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The economy has been hit severely by the international financial crisis through its exposure to financial services and trade. There are signs that activity has bottomed out, however, thanks to stronger equity markets and policy support. Further ahead, gradual recovery will be sustained by improving financial conditions and growth in world trade.

Further fiscal stimulus of around 1 1/2 per cent of GDP has been put in place for 2010. The authorities should lay out a credible path for medium-term fiscal consolidation.

The sharp downturn appears to have ended

Economic activity contracted by 6.3% from the peak in early 2008 to mid-2009, due to the financial crisis and the collapse in world trade. However, industrial production in August was 27% lower than a year previously, output of financial and business services also fell, although rising government spending and accommodative monetary policy lent support. In the second quarter, GDP contracted by just 0.3%, though consumption increased by 0.5% and industrial production rose. Confidence indicators have picked up strongly in recent months.

There is widespread labour hoarding

Unemployment stood at 5.8% in September, up from 4.4% a year previously, even though overall employment increased modestly. The number of people on active labour market programmes has risen. However, the fall in output has been partially absorbed by an increase in the number of workers on reduced work time, from near zero before the crisis to 2.8% of the labour force in August. This has been encouraged by the decision to reimburse the employers' share of the partial unemployment allowance and extend its duration.


The recovery will be slow

Activity will recover towards long-term trend growth rates in the next two years as financial conditions improve and world trade strengthens. The rise of European stock markets and inflows into funds based in Luxembourg point to higher exports of financial services in the near term. But, considerable economic slack is likely to persist, the extensive labour hoarding will limit any rebound in employment and unsettled financial conditions could restrain the pick-up in investment.

Inflationary pressures are easing

Underlying inflationary pressures have eased, despite the increase in wages in March through the wage indexation mechanism, and price pressures are likely to remain subdued over coming quarters. A further uplift to wages may occur during 2010.

The general government balance is moving further into deficit

The general government balance has deteriorated sharply from a surplus of 2.6% of GDP in 2008 to a deficit of over 2% in 2009. Around half of this change can be explained by the automatic stabilisers. In addition, the 2009 Budget set out a fiscal stimulus package of more than 3% of GDP. The 2010 Budget plans further stimulus of around 1 1/2 per cent of GDP, largely split between investment and higher social spending. While the government has indicated that investment will not rise further in subsequent years, it may be difficult to reverse higher social spending.

The main risk is prolonged financial crisis

Luxembourg remains highly exposed to uncertainty about international financial conditions and the improvement in world trade. The main uncertainty, however, is about the impact of the financial crisis on potential output and the long-term prospects of the economy, given its narrow specialisation in certain financial activities and types of industrial production.
Luxembourg: Demand, output and prices


                        Current    2007   2008  2009   2010   2011
                        [euro]        Percentage changes, volume
                        billion             (2000 prices)

Private consumption         11.3     2.8   3.9   -0.3    1.0    2.0
Government consumption       5.2     2.8   2.7   33.0    2.0    0.5
Gross fixed capital          6.5    12.6  -0.1  -11.5   -1.8    5.1
Final domestic demand       23.0     5.6   2.5   -2.7    0.5    2.6
  Stockbuilding (1)          0.4    -0.9   0.5   -1.6    1.4    0.0
Total domestic demand       23.4     4.2   3.2   -5.1    2.7    2.6
Exports of goods and        57.7     8.8   1.5  -10.9    1.9    5.5
Imports of goods and        47.0     8.3   3.5  -13.3    1.7    5.6
  Net exports (1)           10.7     3.5  -2.4   -0.2    0.9    1.7
GDP at market prices        34.1     6.5   0.0   -3.9    2.4    3.4
GDP deflator                         3.0   5.0   -1.4    2.6    3.2
Memorandum items
Harmonised index of          --      2.7   4.1   -0.1    1.6    1.0
 consumer prices
Private consumption          --      1.9   3.7   -0.3    2.0    1.8
Unemployment rate            --      4.4   4.4    5.9    7.1    7.5
General government           --      3.7   2.5   -2.3   -4.3   -3.6
 financial balance (2)
Current account              --      9.7   5.5    1.9    1.5    2.9
 balance (2)

Note: National accounts are based on official chain/linked
data. This introduces a discrepancy in the identity between
real demand components and GDP. Far further details see OECD
Economic Outlook Sources and Methods

(1.) Contributions to changes in real GDP (percentage of real
GDP in previous year). actual amount in the first column.

(2.) As a percentage of GDP.

Source: OECD Economic Outlook 86 database.

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Publication:OECD Economic Outlook
Article Type:Statistical data
Geographic Code:4EULU
Date:Nov 1, 2009
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