Prospects for individual economies.
The headline figure for US GDP growth in the final quarter of 2010 was perhaps slightly higher than expected given the slowdown in Europe and Japan, at an annualised rate of 3.1 per cent. But a closer look at the components of GDP reveals an underlying weakness in the US economy. Domestic demand stagnated in the final quarter of 2010, and the strong rise in GDP is entirely attributable to a 12.6 per cent (annualised) contraction in import volumes. The slowdowns in Europe and Japan should be seen as at least partly attributable to this loss of demand from the US, which remains the world's largest importer of goods and services, accounting for about 121/2 per cent of world trade (see Appendix figure B3). Available information for the first quarter of 2011 suggests that consumer spending growth moderated to about 11/2 per cent at an annualised rate, and we expect GDP growth in the US to average about 21/2 per cent per annum this year and next.
While GDP growth may have been unimpressive, the unemployment rate dropped much more rapidly than anticipated in the first quarter of 2011, reaching 8.8 per cent in March compared to 9.8 per cent in November 2010. Coupled with the sharp rise in commodity prices and the weakness of the dollar, we expect inflationary pressures to accelerate rapidly. While the year-on-year change in the consumer expenditure deflator stood at an estimated 1.5 per cent in the first quarter of 2011, the quarterly momentum suggests an annualised rate of 3.7 per cent, and we expect annual inflation by this measure to exceed 3 per cent both this year and next.
Monetary policy in the US remains extremely loose and has thus far shown little reaction to rising inflationary pressures. The Federal Open Market Committee (FOMC) continues to maintain that conditions are likely to warrant exceptionally low levels for the federal funds rate for an extended period. Figure 14 illustrates the yield curve for the federal funds rate suggested by the rates of return on US treasuries of different maturities, and how it has evolved since July 2010. There was a clear flattening of the curve between July and October 2010, probably reflecting the anticipation of the new round of quantitative easing (QE2). Since then the curve has steepened, probably reflecting the rise in the oil price as well as the future interest rate trade-off of a looser monetary stance today. Financial markets continue to expect some movement in the federal funds rate by the end of this quarter, despite the announcements of the FOMC.
In early April, the US Congress finally agreed a budget for the 2011 fiscal year. The political debate that nearly brought the public sector to a standstill was over the allocation of expenditure cuts totalling 1/4 per cent of GDP, a very modest consolidation by global standards, especially given the size of the deficit, which reached 10.6 per cent of GDP in 2010. Without a clear strategy for fiscal consolidation, a shadow has developed over the credit rating of US government debt. Our forecast assumes that the 2012 budget agreement will include a more stringent set of tightening measures, allowing the deficit to decline towards 7 per cent of GDP next year. However, as any tax rises have been effectively vetoed by Congress, we expect the political debate over which public services to cut to be long and drawn out.
[FIGURE 14 OMITTED]
In a global context, the Canadian economy is on a relatively strong footing. GDP expanded by 3.1 per cent in 2010, following the contraction of 2.5 per cent in 2009. The expansion was supported by strong domestic demand and a steady rise of export volumes, which persisted into the final quarter of 2010 despite the contraction in US imports. Canada has nearly regained pre-crisis levels of GDP per capita and has embarked on a gradual fiscal consolidation process. During the economic crisis, Canada's fiscal deficit widened to 5.5 per cent of GDP, after ten years of running a surplus or nearly balanced budget. Restoring fiscal balance was a matter of priority for the outgoing government, and is likely to remain high on the agenda following Canada's general elections on 2 May 2011.
Private sector demand in Canada appears to have recovered to a degree that fiscal consolidation is unlikely to derail the recovery. We project output growth of 2.9 per cent in 2011, and forecast a steady economic expansion of 2.7 per cent in 2012 and about 21/2 per cent per annum from 2013 to 2017. Canadian inflation is expected to exceed 3 per cent in the second quarter of 2011 for the first time since 1991. But the strong exchange rate will allow less of the global oil price rise to feed into consumer prices in Canada than elsewhere, and inflation is expected to fall back to 21/2 per cent next year.
