by Michael Mussa, Peterson Institute for International Economics
© Institute for International Economics. All rights reserved.
Michael Mussa, senior fellow, served as economic counselor and director of the research department at the International Monetary Fund from 1991 to 2001. He served as a member of the US Council of Economic Advisers from August 1986 to September 1988, and was a faculty member of the Graduate School of Business of the University of Chicago (1976-91) and the department of economics at the University of Rochester (1971-76). He has written extensively on international economics, macroeconomics, monetary economics, and municipal finance.
The world economy will see a significant recovery of growth in 2002 and 2003, reversing the global slowdown of last year. The global economic recovery will be led by the United States where a vigorous cyclical rebound is already under way. Economic growth will also strengthen in western Europe during 2002; however, recovery will slightly lag that of the United States and will likely proceed at a more subdued pace. For Japan, the risks remain substantial, but a modest-paced cyclical upturn beginning by mid-2002 and extending through 2003 appears to be the most likely outcome. Among the other industrial countries, Australia should sustain its relatively strong growth performance at least through 2002, while economic growth in Canada should pick up roughly in line with that in the United States. Most developing countries, too, can expect significant strengthening of economic growth as the global economy recovers—Mexico and the emerging-market economies of Asia are likely to benefit particularly from US economic recovery and central and eastern European countries are likely to get a boost from stronger growth in western Europe.
On a year-over-year basis, the pick-up in global growth between 2001 and 2002 appears quite modest—from an estimated 2¼ percent last year to only a projected 2¾ percent this year (see table 1). However, these year-over-year growth rates conceal the sharp acceleration of growth during 2002 in comparison with the very sluggish growth during 2001. In particular, for the United States the underlying forecast has real GDP rising during 2002 (measured on a fourth quarter-to-fourth quarter basis) to about 4 percent, versus barely ½ percent growth of real GDP during 2001. The year-over-year results, however, show a much more modest acceleration of growth, from 1¼ percent last year to 2½ percent this year. For western Europe, the year-over-year growth rates show essentially no pick-up between 2001 and 2002; whereas the underlying forecast has real GDP growth on a fourth quarter-to-fourth quarter basis accelerating from under 1 percent to 2½ percent. Sharply negative growth during 2001 (particularly in the fourth quarter) keeps the year-over-year forecast for Japanese growth in 2002 in negative territory; whereas the forecast has fourth quarter-to-fourth quarter growth at nearly 2 percent during 2002 versus –2 percent during 2001.
|World (WEO weights)||2¼||2¾||4½||1¼||3¾||4½|
In many countries, especially developing countries, quarterly GDP estimates are not very reliable. This explains why table 2 on global growth prospects at the end of this brief, like many other forecasts of global growth, reports projections only on a year-over-year basis for developing countries. On that basis, growth for developing countries is projected to rise only very modestly from 3½ percent for 2001 to 3¾ percent for 2002, and then to accelerate to 6 percent for 2003. However, by making use of quarterly GDP estimates where they are available and by making plausible inferences from annual figures where quarterly data are not available, it is reasonable to infer that growth during 2001 in developing countries was about 2¼ percent. Growth during 2002 in developing countries is forecast to accelerate to 4¼ percent and then pick up to 6 percent during 2003.
On a year-over-year basis, world economic growth (using the relative country weights from the IMF’s World Economic Outlook) is expected to pick up modestly from about 2¼ percent in 2001 to about 2¾ percent. Taking into account the results for the industrial countries and my estimates for developing countries, global growth during 2001 was only about 1¼ percent, and it will accelerate to about 3¾ percent during 2002 and to 4½ percent during 2003.
I estimate the potential growth rate for the world economy to be about 3½ percent. I would classify last year—with growth during the year about 2 percentage points below global potential (and the slowest in a decade)—as a global growth recession. The world economy is forecast to begin a new global economic expansion in 2002, which should gather pace in 2003 and hopefully last considerably longer.
Three main forces will drive the recovery in global economic growth: (1) the normal processes of cyclical recovery, in particular those associated with a sharp turnaround of inventory investment, followed by an upturn in business fixed investment; (2) substantial policy stimulus arising primarily from the easing of monetary policies last year in virtually all industrial countries, especially the aggressive easing undertaken by the US Federal Reserve; and (3) the tendency for roughly simultaneous recovery in different regions of the world economy to be mutually reinforcing. All three forces now appear to be operating or starting to operate, implying considerable confidence in projections of a global economic recovery.
