Observer

The OECD Observer
January 1999, No. 215

 

A Moderate Rebound in 2000

 

This article is based on the OECD Economic Outlook, No. 64, December 1998.

Some calm has recently returned to international financial markets following 18 months of sharp, and widening, turbulence. The outlook is for a further slowdown in the OECD area as a whole in 1999, and if the calm persists, a moderate rebound should follow in 2000.

Until the middle of 1998, economic developments remained rather favourable in North America and Europe, despite financial turbulence in emerging market economies. By September, however, it became increasingly evident that financial turmoil was also adversely affecting OECD countries' financial markets, especially following the financial collapse in Russia, with significant falls in equity markets, a widening of spreads between corporate and government bonds in some OECD countries, and trading losses by some large investment funds. At the same time, indications that the economic situation in Japan was deteriorating and that problems in the banking sector were not improving added to market uncertainty. Finally, the US dollar started to depreciate vis-à-vis other major currencies.

These developments led to a change in perception about the balance of risks affecting future economic prospects in OECD countries and authorities in several countries have taken some action.

Monetary policy has been eased in the United States, the United Kingdom and in a number of countries in the euro area. In Japan, a broad agreement was achieved to revitalise the financial system.

In Brazil, the government announced an ambitious programme to restore its budget and current account positions, and the broad lines of a financial package to help protect the exchange rate have been agreed with the IMF. Finally, in late October, the G7's leaders formally endorsed several specific reforms to strengthen the international financial system.

Outlook Summary a/
Seasonally adjusted at annual rates
  1998 1999 2000
Real total domestic demand (% change from previous period)
United States 4.9 2.0 2.2
Japan -3.3 -0.1 0.6
European Union 3.3 2.5 2.6
Total OECD 2.4 2.0 2.5
Real GDP (% change from previous period)
United States 3.5 1.5 2.2
Japan -2.6 0.2 0.7
European Union 2.8 2.2 2.5
Total OECD 2.2 1.7 2.3
Inflation b/ (%)
United States 1.0 1.2 1.8
Japan 0.7 -0.4 -0.5
European Union 1.8 1.8 1.8
Total OECD less high inflation countries c/ 1.3 1.3 1.5
Total OECD 3.3 2.6 2.4
Unemployment (% of labour force)
United States 4.6 5.0 5.4
Japan 4.2 4.6 4.9
European Union 10.6 10.3 10.1
Total OECD 7.1 7.3 7.3
Current balance (% of GDP)
United States -2.7 -3.1 -3.1
Japan 3.2 3.3 3.6
European Union 1.4 1.3 1.3
Total OECD 0.0 -0.1 -0.1
Short-term interest rates d/ (%)
United States 4.7 3.8 4.0
Japan 0.7 0.5 0.5
Euro area 3.9 3.0 3.1
  1. Assumptions underlying the projections include:
    - no change in actual and announced fiscal policies,
    - unchanged exchange rates from 27 October 1998; in particular $1 = y 119.25 and DM 1.66;
    - the cut-off date for other information used in the compilation of the projections was 4 November 1998.
  2. GDP deflator, percentage changes from previous period.
  3. High inflation countries are defined as countries which have had, on average, 10% or more inflation in terms of the GDP deflator during the 1990s on the basis of historical data. Consequently, the Czech Republic, Greece, Hungary, Mexico, Poland and Turkey are excluded from the aggregate.
  4. United States: 3-month Treasury bills; Japan: 3 month CD; Euro area: 3-month interbank rates.
Source: OECD

Following these moves, financial tensions appear to have abated in emerging market economies while equity markets in most OECD countries have rebounded. The OECD now projects a slowdown in real GDP growth for the OECD area, from above 3% in 1997 to about 2.25% in 1998 and then to 1.75% in 1999, before a recovery to around 2.25% in 2000. This reflects different economic situations across the major OECD regions.

In Japan, for example, strong deflationary forces are expected to continue acting on the economy (see p. 8). In the United States, the economy is projected to slow to below potential growth over the next two years, reflecting lower business profit expectations, the widening in credit spreads and the stabilisation, if not a reversal, of equity prices. In the euro area, real activity is also expected to decelerate somewhat, although growth should remain around potential in both 1999 and 2000, reflecting the momentum for recovery in domestic demand.

In most emerging markets, the outlook is for continued weakness, while prospects for stabilisation in Russia appear bleak in the short run.

A number of downside risks to the outlook are still present. To avoid them, it will be important that OECD countries do not resort to protectionist measures and that their markets remain open to exports of emerging countries affected by the crisis. In Japan resolution of problems in the domestic banking sector is essential to heading off the risk of global recession. In the United States and in the euro area, monetary policy should remain biased towards easing, as inflation risks have been considerably reduced or become non-existent. Nonetheless, there is no case for an activist fiscal policy, as there is still a need to reduce public debt to levels sustainable over the longer term.