[FIGURE 15 OMITTED]
Mexico and Brazil
Economic activity in both Mexico and Brazil has been buoyant. In the last quarter of 2010, output in Brazil stood 7 per cent above its pre-crisis peak level, whilst Mexico has now recovered most of the output lost during the financial crisis. In 2010 as a whole, GDP expanded by 7.5 per cent in Brazil, and 5.5 per cent in Mexico. Both countries have the potential to grow by about 4 per cent per annum over the medium term and we expect GDP growth to moderate this year.
High food and oil prices have raised inflationary pressures, adding to wage pressures in Brazil, as the unemployment rate dropped to its lowest level in recent history. Inflation averaged 5.1 per cent in Brazil last year, and we forecast a similar rate of inflation for 2011. Mexican inflation is expected to accelerate to over 5 per cent this year, from 4.2 per cent in 2010. In an effort to curtail inflation, Brazilian authorities have raised interest rates, which are among the highest in the world's large economies. A tighter monetary stance in Brazil and Mexico relative to that in the US has put upward pressure on the exchange rates, and real effective exchange rates in both countries have risen steadily since early 2009. This should be seen largely as a correction to the sharp depreciations at the onset of the global financial crisis, rather than an exchange rate realignment, as illustrated in figure 16.
[FIGURE 16 OMITTED]
Japan recorded an economic expansion of 4 per cent in 2010, one of the fastest rates of growth in the OECD. However, even before the devastating earthquake and tsunami that hit the eastern part of Japan on 11 March, economic prospects had deteriorated sharply. Output contracted by 0.3 per cent in the final quarter of last year, despite two supplemental fiscal packages introduced in that quarter and further monetary easing measures introduced as the government became concerned about the potential impact of the appreciation of the yen and the re-emergence of price deflation. Based on preliminary information on the magnitude of the damage wrought by the Great East Japan Earthquake, in terms of capital stock destruction, power outages and displacement of the population of the Tohoku region, our estimates suggest that GDP contracted by 0.9 per cent in the first quarter of 2011. Japan will almost certainly record a technical recession of two consecutive quarters of output decline. However, this should not be viewed as a 'double-dip' recession, as the roots of the 2010-11 recession in Japan are clearly distinct from those that led to the global recession of 2008-9.
There remains a great deal of uncertainty surrounding the magnitude of damage to Japan's infrastructure, homes and production facilities, which we refer to collectively as the capital stock of the economy. The Cabinet Office (2011) released preliminary estimates of the damages on 23 March 2011, outlining two potential scenarios that can be viewed as upper and lower bounds to the expected losses. The more conservative estimate is that damage to capital stocks will amount to 16 [yen] trillion, which is around 9 per cent of total stocks in the affected areas and 0.9 per cent of nationwide capital. A more severe outlook is suggested by the second scenario, whereby damages to stocks are estimated at 25 [yen] trillion. Our forecast is based on the more conservative estimates, which in themselves imply a loss of 0.3 per cent per quarter to potential output in Japan over the short term.
While we do not attempt to equate the enormous human costs of the tragedy to a macroeconomic figure, we do take account of the impact on productive capacity of temporary displacements and evacuations, which may have affected up to half a million people initially. Our forecast assumes temporary job losses related to displacement, amounting to about 0.4 per cent of the workforce. In addition we have made an assumption regarding the impact of the large-scale power outages caused by the failure of the Fukushima Nuclear Power Plants. According to the preliminary estimates by the Cabinet Office (2011), supply of electricity in the first weeks following the earthquake was on average around 85 per cent of demand. We have allowed for a decline in production of 1.2 per cent in both the first and second quarters of 2011 to capture these effects. This is modelled through a shock to stockbuilding, as firms will have to deplete stocks to meet demand. The decline in the second quarter is offset by additional government spending. We have assumed no further disruption to energy supply from the third quarter of 2011, although it is difficult to estimate how long the problems at the Fukushima nuclear plant will affect economic activity in the country.
We have allowed for about 10 [yen] trillion over the next year in fiscal support to provide relief for the victims of the disaster and begin reconstruction work. In addition, much of the reconstruction costs can be expected to be financed by the private sector, and we expect a strong recovery in investment from the middle of this year. Figure 17 illustrates our forecasts for GDP growth in Japan before and after allowing for the impact of the earthquake. In annual terms, our forecast for GDP growth this year is only marginally affected, with output projected to expand by just over 1 per cent. In 2012 we forecast growth of 2 3/4 per cent, about 1 percentage point higher than we would have anticipated in the absence of the earthquake.