A year ago, it was clear that the US economy was slowing significantly below its potential growth rate, and the Federal Reserve had begun to cut policy interest rates. The likely extent and duration of the slowdown in the United States, however, were not yet fully appreciated (even allowing for the negative surprise from the events of September 11). For most of the rest of the world, the likely extent of the global slowdown was not recognized. In particular, it was not understood that the same forces producing the slowdown in the US economy were operating much more broadly and the global economic slowdown would be mutually reinforcing across different regions. Now that process is going into reverse, and once again, the US economy is a leading indicator—this time of global recovery.
As always, of course, there are risks. A major terrorist outrage on the scale of September 11 or larger, could undermine confidence and potentially abort recovery. A sustained upsurge in world oil prices arising from political/military events in the Middle East could impair growth and increase global inflation. However, barring a major noneconomic shock, global recovery for at least this year and next appears reasonably well assured. Subdued inflationary pressures are a key reason for such confidence. Monetary policies that were eased very substantially to resist recession will surely need to be tightened significantly as the economic recovery gathers strength. But, there is no apparent need to undertake aggressive tightening that would threaten to stall recovery at an early stage—producing a so-called “double dip.” Rather, the main risks for the global recovery concern how strong it is likely to be and how successfully it can be sustained beyond the next two years. These risks are most usefully discussed in light of the somewhat differing conditions, prospects, and policy issues in different regions of the world economy.
After supporting global economic expansion through most of the 1990s, the sharp slowdown of the US economy beginning around mid-2000 led the world economy into the global growth recession of last year. Now, cyclical recovery of the US economy from the brief and shallow recession of 2001 will be a key factor contributing to renewed global economic expansion. Somewhat surprisingly, US real GDP shifted to modest growth in the final quarter of 2001, after only one quarter of modest decline. Preliminary indications suggest that real GDP growth strengthened considerably in the first quarter of 2002, indicating that the process of cyclical recovery is now well under way.
Usually in cyclical recoveries, real GDP growth during the first year exceeds the longer-run potential growth rate of the US economy. The strong productivity results for the US economy in recent years (including the continuation of substantial productivity gains since the slowdown began in mid-2000) suggest that the longer-run potential growth rate of the US economy is better than 3 percent and perhaps as high as 3½ or even 4 percent. Thus, with cyclical recovery now clearly under way, it would be reasonable, based on normal cyclical dynamics, to expect that real GDP growth during 2002 would be around 4 to 5 percent or perhaps somewhat higher.
Indeed, a rebound of inventory investment from minus $120 billion in the fourth quarter of 2001 to a modest positive level of plus $30 billion by the fourth quarter of 2002 would, by itself, contribute more than 1½ percent to real GDP growth during 2002. Even a partial recovery of business fixed investment from the sharp declines of last year could easily add another $50 billion to $80 billion to real GDP growth this year (probably concentrated primarily in the second half). Personal consumption expenditures held up very well last year despite the economic slowdown, and surely should be expected to continue to grow in a more robust economy. The strong gain in consumption at the end of last year (reflecting primarily very strong auto sales), however, suggests that real consumption spending this year should advance somewhat less than proportionately with the gain in real GDP. All things considered, the rise in real consumption spending might reasonably be expected to contribute $150 billion to $250 billion to real GDP growth during 2002. Government purchases of goods and services will likely make no more than a modest contribution to real GDP growth, as spending at the federal level continues to rise but state and local governments are constrained by budgetary pressures. Further deterioration of US net exports will make a negative contribution to US real GDP growth (of perhaps $60 billion to $120 billion) as the US economy helps, once again, to drive recovery in the rest of the world. Adding it up, this suggests an increase in real GDP during 2002 of between $280 billion and $420 billion, or a fourth quarter-to-fourth quarter growth rate of real GDP between 3 and 4½ percent; and I would shade the point forecast up from the mid-point of 3¾ percent to an even 4 percent.
