The world economy.

Delannoy, Aurelie ; Fic, Tatiana ; Holland, Dawn 等

World Overview

The ongoing crisis in the Euro Area continues to weigh heavily on the world economy. European policymakers face a stark choice between forging ever stronger economic and political integration within the Euro Area or accepting that at least one country leaves the EMU with all the contagion risk this carries. Neither option is politically palatable, and European leaders have yet to commit decisively to a credible way forward. The outcome of the Greek elections in June confirmed the desire of the Greek populace and politicians to remain part of EMU, and other European leaders during the EU summit shortly thereafter openly stated their commitment to the same. Given these stated policy objectives our central forecast is based on the assumption that EMU remains intact, although it is clear that this will require some significant shifts in policy that European leaders and their public are currently reluctant to embrace. We review some of these policy implications and consider the possible impact of some alternative scenarios for the evolution of EMU below.

Events in Europe demonstrate the limited progress that has been made in restoring credibility in the global banking system since the crisis began in 2008. The world's largest and most respected financial institutions insisted that they had low exposures to toxic assets, only to then need government support on a scale never seen before. Four years after the full crisis began, little has changed in the opacity and risk of the world's largest financial institutions. This is shown in figure l, which compares funding costs of financial institutions (mainly banks) and non-financial corporations. When the financial system works properly the low-risk banking system has lower funding costs and lends to the higher-risk corporate sector with the higher funding costs. Since 2008, financial sector funding costs have exceeded large corporate funding costs, suggesting that banks should be borrowing from firms rather than the other way around. This is the fundamental dislocation in the world economy which is yet to be resolved. This discrepancy widened sharply towards the end of 2011, and remains high.

The recession in Europe is expected to persist into the second half of this year, with output in countries suffering from the most severe overhangs of current account deficits (Greece, Spain, Portugal) expected to continue to contract sharply next year and even into 2014. Japan is supported by rebuilding activity this year in the wake of last year's tsunami and earthquake, but we have seen a slowdown in many of the major emerging economies, including China, Brazil and India, and Russia will also be adversely affected by the recent drop in the oil price. The $20 drop in the oil price since April is in itself partly a reflection of the weaker global economy, alongside easing geopolitical tensions regarding oil supply. Economic recovery in the US has yet to become entrenched, and GDP growth will continue to remain below trend until 2014. The economy is needlessly being held back by uncertainty regarding the evolution of fiscal policy over the coming year. If current legislation is not amended--difficult to achieve in advance of the presidential election in November--fiscal tightening measures amounting to 4 per cent of GDP will be introduced in 2013, pushing the economy into recession.

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Figure 2 compares our central forecasts for major economies in 2013 to an alternative scenario in which there is no amendment to the current fiscal legislation in place for the US. Our central forecasts for Japan and Europe would be revised down by about 1/4 percentage point, while the impact on Canada would be somewhat more significant and the US economy would be expected to contract by 0.6 per cent next year if US authorities fail to amend current legislation.

A summary of our main global forecast figures is reported in table 1. The global economy is expected to expand by 3.3 per cent this year, and 3.7 per cent in 2013, compared to an estimate of trend growth at the global level of 4-4 1/4 per cent. World trade growth remains weak and investment is unlikely to strengthen in the current environment of uncertainty, with high borrowing costs outside of a few 'safe haven' countries such as Germany, the US and Switzerland. Fiscal policy will remain tight--especially in Euro Area countries suffering the deepest recessions--with measures amounting to 1 per cent of GDP in the US factored into our forecast for 2013, 1/2 per cent in France, 1.1 per cent in Italy, 1.8 per cent in Spain and 1.5 per cent in the UK. The methodological approach to the forecast and key underlying assumptions are discussed in Appendix A, while detailed projections for 40 countries are reported in Appendix B at the end of this chapter.

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Core assumptions with EMU intact

If EMU is to remain intact, this will require four core developments: the establishment of a single financial regulator with full enforcement powers to allow the creation of a banking union within EMU; credible commitment to the sharing of sovereign credit risk, which could be effected by the ECB committing to guarantee a cap on yields on sovereign debt through direct (unlimited) intervention in secondary markets; a move towards fiscal policy integration, which will entail a loss of fiscal sovereignty at least to some degree; internal devaluations within countries that suffer competitiveness issues. At the most recent EMU summit, an agreement was reached on establishing a single supervisory mechanism for Euro Area banks, and an enhancement of the European Stability Mechanism (ESM) facility- which replaces the European Financial Stability Facility (EFSF) towards the end of the year--to allow it to directly recapitalise banks. This puts in place a mechanism to break the adverse links between sovereign stresses and banking sector assets and addresses the first of the requirements listed above.

However, the establishment of a banking union is likely to be contractionary in the short run if the aim is to improve the quality of banks. The effectiveness of a banking union will be limited until there is also an agreement on sovereign risk sharing within EMU. Domestic authorities in countries like Spain and Italy have used their influence over the banks in their jurisdictions to compel the purchase of sovereign debt in the primary markets at yields well below what these banks would have demanded if they had not been subjected to financial repression (Buiter and Rahbari, 2012). It will be difficult to break the spiral between sovereign debt and bank fragility if this continues. It will be much more challenging to reach agreement on risk sharing and fiscal integration within EMU, given opposing political pressures from borrower and lender countries, and the moral hazard and contagion risks involved.

In order for lender countries to agree to risk sharing with the borrower countries, they require some assurance that they will not simply be exploited for their superior tax raising abilities to cover the shortfalls of consistently insolvent governments. The disbursement of funds under the bail-out programmes for Greece, Portugal and Ireland are conditional on stringent targets for fiscal retrenchment and structural reform. The severity of the domestic austerity measures is politically difficult to implement, as evidenced by the number of government changes that have taken place in the Programme countries and other vulnerable economies (Spain and Italy) in recent times. While there has been some improvement in fiscal balances as a result of the measures, the extreme recessions suffered in Greece and Spain in particular have pushed measured unemployment well above 20 per cent and the consolidation measures on which further disbursements are contingent will lead to further contractions in output and higher unemployment. There is certainly an argument for some relaxation of the austerity measures, although repeatedly revising the targets, as has been necessary in Greece, has implications for the credibility of the programmes overall. It would have been wiser to set more achievable targets, as the magnitude of short-term adjustment is less important than the credibility of long-term adjustment.

Internal devaluations are also difficult to achieve, as they must be effected through a decline in real wages, while not reducing productivity growth. This, in turn, may raise the risk of mortgage arrears and default, putting additional strain on an already ailing banking system. Figure 3 illustrates real wages in Germany, Greece and Ireland relative to their level in 2000, including our projections for 2015 and 2020. By 2005, real wages in Greece were 20 per cent above their level in 2000, compared to a 10 per cent rise in Ireland and negligible change in Germany. By 2010, real wages in Greece had gone some way to correcting this discrepancy, while adjustment in Ireland was delayed until after the height of the financial crisis. Our forecast projections see continued real wage declines over the next decade for Ireland and Greece, while real wages in Germany are projected to rise, eroding some of the internal imbalances that had built up within the Euro Area during its first decade. Yet the adjustment is likely to be long and drawn out, as nominal wages are proving remarkably 'sticky' given the exceptionally high unemployment in some countries.

