Prospects for individual economies.

Holland, Dawn ; Barrell, Ray ; Delannoy, Aurelie 等

United States

The pace of economic recovery in the US eased in the second quarter of 2010, with quarter-on-quarter GDP growth moderating from 0.9 per cent in the first quarter of the year to 0.4 per cent. The source of the slowdown stemmed from a negative contribution to growth from net trade, as import volumes rose by 7.5 per cent on the back of a sharp acceleration in domestic demand. This allowed the US current account balance to widen to 3.4 per cent of GDP. Our forecast sees the current account balance hovering between 2 1/2-3 1/2 per cent of GDP over the forecast horizon, well below the 6 1/2 per cent of GDP deficits seen at the height of the housing market bubble in 2005-6. NIESR's index of global imbalances, illustrated in appendix chart B3, clearly shows that global current account imbalances have receded from the unsustainable levels reached in 2007.

Strong import demand from the United States bodes well for the rest of the world, as the US remains the world's biggest importer of goods and services, as illustrated in appendix chart B4. US exports have not kept pace with import demand, and the US appears to have lost some global market share. In particular, the net trade position with the Euro Area, China and oil exporting economies has worsened substantially since the beginning of 2009, while the US trade balance with South America, Australia, Korea and some other Asian economies has improved.

Unemployment remains stubbornly high in the US, although there has been a modest decline in the unemployment rate since the peak of 10 per cent reached at the end of last year. As discussed by Holland, Kirby and Whitworth elsewhere in this Review, the US requires a 6.4 per cent rise in labour input to close the labour gap opened during the recession. We forecast a gradual decline in the unemployment rate over the forecast's horizon, to average 9 per cent in 2011 and 8 1/4 per cent in 2012.

The high unemployment rate acts as a strong restraint on inflationary pressures, and we expect real wages to decline this year. Prospects for inflation remain benign, with annual inflation measured by the consumer expenditure deflator expected to average 1.8 per cent this year. The Federal Open Market Committee is watchful of any signs of deflation, and is prepared to step in with additional monetary easing measures if necessary. The commitment to maintain an accommodative stance has pushed long-term government bond yields down, and they currently stand at 2.4 per cent, compared to an average of 3.3 per cent in 2009. It has also put downward pressure on the dollar, which has depreciated by more than 4 per cent in effective terms since the second quarter of 2010. The real exchange rate has also depreciated over this period, allowing some gain in competitiveness. On a bilateral basis, the dollar has depreciated against almost all the major trading currencies since mid-2010. A weaker exchange rate will offset some of the disinflationary pressures coming from the labour market, and will also help stem the recent rise in the current account deficit.

Fiscal policy also remains accommodative. NIESR estimates indicate a fiscal stimulus worth 0.7 per cent of GDP in 2010. However, current policy commitments entail a tighter stance in 2011, and tightening measures worth 2 1/2 per cent of GDP in 2012. Fiscal tightening will moderate the pace of recovery, allowing the output gap to close only gradually over the forecast horizon. We forecast GDP growth in the US of about 2 3/4 per cent per annum over the next several years.

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Canada

The level of output in Canada approached its pre-crisis peak in the second quarter of 2010, making Canada the first of the G7 economies to recover output levels. In response, the Bank of Canada was the first major central bank to begin normalising interest rates from the unprecedented lows reached during the recession. A cumulative rise of 75 basis points since June brought the target rate to 1 per cent in September 2010. Employment in Canada held up relatively well during the recession, and the level of employment has regained pre-crisis levels. After reaching a 10 year high of 8.3 per cent in 2009, the unemployment rate is expected to average 8 per cent in 2010 and 7 per cent in 2011.

Canadian trade volumes, however, remain depressed relative to pre-crisis levels. Export volumes in particular remain low, reflecting a loss of global trade share, while import volumes have been supported by a strong revival in domestic demand. We forecast GDP growth of 3 per cent per annum in Canada from 2010-12. Domestic demand is expected to grow by 4.8 per cent this year and 31 1/4-3 1/2 per cent per annum in 2011-12.

Over the medium term we see GDP growth averaging 2 3/4 per cent per annum. Underlying the stronger medium-term prospects in the North American economies relative to Japan and the Euro Area are demographic projections. The working-age population in Canada is expected to grow by about 1/2 per cent per annum from 2010-17.

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Mexico and Brazil

Brazil has experienced very rapid GDP growth since mid-2009, although the pace of expansion eased somewhat in the second quarter of 2010. The combination of expansionary policies and strong commodity prices has resulted in a robust recovery. We forecast GDP growth of 7.9 per cent in Brazil this year and 4.5 per cent in 2011.