[FIGURE 17 OMITTED]
Domestic demand in China continues to fuel the world economy, compensating for weaker import demand in the US. GDP increased at an annualised rate of 8.7 per cent in the first quarter of 2011, following a rise of 10 per cent in the previous quarter. However, China is relatively sensitive to global commodity prices, as food prices have a high weight in the consumption basket and it is the world's second largest energy consumer after the US. China's oil consumption has increased nearly fourfold since 1980, reaching about 10 per cent of total world consumption. While the impact of the oil price is limited to some extent by subsidies on oil products for domestic consumers, about half of oil consumed in China is now sourced from abroad, (2) limiting the extent to which the government can offset global price rises without fiscal tightening measures. This may be one factor behind the recent revision to the GDP growth target in China's next five-year plan, which was passed in March 2011, to an average of 7 per cent per annum, compared to a previous target of 8 per cent per annum. Our forecast sees growth in China moderating from about 9 per cent this year to 71/2 per cent next year and about 7 per cent per annum from 2013, in line with government targets.
Consumer price inflation rose to 5.4 per cent in March, compared to 2.4 per cent a year earlier. While China has raised interest rates four times since mid-2010, the main instrument of monetary policy remains the exchange rate. The modest 4.2 per cent rise in the yuan against the dollar over the past year has been insufficient to allow an appreciation of the Chinese effective exchange rate, adding to domestic inflationary pressures. The downward revision to the growth target in the next five-year plan may signal a greater willingness to allow currency appreciation over the next several years. Our forecast assumptions allow for a very modest appreciation against the dollar of about 1/2 per cent per annum. We forecast annual inflation of more than 4 per cent in China this year and next. As GDP growth moderates, we expect inflation to ease towards about 1 per cent per annum in the medium-term.
In 2010, GDP growth in Taiwan reached a recent historical high of 10.8 per cent, the fastest rate of growth since 1986. Driven by domestic demand, Taiwan has been a strong force behind the recovery in world trade, and import penetration is now close to its pre-crisis level. GDP growth in India also exceeded 10 per cent last year, while Hong Kong and Korea both expanded by more than 6 per cent, somewhat above trend rates of growth.
Inflation remained relatively subdued in Korea, Taiwan and Hong Kong last year, while it reached 12 per cent in India, largely reflecting the sharp rise in food prices. Korea, Taiwan and India are all relatively oil intensive in their production processes, and we expect the sharp rise in oil prices to add to inflation this year. We forecast inflation in excess of 14 per cent in India in 2011, close to 6 per cent in Korea and about 3 per cent in both Hong Kong and Taiwan.
Figure 18 illustrates the share of exports from India, South Korea, Taiwan and Hong Kong sent to the US and to China in 2007. While exposure to the US is in line with the world average, exposure to China differs markedly across these large Asian economies. India's export exposure to China is broadly in line with the global average, but the other countries are more closely tied to China, and have benefited front strong Chinese demand in recent years. Hong Kong is especially reliant on trade with China, although this is partly capturing re-exports front firms with distribution headquarters located in Hong Kong. More moderate growth in China over the next few years will impact more on Korea, Taiwan and Hong Kong than most of the rest of the world.
[FIGURE 18 OMITTED]
Australia and New Zealand
New Zealand was struck by a second earthquake in February 2011. Far more devastating than the earthquake of September 2010, the cost of the damage has been put at an estimated NZ$15 billion, or about 1.1 per cent of national GDP. New Zealand is expected to record a sharp decline in output in the first quarter of 2011 as a result, but rebuilding work will raise growth from the second quarter of the year. We forecast growth of just 0.8 per cent in 2011 as a whole, a downward revision of 1.4 percentage points compared to our pre-earthquake forecast. A strong boost to investment reflecting the recovery work should raise growth to just over 3 per cent in 2012.
Australia is one of the few OECD economies to have regained pre-crisis levels of GDP per capita. The good overall shape of the Australian economy owes much to its valuable exports of ore and coal, as well as strong economic partnerships with Pacific Asian economies. We forecast GDP growth of 2.5 per cent this year. Severe flooding had an adverse effect in the first quarter of 2011, but rebuilding work will raise growth in subsequent quarters. Fiscal consolidation is less pressing in Australia than elsewhere, as the stock of government debt currently stands at just 26 per cent of GDP. Nonetheless, a strong economic position will enable the Australian government to continue its fiscal consolidation programme, albeit with an allowance for the fiscal costs related to the flood damages and relief efforts.