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Maintaining the current EMU membership intact will require unwavering commitment from its member states, which are likely to see high bond yields persisting into 2014; further rises in unemployment and losses in real earnings; some measure of bailout programmes in both Spain and Italy--beyond the current plan to recapitalise Spanish banks while circumventing exposure of the sovereign; and additional restructuring of debt in Greece and possibly other Programme countries, including debt held by the ECB. At some point these burdens may prove too great to bear for either the lender or borrower countries. Below we consider some alternative scenarios. While these alternatives are not embedded in our central forecast detailed in Appendix B, the consequences of these tail risks certainly warrant full consideration.

Greek exit from EMU

While the election demonstrated the commitment of Greece to remain a part of the Euro Area, repeatedly breaching the conditionality targets specified in the bailout agreements may eventually lead the Troika to stop further disbursements to the Greek sovereign. While Greece is a small economy, and, arguably, the transfer payments required to subsidise the sovereign can easily be met by the other Member States, in order to credibly give support to a large country, such as Spain, the conditionalities imposed must be seen to be binding.

If disbursements from the Troika to Greece are stopped or interrupted, this would probably make a Greek exit from EMU inevitable. Without the funds, the government would default, and emergency liquidity assistance currently being provided to keep Greek banks afloat would cease, leading to a collapse of the banking system.

In the July 2011 issue of this Review, we discussed some of the possible scenarios that a Greek withdrawal from EMU might entail (Holland, Kirby and Orazgani, 2011). Little has changed over the past year, and there remains a high degree of uncertainty around exactly what would happen to the Greek economy in the event. The two key developments that we take as essentially given are: a severe disruption to the financial sector; and a sharp devaluation of the new currency, as investors will attach a high risk premium to it. We doubt that an orderly EMU exit is possible. At stake is contagion to other vulnerable economies and a widespread banking crisis within the Euro Area, which could also become global. The politicians would need to be prepared to do whatever is necessary to support Italy and Spain as the inevitable pressure builds. This would include the ECB publically committing to buy their sovereign bonds in unlimited quantities. If there is any hint that other countries may follow in the wake of Greece, agents would become unwilling to make contracts that may be redenominated and we would expect bank runs in the other vulnerable economies.

Under what conditions could a contained EMU exit occur? After allowing a partial break-up of EMU, the priority would be to maintain the integrity of the European Union. This would be in the interest of Greece, which would continue to benefit from transfers through the structural and cohesion funds, no trade barriers with its primary trading partners and continued participation in the political union of Europe, which has benefits well beyond economics. This would also be in the interest of other Member States, as it would reduce the risks of a disorderly collapse of the entire European project.

In order to allow a contained withdrawal of Greece from EMU, the private sector in other Member States would need to absorb some up-front losses, as would the official sector. These are always difficult to negotiate, as demonstrated by the protracted negotiations on the private sector involvement in the Greek debt restructuring and the number of legal cases that remain ongoing in Argentina more than a decade after their default in 2001. However, absorbing up-front losses would no doubt prove far less costly than the losses that a disorderly collapse of the entire Euro Area would entail. All debts, both public and private, would be redenominated into the new currency, which would already entail significant losses to external lenders once the new currency depreciates. (1) On top of this there would need to be significant write-downs on this debt, including sovereign debt held by the ECB. After absorbing these losses, these same lenders will have to make some new sources of soft funding available to Greece, as it will be unable to access market borrowing for many years. This could be effected through, for example, the Balance of Payments Facility of the European Union.

It is clear that a withdrawal from EMU would lead to massive short-term disruption in Greece, regardless of whether there is contagion to other Member States. The banking system would freeze while the new currency was put in place. The experience of the dissolution of the Czech and Slovak currency union in 1993 gives us some information on the technical aspects of how this transition would take place. In the Czech-Slovak case, the entire national banking systems were essentially frozen for about five days. Greece is a similar size geographically, and we could expect the transition to take a similar amount of time. Euros would then cease to be legal tender in Greece, and all transactions would have to take place using the new currency.

It is unlikely that the transition could be effected without imposing capital controls and suspending the Schengen Agreement. In the successful example of the Czech-Slovak dissolution, no capital controls were imposed. As such, anyone holding large sums of cash outside of the banking system in Slovakia was able to take it across the border into the Czech Republic and exchange it for the higher valued Czech Koruna, which could then be re-exchanged for Slovak Koruna for a profit. In this example, the Slovak currency depreciated by just 10 per cent against the Czech currency, so after allowing for transaction fees, the potential gains from shifting capital across borders were relatively limited. This is unlikely to be the case for Greece, which is a more mature and globally integrated economy than the Czech and Slovak Republics were in 1993, and where we anticipate a very significant depreciation of the currency. While the introduction of capital controls would be difficult to police and could potentially lead to widespread civil unrest, they would be essential to put limits on what we expect to be massive capital outflows from the economy. We would be very likely to see a dual-currency/black market system develop in Greece following an EMU exit.

It is difficult to assess with any degree of certainty the magnitude of depreciation expected of a new Greek currency. Recent studies such as Coudert et al. (2012) suggest that the Greek real exchange rate was roughly 11 per cent overvalued in fundamental terms relative to the euro in 2010. However, the fundamental calculations exclude the very wide risk premium that can be expected to be attached to the new currency. We can use the risk premium on sovereign debt as a guide to this magnitude. Over the next decade, our forecast baseline that assumes Greece remains within EMU sees the market yields on government debt at a level that averages 10 percentage points above its long-run level, as illustrated in figure 4.

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If this risk premium were shifted from the interest rate to the exchange rate, NiGEM simulations indicate that we would expect a depreciation in the order of 45 per cent, in addition to the 11 per cent fundamental realignment. In the short term there would likely be some overshooting as markets settle on the price, and we would expect the currency to lose at least 50 per cent of its value initially.

While the depreciation would lead to an improvement in the external trade balance, there would be a sharp rise in inflation and households would suffer. Industrial production would also be adversely affected by the sharp rise in energy prices, as nearly all oil used in Greece is imported. Over the medium term there may be scope for substituting imported oil with domestic coal, but this structural shift would take time, and would only be appropriate in a limited sphere. It will take time to re-establish a working banking system in Greece, and domestic investment can be expected to continue to suffer at least in the short-term. We would also expect a rise in emigration, especially of skilled labour, towards higher wages in the other EU countries, which would entail long-term negative implications for the Greek economy. In short, withdrawal from EMU is not likely to be a choice that Greece makes voluntarily, but if the Troika lenders fail to set achievable targets for consolidation, it may eventually become inevitable.

German exit from EMU

The idea of Germany withdrawing from EMU may seem unthinkable, as the credibility of the ECB's monetary policy from the onset relied heavily on the longstanding reputation of its predecessor under the ERM arrangements, the Bundesbank. But German politicians are also subject to political pressures at home, and voters have already voiced objections to many of the concessions that they are being asked to make in order to preserve the Euro Area--backed by an open letter signed by a number of well-respected economists. Germany has contributed close to 30 per cent of the EFSF bailout fund (see the discussion in the next chapter), and contributes 27 per cent of the ECB's capital. Not surprisingly, this rise in contingent liabilities associated with deeper integration is viewed with increasing unease. Germany is clearly viewed as the safe haven within the Euro Area, as evidenced by government bond yields that have dropped essentially to zero, and it is not clear that the credibility of the ECB would stand up to the loss of its backbone. In which case, the withdrawal of Germany may essentially presage a more widespread break-up of EMU.

