UNUnited Nations Economic Commission for Europe

Press Release


Geneva, 2 May 2002


2002 - United States: leading the global recovery
Western Europe: moderate growth prospects

UNECE releases the Economic Survey of Europe, 2002 No. 1

"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 of 2001.

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 to income.

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 external environment.

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 countries.

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
E-mail: info.ead@unece.org
Web site: http://www.unece.org/ead/ead_h.htm

Ref: ECE/GEN/02/12