[FIGURE 19 OMITTED]
As one of the largest exporters of oil and gas, the Russian economy is profiting from the rising oil prices. We project GDP growth of about 41/2 per cent for 2011, rising to 53/4 per cent for 2012, broadly in line with our estimate of trend growth in Russia. This should allow GDP per capita in Russia to regain its pre-recession peak by the end of this year.
Inflation in Russia moderated from 11.7 per cent in 2009 to 6.9 per cent in 2010, largely reflecting the recovery in the exchange rate. The Russian currency depreciated by 15 per cent in effective terms at the onset of the global financial crisis, perhaps reflecting the drop in the oil price. The ruble remains more than 5 per cent below its pre-crisis level, but has recovered much of its lost value. inflation in Russia is expected to remain high by global standards, and is forecast to average close to 7 per cent this year, and 5-6 per cent per annum from 2012-17. Nonetheless, this represents a significant deceleration compared to average annual inflation of over 11 per cent per annum from 2004-9.
Following a contraction of 1.7 per cent in 2009, the South African economy experienced a strong rebound of 4.2 per cent last year. We expect growth to average about 3.3 per cent per annum for the next several years. It is not clear that growth rates of this magnitude will be sufficient to tackle the severe and persistent social problems in South Africa. The unemployment rate remains exceptionally high, exceeding 20 per cent since 1996, reflecting the impact of a high minimum wage. With its Industrial Policy Action Plan, the government plans to make significant investment into its ailing infrastructure and into new high-growth sectors, such as oil, gas, food, green energy, agro-processing, boat-building, and metal-fabrication. They aim to create over 100,000 new jobs, but with more than 4 million unemployed this can only be expected to make a small dent in the unemployment rate.
As in many emerging economies, the South African exchange rate depreciated sharply at the onset of the financial crisis. The rand has now fully recovered its lost value, and stands more than 15 per cent above its level of early 2008 in effective terms. This helped to restrain inflation last year, which moderated from 7.3 per cent in 2009 to 4.2 per cent. High commodity prices add inflationary pressure this year and we forecast inflation of close to 7 per cent in 2011.
In the final quarter of 2010 the Euro Area economy expanded by 0.3 per cent, while the economies of the EU's new member states grew by 0.6 per cent in aggregate. We expect that the Euro Area as a whole will expand by 1.6 per cent this year and 1.9 per cent in 2012. However, growth differentials across Euro Area economies are projected to remain wide. The largest economy, Germany, is forecast to grow by 2.6 per cent this year. In the north of Europe, Sweden and Finland are also forecast to record growth rates close to or above their potential. But prospects for the Southern European economies remain gloomy. Output in Greece is forecast to decline by 2.5 per cent and that in Portugal by 1.3 per cent, as illustrated in figure 20. Growth differentials within the new member states are expected to narrow this year, with growth projections ranging from about 1 1/2 per cent in Romania to about 41/4 per cent in Poland, Estonia and Slovakia.
Inflationary pressures in the Euro Area are rising, and as a result the ECB increased interest rates by 25 basis points in April, the first rate rise since 2008. In the first quarter of 2011 inflation in the Euro Area rose above the ECB target, to 2.5 per cent, driven mainly by the supply side. Natural disasters, weather anomalies and unrest in North Africa and the Middle East have significantly contributed to rises in food and fuel prices that began in the second half of last year. We expect that in 2011 all Euro Area members, except Ireland, will record inflation rates exceeding 2 per cent. Risks of a wage-price spiral are higher in countries such as Spain and Italy than in Germany where, historically, inflation has been relatively well anchored and the strength of transmission of supply shocks to wages has been weaker. However, protracted recessions in several of the more inflation prone economies of southern Europe may keep wage growth moderate.
