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

Global economic activity has continued to strengthen significantly since the end of last year, with all the major regions experiencing cyclical upswings in economic activity for the first time since 1994. World GDP is expected to rise by over 4 1/2 per cent this year (on a purchasing power parity basis) and the volume of merchandise trade is projected to rise by 10 1/2 per cent, approximately twice the growth seen last year. In the industrialised economies growth is expected to turn out at 4 per cent this year, which would be the fastest experienced since 1988.

The North American economies have continued to enjoy strong economic growth in recent months and there has been a marked improvement in economic prospects for the major Euro Area economies, largely fuelled by the depreciation of the euro. Strong growth is also expected in the UK. There are also some signs that a modest recovery in private sector demand may have begun to get underway in Japan. Prospects for many of the industrialized economies have been improved by the rebound in many emerging markets. Economic activity has recovered rapidly in all Asian economies, apart from Indonesia, as well as in other large economies such as Mexico, Brazil and Russia, helped by weaker real exchange rates and the recent strength of many commodity markets. Chart 1 illustrates the extent of the recovery in trade volumes in the developing and industrialised regions. In much of Asia the dollar value of trade in the first half of this year was 25-30 per cent higher than a year earlier.

Many of the key forces shaping global economic developments this year and next are the mirror images of those that occurred in 1997 and 1998. A robust recovery in the developing economies is now helping to push up commodity prices and support external demand in the industrialised countries. The coordinated easing in monetary policy in the wake of the turmoil in financial markets in 1998 has helped to stimulate private sector demand and has more than outweighed the impact of the downturn in business and consumer sentiment at that time. Fears of recession have now given way to concerns about inflation, and, with the exception of Japan, short-term interest rates have been raised significantly in all the major economies over the past year and appear likely to be raised further in the coming months. Together with the recent moderation in global equity markets, this has tightened financial conditions and should help to ensure that global demand growth eases to just under 4 per cent next year. Growth has continued a t a rapid pace in the North American economies, helped by strong growth of labour and capital productivity. Weighting these by their approximate shares in national income indicates that the underlying rate of growth of total factor productivity in the United States has risen by 1 per cent per annum over the past four years. GDP in the US is projected to rise by 5 per cent this year, well above potential long-term growth even allowing for improvements in productivity. Despite some recent moderation in equity prices it continues to appear likely that tighter monetary conditions will be required to help check the momentum of the present expansion and bring domestic demand and supply back into balance. Indeed higher real interest rates should be expected if recent technological changes have raised the marginal productivity of capital. This also suggests that further monetary tightening may be required. We expect that the Federal Funds rate will rise by a further 75 basis points to 71/4 per cent by the end of this year, and remain around that level in the first half of next year.

The underlying strength of activity in the Japanese economy remains difficult to discern. Output rose by 2.4 per cent in the first quarter of this year, but over a third of this can be accounted for by the inclusion of an extra working day in the quarter due to the leap year. …

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