Brazil's Monetary Policy Committee, Copom, have raised interest rates by a cumulative 200 basis points since May 2010 to offset rising inflationary pressures. We forecast annual inflation of 6.4 per cent this year, somewhat higher than the targeted rate of 4.5 per cent. Relatively high rates of return and a recent upward revision to estimated reserves in the Libra oilfield have attracted capital inflows into Brazil, and the Brazilian real has appreciated by 6 per cent in effective terms since the beginning of the year. While this should moderate inflationary pressures, it has also sparked comments regarding the possibility of a global currency war.

Mexico is now experiencing a steady recovery, although the level of output in the second quarter of 2010 remained 3 per cent below its pre-crisis peak. The Mexican economy is closely linked to the US, with 81 per cent of exports sent across the border, compared to just 16 per cent of Brazilian exports. The outlook for Mexico is therefore reliant on a sustained rise in demand from the US. We forecast growth of 5.2 per cent in Mexico this year and 4.4 per cent in 2011.

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Japan

Following two quarters of rapid expansion, GDP growth in Japan slowed to 0.4 per cent in the second quarter of 2010. Unlike the US, the slowdown in Japan reflects stagnation in domestic demand, as consumer spending ceased to expand and inventory destocking detracted from growth. Export volumes continued to expand rapidly, with a rise of 5.9 per cent relative to the previous quarter.

The moderation in the speed of recovery and persistent strengthening of the yen has prompted calls for additional policy stimulus. Monetary authorities have reduced the interest rate target range from 'around 0.1 per cent' to '0-0.1 per cent', and have made it clear that they are ready to maintain a zero interest rate policy for an extended period and introduce additional easing measures in order to offset deflationary pressures. The Japanese government has brought in a supplementary budget plan and is considering a cut in corporate tax rates next year. Our forecast assumes that these easing measures are effective, allowing the yen to stabilise at current levels of 82.9 per US$. Under these conditions, we forecast GDP growth of 3.2 per cent in 2010 and 2 per cent in 2011. However, further appreciation of the yen could put the outlook in jeopardy, and allow deflation to persist into 2012.

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Japan's nominal effective exchange rate has appreciated by more than 30 per cent since the onset of the economic crisis. This has pushed up Japan's export prices relative to their competitors by about 7 per cent. Thus far, Japan has managed to maintain most of its global trade share despite a loss of competitiveness, primarily through increased trade linkages with China. However, exporting firms have absorbed much of the exchange rate rise in profit margins, as shown by the sharp divergence between Japan's export prices relative to their competitors and relative to domestic prices, illustrated in the figure.

The unemployment rate in Japan remains low relative to other major economies, at just above 5 per cent, but the economy has suffered some

job losses since the onset of the recession. The bulk of adjustment to labour input has been effected through a reduction in hours of work, with significant levels of labour hoarding (see Holland, Kirby and Whitworth elsewhere in this Review). With the strong yen putting additional pressure on profit margins, exporting firms are unlikely to be able to maintain this excess labour for much longer. Equity prices in Japan have fallen sharply relative to those in the US and Europe as a result. Compounded by the expected decline in real disposable income next year, we forecast little growth in consumer spending over the next several years.

China

China has been one of the world's fastest growing economies for the past three decades. The rapid expansion allowed China to overtake Japan as the world's second largest economy (calculated in terms of PPPs) in 2001, and we expect it to overtake the US as the world's largest economy by 2019. Supported by a strong fiscal stimulus last year, GDP in the first quarter of 2010 was 11.9 per cent higher than a year earlier, with only a small moderation in growth to 10.3 per cent in the second quarter. We forecast GDP growth of 10 3/4 per cent for 2010 as a whole, and close to 9 1/2 per cent in 2011. Over the medium term the economy has the potential to grow by about 71/2 per cent per annum. This assumes average productivity growth of about 7 per cent per annum to 2017.

Inflation has accelerated in China. Labour shortages in some regions have put upward pressure on wages, which has fed into the price level, while certain industries are also faced with capacity constraints. The withdrawal of policy stimulus measures is expected to restrain any further rise in inflation over the coming quarters, and we forecast annual inflation of 2-2 1/2 per cent per annum over the period 2010-12.

There have been persistent calls for a revaluation of the Chinese exchange rate. China has officially operated a managed floating exchange rate regime since 1994. However, only since 2006, when the Chinese current account surplus exceeded 10 per cent of GDP, did external pressure induce any significant movement of the yuan against the US$. Figure 9 shows the Chinese exchange rate against the US$, as well as both nominal and real trade-weighted effective exchange rates since 2004. The currency was allowed to appreciate gradually between mid-2006 and mid-2008, while the current account balance fluctuated between 10-12 per cent of GDP.