[FIGURE 20 OMITTED]
Given the poor performance of the Stability and Growth Pact in recent years, the EU has been seeking a new institutional framework for fiscal policy. At the end of March, the European Council agreed measures aimed at improving fiscal discipline, avoiding macroeconomic imbalances, expanding economic policy coordination and replacing, in 2013, the current rescue package for the troubled Euro Area countries with the European Stability Mechanism. In addition, the Euro Plus Pact between EMU members and 6 non-members (Bulgaria, Denmark, Latvia, Lithuania, Poland and Romania), aims to improve the macroeconomic performance of countries in the long term. Members of the Pact commit to a list of reforms in the following areas: competitiveness, employment, sustainability of public finances, financial stability and tax policy coordination.
Germany remains a leader of growth in Europe. The economy recovered rapidly from the global financial crisis, driven by a cumulative fiscal stimulus worth 2.7 per cent of GDP implemented between 2008 and 2010, a recovery in investment supported by low interest rates and a surge in exports. A modest slowdown in the fourth quarter of 2010 was largely a reflection of poor weather, and most of the lost output should have been recovered in the first quarter of 2011. We expect that German GDP will rise by 2.6 per cent this year and 2.3 per cent in 2012.
The German labour market was remarkably resilient during the financial crisis. The unemployment rate declined from 10.6 per cent in 2005 to 6.8 per cent in 2010, and we forecast that in 2011 it will decrease towards 6 per cent. The improvement can be largely attributed to a cycle of Hartz reforms designed to liberalise the labour market and reduce benefit generosity, which appear to have significantly reduced the long-run equilibrium rate of unemployment.
On 1 May Germany, along with Austria, will fully open its borders to workers from the ten countries that joined the EU in 2004. (3) This follows a seven-year period of transitional arrangements that have restricted access to the German labour market. Our estimates suggest that these temporary restrictions had a small negative impact on productive capacity in Germany, but the magnitudes are small and unlikely to have affected GDP growth by more than 0.1 percentage point in any given year since 2004.
Prior to 2004, Germany was the primary destination for emigrating Polish workers. Subsequently, the UK has become the favoured destination, at least in part reflecting the relative ease of access of the labour market compared to Germany. Lifting the barriers on 1 May could divert some new or returning Polish workers away from the UK and towards Germany, especially given the relative strength of the German economy and labour market compared to that in the UK. This could help to relieve pressures on the German labour market, which suffers from a skills gap for qualified engineers, construction workers and nurses. Higher immigration into Germany could help offset the anticipated slowdown in medium-term potential growth, which is driven by declining numbers of graduates of technical universities, in combination with rapid aging of the German society.
Private consumption growth in France accelerated in the final quarter of 2010, largely reflecting a rise in car purchases before the expiration of the car scrappage scheme in December 2010. As figure 21 illustrates, the gradual decline in the size of the car scrapping bonus since January 2010 has been associated with a rise in spending on cars in the period just preceding the change in policy. This can be expected to restrain consumer spending growth this year. Consumption will also be held back by a projected decline in real disposable income in 2011, reflecting rising taxes and strong inflationary pressures. We forecast inflation in 2011 of 2.7 per cent, while consumer spending is forecast to rise by 1.4 per cent and GDP is forecast to grow by about 11/2 per cent.
Housing investment growth slowed in the fourth quarter of 2010. Meanwhile, business investment growth remained stable and government investment continued to fall, reflecting the ongoing fiscal consolidation process. After announcing a target for the public deficit of 7.7 per cent in 2010, the outturn proved slightly more favourable, with preliminary estimates showing a deficit of 7 per cent for the year. The unexpected improvement in the deficit reinforces the government's target of a 3 per cent public deficit by 2013, although our estimates suggest this remains slightly out of reach in the absence of additional fiscal tightening measures.
[FIGURE 21 OMITTED]
Macroeconomic conditions in Italy are improving at a modest pace. In 2010 output grew by 1.2 per cent as result of strong domestic demand, while net trade detracted from growth. Domestic demand grew by 1.8 per cent in 2010. Whilst consumption, private investment and stockbuilding all contributed positively to GDP growth, government consumption and investment declined by 0.6 and 3 per cent, respectively, allowing the fiscal deficit to narrow.