The technical arrangements for an EMU withdrawal by Germany are more straightforward than they would be for Greece. There would be no need to impose capital controls, and it would be easier to reach agreement on the redenomination of contracts. There would, however, be economic consequences for Germany, which currently benefits from exceptionally low interest rates and an undervalued exchange rate compared to what it should expect with an independent currency. Figure 5 illustrates the difference between 10-year government bond yields in Germany and the Euro Area average, which indicates a negative risk premium of close to 2 percentage points. Upon an EMU exit, we would expect borrowing costs in Germany to rise by roughly this margin. According to NiGEM simulations, this would be consistent with an appreciation of the new Germany currency of about 10-15 per cent.

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In addition to the direct impact on interest rates and exchange rates, the German economy would be adversely affected by the fall-out in its main trading partners. Even in a best-case scenario, where the remaining EMU membership remained intact, we would anticipate a significant rise in the risk premium attached to assets denominated in a euro that excluded Germany, which would slow investment and domestic demand in the rest of the Euro Area. The risk of a widespread breakup of EMU would be significantly higher in the event of a withdrawal of Germany than it would in the case of Greece, which could drive a widespread banking crisis within the Euro Area, with severe consequences for Germany as well as the rest of the world. It may be difficult to maintain the European Union under these circumstances, which would entail further far-reaching consequences.

Prospects for individual economies

United States

The financial system of the United States is, to a large extent, insulated against the turmoil in the sovereign debt markets and banking systems of countries such as Spain, Greece and Ireland. Nonetheless, it is not immune to events in Europe. The financial crisis demonstrated the deep interconnectedness of the European and American financial systems. US banks are highly exposed to the UK financial system, which is, in turn, exposed to developments in the vulnerable Euro Area economies. In the event of a widespread banking crisis within the Euro Area, the US can expect some degree of contagion through this channel, despite the advances in banking supervision and capital adequacy that have been introduced, such as in the 2010 Dodd-Frank legislation.

In addition to banking vulnerabilities, the US is feeling the strain of the recession in many European countries through the trade channel, with more than 1/4 of exports exposed to EU markets. The US has suffered a significant loss in its export market share within the EU since 2007. While it is hardly surprising that exports to countries that are in deep recession, such as Greece, Spain and Italy, have dropped sharply, more worrying is the drop in the volume of exports to Germany. In the first quarter of this year, import volumes in Germany were nearly 10 per cent above their pre-recession peak in 2008, whereas US exports to Germany remained over 15 per cent below their level in 2008--suggesting that the loss of trade share with Germany may prove persistent. While a slowdown in China will also have repercussions in the United States, only 7 per cent of US exports of goods were destined for China and Hong Kong in 2011, limiting the direct sensitivity of American exporting firms to this region. Moves towards liberalisation of the Renminbi are expected to allow a slightly more rapid appreciation, which will contribute to stabilising the US current account over our forecast horizon at 2 1/2-3 per cent of GDP.

The moderate external headwinds mean that economic recovery in the US is reliant on a revival of domestic demand, which is proving slow to materialise. Domestic demand remains restrained by cuts in government spending, a troubled housing market and a high level of uncertainty regarding the evolution of fiscal policy over the coming year. We forecast GDP growth of about 2 per cent per annum in both 2012 and 2013, which will allow the output gap to continue to widen and unemployment to rise over the short term. Only in 2014 do we expect the economy to begin to operate at or above trend rates of growth. In the second half of this decade, growth in excess of 3 per cent per annum will allow the unemployment rate to fall towards 6 per cent.

Fiscal uncertainty remains the greatest risk to the outlook, and is unlikely to see any further clarity until sometime after the presidential election in November. Current legislation mandates an extreme fiscal tightening amounting to close to 4 per cent of GDP in 2013. Roughly one third of this is related to expiring tax provisions, such as income and payroll tax cuts and limitations on the Alternative Minimum Tax, while the remainder reflects spending caps and agreed automatic spending cuts mandated by the 2011 Budget Control Act. Given the state of the economy, it is extremely unlikely that any government would follow through with these measures, which would push the economy back into recession. However, political deadlock in advance of the election is preventing any agreement on how the legislation can be adjusted, as well as agreement to raise the federal debt ceiling which will be binding towards the end of this year. In August 2011, the inability of Congress to reach a timely agreement on a new debt ceiling led to heightened financial tensions and a downgrade of US government debt, a policy mistake that may well be repeated.

Our forecast is based on the assumption that 'temporary' (2) tax cuts due to expire in 2013 are extended and withdrawn gradually over the next ten years. This is in line with the budget proposal put forward by President Obama in February 2012. Failure to extend these tax cuts would raise the tax burden by $228 billion (1.4 per cent of GDP) according to estimates by the Congressional Budget Office. The President's 2013 Budget also proposes postponing $137 billion in mandated spending cuts--about one third of the total cuts legislated in the 2011 Budget Control Act. Our forecast is based on an even more benign assumption, which allows the mandated $2.1 trillion in spending cuts over the next ten years to be eased in as gradually as possible, with $40 billion in spending cuts per annum expected over the next 10 years. If the full legislative fiscal tightening measures were introduced in 2013, NiGEM simulations suggest that US output would contract by 0.6 per cent next year, rather than the 2.1 per cent growth currently forecast. The global economy would be expected to expand by just 3 per cent in this scenario, as discussed in the previous section.

Canada

Owing to the structure and regulation of the financial system in place before 2008 Canada was able to take decisive fiscal and monetary responses to the crisis, and the economy is therefore in relatively good shape. Unemployment is expected to continue falling from the recession peak, supporting household incomes and consumption. Canada has little direct exposure to the Euro Area which accounts for less than 10 per cent of exports.

Tighter fiscal policy is likely to have a slight dampening effect on growth. The speed of consolidation is moderate and balanced between spending cuts and higher taxation. However, some provinces, in particular the most populous province of Ontario, face more severe fiscal programmes due to high levels of indebtedness. Dealing with the debt at a provincial government level will be more challenging as they are responsible for health care spending, which makes up around half of the provincial budget.

Canada is currently reforming its already impressive system of financial supervision to tackle weaknesses exposed in the crisis. The Bank of Canada will introduce stronger macro-prudential regulation, such as a countercyclical capital buffer, and regulation is proposed for internal control of credit rating agencies. There are some risks arising from growing household indebtedness to finance house buying. Canadian house prices have increased substantially since the crisis, especially in some urban areas such as Toronto and Vancouver, supported by low interest rates.

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Mexico

To sustain economic growth in the future, Mexico should find internal sources of growth and further diversify its export markets. The winner of the July 1st presidential elections, Enrique Pefia Nieto, promises reforms that, if fully implemented, would attract foreign investments to the country. But for this to happen internal security issues connected to drug violence have to be resolved. We project that Mexico will grow at 3 1/2-4 per cent per year in the short and medium term. If the proposed reforms are successful, it has the potential to increase its growth rate by several percentage points.

