IMF: the world economy is likely to grow next year, despite the latest 'oil shock.' - International Monetary Fund

Business America, Oct 8, 1990

Higher oil prices will weaken world economic output slightly in 1990-91 and cause inflationary pressures to increase, but the impact of the latest oil shock" is expected to be less severe than earlier ones in the 1970s, according to the latest projections contained in the World Economic Outlook of the International Monetary Fund (IMF).

The updated projections show real GDP growth for the world economy averaging 2 percent in 1990 and 2 1/2 percent in 1991, with industrial countries growing 2 1/2 percent in both years. Developing countries may grow by 2 1/4percent in 1990 and 4 1/4percent in 1991, but this masks wide differences among the oil-exporting developing countries, whose growth is projected to be 3 1/2 percent in 1990, and oil-importing countries, whose growth is only expected to be 1- 1/4percent in 1990 due not only to the oil price rise, but also to somewhat lower levels of economic growth in the industrial countries.

The new projections assume that the price of oil will average $26 per barrel for the rest of 1990 and come down gradually to the OPEC reference price of $21 per barrel by the fourth quarter of 1991. This would represent an annual average increase in the price of oil of 20 percent in 1990 and a further increase of 10 1/2 percent in 199 1. The projections are based on the assumptions of constant real exchange rates at the August 1990 level, a slight decline in non-fuel commodity prices in 1991, and a U.S. dollar LIBOR (London Interbank Offer Rate) interest rate at a constant 8 percent.

Consumer price inflation in the industrial countries may be about 1/4 to 1/2 of a percentage point higher in 1990 4- 1/4percent) compared with 1989, reflecting the higher oil prices, but declining somewhat in 1991 (to 4 1/4 percent). In the developing countries, already high rates of inflation are expected to persist in 1990, but could decline sharply in 1991 assuming that current stabilization efforts in the high-inflation countries are sustained.

The continuing uncertainties surrounding the political and military situation in the Middle East suggest that the economic consequences of events there could be more serious than shown in the projections. However, appropriate economic policy responses could potentially reduce uncertainties. The report says that the experience of previous oil shocks indicates that attempts to limit the pass-through of oil price increases to domestic energy prices would be counterproductive. Oil subsidies would have negative effects on the fiscal position while resorting to domestic price controls would distort the functioning of the markets and give rise to shortages of oil products.

In the longer run, any attempts to keep domestic oil prices below world prices would hinder conservation and discourage development of new sources of energy. Similarly, attempts to mitigate the adverse short-run economic effects on output and employment by easing monetary policy would increase price pressures which would evolve into an inflationary process. Further escalation of inflation and expectations of inflation would ultimately require a sharp tightening of monetary conditions, resulting in high interest rates and lower output and employment. These policy considerations are valid for both the industrial and the developing countries. In those developing countries where incomes policies in the form of wage indexation, public sector wage policies or other mechanisms are prevalent, it will be important to ensure that a one-time increase in domestic prices stemming from the rise in oil costs is not translated into an escalation of wages and a subsequent wage/price spiral. Inasmuch as the increase in oil prices involves a decline in national income, both producers and consumers must clearly understand that real wages as well as profits will unavoidably be lower than they would have been otherwise, the report says.

The updated projections confirm a trend toward a slower growth rate in the world economy after several years of high levels of resource utilization. Industrial countries had grown by an average of almost 4 percent in 1988-89. In 1990-91, North America, the United Kingdom, and a number of smaller industrial countries are expected to experience relatively slow growth, in contrast with Japan and Germany where relatively high growth will be driven by increased domestic demand and investment.

Contrasts in the growth rates of the developing countries will be sharper. The Asian region is expected to experience continued high rates of growth, exceeding 5 percent in 1990-91, while in the developing countries of Europe and the Western Hemisphere, output is projected to decline in 1990 as those countries pursue stabilization and anti-inflation financial policies in the face of average inflation in excess of 100 percent, compared with slightly more than 10 percent in other developing countries. Growth is expected to increase and inflation to be reduced substantially in 1991 if recently adopted stabilization programs are sustained.