Looking further ahead to 2003, the inventory rebound should be largely complete. Growth during the year will reflect continued growth of personal consumption spending about in line with real GDP growth (in contrast to a growth rate of real personal consumption spending during 2002, which will likely be moderately below the growth rate of real GDP). By next year, a significant recovery in business fixed investment should be gathering steam. And, the drag on US growth from further deterioration in net exports should be ameliorated by the acceleration of growth in the rest of the world. Annualized real GDP growth slightly above 4 percent at the start of the year, tapering down toward 3 percent by late 2002 is consistent with a fourth quarter-to-fourth quarter forecast of 4 percent growth and a year-over-year forecast of slightly over 4 percent for 2003.
Of course, even without further terrorist outrages, there are factors that could keep real growth this year below 3 percent. While inventory investment must almost surely shoot back to positive levels, a recovery in fixed investment is more questionable. Capacity utilization rates are low, and a recovery in corporate profits that would help to stimulate business fixed investment is not necessarily assured. Meanwhile, residential investment could be vulnerable as the Federal Reserve moves to tighten monetary policy. If the recovery in corporate profits lags while interest rates are rising, equity values (which remain high relative to corporate earnings and other standards of valuation) could correct downward, with negative effects on both consumption and investment. And, if recovery in the rest of the world lags, this would not be good for US exports.
On the other hand, real GDP growth above 4½ percent, or even 5 percent, during this year is also a possible outcome. In addition to the usual tendency for real GDP growth to exceed potential in the early stages of a cyclical recovery, it must be recognized that both monetary and fiscal policies (at the federal level) are unusually stimulative. At 1¾ percent, the federal funds rate is at its lowest level ever and (measured relative to the core CPI inflation expectations embodied in indexed treasury securities) is negative in real terms. The treasury yield curve has a very steep positive slope. The monetary aggregates are growing very rapidly. Tax cuts and increasing federal purchases are adding further stimulus. Indeed, taking account of all the policy stimuli, I would shade up the central forecast of real GDP growth during 2002 from 3¾ percent to 4 percent. I would not, however, go above 4 percent at this time as it is important for the central forecast to allow for meaningful risks both on the upside and on the downside.
My main worries about the US economy (aside from possible noneconomic shocks) do not concern recovery this year or its likely continuation next year, but rather what may happen in 2004 and thereafter. In particular, despite the downturn in equity values over the past two years, stock prices remain high relative to corporate earnings and most standards of sustainable valuations. However, recognizing that equity markets are volatile and some downward correction in stock prices is certainly possible, a recovering US economy supported by relatively easy monetary and fiscal policies seems unlikely to be the environment that would engender a stock market collapse. Something more fundamental would need to go wrong in order to induce a major stock market decline and/or to threaten a sustained economic expansion. On this score, there are three main worries.
First, as the US economy gathers forward momentum over the next year and a half or so, the Federal Reserve will face the delicate task of shifting the stance of monetary policy from highly stimulative to neutral or even moderately restrictive. Too much tightening too soon will slow down the economy too much late next year and during 2004, even though there remains no inflationary threat. But, too little tightening too late will allow inflationary pressures to build up and later necessitate sharp monetary tightening that might throw the economy back into recession.
And, it may be particularly difficult to judge how much monetary tightening at what pace is needed to hit the desirable middle ground. Experience in the 1990s suggests that a federal funds rate of 5¼ to 5¾ percent is “neutral,” in the sense that it will accommodate and support real GDP growth in line with potential when core CPI inflation is running about 2½ percent. Is this experience still relevant? Is it right to think that raising the federal funds rate from 1¾ percent to about 5½ percent over the course of a year or 18 months when the economy is recovering toward potential is essentially restoring monetary policy to a neutral stance—or, is such an increase in the federal funds rate likely to be a much tighter policy than keeping the rate at about 5½ percent when the economy is growing in line with potential? Will the favorable factors that helped to keep inflation relatively low in the late 1990s, despite very low unemployment, continue to operate in 2003 and beyond? The Federal Reserve will need to find the right answers to such questions—and persuade financial markets that it has the right answers—if monetary policy is to help navigate the course of the US economy over the next three or four years as successfully as it has for the past decade.
Second, partly by design and partly by accident, expansionary fiscal policy at the federal level helped cushion the recession of last year and will help to spur recovery this year. The substantial budget surpluses that built up before the recession provided room for this discretionary fiscal stimulus—in contrast to the budgetary situation that prevailed at the time of the previous recession in 1990-91. Now, however, the federal budget is once again in deficit (although not nearly to the same extent as in 1990-91); and, notwithstanding any projections or pronouncements to the contrary, neither the Administration nor the Congress shows any inclination to move the budget back into surplus any time soon. Accordingly, if the US economy gets into difficulty in the next few years, there will not be the budgetary room that there was this time to use discretionary fiscal policy in a counter-cyclical manner.
