Academic journal article National Institute Economic Review

The World Economy

Academic journal article National Institute Economic Review

The World Economy

Article excerpt

The overall outlook

Output growth in the OECD as a whole is likely to be around 2 per cent in 1994, the fourth year in succession when it has been below estimates of potential growth. A number of economies were growing very rapidly in 1990 and 1991, and capacity was stretched in both Germany and Japan. However, subsequent recession has taken these economies to levels of capacity utilisation and unemployment that have resulted in downward pressure being put on wage and price inflation. Inflation generally falls in recessions, and the fall from an OECD average inflation rate of 4.5 per cent in 1990 to around the 2.5 per cent projected for 1994 is not without precedent. However, the prospects for inflation over the next few years look a little better than one might expect in an upturn, and we are forecasting that OECD consumer price inflation will stay around 3 per cent for the next few years.

Inflation pressures are likely to be low for this year partly because of a lack of synchronisation in the world business cycle: the US, which still represents around 40 per cent of OECD GDP, and the other English speaking countries have only just emerged from a recession whilst Continental Europe and Japan are still experiencing stagnant or declining output. It appears likely that EC GDP fell in 1993, and the same may well have happened in Japan, although the signals from that country are mixed. Capacity utilisation in both Germany and Japan was at historically high levels in the recent boom, as can be seen from Chart 1, and it has only returned to levels seen in the early 1980s. However, some output gap has emerged in both countries(1), and more resources are available for serving export markets than one would expect in a concerted upturn. Capacity utilisation has been rising in North America, but the availability of excess foreign capacity, along with intensifying price competition from the newly industrialising economies in South East Asia, should prevent any bottlenecks in the US economy from leading to an increase in inflationary pressure in the short term.

Over the medium term we are expecting inflation in the OECD as a whole to average just over 3 per cent, with inflation for the EC averaging 3 3/4 per cent. Both are relatively low by historical standards, although they are close to the averages seen through the upturn of the mid-1980s. Over the same period we are expecting that GDP growth will also be somewhat below levels experienced in the 1980s, after a relatively weak recovery, especially in Europe, but also in the US and Japan. This slow growth is not the consequence of the tendency of a model based forecast to 'revert to the mean', but rather the result of our understanding of the future restrictive path of fiscal policy in a number of economies, and the consequential effect on unemployment and the pressure of demand and hence on inflation.

During the 1980s fiscal policy was expansionary in the US, and as a result debt and deficit both rose, as can be seen from Chart 2. The recession of the early-1980s raised both unemployment and budget deficits in Europe, and although contractionary policies were adopted they worked more through high real interest rates than through reductions in primary government budget balances. As a result, debt stocks rose throughout much of Europe, and even in fiscally prudent France and Germany TABULAR DATA OMITTED debt stocks were 10 per cent higher, as a per cent of GDP, in 1990 than they were in 1980, with the sharp upturn in the 1990s in Germany displayed in Chart 3 being driven by the effects of the budgetary costs of German reunification.

Serious worries have emerged about the sustainability of the trajectory for the debt stock in Europe. One would expect debt stocks to rise during wars and recessions, but to decline, at least as a per cent of GDP, in booms. This did not happen in Continental Europe during the 1980s, and the worries that have emerged have been enshrined in the debt and deficit targets spelled out in the Maastricht Treaty. …

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