Academic journal article National Institute Economic Review

The World Economy

Academic journal article National Institute Economic Review

The World Economy

Article excerpt

CHAPTER II. THE WORLD ECONOMY

The overall outlook: longer-term prospects

The second half of the 1980s has seen relatively strong, and rising growth in most of the major seven economies. This performance has been accompanied by a slow increase in the average rate of inflation. This combination was aided by the fall in world oil prices in 1986 and weak commodity prices. Only toward the end of the decade did strong growth begin to put pressure on commodity prices, and then only temporarily because of stock shortages of metals and minerals. The world economy was also operating with some degree of spare capacity in 1986 and 1987, allowing a period of sustained non-inflationary growth.

The performance of the advanced economies in the last few years is even more remarkable when account is taken of the serious worries that have been expressed both about large scale current account imbalances and the size of the US Federal deficit. Many commentators saw the current account imbalances as unsustainable and hence ultimately destablising. This position appears to have been rather pessimistic. In a world with minimal capital controls, exchange rates are likely to be determined by the demand for asset stocks rather than by flows across the exchanges. Simple portfolio models can be constructed that suggest that even a small preference on the part of non-residents for US assets is sufficient to produce large scale capital flows into the US.(1) Fiscal deficits also appear to be financable, at least in the short run.

We have tried to take account of these lessons when constructing our forecast for the next decade. Table 1 outlines our forecast. (We have, for the first time produced a forecast base up to the year 1999.) Although we expect some slowdown in world activity through to 1992, it is nowhere as severe as that experienced in the early 1980s. We also anticipate that growth will thereafter strengthen. Model based forecasts do have a tendency to smooth the future. We may expect cycles, but if they are produced as a response to shocks then they are difficult to forecast. However, we do feel that the average performance of the world economy in the 1990s will be significantly-different from the 1980s. The inflationary pressures at the beginning of the decade are unlikely to be so severe, and the monetary response is unlikely to be so savage as in the early 1980s. Also, cycles are often produced by sharp fiscal policy changes, and we do not see any need for major fiscal policy changes in any of the major economies. Fiscal consolidation has proceeded successfully in Germany, Japan, and France, and there may even be room for increased government expenditure growth in these countries. Fiscal policy in the US is tightening, but the political problems involved in reconciling the views of a Democrat Congress with a Republican President inevitably mean that the process of deficit reduction will proceed slowly.

Developments in Europe during the 1990s are likely to be much influenced by the moves to closer economic integration that are resulting from the single market programme. The gradual reduction of barriers to trade that will take place is in many ways a continuation of the process that has been underway in Europe since the Treaty of Rome in 1958 and in the world at least since the Kennedy round GATT agreements in the early 1960s. It may be true to say, as the Commission does, that the level of output in Europe will eventually be 5 per cent higher with the single market programme than it would otherwise have been. It is however wrong to necessarily conclude from this that growth in Europe will in future be higher than it has been in the past. The Community has already reaped major output gains from freer trade, and although the 1992 programme may be broader than those seen earlier, it has had a rather small effect on our projections of the average growth rate in Europe in the 1990s. Nevertheless, we do expect higher growth in Europe in the next ten years than in the last ten. …

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