Academic journal article National Institute Economic Review

The World Economy

Academic journal article National Institute Economic Review

The World Economy

Article excerpt

Section I: Recent Economic Developments


Output growth throughout the OECD has been rising this year, and several economies including the US, Canada and the UK look as if are reaching their cyclical peak. Other economies, such as France, Italy and Spain, are still operating below capacity, but have been growing rapidly enough to prevent output gaps widening. Output gaps in Europe appear to be small, and Barrell and Sefton (below) calculate they could be approaching zero. This upturn in activity has been unlike most in the post-Bretton Woods era, as inflation has not, until recently, begun to rise. Inflation in the US was, it appears, lower in 1994 than in the previous four years, despite a strong output recovery. The appreciation of the yen, and the subsequent recession have, of course, kept Japanese inflation low. However, exchange-rate movements are part of a process of 'sharing' world inflation, and over the past three years there has been little to share. For example, inflation in Europe has been lower than we anticipated 18 months ago, even though a slowdown in activity was already apparent then.

Part of the explanation for low inflation comes from the moderate growth that has resulted from the asynchronisation of the economic cycle across the OECD. Charts 1 and 2 plot output growth and inflation in the English speaking countries (apart from Ireland) and in the EU states, excluding the UK. While growth was strong in Europe, there was spare capacity in the rest of the (English speaking) world. Recovery began much earlier in these five economies, much as it did in Scandinavia, but, as recovery got underway, the European economies entered recession. Thus, for some years half the OECD (excluding Japan) has benefited from the effects of spare capacity elsewhere and from low import prices from the other half, although the countries benefiting have varied.

Growth in Europe in 1994 was slightly more robust than we anticipated in November, and the early signs are that the fourth quarter was also strong. Output growth in France reached 0.8 per cent in the third quarter, and was well above 1 per cent in west Germany. The other continental European countries have also been growing strongly, with the exception of Spain. However, there is little sign that actual growth is more rapid than potential and hence we are not anticipating a significant increase in the inflation rate. Our forecast is set out in Table 1. We expect inflation in the core countries such as France and Germany to rise from 2 1/4-2 1/2 per cent in 1995 to around 3 per cent in the medium-term. Inflation in the EC(1) is likely to be higher, in part because we anticipate that Italy, Spain, Greece and Portugal, along with the UK, will continue to experience higher inflation than the countries in the core, and hence they will continue to depreciate against the D-mark.

Output growth in the US gradually accelerated through 1994 and reached more than 1 per cent in the fourth quarter. This strong growth was, however, accompanied by a weakening housing market and a considerable build-up in inventories, and hence it could be suggested that growth has reached its peak. Growth throughout the OECD has been strong, and we expect it to rise from 2 3/4 in 1994 to 3 per cent a year in 1995 and 1996. The gradual slowing of growth in the US will ultimately alleviate inflationary pressures there, although we are forecasting there may be some modest rise both this year and next.

There remains a slight puzzle over why inflation has been so low in the latest upturn. Commodity prices have begun to rise, and in the past they have been a harbinger of inflation. (However, as can be seen from Charts 1 and 2, inflation has been lower than in previous upturns.) A number of factors might explain this, some temporary, some specific to the conjuncture and perhaps some permanent. The upturn in activity has taken place just as the structure of retailing has changed with 'creative price destruction' (the cutting of retail margins) produced by the growth of aggressively discounting retailers in countries such as the UK, France, Italy and Japan. …

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