credibility, but the disorderly rout seen in September appears to have damaged the reputation of a number of governments outside the core ERM countries, and it has affected confidence badly. A realignment could have been an aid to a weak recovery. It appears that the effects of the realignment and decline in confidence in the abilities of the authorities have helped turn what might have been a concerted upturn in France, Italy and the UK into a period of, at best, stagnation.

The US recovery seems moderately strong, and US imports continue to grow more rapidly than one might expect given past experience. This should help sustain world trade growth, as should a continued increase in imports into mainland China. However, trade is not the only, or even the main source of linkages between the major economies. Interest rates remain extremely important in the propagation to others of developments in one country. High interest rates are a major factor behind the problem of high unemployment that appears to be worsening once again throughout Europe.

The early-1980s saw a sharp rise in unemployment, and it remained stubbornly high until the late-1980s, when the recovery in demand growth, along with structural policies, helped reduce it throughout Europe. Unemployment has risen in France, Germany, the Netherlands and Belgium in the last year, and it is above 10 per cent in France. Unemployment has remained stubbornly high in Italy at over 11 per cent.

Short-term prospects

The decline in short-term interest rates in North America over the last four years appears to be beginning to have an effect. Growth was strong in the US in the second half of 1992, and the outturn for the year at two per cent was reasonably good by historical standards. There are, however, no real signs of a strong recovery outside North America, as is clear from the summary of our forecast in Table 1. Japanese growth was very low in 1992, despite the low level of interest rates. Prospects in the medium term are better, and we are expecting Japanese growth to rise to four per cent next year after two per cent in 1993. This recovery will be aided by low interest rates. As can be seen from Chart 1, Japanese rates began to fall two years later than in the US, and long rates were very high in 1989 and 1990. Both factors suggest that the Japanese recovery will mirror that in the US.

The two largest economies have differing prospects for 1993 in part because of their different fiscal positions. The US public sector deficit remains large, with little prospect of reduction in the short run. Chart 3 makes the contrast with Japan very clear. The government has been TABULAR DATA OMITTED in surplus for four years, and despite a number of fiscal packages, there appears to be little intention to use fiscal policy to expand the economy. The package announced in the Autumn has gradually been whittled away in the Diet until it is little more than a set of financial measures to aid the banking sector. …

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