Note: l aggregates exclude Israel.
Growth rates of regional aggregates have been calculated as weighted averages of growth
rates in individual countries. Weights were derived from 1996 GDP data converted from
national currency units into dollars using purchasing power parities.
a Preliminary estimates or forecasts.
b Forecasts.
c France,
Germany, Italy and United Kingdom.
Slow down in the United States
In the United States, the long economic expansion, which, if maintained
in the first quarter of 2001 will have lasted for 10 years, was expected to slow down in
2001 against the background of tighter monetary policy and the real income effects of
higher energy prices. In fact, a slowdown was seen as highly desirable, given that actual
output had grown at a rate significantly above potential for quite some time with
increasing risks of overheating and a hard landing. There were, moreover, mounting
concerns about the huge imbalances which had accumulated over the past five years as the
result of an unsustainable investment and consumption boom. These were reflected in a
decline of personal savings to a very low level (in fact, they turned negative in 2000),
increases in corporate and personal debt to very high levels, a huge current account
deficit and, last but not least, a stock market bubble, notably, but not only, in the
market for high-technology shares.
The orderly unwinding of these imbalances is the central assumption of
the "soft landing" scenarios, which assume a gradual slowing down in economic
expansion to a rate somewhat below potential. This in turn would spread the inevitable
adjustment costs to be borne by the rest of the world over a reasonable period of time. In
the event, however, there was an unanticipated abrupt cyclical downswing in the United
States economy after the second quarter of 2000, a development which serves as a sharp
reminder of the inherent difficulties of forecasting cyclical turning points. The
investment boom in information technology equipment, a major force behind the long
expansion, petered out in the face of growing excess capacity in the manufacturing sector.
To this was added a sharp fall in the demand for consumer durables and for exports in the
last quarter of 2000, which led to a build-up of excess inventories and a weakening of
industrial activity. The reaction of the United States monetary authorities to the
deteriorating economic conditions was very swift. The target for the federal funds rate
was lowered in three steps by 1.5 percentage points between January and March of 2001.
Against this background and the decline in actual and expected business profits, there has
been a sharp decline in equity prices for a broad range of stocks in the first quarter of
2001, with adverse consequence for households’ net wealth and the debt-equity ratios
of the corporate sector.
While imbalances are more or less typical of any strong and sustained
cyclical upswing – largely a reflection of overly optimistic production and profit
expectations – there has been a degree of excess in the United States, especially in
the financial markets, which would not have been possible without the generous credit
expansion allowed by the United States Federal Reserve. But this kind of miscalculations
are always easier to diagnose post facto and can often only be avoided ex ante by stifling the expansion itself.
Weaker economic activity in 2001 in Europeup relatively well in the
second half of 2000, but there was also a noticeable slowing in the rate of economic
expansion. The optimistic view that the European economies would be largely immune to the
deterioration in the rest of the global economy, however, has been overtaken by events as
evidenced by the significant lowering of forecasts for GDP in 2001. This is also reflected
in the sharp drop in business confidence in Germany, the largest west European economy.
Many forecasters now expect real GDP in Germany to increase by only 2 per cent in 2001,
down from the 2¾ per cent forecast in the autumn of 2000.
It is therefore fortunate that a number of European governments had
already decided some time ago to shift to more expansionary fiscal policies, mainly by
cutting income taxes in 2001. In the United Kingdom and Switzerland, the central banks
also lowered interest rates in early 2001 to support economic activity.
In contrast, in the euro area, despite deteriorating growth prospects,
the ECB has left its main refinancing rate unchanged at 4¾ per cent since October 2000,
when it was raised by a ¼ of a percentage point, just at the time when the evidence of
the slowdown was becoming available.
Major downside risks
A major source of downside risks to the current growth forecasts are
– apart from developments in Japan – the uncertainties surrounding future
economic developments in the United States. The expected annual growth rate of some
1¾ per cent implies a moderate upturn in economic activity in the course of 2001,
given a statistical carry-over effect of 0.8 percentage points from the final quarter of
2000. The current consensus of forecasts is that this will be followed by a further
strengthening of growth in 2002.
But this scenario could well turn out to be too optimistic and the
cyclical downturn could well be more protracted. Much will depend on the extent to which
private households desire, or are forced, to adjust their expenditures (and savings) in
response to the deterioration in economic conditions and the loss of financial wealth
implied by the marked decline in equity prices (a fall which had still not bottomed out at
the time of writing). Also the response of business investment to the cyclical downturn is
currently difficult to gauge. Relatively large margins of excess capacity in the
manufacturing sector will tend to weaken the accelerator principle which links net
investment to changes in output. This will add to the dampening effects of falling
profits, higher financing costs associated with lower share prices and the need to reduce
high levels of corporate debt. More generally, the effectiveness of the more expansionary
monetary policy in the United States may be reduced in an environment dominated by excess
capacity and the need for balance sheet adjustments in the private sector.
The need to rebuild private sector savings is the counterpart to the
required United States current account adjustment given that the very large deficit
($435 billion or some 4.4 per cent of GDP in 2000) cannot be sustained. It depends
crucially on the willingness of foreigners to hold dollar-denominated assets. In a
deteriorating economic environment this willingness is likely to become increasingly
stretched with increased downside risks for the dollar exchange rate. There are mixed
opinions as to whether the continued strength of the dollar, so far, reflects its
"safe haven" properties in a more uncertain world outlook or expectations that
the loosening of monetary policy will lead to a rapid recovery of domestic demand. But
neither scenario bodes well for the stability of the world economy. A quick recovery based
on domestic demand would only postpone the inevitable reduction of the domestic and
external imbalances. This is a necessary condition for laying the foundations of a new
sustainable upswing. The longer these adjustments are delayed the greater is the
probability that when they do eventually occur they will involve very abrupt changes in
behaviour with a much greater risk of international financial turmoil. A reduction of the
United States external deficit implies a correspondingly smaller external surplus in the
rest of the world, and the major policy challenge is to reduce these imbalances with as
little disruption as possible to global economic activity.
"Given the current cyclical weakness in the United States and the
chronic weakness in Japan," concludes Dr. Hübner, "the adjustment process will
largely depend on a strengthening of economic growth in western Europe. This will not only
help to reduce the downside risks to global economic activity but would match regional
ambitions to turn Europe into the world’s strongest economy."