Following a Cyclical Peak in 2000, Industrial Countries Enter a Stagnation Phase

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I. Global Assessment and Outlook

Following an economic expansion at an average annual growth rate of 2.9% during 1996-99 and an estimated advance of 3.7% in 2000, the industrialized countries are forecast to have entered a growth-- recession phase in the global business cycle. The forecast for growth in the United States shows a modest expansion of 1.7% in 2001 and 2.3% in 2002, compared to the robust above long term growth performance in the last two years at an annual average growth rate of 4.0%. After an estimated growth rate of 3.1% in 2000, Euro Area's output growth is forecast to slow down to 2.7% in 2001 and 2.3% in 2002. The Japanese economy is expected to continue its recovery with output growth gradually advancing by 1.4% in 2001 and 2.3% in 2002, compared with an average annual growth rate of 1.0% during 1999-2000. The industrialized countries economic upswing reached its peak in 2000. The baseline forecast scenario projects that a below trend growth-recession phase in the global business cycle has begun.

The worldwide-based forecast for a growth-recession in the industrialized world rests on two factors. First, a technology convergence process amongst integrated industrial countries is underway that will provide the basis for synchronization in their economic growth patterns. The United States economy underwent an accelerated technological transformation resulting in spectacular gains in productivity growth. Consequently, the contribution of productivity to economic growth led to output growth rates in the United States that were about twice those in Europe and Japan. During 1994-99, the technology-driven average annual growth rate in the United States was 3.9%, compared with a 2.3% rate in the Euro Area and 1.1% in Japan during the same period. The technology gap generated a productivity gap leading to economic growth imbalances and an excessive inflow of international investment to the United States that resulted in asset price inflation and increased vulnerability in financial markets. The expected technology growth saturation in the United Sates was reached in 2000 and resulted in an unwinding of the high tech expenditures boom. As declining US growth rates of high tech investments were not matched by accelerating growth rates of foreign demand for US high tech products, sharp declines in business fixed investment have started and are expected to continue leading to a dramatic slowing in output growth in the United States. The lead-lag relationships of technology adoption, investment expenditures, labor market adjustments and new product marketing are not and will not be in the foreseeable future synchronized amongst different countries. The United States, European and Japanese markets have their own unique institutional, policy and market-related flexibility characteristics resulting in different transmission mechanisms of technology. The overall moderation of growth in the industrial countries will synchronize these technology mechanisms and provide the output convergence needed for financial stability. The forecast assumes an orderly reversal of financial flows that will also gradually reduce the United States current account deficit.

Second, the lagging effects of the last two years' restrictive monetary policies in response to inflationary expectations and asset price acceleration have resulted in dramatic changes in consumer spending on interest sensitive products, construction and fixed business investment. The Federal Reserve's increase in short-term rates by 175 basis points from June 1999 to May 2000 has also changed financial markets sentiments. Similarly the ECB raised interest rates in bringing rising inflation to the 2% target and stopping the fall of the euro. The adverse effects of these restrictive monetary policies on the economy are expected to last for about eighteen months. This leading relationship between monetary policy and the economy reinforces the view of an economic slowdown during 200001. …

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