When the financial crisis hit, the yuan was held stable against the US$. At the same time, the current account surplus narrowed sharply, towards 6 per cent of GDP, driven by a shift in the balance of domestic demand away from the US and towards China. In July 2010, a modest adjustment to the exchange rate regime was adopted, and the yuan has since appreciated by 2.5 per cent against the US$. We expect the yuan to continue to rise by about 0.4 per cent per annum against the US$. The current account balance is expected to remain below the highs reached in 2007, but is forecast to drift upwards as domestic demand gains momentum in the OECD. Any decline in the surplus will rely on policies designed to stimulate domestic demand in China in addition to allowing a more freely floating exchange rate regime.

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Other Asia

Domestic demand in Asia continues to be an important source of strength in the global economy. Figure 10 illustrates the contribution to GDP growth in the first half of 2010 of domestic demand and net trade in India, Korea, Taiwan and Hong Kong. In all countries, domestic demand contributed more than 3 percentage points to GDP growth on a semi-annual basis. Only in India did net trade make a larger contribution than domestic demand, which shows that Korea, Taiwan and Hong Kong have continued to support the recovery in world trade. We forecast GDP growth of 10 3/4 per cent in India this year, 6 3/4 per cent in Korea, 11 3/4 per cent in Taiwan and 6 1/2 per cent in Hong Kong.

Inflationary pressures remain moderate in most countries, suggesting that the strong growth has yet to lead to capacity pressures. However, careful withdrawal of the expansionary fiscal policies introduced in 2009 is needed to ward off an acceleration in inflation. India stands out as having experienced a sharp rise in inflation in recent months. The year-on-year inflation rate rose to about 15 per cent at the beginning of 2010, compared to the central bank's target of 5-6 per cent. We forecast annual inflation of more than 10 per cent this year in India, while elsewhere inflation is not expected to exceed 2 1/2 per cent in 2010 or 2011.

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Australia and New Zealand

In contrast to most developed countries, Australia's economy did not contract in 2009, sustained by a strong policy stimulus and commodity exports to China. Expansion has continued in 2010, with our forecast estimating real GDP growth of 3.6 per cent for the year. Despite a relatively modest slowdown in output, the unemployment rate in Australia rose from a low of 4 per cent at the beginning of 2008 to reach 5.8 per cent in mid-2009. Although conditions have improved, we do not expect the unemployment rate to fall below 5 per cent before 2013. In addition to higher unemployment, average working time in Australia has declined by 2.5 per cent since the beginning of 2008, as discussed by Holland, Kirby and Whitworth elsewhere in this Review. This may reflect a shift in preferences towards leisure, or may be an indication of underemployment at a broader level.

Following two years of contraction, New Zealand's economy is projected to grow by 2.5 per cent in 2010. Both Australia and New Zealand should benefit from increasing exports to the fast-growing Asian markets. Australia exports more than 60 per cent of its goods and services to Asia. New Zealand exports a somewhat smaller share, but has additional indirect ties to the region through its largest trading partner, Australia.

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Russia

Russia's position as the second largest oil exporter made it vulnerable to the sharp drop in oil prices in 2009, with the lower prices contributing to the 7.9 per cent contraction of the country's economy last year. Subsequent rises in the price of oil have helped reverse the trend and the economy is forecast to grow by 2.8 per cent in 2010. The rebound in growth has thus far been driven entirely by external demand. Export volumes have regained their pre-crisis levels, and Russia has even managed to gain global trade share over the past two years. We expect the Russian economy to grow by about 5 per cent per annum over the next few years, aided by its strong exports in oil, steel and gas.

Inflation in Russia remains high relative to most advanced economies, but several years of disinflation brought it to a recent historical low of 5.5 per cent in July 2010. The August rate showed a modest increase, but inflation remained below the 7 per cent target of the Central Bank. We forecast annual inflation of about 7 per cent in both 2010 and 2011.

South Africa

The collapse in global trade led to a sharp contraction of South African exports in 2009, which recorded a decline of nearly 20 per cent. The loss of demand for mining and manufacturing exports caused job losses and a decline in income, leading to a drop in domestic demand of 1.8 per cent. Supported by a revival of both internal and external demand, the South African economy is expected to grow by 3.2 per cent this year. We forecast growth of about 3 per cent per annum throughout our forecast horizon to 2017.