Third, there are substantial and related imbalances in the US economy that have not been corrected in the recession and potentially pose important problems in the future. The US national savings rate is low and a substantial net inflow of foreign savings is necessary to finance US domestic investment. This foreign capital inflow, which corresponds (approximately) to the US current account deficit, will probably need to grow as US investment recovers during the expansion. Large amounts of foreign capital continue to flow to the United States because foreigners see the United States as an attractive place to invest. These voluntary capital flows into the United States keep the US dollar strong in foreign exchange markets; and the strong dollar, in turn, helps to produce the current account deficit that is the necessary counterpart of the capital inflow. Strong productive growth in the US economy plays an important role in keeping all of this going. Saving can remain low if US households continue to enjoy gains in income and wealth due to rising productivity. Investment can remain strong if rapid productivity growth keeps profits rising despite limited increases in product prices and in the face of rising real wages. Foreign capital will continue to be attracted by the opportunity to participate in the gains from rising productivity; and the dollar will remain relatively strong. However, the United States cannot continue indefinitely to add to its net foreign liability position at a rate of 4 or 5 percent of GDP. At some point, a correction must come; and this correction could be disruptive for the US economy and also for the rest of the world if it occurs too rapidly.
Turning briefly to Canada, the economy has been following a path that is similar to its large southern neighbor. With the sharp slowdown in growth last year, the Bank of Canada considerably eased monetary policy, although not as aggressively as the Federal Reserve. Most indicators now point to a cyclical recovery. The timing of this recovery looks to be only marginally behind that of the United States. The strength of the recovery may also be just slightly below that of the United States.
A similar story applies to the United States’ southern neighbor, Mexico.
Unsustainably rapid growth in 2000 led to monetary tightening by the Bank of Mexico. The resulting domestic cyclical correction was augmented by the spillover effects of the sharp slowdown north of the border, and the Mexican economy shrank slightly on a year-over-year basis in 2001 (in comparison with 1¼ percent positive year-over-year growth for the US economy). Now, aided by policy easing in Mexico, by recovery north of the border, and by foreign capital inflows at attractive terms, the Mexican economy is set for recovery. The timing of recovery may slightly lag that of the United States’, but by 2003 Mexico’s economic growth should once again exceed its northern neighbor’s. Substantial inflows of both direct and portfolio investment will help to finance the recovery of the Mexican economy and keep the peso strong. At some point, a downward correction of the peso will probably be needed as part of the process of reducing the current account deficit, but this should be feasible without the disruptions that have accompanied previous corrections.
In South America, the situation is more uncertain and more worrying. With sovereign default, the collapse of the Convertibility Plan, the general insolvency of the banking system, and the disintegration of much of the institutional underpinnings of a modern market economy, Argentina is in the midst of its greatest economic crisis of the past half-century, if not indeed its entire history since independence. Already in the fourth year of recession, with the economy and financial system in chaos, it is speculative to estimate by how much real GDP may decline further this year—and a reliable figure may never be available. Optimistically, I assume that the year-over-year decline in real GDP for 2002 will be between 10 and 15 percent and that recovery will begin soon enough to produce year-over-year growth of plus 3 percent for 2003—but who really knows?
Fortunately, the spillover effects from the catastrophe in Argentina have been limited. Uruguay, of course, is feeling the impact; and its economy will likely shrink modestly this year. Chile too will feel some effect, and this is a key reason to expect that growth this year will only be about half the average rate of the past decade, before picking up again next year. Colombia, Peru, and Venezuela should feel little effect from Argentina, but domestic economic and political difficulties (and the effects of the global slowdown) will likely keep growth subdued in Colombia and Peru, while real GDP may well contract this year in Venezuela (despite the benefits of higher oil prices).