Mexico experienced a sharp recession in 2009 following the financial crisis. It has weathered this relatively well, and output recovered strongly in 2010 due to buoyant exports and domestic demand. Exports account for one third of GDP, and approximately 80 per cent of them go to the US. Such close links with the US economy allowed growth to resume in 2010, when the US was recovering. However, the US is expected to grow below potential this year and next, so Mexico must rely more on internal demand and diversify its trade links. The key reforms required to achieve more sustainable growth are: reduction of the size of the informal economy, creation of greater employment opportunities for young people, and tackling poverty.

The newly elected President promises to implement important structural reforms. One of the most discussed is breaking the energy monopoly of the state-owned company Pemex. This would attract investments and bring positive change to a sector that is very important for the economy. The reform is controversial, because public ownership of natural resources is protected by the constitution. Mr Pefia Nieto also wants to reduce the dependence of the government budget on oil revenues (currently contributing about a third) by abolishing tax breaks. He promises labour, fiscal, education and social security reforms, all of which are required for building a stable economy.

Economic development is closely linked to curbing drug-related violence, since the attractiveness of the economy to investors suffers due to criminal instability. On the other hand, solving security issues is impossible without extensive economic and social reforms. Almost 50 thousand people have been killed since December 2006 when the previous President Felipe Calderon launched his crackdown on the drug cartels. The President-elect has made the security issue one of the cornerstones of his election campaign.

Brazil

Economic activity has slowed sharply. Policy tightening introduced to curb capital inflows and credit growth has been reversed, with the official interest rate target being reduced 300bps to a record low of 8 per cent since the start of the year. The ongoing debt crisis in Southern Europe and weaker growth in the US are likely to have a further dampening effect on activity coming at a time of already weak business confidence. Brazil's banks have significant exposure to Spanish sovereign bonds and almost 40 per cent of exports are sold to the EU and China. These factors led Moody's to reduce its ratings on the largest banks.

As the developed markets kept interest rates low to support their banking systems in 2009-10, Brazil had high interest rates to dampen inflation. This attracted capital inflows, creating a policy dilemma for the authorities. The central bank intervened to prevent the currency appreciating and sterilised the money expansion. However, local markets attracted further inflows. Credit growth accelerated to 30 per cent and the household debt to income ratio almost doubled in the six years from 2006. At the same time the current account eroded sharply despite the benefit of higher oil prices.

The government believes the economy is overly exposed to external factors and has consequently taken steps towards more protectionism and the generation of domestic demand by imposing higher import tariffs and introducing tax cuts and other stimulus measures. These are unlikely to compensate for the very large real exchange rate appreciation, notwithstanding the recent depreciation.

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Australia and New Zealand

Australia and New Zealand have little direct exposure to the European debt crisis. Less than 10 per cent of exports go to Europe and the banks have very small exposure to the Southern European economies. However both countries are exposed to the risk of weaker growth in China, although each in different ways.

Australian exports to China are concentrated in iron ore and coal which are concentrated in production and so more exposed to an extended slowdown. Mining has been an important source of employment growth in Australia over the past decade, contributing more than 20 per cent of the total increase in employment over the past nine years. The large infrastructure projects commissioned by the Chinese government are expected to generate enough ongoing demand to offset any private sector weakness. By contrast, New Zealand's exports to China, its largest market, are comprised of meat and dairy products, which are likely to have far less sensitivity to a downturn.

The outlook is not without domestic concerns. The return to housing and the ratio of household debt to income has almost doubled in Australia since 2000, faster than almost all other countries including the UK and US, and has also risen sharply in New Zealand. This followed a period of zero and even negative saving ratios in both countries. However, the saving ratio has since risen significantly in both countries, enabling households to build some buffer into their finances. First quarter growth was stronger than expected and income and consumption growth are expected to follow similar trajectories after the adjustment in saving behaviour. We forecast stable GDP growth of 3.2 per cent per annum in Australia and 2 3/4 per cent per annum in New Zealand. Importantly, the four largest banks have adequate capital ratios and regulation is described as intensive. The same four banks dominate the New Zealand banking sector. However, it is worth noting that CDS spreads for these banks have widened somewhat.

The Australian dollar has edged lower over the past quarter, but remains near to its highest levels since floating almost thirty years ago. This has been a very large terms of trade shock over the past ten years which has enabled New Zealand to gain competitiveness. Both countries continue to run significant external deficits, although the governments are committed to fiscal tightening in order to reduce exposure to foreign borrowing.

Japan

The Japanese economy may show a rare bright spot in the world this year with a modest recovery to around 2 1/4 per cent GDP growth, supported by spending on reconstruction and consumption. The sovereign debt crisis in Southern Europe, weaker growth in the US and the slower Chinese economy represent risks.

The financial system has proved quite resilient to the deterioration in global financial markets. Japanese banks hold little sovereign or bank debt from Southern European countries. The deleveraging of the European banks has had limited impact, as liabilities to European banks are modest as a ratio to Japanese GDp (3) (figure 8).

In the short term, the banks have the capacity to survive further economic and financial shocks. There is a healthy buffer in the banking system, judging from the Tier 1 capital adequacy ratio of 13.5 per cent of the top three banks, (4) which gives room for manoeuvre in case of further deterioration overseas. Moreover, Japanese banks have been recently using their extra funds to increase credit supply to neighbouring countries in response to a withdrawal of funds by the European banks. Yet banks' core profitability is still weak, and the large quantities of government bonds and equities on their balance sheets endanger future financial stability.

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Japan faces a remarkable long-term challenge to reduce its public debt to GDP ratio. The fiscal deficit is almost 10 per cent of GDP and the government debt ratio exceeds 205 per cent of GDP, as illustrated in figure 9. In order to bring this huge public debt under control, fiscal consolidation of around 10 per cent of GDP is needed over the next decade according to IMF estimates. (5) Concerns about public debt levels have already caused Fitch, the credit rating agency, to cut the credit rating of Japan's sovereign debt in May to 'A+', followed by the downgrade of three of Japan's biggest banks ratings to 'A-' from 'A' in July. We would not wish to downplay the seriousness of this debt; however, Japan is a net foreign creditor, so all of the debt of the Japanese state is owned by domestic investors or covered by holdings of foreign assets. This is a very different scenario from that in Southern Europe, whose countries are net debtors and therefore much of their debt is held overseas.

Energy shortages continue to represent a risk, with only two out of 54 nuclear plants restarted recently, against huge public opposition. The government is desperate to close the gap in energy supply left by the shutdown of the nuclear plants, generating 30 per cent of total energy. It faces massive challenges in either reopening the plants, or in securing alternative energy sources, with delays causing a trade deficit and the deterioration of the current account balance.

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China

A weaker world economy will add to the complex challenges facing policymakers this year. Despite having the largest population in the world, the ratio of total trade to GDP is 72 per cent. Moreover, the combined market of Europe and the US is the destination of nearly 40 per cent of exports. While China helped to support the world economy during the 2008-9 recession, she is no longer able to create the same support this time around. With growth slowing, the authorities are under pressure to address weaknesses in the banking system. The government has stepped up reforms aimed at liberalising the financial system, including steps towards the internationalisation of the Renminbi (RMB).

The economic growth model has been heavily reliant on exports, foreign direct investment and the extension of cheap credit from state-owned banks that flowed to large enterprises on favourable terms. The government's fiscal stimulus after the 2008-9 recession encouraged banks to release yet more credit into the economy. This led to an accumulation of inventories as production outpaced demand and further increases in house prices. At this juncture, the high investment ratio of around 45 per cent of GDP, and a desire to dampen house prices, makes repetition of the previous package very unlikely.

