"There are increasing signs that the pronounced cyclical downturn of
2001 has started to bottom out," stresses Mrs. Brigita Schmögnerová,
Executive Secretary of the United Nations Economic Commission for Europe (UNECE)
commenting on the latest issue of the Economic Survey for Europe just released
by the UNECE. "The short-run outlook, however, remains very uncertain
and the prospects are for only a gradual recovery in 2002".
Prospects for 2002 in a nutshell
In the United States, economic conditions improved in early 2002.
The main driving force behind this was a swing in business inventory investment,
which had been lowered in 2001 in response to the sharp deterioration in sales
prospects. But a sustained recovery will require a strengthening of final
demand, i.e. private consumption, business fixed investment and exports and
the prospects for this are uncertain.
When the Survey was written, the consensus was for an increase in real GDP
by some 1.5 per cent in 2002. Since then forecasts for growth of real GDP
in the United States have been revised upward to some 2¼-2.5 per cent
for 2002, but whether this is really justified remains to be seen.
The currently forecast rate of output growth is unlikely to lead to any significant
reduction in excess capacities in the business sector in 2002. These, in combination
with a meagre growth of profits, will continue to depress business fixed investment
which, for the year as a whole, is expected to be less than in 2001. In contrast,
economic activity in 2002 will be supported by the completion and partial
reversal of the large cuts in business inventories that occurred in the course
The growth of private consumption remained resilient to the overall deterioration
in the economic environment in 2001, largely because of income tax cuts, falling
energy prices and generous financing conditions for car purchases. However,
growth of household spending could well slow down in the course of 2002, given
that the personal savings rate has fallen to a very low level, and that the
burden of debt-servicing has risen steeply since the mid-1990s, approaching
its previous peak of end 1986. In addition, the loss in net wealth triggered
by the fall in equity prices can also be expected to dampen the spending propensity.
Moreover, the growth of disposable incomes will be restrained by weak labour
market conditions, although this will be partly offset by fiscal policy measures.
No significant support is expected from exports given the overall weakness
of overseas demand. However, there could be some feedback effects if a gradual
strengthening of domestic demand spilled over to other major economies, boosting
their growth and, in turn, stimulating demand for United States products.
Domestic demand in the United States will continue to be supported by the
lagged effects of the more expansionary monetary policy in the course of 2001
which led to a decline of short-term interest rates to very low levels. Depending
on the strength of the recovery, it can be expected that this expansionary
stance of monetary policy will be partly reversed in 2002. In addition, and
despite the failure of Congress to agree to the fiscal stimulus package proposed
in the wake of 11 September, income tax cuts and increased government spending
on defence and security will also support domestic activity levels.
In the euro area, the fall in real GDP in the final quarter of 2001
is generally expected to be followed by a small increase in economic activity
in the first quarter of 2002. The confidence of consumers, industrial managers
and producers of services has improved somewhat in the first quarter of 2002.
This contrasts, however, with increasing pessimism in the retail trade sector.
As in the United States, a reversal of the inventory cycle is expected to
support domestic demand. The growth of private household consumption will
be relatively weak with the impact of adverse developments in the labour markets
on aggregate real disposable incomes being partly offset by the expected fall
in the rate of inflation. Fixed investment is expected to remain sluggish
in view of weak sales prospects and relatively large margins of spare capacity
in industry. Exports are expected to strengthen in the course of the year,
stimulated by the direct and indirect effects of stronger import demand originating
in the United States.
For the year as a whole, real GDP in the euro area is forecast to increase
by only about 1.25 per cent, down from 1.6 per cent in 2001. In line with
the expected profile of the United States recovery, economic activity is expected
to strengthen in the second half of the year. As a result, the average annual
level of employment can be expected to more or less stagnate and the unemployment
rate to edge up slightly in 2002.
The ECB lowered its main refinancing rate in response to the pronounced cyclical
downturn in 2001 and the resulting lower interest rates have increasingly
supported economic activity in the euro area.
"But a more rapid policy response to the cyclical weakness in early
2001 would have improved growth prospects for 2002, said Mrs. Schmögnerová."