The major question for Latin America (aside from the uncertainties about Argentina) is the likely performance of the Brazilian economy—which accounts for 40 percent of Latin America’s GDP. After recovering relatively strongly from the recession of 1998-99 (associated with the defense and collapse of Brazil’s previous crawling peg exchange rate regime), the Brazilian economy slowed to only 1½ percent growth last year, partly reflecting the global economic slowdown and spillover effects from events in Argentina. With growth sluggish in the second half of last year due to external influences and the lagged effect of monetary tightening to resist excessive depreciation of the real, year-over-year growth for 2002 is likely to be subdued (about 2 percent). The key question for Brazil is whether growth will reaccelerate during 2002-03 as global growth recovers, or whether uncertainties arising from the October elections and spillovers from Argentina may provoke a crisis of confidence in the sustainability of Brazil’s debt dynamics, leading to another economic downturn.
The fact is that, for an emerging-market country, Brazil has a relatively high ratio of public debt to GDP. Most of this debt is either quite short-term, has floating interest rates that adjust rapidly to movements in short-term market rates, is denominated in foreign currency, or has some combination of these features. This implies that if for any reason (including rising doubts about Brazil’s ability to meet its debt service obligations), interest rates on Brazilian debt rise or the foreign exchange value of the real falls, Brazil’s debt service burden and/or the ratio of debt to GDP will rise—contributing to worries that debt dynamics may be unsustainable. Moreover, Brazil has a relatively small share of exports in GDP and, accordingly, is dependent on a continuing inflow of foreign capital to finance a significant current account deficit and also to finance a continuing rollover of substantial foreign indebtedness. Thus, apart from possible concerns about the stability of public sector debt dynamics, there are also potential concerns about the financing of Brazil’s external payments. If confidence is lost in either of these key areas, a crisis would likely ensue, and Brazil’s growth prospects for 2003 would be seriously undermined.
As an optimist, I assume that chances are three to one that Brazil will navigate through the difficulties of 2002 without a crisis, and growth next year will surge ahead at a 5 percent rate or greater. But, there is also at least a modest chance that Brazil may be caught up in a crisis. I would not anticipate a catastrophic crisis (like Argentina), but quite possibly a crisis that would produce zero or somewhat negative real GDP growth for 2003.
The economy of Europe is dominated by the twelve countries that make up the euro area. The same factors that helped to induce the slowdown of the US economy in 2001 (tighter monetary policy in 1999-2000, the build-up and subsequent unwinding of the investment bubble in telecoms and high-tech, and higher oil prices in 1999-2000) also contributed to a significant slowdown of growth in the euro area—from a year-over-year growth rate of 3½ percent for 2000 to 1½ percent for 2001. The slowdown of growth was less in the euro area than in the United States—reflecting the fact that the preceding boom was smaller and the tightening of monetary policy did not proceed as far. The largest economy in the euro area, Germany, was also the most sluggish last year. With a year-over-year growth rate of only about ½ percent (versus year-over-year growth of 1¼ percent for the United States) and a couple of quarters of negative growth, 2001 should probably be classified as a recession year for Germany. The euro area as a whole, however, skirted the edge of outright recession last year, although it recorded modestly negative growth in the final quarter. Nevertheless, it is relevant to think of the euro area as experiencing a growth recession last year. This is likely to be followed by cyclical recovery in 2002-03, driven by a dynamic process that is qualitatively similar to that operating in the United States.
In the first year of cyclical recovery, growth normally exceeds potential, which for the euro area appears to be a real GDP growth rate between 2¼ and 2½ percent. With indicators for the euro area suggesting that recovery probably began in the first quarter but probably was not yet at full speed, a fourth quarter-to-fourth quarter growth forecast for this year of 2¾ percent seems reasonable, with the prospect that growth during 2003 could be slightly stronger. Because the euro area economy was very weak in the second half of this year, the year-over-year growth forecast for this year is only about 1½ percent, rising to 2¾ percent for 2003.
These forecasts leave some room for both upside and downside surprises. On the upside, the normal process of cyclical recovery together with the lagged effect of monetary easing in 2001 by the European Central Bank (ECB) could push real GDP growth up to 3½ percent during 2002. Growth at this pace, however, would likely induce the ECB to move relatively early to reverse the easing in 2001, with the likely result that growth during 2003 would slow to no more than potential. On the downside, because the extent of policy stimulus already in the pipeline is far smaller in the euro area than in the United States, there is greater reason to worry that the pace of recovery could prove disappointing. Even if the ECB responded to this situation with further monetary easing (which is far from a certainty), the lagged effect would probably not have much effect on euro area growth until 2003.