As ever, the authorities are very concerned about social stability, especially during a period of changing leadership, which will take place this autumn. Recent fiscal and monetary stimuli support this conclusion. Monetary policy was eased in June with a cut in interest rates. Based on this, we project that the economy will slow down only modestly over the next two years.

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The slowing economy presents a risk to the banking system as lower property prices usually translate into loan losses. However, in China, banks can roll over the loans for the developers who fall into arrears. This has negative consequences both for the banks, which are burdened with bad loans for a long time, and the investment prospects in the economy. Until now the authorities have helped the state-owned banks to clear bad loans off their balance sheets, while banks continued to prosper on the huge gap between lending and deposit rates. But now this gap is narrowing. The central bank has liberalised deposit and lending rates by allowing up to a 10 per cent margin on official deposit rates and a 30 per cent discount on official lending rates. The idea is to allow banks to differentiate the rates they offer depending on credit risk. As a result banks' profit margins will be squeezed, forcing them to become more competitive.

Over the past several years there have been an increasing number of measures aiming to convert the RMB into an international currency. So far, however, the authorities have not explicitly announced a target for this policy or specified the configuration of the monetary system that China is aiming for.

The internationalisation of the RMB suggests an important change in policy direction for the financial and non-financial sectors of the economy. The financial market infrastructure will have to be modernised to allow expansion of the private sector share in credit allocation and bring an end to financial repression. Domestic interests that facilitate the creation of subsidised exporting companies will be difficult to maintain and exporters will face more competition (assuming that the currency appreciates over time, figure 10). A successful implementation of these steps will enable the economy to rebalance internally to rely more on consumption and less on heavily subsidised investment. The rebalancing should lead to slower but more sustained and balanced growth.

For the RMB to become not only an internationally traded but also a reserve currency, would require China to be able to supply large quantities of high quality assets. This in turn would require the creation of a more competitive banking environment including a secure legal framework. Recent political events show that this is unlikely to happen anytime soon.

India

Activity has weakened more than expected with year-on-year growth in the first quarter of 5.6 per cent, compared to average growth of 8 per cent per annum since 2003. The reasons are home grown, with the economy relatively unexposed to the problems in Southern Europe and the slowdown in China. The fiscal deficit is a growing concern, reaching 5.9 per cent of GDP in the first quarter of this year, despite a decade of historically robust growth.

The downshift in business investment as a share of output shows no sign of improving. Studies using firm level data suggest this may reflect the high costs of doing business, due to a myriad of regulations, subsidies and supply constraints after a long period of rapid growth. (6) S&P and Fitch credit rating agencies changed the outlook on Indian sovereign debt from stable to negative, leaving India one step away from losing its investment grade rating. The exchange rate has fallen to a record low against the US dollar, leading the Reserve Bank to introduce limits on FX overnight positions and futures and options exposures. The last bond auction lacked interest from foreign investors, despite offering an annual yield of 8.2 per cent, much higher than in neighbouring countries. Unless the authorities start addressing some of these problems, managing government's borrowing and costs associated with it could become difficult. Deleveraging by European banks has a limited impact as their exposure to India is small. Exports to the EU account for almost one-fifth of total exports; further slowdown in trade within the EU will put additional negative pressure on the economy.

[FIGURE 11 OMITTED]

Russia

Economic growth is expected to slow down over the next two years. Accession

to the World Trade Organisation (WTO) provides a unique chance to diversify from being an oil and gas dependent economy and attract foreign investments. However, the recent parliament and presidential elections have increased political instability which may deter progress.

The general weakness and uncertainty of the world economy affects Russia mostly through the price of oil. Between March and mid-June, the URALS (Russian export oil mix) price fell by almost 30 per cent, although it has rebounded slightly since then. The impact on government finances is significant, as over 50 per cent of government revenues directly depend on oil. The breakeven price of oil, i.e. the price at which the government budget is balanced, has increased from about $20 at the turn of the century to $115 this year. This indicates the scale of deterioration in the non-oil budget balance.

After eighteen years of negotiations, Russia became a member of the WTO in July. Few analysts believe that she will benefit as much as China because of the relatively small non-oil traded goods sector and the significant challenge of attracting foreign direct investment in competition with other large emerging economies. Tarr and Volchkova (2010) estimate that Russia will gain about 3 per cent of GDp (7) in the medium term, and about 11 per cent of GDP in the long term, mostly from structural reform and the liberalisation of business services sectors. However, to achieve this potential it is necessary to improve the business climate. Currently, Russia ranks 120 out of 183 on the Doing Business index (World Bank), and 143 out of 182 on the Corruption Perceptions Index (Transparency International).

Growing political instability increases sovereign risk and reduces a country's attractiveness to international investors. Mass political protests started after the parliamentary elections in December last year. In April President Putin was elected for a third term. Yet this victory came at a high cost. According to the President, pre-election promises will amount to a stimulus of 1.5 per cent of GDP, but some analysts estimate them to be as high as 5 per cent of GDP. The government will find it difficult to reconcile these promises with the new budget rule, presented by the President in his Budget address to Parliament.

European Union

Our central scenario remains that the Euro Area stays intact over the forecast horizon due to the strong political commitment of national leaders to the European project. However, while this is the most likely (modal) outcome, the tail risks are rising as policymakers are too slow to escape the self-imposed constraints of moral hazard worries and embrace the fiscal, financial and political integration necessary to progress. The longer this is delayed, the more countries will become embroiled in the vicious cycle between recession, deteriorating bank assets, rising sovereign risk and interest rates and imposed austerity.

That Europe has the capacity to resolve the challenges it faces should not be overlooked. The combined output and debt of Greece, Portugal and Ireland are 12 per cent and 19 per cent, respectively, of the combined output and debt of France and Germany. Therefore, even the most extreme forecasts are within manageable bounds. Indeed, that Germany is forecast to have above trend growth and some Southern European countries are forecast to be in recession shows the potential for risk-sharing in an integrated Europe.

However, there are currently insufficient institutional mechanisms to guarantee the survival of the Euro Area. The key policy challenge in Europe is to complement the monetary union with full banking union, and in large part fiscal union, while at the same time respecting national sovereignty.

To strengthen budgetary surveillance mechanisms in the Euro Area, the European Commission proposed two new regulations ('two-pack'), which reinforce the rules introduced previously under the European Semester, the Six-Pack and the new Fiscal Pact. The new monitoring regulations include the introduction of a common budgetary timeline and common budgetary rules. Euro Area members will be required to present their budgetary plans to the Commission in advance of their adoption by national parliaments. While the new law does not give the Commission the power to change the plans, it will equip the Commission with early information on whether a country should be placed on an Excessive Deficit Procedure, which would force the country to adjust fiscal plans over the following years.

The foundations for a banking union build on the introduction of the European Systemic Risk Board (ESRB) and its new supervisory bodies, and various measures strengthening the banking system (for example through securing better capitalisation), that have been introduced since the beginning of the crisis.

