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Slow economic growth in the United States and weaker prospects for Europe

UNECE releases its first 2001 Economic Survey of Europe

Published:04 May 2001

 The short-term economic outlook for the western market economies does not look very favourable" stresses Dr. Danuta Hübner, Executive Secretary of the United Nations Economic Commission for Europe (UNECE) commenting the latest issue of the Economic Survey for Europe, just released by the UNECE. "The main factor behind this is the unexpectedly sharp slowdown in economic growth in the United States since the second half of 2000, the stalled recovery in Japan and the weakening of growth in western Europe itself."

Prospects for 2001 in a nutshell

Activity in the two largest economies in the world is weakening rapidly or continuing to stagnate. This has started to feed through changes in net exports to other regions of the world economy. As a result, there has been a progressive lowering of growth forecasts, especially for the United States, since late 2000 (chart 1).

 

CHART 1

Real GDP growth in the ECE region in 2001: changes in consensus forecasts, January 2000-March 2001

(Percentage change over previous year)

Source: Consensus Forecast.

 a From January 2001 Greece is included.

 In the United States, real GDP is now expected to increase by only some 1¾ per cent in 2001, a very abrupt deceleration from an average growth rate of 5 per cent in 1999. In Japan, economic growth is expected to only slightly exceed 1 per cent in 2001, and even that is uncertain given disagreements over economic policy and delays in introducing another economic emergency programme. Growth forces are seen to hold up somewhat better in western Europe. In the euro area, real GDP is currently forecast to increase by some 2.5 per cent in 2001, down from 3.4 per cent in 1999 and half a percentage point less than was being forecast last autumn. Broadly similar changes are expected for the European Union and for western Europe as a whole (table 1). For the industrialized economies in aggregate, the average rate of economic growth is likely to be only some 2 per cent in 2000, down from 3.8 per cent in 2000 and the smallest annual increase since 1993.  

TABLE 1

Annual changes in real GDP in western Europe, North America and Japan, 1998-2001

(Percentage change over previous year)

 

 

1998

1999

2000 a

2000 b

France

3.3

3.2

3.2

2.7

Germany

2.1

1.6

3.0

2.1

Italy

1.8

1.6

2.9

2.5

Austria

3.3

2.8

3.3

2.6

Belgium

2.4

2.7

3.9

2.5

Finland

5.3

4.2

5.7

4.0

Greece

3.1

3.4

4.0

4.0

Ireland

8.6

9.8

10.0

7.5

Luxembourg

5.0

7.5

8.1

6.2

Netherlands

4.1

3.9

3.9

3.3

Portugal

3.6

3.0

3.2

2.6

Spain

4.3

4.0

4.1

3.0

Euro area

2.8

2.6

3.4

2.6

United Kingdom

2.6

2.3

3.0

2.5

Denmark

2.8

2.1

2.4

1.8

Sweden

3.6

4.1

3.6

2.5

European Union

2.8

2.6

3.3

2.6

Cyprus

5.0

4.5

4.9

4.1

Iceland

4.5

4.3

3.6

1.3

Israel

2.2

2.3

3.0

3.0

Malta

3.4

4.0

4.3

4.3

Norway

2.0

0.9

2.2

1.5

Switzerland

2.3

1.5

3.3

2.1

Turkey

3.1

-5.0

7.0

Western Europe

2.8

2.2

3.5

2.5

Canada

3.3

4.5

4.7

2.4

United States

4.4

4.2

5.0

1.7

North America

4.3

4.3

5.0

1.8

Japan

-1.1

0.8

1.7

1.2

Total above

2.8

2.8

3.8

2.0

Memorandum items:

 

 

 

 

4 major west European economies c

2.4

2.1

3.0

2.5

Western Europe and North America

3.6

3.2

4.2

2.1

 

Source: National statistics and national economic reports.

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."

 

For further information please contact:

Economic Analysis Division

United Nations Economic Commission for Europe (UNECE)
Palais des Nations
CH - 1211 Geneva 10, Switzerland

Tel: (+41 22) 917 27 78
Fax: (+41 22) 917 03 09
E-mail: paul.rayment@unece.org
Website: http://www.unece.org/ead/ead_h.htm

Ref: ECE/GEN/01/05


United Nations Economic Commission for Europe

Information Unit

Palais des Nations, 

CH-1211 Geneva 10, Switzerland

Tel.: +41 (0) 22 917 44 44

Fax: +41 (0) 22 917 05 05


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