In fact, the European Central Bank's main refinancing rate, which has remained
unchanged since November 2001, is still 0.25 percentage points above its level
in November 1999. In view of moderate inflationary expectations and a sizeable
increase in the output gap, the ECB should maintain its policy stance unchanged
until there are clear indications that the recovery has been firmly established.
Outside the euro area, in the United Kingdom, a relatively moderate
slowdown in the rate of economic growth to 2 per cent is forecast for 2002
(down from 2.3 per cent in 2001). This mainly reflects continued vigorous
growth in private household consumption and a large increase in public sector
spending. Moreover, there are increasing concerns about the sustainability
of the recent surge in private household debt, which is at record levels relative
In western Europe as a whole, real GDP is forecast to increase by about
1.5 per cent in 2002, largely a reflection of weak domestic demand and the
Risks to the outlook for 2002
"An important risk to the forecast recovery in Europe and other regions
of the world economy is its dependence on a sustained and gradually strengthening
expansion of domestic demand in the United States," said Mrs. Schmögnerová.
This is expected to stimulate domestic activity in the rest of the world,
including Europe, via exports and the spillover effects from increasing business
and consumer confidence in the United States.
However, the strength of the cyclical upturn in the United States economy
will crucially depend on the spending behaviour of private households and
the upward adjustments to currently low savings that they consider desirable
or necessary in the face of increased job insecurity, higher debt service
burdens and a substantial loss in net financial wealth.
Against the background of large margins of spare capacity, prospects are
also uncertain for corporate profits and fixed investment. A major uncertainty
is how spending on high-technology goods will respond to an improved outlook
for growth. It is still controversial to what extent the surge in investment
in ICT goods has contributed to the acceleration in United States productivity
growth in the second half of the 1990s. This performance appears to have been
not broadly based but rather concentrated in a few sectors. It is also not
clear to what extent the massive spending on these products has generated
the expected high rates of return. The changing expectations of companies
could lead to a much lower growth of IT spending in the year ahead with subsequent
repercussions on profitability and equity valuations in the IT sector. This,
in turn, is likely to have negative feedback effects on private consumption
and other business investment.
The shallow recession, moreover, has not led to a correction of the sizeable
external imbalance of the United States economy. The current account deficit
fell only slightly in 2001 and is still more than 4 per cent of GDP. As a
domestic demand-led recovery in the United States can be expected to lead
to a further deterioration of the United States external imbalance in 2002
(and 2003) there is a risk that financial markets will feel increasingly uncomfortable
with such a tendency. A reversal of capital flows could lead to a sharp fall
in the exchange rate of the dollar which, on a trade-weighted basis, is close
to a 16-year high against other major currencies. The other side of the coin
would be a strong appreciation of the euro, which would act as a brake on
export growth and be likely to bring the cyclical upswing in western Europe
to a premature end.
More generally, current levels of private sector indebtedness in the major
industrial countries are quite high given the stage of the business cycle.
A weak or aborted recovery in the second half of 2002 would test the profit
expectations built into current equity prices. Any disappointment could trigger
a sharp fall in prices and a further deterioration in the balance sheets of
households, the corporate sector and financial institutions in the major industrial
Other sources of downside risks come from the lingering financial sector
problems in Japan and uncertainty over the evolution of the price of crude
oil. The price of Brent crude rose above $26 a barrel in April 2002 for the
first time since the third quarter of 2001.
If sustained for a longer period, the rise in oil prices would have adverse
effects on households' real expenditures on non-energy products with concomitant
dampening effects on domestic activity levels and business profits. Business
profit margins will also be squeezed by higher energy costs and this could
affect investment. Moreover, higher energy prices will also feed through to
headline inflation and trigger a more cautious monetary policy stance to prevent
second-round effects. In the absence of risks of second-round effects, however,
the stance of monetary policy should not be tightened.
For further information please contact:
UNECE Economic Analysis Division
Palais des Nations
CH - 1211 Geneva 10, Switzerland
Tel: +41(0)22 917 24 79
Fax: +41(0)22 917 03 09
Web site: http://www.unece.org/ead/ead_h.htm