The key objectives of the banking union are to ensure financial stability through the introduction of effective supervision and crisis management, to preserve the single market of financial services which shows signs of fragmentation, and to avoid competitive distortions in the single market. The banking union within the Euro Area will imply a common supervisor, common rules for bank resolutions and a common deposit guarantee scheme. At the latest summit the European leaders agreed that the responsibility for banking supervision in the Euro Area should be transferred to the ECB and that Euro Area banks may be recapitalised directly by the European Financial Stability Facility (EFSF), and its future replacement the European Stability Mechanism (ESM).

Figure 12 shows the current contribution of individual Euro Area members to the European Financial Stability Fund mechanism. In case a country steps out (Greece, Portugal and Ireland have done so), contributions are readjusted among the remaining guarantors, and the guaranteed amount decreases accordingly. The effective lending capacity of the EFSF is 440 billion [euro]. Ireland, Greece and Portugal have already received 192 billion [euro], and the EFSF's remaining lending capacity is 248 billion [euro]. The implication is that there is a direct link between the financial distress in the Southern European countries and the contingent liabilities of the nations in the rest of the Euro Area.

[FIGURE 12 OMITTED]

The programme of recapitalisation of the Spanish banking sector envisages covering an estimated capital shortfall of 51-62 billion [euro] with an additional safety margin adding up to 100 billion [euro]. The loan will be transferred to the ESM, which is expected to become operational from September this year. It will take over all the features of the EFSF, and its lending capacity should increase to 500 billion [euro], both through new issuance programmes, and, if necessary, through accelerated capital payments.

Figure 13 shows the scale of exposure of major countries of the Euro Area to risks emanating from periphery countries' banking systems, that is the amounts of claims of banks in selected countries of the Euro Area towards banks in Greece, Portugal, Spain, Italy and Ireland.

While the EFSF is sufficient to cover losses resulting from the banking systems in Greece and Portugal, and possibly even Ireland, a collapse of the Spanish and Italian banking systems might have disastrous consequences in terms of the knock-on effects to other European countries. To make the European banking system more robust, the European Banking Authority recommended strengthening the capital base of banks and increasing the core capital to 9 per cent of risk-weighted assets. The vast majority of banks met the requirement raising 94.4 billion [euro] capital over the first six months of this year, exceeding the 76 billion [euro] shortfall identified in December. For the few banks that were not able to meet the capital requirement, backstop measures have been implemented.

[FIGURE 13 OMITTED]

Although the overall resilience of the banking system has improved, the adverse loop from recession to banks to sovereign risk and fiscal deficits continues. The economic situation in the Euro Area remains fragile, with clear divergence in growth rates among individual member states. Greece, Portugal, Spain and Italy are expected to experience painful recessions this year and next, while Germany, Austria, and Finland will expand faster with Germany's growth rate exceeding potential. The stark divergence of macroeconomic conditions among individual countries in the Euro Area has spurred capital flight from the periphery to the core.

All of these reforms are possible, but they will require a wider political support and in a timely fashion. The more that progress stalls or is compromised, the more likely it is that Spain and Italy will need support packages from the Troika (IMF, ECB and EC). While this can be accommodated, formulation of the packages must be such that there is credible scope to meet the conditions. Failure to do so will create problems for other countries in the Euro Area and diminish prospects of the system surviving with its current membership.

Germany

The German economy remains one of the strongest performers in the Euro Area despite a very difficult external environment. Increasing risks in the Southern European countries have resulted in capital inflows to Germany creating a stark divergence of conditions. As the largest and economically strongest member of the Euro Area, Germany is expected to play a major role in combating the crisis in Europe. Our view is that the German stance towards the euro will remain steadfast, but the mounting costs cannot be ignored and will no doubt make for political challenges in the run-up to the leadership election in autumn next year.

While the weak external environment will act as a drag on the economy, the buoyant labour market and historically low interest rates are expected to support the core economy this year and next. Fears of a major credit crunch have not materialised and indeed the capital inflows from Southern Europe are paradoxically likely to be supportive of the economy, at least in the near term. While the strong growth in the first quarter probably overstates the underlying cyclical trend, GDP growth is expected to pick up over to 1.7 per cent in 2013.

Bank lending rates to both enterprises and households have been benefiting from the broad downward trend of interest rates in the money and capital markets. Lending to non-financial corporations in particular increased significantly. In the first quarter of this year growth of loans to households was highest in almost a decade, driven by the loans for house purchases. Figure 14 shows the growth in lending to domestic enterprises and households. While a substantial share of lending is for the purpose of house purchase, the growth of house prices has remained broadly in line with HCP inflation, with stronger localised increases in some areas, spurring construction activity.

[FIGURE 14 OMITTED]

The winter saw a continuation of positive trends in the labour market with the unemployment rate hitting post-unification lows (see discussion in the April Review). The strong growth trend in employment continued in the first quarter of 2012, when the number of persons in employment increased due both to additional jobs subject to social security contributions, and to increases in the number of self-employed. In line with the trend observed in the previous quarters, the number of government-assisted working arrangements ('one euro jobs') and persons working in low-paid part-time jobs has decreased (Bundesbank, 2012).

Despite the crisis, the current account with most of the Southern European economies is still in surplus. The variation in financial account has been much larger with recent relatively strong increases in capital inflow from the periphery countries. Initially, the increased capital inflows came from repatriation by German residents, but the sound position of the economy relative to its neighbours is attracting inflows. As a result of strong demand for safe assets government bond yields have declined to record lows and some of the shorter-term bond yields have even turned negative. The growing bill for the rest of Europe is a rising contingent liability for Germany. This led one rating agency to change the outlook for AAA rated Germany from stable to negative. We believe that the German economy is robust and remains an anchor of economic stability in Europe.

We expect that the strength of the German political commitment to the Euro Area will remain unchanged over the forecast horizon. While the outcome of the autumn 2013 elections is uncertain, the major parties, the CDU and the SPD, share the view that the euro is beneficial for the German economy.

France

The outlook for the economy weakened in recent months amid escalating financial stress in the Euro Area, fiscal austerity introduced by the new government, tighter credit market conditions and slowing growth in Asia. Overall, our GDP forecast has been revised downward in the near term, with the economy expected to remain broadly flat this year, whilst next year's forecast for GDP growth has been lowered to 0.7 per cent. The main risk to the outlook is that the credit crisis in the rest of Europe escalates further, affecting French banks.

Weak growth expectations reflect a drop in domestic demand, tighter fiscal policy and weaker trade prospects. Falling real disposable income and rising unemployment hold back household consumption, while weak demand along with greater uncertainty and tight lending conditions also point to a sharp drop in business investment. President Hollande has also reiterated his commitment to reduce the public finance deficit from 5.2 per cent of GDP in 2011 to 4 1/2 per cent this year and to 3 per cent next year. Additional fiscal tightening measures, mainly implemented by raising tax revenues from the industry and banking sectors, are being introduced. Whilst we expect this year's target to be achieved, we doubt that the 3 per cent target will be achieved, reflecting the poor outlook in the near term.

The large exposure of the banking system to Spanish and Italian debt presents a clear downside risk to the economy. French banks' exposure to Italian and Spanish sovereign and banking sector's debt is equivalent to just over one third of their tier 1 capital. French banks' credit default swaps (CDS) here followed Spanish and Italian CDS through a sharp rise since last April. Clearly, as the situation in southern countries worsens, this has negative consequences for the banks, growth and fiscal prospects.