Figure 22 shows the average contribution of major components of GDP to growth over the pre-recession period (1994-2007), the recession period (2008-9), and the post-recession period (2010-12), based on our forecasts for 2011-12. The figure illustrates that the main drivers of the recovery are expected to be external demand and private investment. While the contribution of private investment to growth is expected to return to pre-recession levels in 2010-12, net trade is expected to begin to support GDP growth, compensating for a smaller contribution from consumer spending. Government consumption and investment are expected to continue to detract from GDP growth, in order to address the high levels of government debt in Italy. We forecast the fiscal deficit to narrow to about 4 per cent of GDP this year, from 41/2 per cent in 2010. Overall, the recovery is expected to remain weak. GDP growth of just I per cent is forecast for 2011, rising to about 11/2 per cent per annum from 2012.
[FIGURE 22 OMITTED]
The recession in Spain has been protracted compared to most of the rest of the Euro Area. Output contracted by 0.1 per cent in 2010 and we expect an annual growth rate of just 0.9 per cent for this year. Private consumption grew by 1.2 per cent in 2010, but growth will be weaker this year as a result of increased inflation, which is expected to exceed 3 per cent per annum in both 2011 and 2012. This will weigh on real disposable income, which is forecast to decline this year, for the second year running. Over the forecast horizon the high levels of the unemployment rate and government debt represent the main challenges for the Spanish economy.
House price indices for a selected group of countries are illustrated in figure 23. This shows that the cumulative rise in Spanish house prices between 2000 and 2008 was higher than in the other countries in the sample. The subsequent decline has not been as sharp as in some countries, such as Ireland, where prices have reverted towards their level in the first few years of the decade. This may suggest that house prices in Spain have a lot further to fall, or may indicate that house prices in Spain at the onset of the recession were less overvalued than elsewhere. Rapid house price growth between 20002008 may have been more of a reflection of the rapid immigration fuelled population growth.
[FIGURE 23 OMITTED]
New Member States
The recovery in the EU's new member states has gained momentum. We expect that in aggregate GDP in this group of countries will expand by 31/2 per cent in 2011 and about 4 per cent in 2012. Growth differentials within the new member states are expected to narrow this year, with growth projections ranging from about 11/2 per cent in Romania to about 41/4 per cent in Poland, Estonia and Slovakia.
Slovenia, Slovakia and Estonia joined the Euro Area in 2007, 2009 and 2011, respectively. The next members to join will probably be the signatories of the Euro Plus Pact, which include Bulgaria, Latvia, Lithuania, Poland and Romania. The Czech Republic and Hungary have not signed the treaty and it seems that the political will in these countries to join the common currency area is somewhat weaker. Countries wishing to become members of the Euro Area need to fulfil the Maastricht criteria. At the current juncture the biggest obstacles on the road to the euro remain high inflation in Central Europe and high budget deficits, particularly in the Baltic economies. Levels of public debt in new member states, on the other hand, are much lower than in their EU-15 counterparts, as illustrated in figure 24. The Maastricht limit on government debt is 60 per cent of GDP, exceeded only in Bulgaria and Hungary.
[FIGURE 24 OMITTED]
We would like to thank Simon Kirby for helpful comments.
Exchange rate, interest rates and equity price assumptions are based on information available to 15 April 2011. Unless otherwise specified, the source of all data reported in tables and figures is the NiGEM database and NIESR forecast baseline.
Cabinet Office (23 March 2011), Analysis of the Macroeconomic Impact of the Tohoku-Pacific Ocean Earthquake, provisional translation, http://nsearch.cao.go.jp/cao/search.x?q =earthquake&mode_ja_cao=ja_cao&page=I&ie=UTF8&tmpl=en.
(1) See IMF Fiscal Monitor, April 2011, p. 30.
(2) Up until the early 1990s. China was a net exporter of oil.
(3) Poland, Hungary, Czech Republic, Slovakia, Slovenia, Estonia, Latvia, Lithuania, plus Cyprus and Malta, although the latter two have been exempt from labour market restrictions since acceding to the EU in 2004.
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|Title Annotation:||THE WORLD ECONOMY|
|Author:||Holland, Dawn; Barrell, Ray; Delannoy, Aurelie; Fic, Tatiana; Hurst, Ian; Orazgani, Ali; Paluchowski|
|Publication:||National Institute Economic Review|
|Date:||Apr 1, 2011|
|Previous Article:||World overview: oil prices and the fiscal stance.|
|Next Article:||Appendix A: summary of key forecast assumptions.|