Aside from the possibility of noneconomic shocks (e.g., terrorist attacks or political events that might induce a large increase in world oil prices), the risks to achieving moderate-paced recovery in the euro area this year and next seem relatively small. This includes the risks associated with economic policies. With elections in both Germany and France, and with recovery holding the promise that fiscal deficits will remain within the limits prescribed by the Stability and Growth Pact, fiscal policy is unlikely to be a drag on recovery (beyond, or even up to, the operation of the automatic stabilizers). Because the ECB reacted far less aggressively than the Federal Reserve to the economic slowdown last year, the ECB was less successful in cushioning the economy from the forces tending to depress economic activity (forces that were significantly weaker than those tending to depress activity in the United States). Now, the benefit is that the ECB faces a less challenging task in moving monetary policy gradually back to a neutral stance. However, if the ECB behaves asymmetrically—easing timidly in the face of a weakening economy and tightening aggressively in the face of a strengthening economy—then there would be a policy risk to achieving maximum sustainable growth with reasonable price stability in the euro area.
In the United Kingdom, deft management of monetary policy and fortunate timing of fiscal policy have helped to produce the most stable economic performance among the major industrial countries in recent years. Policy resisted the boom of 1999-2000 and policy cushioned the UK economy from the slowdown of 2001 more successfully than in either the United States or the euro area. Now, with only a limited margin of slack in the UK economy, policy appears well-positioned to support growth in line with or slightly above potential, while keeping inflation close to its targeted rate. This suggests a forecast of real GDP growth of 2¼ to 2¾ percent during both 2002 and 2003. Taking account of the slowdown that did occur last year, the forecast for year-over-year growth is moderately weaker for this year (at 2¼ percent) than for next year (at 2½ percent).
The smaller industrial countries of western Europe outside of the euro area should also be expected to participate in the cyclical recovery during 2002-03, and the average growth rate for these countries will probably not differ very much from that of the euro area (or the United Kingdom). Thus, on a year-over-year basis, growth for western Europe as a whole is forecast to be about 1½ percent for 2002 and about 2¾ percent for 2003.
Economic growth in central and eastern Europe slowed sharply last year, with Turkey experiencing a severe recession and most other countries feeling the negative effects of the general global slowdown. Russia also saw its growth slow last year as the favorable effects of the large real devaluation of the ruble and rise in world oil prices (of 1999-2000) began to wear off; and this process may contribute to some further slowing of growth this year. In contrast, Turkey should stage a significant economic recovery during 2002. Provided that Turkey’s potentially explosive debt dynamics can be stabilized, growth should strengthen further, on a year-over-year basis, in 2003. But, it must be recognized that the provision of massive new international financial support to Turkey in early 2002 has not convincingly resolved the problem of potentially unstable debt dynamics. Without massive further official support in 2003, a debt-sustainability crisis could well emerge. At $31 billion, the level of official support for Turkey already committed by the International Monetary Fund is, by any relevant standard, well beyond that ever committed to any country. It is difficult to know whether the Fund’s major shareholders would be willing to swallow the enormous embarrassment they rightly should feel in extending a further $10 billion to $20 billion of Fund support to Turkey next year to avert a possible financial crisis. Given the uncertainty in this regard, I would rate the risk of a debt-rescheduling crisis for Turkey in 2003 as a one in three or one in four possibility. Other countries in the region should generally expect to see significant increases in growth during 2002-03, reflecting normal cyclical processes, the effects of policy easings undertaken last year, and the more favorable external environment.
The Japanese economy fell into recession again last year, for the third time in a decade, and was still shrinking at year-end. Persistent economic weakness over the past decade has led to the only episode of sustained price deflation in any industrial country since the 1930s. With short-term interest rates pushed down virtually to zero, the room for traditional monetary policy to provide stimulus has been exhausted—with real short-term interest rates stuck at positive levels. Quantitative monetary easing has been implemented, first rather timidly and recently more aggressively, but its effectiveness remains to be demonstrated. With an already large fiscal deficit and a huge and growing public debt, the scope for fiscal policy to provide effective stimulus is clearly limited. Severe problems in the Japanese financial system, which began with the collapse of the bubble economy a decade ago, and have deepened in the subsequent recessions, pose a potential threat of financial instability. Thus, there is far greater reason to worry about the prospects for recovery in Japan than there is for the rest of the world economy.
