I. General assessment of the macroeconomic situation

OECD Economic Outlook, Dec, 2003

Overview: A firming but uneven recovery

Global activity is picking up, with financial-market conditions improving and business investment in the process of taking over the baton from consumption. OECD-wide GDP growth, which languished below potential during the past three years, has finned to an annualised rate probably exceeding 3 per cent in the second half of 2003 and is set to continue at about that pace during the 2004-05 projection period (Table I.1). The upturn is led by the US economy and, more unusually in light of the poor growth performance of the past decade, by Japan, which has experienced a surprisingly strong rebound. The euro area, where domestic demand has remained weak for longer, will receive some support from the global recovery, but is unlikely fully to work off its considerable slack over the next two years. Overall, inflation will remain low, with some further decline projected for the euro area, while deflation may be receding in Japan. Labour markets are expected to turn around, with employment rebounding rather strongly in the United States, following the shake-out of the past two years. In contrast, in the euro area, the recovery of employment is likely to be more subdued in a context of still relatively large labour hoarding. Improved employment prospects (even if modest) should, in turn, strengthen confidence and support consumption.

The risks appear more balanced than they have been over the past two years. On the downside, several negative risks still surround this baseline projection. The dependence of the global upturn on the US economy is of concern, given its unsustainably wide fiscal and current account gaps. At some point, these might trigger an undesirably large and rapid exchange rate slide and a significant increase in long-term interest rates, which could spill over to other regions. High household indebtedness in a number of countries could cause consumption to be scaled back, especially if interest rates were to rise sharply. The investment recovery is also vulnerable to the extent that stock market valuations may again reflect relatively optimistic expectations about profit growth. On the other hand, a swifter return of confidence could lead to faster recovery, not least via more vigorous business investment. Past experience also suggests that once a recovery is firmly rooted in the United States, growth can be more rapid for several quarters than is projected here.

Against this backdrop, the stance of monetary policy can and should remain accommodating well into the upturn. In most countries, the scope for support from the fiscal side is exhausted. Any easing would compound the already challenging budgetary adjustments lying ahead in many countries, most strikingly in the largest OECD economies. At a minimum, credible fiscal consolidation measures must be prepared now for execution as the recovery strengthens. These measures need to be embedded in a medium-term framework, ensuring that adjustment continues unabated throughout the upswing, which was not the case in the latter stages of the 1990s upturn. This macroeconomic policy mix should be combined with intensified structural reform efforts, which will help raise potential growth and ease the burden of fiscal policy adjustment.

Recent developments and near-term tendencies

Activity and confidence are firming

While some of the forces which caused the global downturn had begun to dissipate by the beginning of 2003, in large part due to the impact of strong policy responses, activity in the OECD area slowed during the period of geopolitical uncertainty preceding the war in Iraq (Figure I.1). For many countries, this meant that the downturn which began in 2001 entered its third year. Global output started recovering in the course of the spring, as the feared oil price surges failed to materialise and as geopolitical tensions eased. Among the major countries, improvement has been concentrated on the United States, where macroeconomic policy action to cushion the cyclical downturn was most vigorous, but has also been noticeable in the United Kingdom and Japan. Output has recently started to increase in the euro area, but only modestly.

[FIGURE I.1 OMITTED]

In the United States, growth picked up to around potential in the second quarter of 2003 and exceeded 7 per cent in annualised terms in the third, despite some drag from stockbuilding. Household consumption accelerated, particularly for durable goods, as did residential investment. Capital formation in the business sector rebounded, especially in high-tech, which had started to firm earlier. In Japan, real GDP accelerated in the second quarter and growth remained above potential in the third, although nominal GDP has risen only slightly. The recovery is mainly driven by business investment and exports, with household consumption remaining flat. The abrupt slowdown witnessed in Canada in the second quarter can be ascribed to a series of mainly temporary adverse shocks while the underlying tendency remains relatively strong. (1)