In contrast to banks' funding costs, government bond yields have proved resilient to rising pressures in the sovereign bond markets. Ten-year bond yields are trading at historic lows, although the spread over Germany has increased in recent months. It is also worth noting that the stock of national debt is very high, reaching over 90 per cent of GDP next year, and may increase further if banks need to be bailed out following a default in other countries in Europe.

Italy

The third largest European country is the latest country to become embroiled in the European debt crisis. As the outlook deteriorates, funding conditions are getting tougher for the government and the banks. Worsening prospects and further downgrades of Italian sovereign bonds and the banking sector will put further pressures on the economy. As a result we expect the country to be in recession this year and next. There is a possibility that the government may eventually be required to seek Troika support.

Output is expected to contract by 1.8 per cent this year and 0.9 per cent in 2013. As a result of austerity measures and a rise in the unemployment rate we expect domestic demand to decline by more than in 2008-9, by 4.1 per cent this year and a further 1.6 per cent next year. The external sector will contribute positively to growth as imports contract while exports are still growing. We thus expect a further improvement in the current account. The unemployment rate has been rising faster than in 2008-9, despite labour market reforms, and is expected to reach 11 per cent next year, the highest since Italy joined the EMU.

Worsening external conditions, higher interest rates, and an increase in unemployment will depress household incomes. Although the country has not experienced a housing or construction boom, the decline in household incomes is expected to result in an increase in doubtful loans. The banking sector is fragile as the banks used the LTRO funding to purchase sovereign bonds. The expectation that the economy will contract will increase risks to the banking system. In June the Banca Monte dei Paschi di Siena had to be rescued by the government.

Funding costs are lower than those for Spain despite the stock of debt being much higher, at 120 per cent of GDP. This is because the economy did not have the same property and lending boom as Spain and so the banking sector is stronger. In light of the weak outlook the government is likely to miss this year's fiscal target. The government has been emphasising expenditure reductions and increases in saving rather than revenue and tax increases. This is again the Southern European quandary; tighter fiscal policy will weaken the economy with adverse consequences for the banking sector, limiting the potential improvement in the fiscal position.

Spain

The economy is expected to be in recession this year and next. Asset quality in the banking sector is expected to deteriorate further as a result of soaring unemployment, falling total income, a higher interest rate and further falls in house prices. As a consequence, the l00 billion [euro] bailout of the banking system may not be enough and the government may be forced to ask for further support from the Troika (ECB, EU, IMF).

The economy remains firmly in recession. The vicious cycle of falling demand, deteriorating conditions in the banking sector and higher sovereign risks leading to more fiscal austerity requires a change in direction. Spain already has the highest unemployment rate of any advanced country. While there is likely to be some internal devaluation through wage adjustment, the key issue is whether productivity is maintained to allow an improvement in competitiveness. Government borrowing costs of around 7 per cent are unsustainable. The government is expected to miss the fiscal targets next year under current conditions.

Output is projected to contract by 1.8 per cent this year and 1.2 per cent in 2013. Falling consumer spending, investment and tight fiscal policy imply even weaker domestic demand, which is forecast to contract by 4.5 per cent this year and 3.1 per cent next. Net exports will contribute positively to growth, largely owing to a decline in imports. Therefore we should expect an improvement in the current account this year and next. The current account is expected to balance in 2013. Unemployment is expected to reach nearly 25 per cent this year and exceed 26 per cent in 2013.

[FIGURE 15 OMITTED]

It seems very long ago that world banking authorities held regulation of the Spanish banking system, with forward looking provisioning, to be best in class. The banking sector has now become a buyer of last resort at sovereign bond auctions with the cheap money provided by the ECB through the LTRO. It is also very heavily exposed to real estate after the housing and construction boom. Despite more than 20 per cent decline in house prices, the banking sector's assets have remained flat since the start of the crisis in 2008 (figure 15).

Bankia, the fourth largest bank in Spain, was nationalised in May 2012. The reluctance of banks to provision for troubled assets in the housing and construction sector could be an explanation for this apparent resilience of bank assets. Reduction in the number of banks from 45 mostly savings banks (Cajas) to 11 commercial banks and the active involvement of the supervisory institution has reduced the influence of banks in the valuation of their assets. As the economic outlook worsens and house prices continue to decline we expect a deterioration of bank balance sheets. The markets have also started perceiving the banking sector as more risky (for example the CDS for the two biggest Spanish banks have increased to the highest level since the depth of the crisis in 2008). The size of the June bailout was much larger than the amounts indicated by the two independent consultants who identified a capital shortfall of 51[euro]-62 billion [euro]. However, considering the full adjustment of house prices and the increasing amount of impaired loans on the bank balance sheet, this may be even more than 100 billion [euro].

The first trench of the bailout, worth 30 billion [euro], has already been authorised by the EU. The money will initially be distributed through the EFSE The bailout will probably buy Spanish banks some time to raise funds. What is needed to resolve this situation is the stabilisation of the economy to prevent even further credit losses, as well as a fundamental improvement in competitiveness. Consequently, sooner or later we may see the Troika being required to stabilise the economy with a fiscal bailout.

Portugal

The forecast is for a continuation of the recession this year and into next. Although the government met its fiscal target last year, the current environment makes this year's target a difficult task to achieve. Output is forecast to contract by 3 per cent this year and nearly 2 per cent next year. Unemployment is expected to exceed 16 per cent next year, mainly affecting young workers. Real wages are expected to contract by more than 6 per cent this year, which should lead to a gradual improvement in the competitiveness of the economy. The external sector is contributing positively to growth and improving the current account deficit. This year the current account deficit will reach 2.6 per cent of GDP, and we expect further improvement next year. As the largest trading partners also struggle with recession the outlook is not bright for the only sector that contributes positively to growth.

Despite the deterioration of the economy, the government implemented and delivered its fiscal adjustments. Last year, it reformed pensions and reduced the budget deficit by 5.6 per cent of GDP. According to the IMF, the Troika welcomed this achievement. This has been met by falling bond yields in a rare case that might yet show that a return to stability is possible. The critical issue is whether the fiscal deficit improves this year. The cost continues to be exceptionally high unemployment.

[FIGURE 16 OMITTED]

Greece

The parliamentary elections on June 17 confirmed that the Greek public (marginally) want to stay in the Euro Area despite the depressed conditions. While this reduced the risk of an early exit from the Euro Area, it has not solved the underlying economic problems. Although the government has repeatedly missed the targets set by the Troika (ECB, EU and IMF), the new coalition plans to renegotiate the terms and conditions in order to focus more on growth. The economy remains in recession for the fifth consecutive year, unemployment is soaring, and we expect three more years of recession before the economy enters a path of slow growth.

Output is expected to contract by 6.6 per cent this year, marginally better than last year but a crisis nevertheless. We expect a contraction of nearly 3 per cent next year. Rising austerity, falling household incomes and mass unemployment point to further contraction and eroding asset values in the Greek banks. Figure 17 shows private sector deposits in the banking system. As the economy deteriorates, households and firms are forced to run down savings and there is less appetite for the private sector to keep deposits in Greek banks. Since the banks do not have access to capital markets, the reduction in deposits must be matched by a reduction in assets such as loans to the real economy.