Nevertheless, a cyclical recovery in Japan, probably beginning in the first half of this year, is the most likely outcome. Recall that after the recession of 1997-98 (when the Japanese economy was hit by sharp fiscal tightening, the crisis in emerging Asia, a strong appreciation of the yen, and a crisis of confidence in Japanese banks), the economy did stage a brief recovery in 1999-2000, with real GDP rising 2½ percent on a year-over-year basis in 2000. This time, the impediments to Japanese recovery are, arguably, somewhat worse than they were last time—but they are not worse by an order of magnitude. With a boost from global recovery, with the aid of a highly competitive exchange rate, and with some positive effect of quantitative monetary easing, the normal dynamics of cyclical recovery should operate in Japan. Net exports should expand. Inventory investment should shift from negative to positive. Consumer spending should begin to rebound. And, with a lag, business fixed investment may begin to pick up. All of the structural problems of the Japanese economy and financial system will weigh down on the pace of recovery, but they probably will not prevent recovery—at least not this time.
Recognizing that Japan’s recovery may somewhat lag that of the United States and other countries and that the recovery in Japan may be relatively weak, the forecast for fourth quarter-to-fourth quarter real GDP growth is 1¾ percent in 2002, followed by growth of 2 percent during 2003. The corresponding forecasts for year-over-year growth are –½ percent for 2002 and 2 percent for 2003. [Note: The preliminary fourth quarter results for Japan seem quite bizarre and I assume that either the revised results will show a somewhat smaller real GDP decline in the fourth quarter or there will be some payback in the first quarter of 2002.]
Although these forecasts are at the top end of the range of forecasts for the Japanese economy (as of March 2002) and are subject to an unusual degree of uncertainty, I would emphasize that risks around these forecasts lie on the upside as well as the downside. Once a cyclical recovery gets started in Japan, real GDP growth of 3 percent or even 4 percent is within the range of reasonable outcomes.
However, in view of the precarious state of Japan’s financial system, the downside risk that recovery might not occur this year and that the economy could enter a deflationary downward spiral clearly merits greater attention than the upside potential for a stronger than expected cyclical rebound. I would emphasize that even if the Japanese economy now enjoys a cyclical recovery—even a moderately vigorous recovery—the underlying weaknesses of the economy and the financial system will not be resolved. A recovery would provide a more hospitable environment in which to address these weaknesses. Unfortunately, however, the experience of the past decade does not provide confidence that this opportunity would be seized by the Japanese authorities as the occasion for vigorous efforts to clean up the mess in the financial system and press ahead with the necessary restructuring of several important sectors of the real economy. And, over time, as the public debt grows and the challenge of supporting an increasingly aged population presses closer, the task of correcting the structural weaknesses of the Japanese economy becomes more difficult. If the opportunity of the likely cyclical recovery is not used wisely and vigorously, there will surely be a rising risk of a far more serious crisis down the road.
China withstood the global economic slowdown remarkably well, with reported real GDP growth last year of 7 percent. There is, perhaps, some reason to doubt the accuracy of these officially reported figures; but, taking them at face value, it is reasonable to expect that real GDP growth for 2002 will again be about 7 percent. As was the case last year, significant fiscal policy stimulus will again help to support the Chinese economy, and the economy should also benefit from a rebound in exports as the global recovery gathers strength. For 2003, a pick up in growth to about 8 percent, in the officially reported figures, is not an unreasonable expectation.
India, too, withstood the global economic slowdown relatively well, with real GDP growth last year of about 5 percent. India remains a relatively closed economy in terms of the share of international trade in GDP; but it is not so closed that it will fail to benefit from the global recovery, despite the adverse economic effects arising from recent domestic and international disturbances.
Australia also did remarkably well in the face of the global slowdown, with the economy picking up strength in the second half of 2001 after slowing earlier on. The easing of monetary policy undoubtedly contributed to this result and helped to overcome the normally adverse effects of the weakening of global commodity prices. Now, with the economy in an upturn, monetary policy will probably need to shift toward a somewhat firmer stance. As with Australia, New Zealand’s economy weathered the global economic slowdown rather well and now seems set to enjoy growth about in line with its potential.
