Academic journal article National Institute Economic Review

The World Economy

Academic journal article National Institute Economic Review

The World Economy

Article excerpt

Growth in the OECD as a whole has been well below trend in the last three years, and the EU as a whole appears to have experienced a fall in output in 1993. Prospects for 1994 look better, and we are forecasting OECD growth of over 2 per cent in 1994, with only slightly slower growth in the EU as a whole. Inflation has been falling in the EU since 1991, and because these economies are likely to be operating below capacity we are projecting that it will continue to fall, albeit slowly, for the next two years. Inflation in the US will probably reach the end of four years of decline in 1994, and we are forecasting that it will edge up only slowly over the next few years. The Federal Reserve has responded to the prospect of higher inflation, and short rates have been pushed up. Long rates, both in the US and elsewhere have, partly as a consequence, risen sharply in the last few months.

Inflation pressures have been low for several years because there has been a considerable degree of excess capacity available in the world economy. This has helped reduce inflation in the US despite the robust growth that has been experienced for several years. The existence of spare capacity in Europe, along with increasing competition from producers in the Asia Pacific rim, has kept up pressure on US producers' margins. However, both of these phenomena must be seen as temporary. The European economies are emerging from recession, and their spare capacity will gradually be absorbed. The pricing policies of newly emergent producers are in part designed to gain entry into the market, and hence the effect on inflation, rather than the price level, is likely to be temporary.

We are forecasting that inflation in the OECD will settle down around 3 per cent in the medium term, with EC inflation averaging around 4 per cent. The forecast is set out in Table 1. In the February Review we warned of a potential rise in commodity prices, and we now have more evidence to support this worry. This has led us to raise our short-term inflation forecast, as has the slightly higher level of growth that we are now projecting. However, since February, there has been a marked rise in long-term interest rates, and this has caused us to revise upward our projections for short-term interest rates over the medium term. This projected tightening of the monetary stance in the future has led to downward revision to our medium-term growth forecast.

The prospects for growth and inflation in the year ahead look relatively good for most OECD countries, but Japan stands out as an exception. The 20 per cent appreciation of the yen in the last two years has put that economy under considerable strain. Output growth fell to almost zero in 1993, and the stimulatory fiscal package that we assumed in November would be implemented has so far failed to materialise. We are projecting growth of around half a per cent in 1994 in Japan, and although we are then forecasting a slow recovery inflation is liable to be kept very low because of pressures from import prices. In the longer term we expect Japanese growth to fall from its high level of the 1980s to around 3 per cent or less as the slowdown in population growth feeds through into potential output growth. The aging of the population is also projected to reduce the current account surplus as the assets accumulated for the retiring generation are used up.

Interest rates and exchange rates

The strength of the upturn in the US in 1993 has induced the Federal Reserve to tighten monetary policy more rapidly than we had previously anticipated, and short-term interest rates have been rising strongly in recent months. However, as Chart 1 shows, short-term rates have continued to fall in Germany (and Japan) in recent months. Long-term interest rates have risen rather more than short rates in the US in the last few months, although they reached their trough in the Autumn of 1994 and have been rising since then. …

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