Given the country's rapid population growth, expected to average 1/2 per cent per annum over the next ten years, annual growth of 3 per cent is unlikely to be sufficient to allow a rapid decline in the unemployment rate, which stands at about 25 per cent. The high rate of unemployment can explain a significant portion of South Africa's unequal distribution of income. The country has one of the highest Gini-coefficient in the world. To ensure a reduction in income inequality, a more rapid pace of job creation is essential.

Europe

GDP growth in the Euro Area is gradually strengthening. In the second quarter of 2010 the Euro Area economy expanded by 1 per cent, an improvement from the 0.3 per cent recorded in the previous quarter. We forecast that GDP growth in the Euro Area this year will be 1.8 per cent with a further increase of 2.1 per cent in the following year.

The rate of economic expansion, post-crisis, differs across the individual member states. For example, Greece, Ireland and Spain are expected to contract this year, whereas Germany is projected to have one of the strongest growth rates of the post-unification period.

GDP growth in the Euro Area will be driven by both domestic and external demand, with the contribution from each of these varying across individual members.

Harmonised consumer price inflation in the Euro Area in the third quarter of 2010 increased to 1.7 per cent and is projected gradually to climb further. Although inflation is on a rising trend, our central forecast does not expect it to exceed the ECB's 2 per cent target over the medium term. However, as figure 12 illustrates, there is more than a 20 per cent chance of exceeding the target in 2011 and 2012. We project that inflation will reach 1.4 per cent this year and 1.5 and 1.7 per cent in 2011 and 2012 respectively. The increase in inflation despite the serious economic downturn is a result of several factors. The collapse in economic activity can be separated into a permanent and a cyclical component. The permanent drop in output--a scar (see Barrell, 2009)--is inflation-neutral, and it is the actual scale of the negative output gap that results in deflationary pressures. As the size of the scar in the Euro Area as a whole is fairly substantial (amounting to about 3--4 per cent of GDP), the impact of the decline in output on prices is smaller than it would otherwise have been. The long-term output scar reflects a drop in potential activity resulting from a higher risk premium, which influences potential output through the capital channel. The higher post-crisis inflation is also attributable to rising prices of food and oil and country-specific factors such as VAT increases.

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The European Commission has set the following target dates by which the Euro Area members are expected to reduce their budget deficits to below 3 per cent of GDP:

Target dates Country

2011 Finland

2012 Italy, Belgium

2013 Denmark, Austria, Germany, Netherlands, Slovakia, France, Portugal, Spain

2014 Greece, Ireland

We forecast that the budget deficit in the Euro Area will widen to 6.4 per cent of GDP this year, and will remain at the high level of 5.4 per cent of GDP next year. The size of the deficit varies across countries with the largest fiscal imbalances expected to materialise in Greece and Ireland. Finland is expected to have the strongest fiscal position. We estimate that Ireland, Greece, Spain, Portugal, Italy and France have an enhanced risk of excessively protracted deficits and will therefore find it more problematic to fulfill the EC recommendation of bringing the deficit below the 3 per cent Maastricht limit by the designated date. The currently proposed measures of fiscal consolidation in these countries may need to be expanded to meet the target dates.

Germany

The pace of recovery in the German economy is unmatched within the Euro Area. We expect it to expand by 3.4 per cent this year, 2.8 per cent in 2011 and a further 1.7 per cent in 2012. Germany is the second largest global exporter of goods after China and has benefited greatly from the global recovery. It is also one of the world's biggest importers and its recent strong growth has been important in restoring growth in Europe. In spite of experiencing a deep and protracted recession, the unemployment rate in Germany showed little inclination to rise, and is now below pre-crisis levels. Figure 13 shows the unemployment rates in Germany, France and Italy.

The German labour market 'miracle' results from two factors. The first relates to the German anti-crisis policy--extension of the short-time work scheme, less paid overtime, the reduction of positive balances on working-time accounts. The second factor concerns a series of Hartz reforms, implemented between 2003-5, aimed at generating greater incentives for the unemployed to seek work, and relaxing regulations for firms that want to create jobs. These reforms are a likely factor in the downward shift in the NAIRU, and we expect that over the medium term the unemployment rate in Germany will reduce to about 5 per cent.

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France

In France, growth accelerated in the second quarter of 2010, and is expected to exceed the government's target of 1.5 per cent for 2010 as a whole. We forecast an expansion of 1.9 per cent in both 2010 and 2011. The acceleration was driven by a significant upturn in domestic demand, expected to rise by 1.5 per cent this year. Although stock-building and investment are the major contributors, household consumption also played a positive role, despite a sluggish start in the first quarter. A relatively strong rise in real personal disposable income will support consumer spending this year. Employment also shows signs of stabilisation. The unemployment rate is expected to average 9.8 per cent in 2010 and 2011, and decline gradually in the medium term. Although we expect the recent recovery in investment to be sustained, the new 2011 budget aimed at tackling the French deficit introduces austerity policies which might significantly challenge the dynamism of domestic demand.