The Korean economy was hit by the global slowdown, but expansionary domestic policies significantly helped to cushion the effect, and recent data point to a recovery that is already under way. After growth of less than 3 percent last year, acceleration to 5 to 6 percent growth this year and perhaps 6 to 7 percent growth next year appears to be a reasonable expectation.
Among the other economies of emerging Asia, those that have particularly strong links to the global economy, especially in exports of high-technology products, (i.e., Hong Kong, Malaysia, Singapore, and Taiwan) were hit particularly hard by the global slowdown. These economies can generally expect a dramatic rebound of growth as the global economy recovers, although they may lag somewhat the general global recovery because of the likely lag in the global recovery in high-tech and telecoms. Other Asian emerging-market economies (e.g., Indonesia, the Philippines, and Thailand) generally suffered less in the global slowdown, and the rebound in growth should be commensurately less dramatic.
The Middle East and Africa
The behavior of world commodity prices, both oil and non-oil, has an important influence on both these regions. With world oil prices running above $20 per barrel, growth prospects for the oil-exporting countries in these regions are generally favorable. This is particularly true for countries where oil exports generate substantial export and fiscal revenues but are not a dominant fraction of real GDP. (Saudi Arabia, Kuwait, and the UAE enjoy high incomes when oil prices are high, but this does not necessarily translate into particularly strong growth of the volume of real GDP.) Exporters of other commodities are likely to benefit as the global recovery generally begins to push up most commodity prices, although this effect is likely to be more uncertain for exporters of agricultural commodities whose prices tend to be more affected by fluctuations (often weather related) in supply than fluctuations in world demand.
Natural disasters (especially in Africa) and political turmoil (in both Africa and the Middle East) also often have an important influence on growth. In this connection, the Israeli-Palestinian conflict is clearly having an important negative impact. Pakistan is feeling negative effects from the tensions with India, but is probably benefiting on balance from international support that it is receiving for its reform efforts and its constructive role in the war on terrorism. In Africa, the incidence of natural and man-made disasters appears to be running somewhat below the average of recent years—and hopefully this will continue.
On balance, I believe that we should expect the Middle East to record growth this year about in line with the average of the past decade, with the possibility of some improvement next year if levels of conflict abate. For Africa, I would anticipate growth this year that is a little bit better than average, with the prospect that growth should strengthen somewhat further next year as Africa benefits further from the general global recovery.
|Argentina||-4½||-10 to -15||3|
|Central and eastern Europe||2½||3½||5|
|World (WEO weights)||2¼||2¾||4½||3¾||4½|
Note: The WEO-based world GDP growth rates aggregate the real GDP growth of countries and regions using weights based on purchasing power parity-adjusted measures of exchange rates, which are slightly modified from those published in the International Monetary Fund’s World Economic Outlook. The modifications involve the following differences with the standard WEO presentation: (i) Three Asian newly industrialized economies (Hong Kong, Korea, and Singapore) plus Taiwan are included in the Asian developing countries; (ii) Russia and most of the former Soviet Union and Turkey are included in central and eastern Europe; (iii) Israel (and Egypt) are included in the Middle East.
Policy Brief 12-25: Currency Manipulation, the US Economy, and the Global Economic Order December 2012
Op-ed: The G-20 Is Failing April 12, 2012
Testimony: An Action Plan for the G-20 October 20, 2011
Paper: Global Economic Prospects as of September 9, 2011: How Deep the Current Slowdown? September 9, 2011
Book: Flexible Exchange Rates for a Stable World Economy October 2011
Paper: Global Economic Prospects as of April 4, 2011: Continued Growth Despite the Turmoil April 4, 2011
Paper: Global Economic Prospects as of September 30, 2010: A Moderating Pace of Global Recovery September 30, 2010
Paper: Global Economic Prospects for 2010 and 2011: Global Recovery Continues April 8, 2010
Policy Brief 10-24: The Central Banker's Case for Doing More October 2010
Paper: World Recession and Recovery: A V or an L? April 7, 2009
Testimony: The Global Economy: Outlook, Risks, and the Implications for Policy January 29, 2009
Paper: Report to the President-Elect and the 111th Congress on A New Trade Policy for the United States December 17, 2008
Testimony: China's Role in the Origins of and Response to the Global Recession February 17, 2009
Testimony: The World Economy and the Outlook for the United States December 5, 2007
Speech: The G-20 and the World Economy March 4, 2004
Speech: The United States and the Global Adjustment Process March 23, 2004