The level of export volumes from France remain some 7 per cent below their pre-recession level, but have been rising rapidly since mid-2009. Although growth in exports decelerated in the second quarter of 2010, imports and exports were 8.7 and 10.2 per cent higher, respectively, than a year earlier. This includes a significant rise in trade with Germany.

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Italy

In the first half of this year the Italian economy recovered slightly, following two consecutive years of recession, with output rising by 0.6 per cent relative to the previous six months. In figure 15 we plot the quarterly contribution of the components of GDP to growth from 2009 to 2010, which shows that the recovery phase has been driven by net trade and to a lesser extent private investment. Export volumes grew by more than 3 per cent per quarter in the first half of 2010, although Italy continued to lose global market share, continuing a trend that has been ongoing for more than a decade. At a recent meeting, between Silvio Berlusconi and the Chinese premier, Mr. Wen, they announced an aim to double bilateral trade between Italy and China by 2015, which may go some way towards reintegrating Italy into the global trading system.

We forecast GDP growth of about 1 per cent for 2010 and 1 1/2 per cent for 2011. Domestic demand growth is expected to grow in line with output growth. Private consumption, the biggest component of domestic demand, is forecast to rise by around 1/2 per cent per annum in both 2010 and 2011. As consolidation measures will restrain public spending, the main driver of the economy over the short term is expected to be investment and external demand.

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Spain

Economic activity in Spain showed a modest revival in the first half of this year, after a deep recession in 2009, with an expansion of 0.2 per cent compared to the second half of 2009. Private consumption was the main engine of growth, with a rise of 1.6 per cent on a semiannual basis. While GDP is expected to continue to rise in the second half of the year, the level of output in 2010 as a whole will remain slightly below the level in 2009, as the modest growth prospects are unlikely to allow output to regain its level at the beginning of last year. We forecast growth of 1 1/2 per cent in 2011.

The unemployment rate reached 20.5 per cent in August 2010 and we expect little improvement in the unemployment rate before 2013. In figure 16, we plot the decline in employment between the first quarter of 2008 and the second quarter of 2010, by sector, age and sex. We can see that the service industry, the biggest employment sector in Spain, has been resilient during the recession, whereas over 35 per cent of jobs in the construction sector have been lost. Youth employment has also suffered disproportionately. Estimates reported by Holland, Kirby and Whitworth elsewhere in this Review suggest that Spain requires a 10 per cent rise in labour input in order to restore the labour market to prerecession conditions.

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New Member States

The macroeconomic situation in the new member states has improved, although growth remains uneven across countries. We forecast that the best performers in Central and Eastern Europe this year will be Slovakia and Poland. Poland was the country least impeded by the crisis, as the only economy in the EU avoiding recession, and small and open Slovakia is recovering on the back of improved external demand, especially from Germany. GDP growth will stagnate or increase only moderately this year in Lithuania, Latvia, Bulgaria, Romania and Hungary. The Baltic countries were severely affected by the crisis, recording double digit declines in output. Estonia is projected to perform somewhat better than its neighbours. It will join the Euro Area next year and this may be one of the factors helping to restore confidence in the economy. Prospects for the adoption of the euro in the other countries are rather weak at the moment, the biggest obstacle being large budget deficits. The outlook is most pessimistic for Lithuania, Latvia, Romania and Poland. These countries need to strengthen their consolidation efforts significantly. Hungary, after several years of fiscal consolidation, is now in a relatively good position and may soon bring down its deficit to below the Maastricht limit. Figure 17 shows the performance of the three largest economies in Central Europe in 2010 in relation to fulfilment of the Maastricht criteria.

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DOI: 10.1177/0027950110389767

ACKNOWLEDGEMENTS

We would like to thank Simon Kirby for helpful comments and suggestions.

The forecast is based on data available to 13 October 2010.

REFERENCES

Barrell, R, (2009) 'Long term scarring from the financial crisis National Institute Economic Review, 210, October, pp. 36-8.

Barrell, R. and Dury, K. (2000), 'An evaluation of monetary targeting regimes', National Institute Economic Review, 174 October.

Barrell, R., Kirby, S. and Whitworth, R. (2010), 'An international comparison of employment in recovery', National Institute Economic Review, 214, October, pp. F35-F40.

NOTE

(1) The central bank cannot control the steady-state interest rate It is influenced by the fiscal stance and saving-investment balance.