With such weakness in domestic demand, net exports are expected to contribute to growth. Although the export sector is primarily based on services, in particular on tourism and transport, the conditions of the global economy are important for the recovery. Deteriorating growth in Europe this year and next brings further downside risks in the only sector of the economy that contributes to growth. The current account deficit is expected to be 4.4 per cent of GDP this year and is an indication of just how uncompetitive the economy remains.

[FIGURE 17 OMITTED]

Unemployment is a major problem. Figure 18 shows the level of employment by sector. The only sector that has so far shown any resilience is the government sector, despite wage cuts, cuts in temporary contracts and cuts in pensions. Employment in construction and manufacturing has declined by nearly 350 thousand in total. One of the major tasks of the new government is to try to negotiate a freeze on public sector layoffs, and extra help for low income households and unemployed workers. One of the conditions set by the Troika is to cut 150,000 jobs in the public sector (about 45 per cent of the total) over the next ten years.

The new government faces the risk of systemic failure if renegotiations with the Troika do not make good progress. The gloomy economic outlook in Spain and Italy weighs over negotiations with the Troika. The Troika has financed 147.5 billion [euro] since May 2010, but the economy shows no sign of recovery. The difficulty is that if Spain fails to meet the unrealistic targets they create moral hazard for other countries who may yet require a bailout. It remains to be seen how they will fare in negotiations when there is an expectation that existing targets will not be met.

[FIGURE 18 OMITTED]

New Member States

Following the major slowdown in the Euro Area, economic growth in Central and Eastern Europe is expected to decelerate. The degree will vary across countries, reflecting country-specific structural idiosyncrasies, differences in monetary and fiscal policies and investors' perception of risk and the size of associated capital flows.

Over the forecast horizon the Baltic economies, as well as Poland and Slovakia, are expected to record slightly higher growth rates (although significantly lower than their potential) than other countries in the region. Growth in the Czech Republic, Hungary and Slovakia will remain broadly flat this year, with a modest recovery expected next year. Economic activity in the Southeastern economies, Bulgaria and Romania, is expected to decelerate, with GDP growth rates, although positive, significantly lower than potential.

Fiscal policy in the region remains restrictive to fulfil the requirements of convergence and stability programmes. Consolidation packages encompass a series of measures such as changes to the retirement age, privatisations (Bulgaria and Romania), management efficiencies (Slovakia), tax increases (the Czech Republic, Hungary), as well as the introduction of progressive taxation (Slovakia). The ratio of government debt to GDP is relatively low compared with other countries in Europe--see figure 19 (for example Estonia's debt is only 6 per cent of GDP). Gloomy prospects for the macroeconomic outlook for Hungary and Slovenia, coupled with their relatively weaker fiscal positions, may affect the smoothness of the debt rollover process for these countries somewhat.

[FIGURE 19 OMITTED]

The overall current account deficit in the countries of the region has decreased. The unwinding of the external imbalance has mainly resulted from a sharper decrease in imports than exports, with the exception of Poland, Lithuania and Latvia. Strong domestic demand in these countries has resulted in an increase in imports and, subsequently, an increase in the current account deficit.

Central, Eastern and Southeastern European banking systems depend on foreign banks' subsidiaries and branches (see fig 20). The ongoing crisis in the Euro Area has raised the risk of a disruptive withdrawal of funding by western banks from the EUS+2 countries which could jeopardise their financial stability. The recently launched European Bank Coordination Vienna II Initiative aims to prevent a large-scale withdrawal of cross-border bank groups from the region, ensure that parent bank groups commit to maintain their exposures and recapitalise their subsidiaries in countries receiving IMF/EC support (such as for example Hungary or Romania), ensure that other potential cross-border stability issues are resolved, and strengthen cross-border regulatory cooperation and information sharing between the home and host countries.

[FIGURE 20 OMITTED]

Appendix A: Summary of key forecast assumptions

The forecasts for the world and the UK economy reported in this Review are produced using NIESR's model, NiGEM. The NiGEM model has been in use at the National Institute for forecasting and policy analysis since 1987, and is also used by a group of about 40 model subscribers, mainly in the policy community. Most countries in the OECD are modelled separately, and there are also separate models of China, India, Russia, Hong Kong, Taiwan, Brazil, South Africa, Estonia, Latvia, Lithuania, Slovenia, Romania and Bulgaria. The rest of the world is modelled through regional blocks so that the model is global in scope. All models contain the determinants of domestic demand, export and import volumes, prices, current accounts and net assets. Output is tied down in the long run by factor inputs and technical progress interacting through production functions, but is driven by demand in the short to medium term. Economies are linked through trade, competitiveness and financial markets and are fully simultaneous. Further details on the NiGEM model are available on http://nimodel.niesr.ac.uk/.

There are a number of key assumptions underlying our current forecast. The interest rates and exchange rate assumptions are shown in tables A1-A2. Our short-term interest rate assumptions are generally based on current financial market expectations, as implied by the rates of return on treasury bills of different maturities. Long-term interest rate assumptions are consistent with forward estimates of short-term interest rates, allowing for a country-specific term premium in the Euro Area.

In this context, we note the ECB Governing Council's recent decision to lower key interest rates by 25 basis points to a record low 0.75 per cent. This decision comes in response to weak growth expectations and high uncertainty on financial markets, whilst medium-term inflation expectations for the Euro Area remain in line with the 2 per cent target. Meanwhile, the Bank of England maintained its interest rate at its record low 0.5 per cent and expanded its programme of asset purchase by a further 50 billion [[pounds sterling]] in July. Total asset purchases amount to 375 billion [[pounds sterling]] to date. The Bank of Japan also maintained its current rate unchanged in the short term in order to support economic growth after the twin disasters of March 2011. In the US, The Federal Reserve continues to stress that interest rates will remain exceptionally low until at least until the end of 2014.

Canada maintained the target for the overnight rate at 1 per cent, anticipating sluggish global growth and moderate inflationary pressures as commodity prices dropped.

Similarly, after widespread interest rate hikes in the emerging economies, official rates in many countries have recently been cut as global inflationary pressures ease, and activity is slowing down. The People's Bank of China lowered benchmark rates twice, in June and July, by a total of 56 basis points to 6 per cent. Policy rates were also reduced in India by 50 basis points to 8 per cent, and in Korea by 25 basis points to 3 per cent. The Reserve Bank of Australia has reduced interest rates by 75 basis points since last April, down to 3 per cent. In Brazil, the central bank continues to loosen its monetary policy as a response to lower growth expectations with eight consecutive interest rate cuts since August 2011. The Selic now stands at record low 8 per cent.

Figure A1 illustrates our projections for real long-term interest rates in the US, Euro Area, Japan and Canada. Long real rates followed nominal rates in a sharp drop since the second quarter of 2011. Announced policies indicate that the monetary stance should remain expansionary until the end of 2014, and real interest rates in North America, the Euro Area and Canada are expected to stabilise close to historical levels by 2017-18. A somewhat higher level in the Euro Area, where the long real rate is forecast to average 1 1/2 per cent this year, reflects the risk premium on sovereign debt in Spain and Italy. We see real interest rates in Japan remaining negative for an extended period.

[FIGURE A1 OMITTED]

Long real rates are illustrative measures of the state of the economy, but do not reflect the actual borrowing costs faced by government on the open market, which in turn reflect sovereign risks of default. Figure A2 depicts the spread between 10-year government bond yields of Spain, Italy, Portugal and Greece over German yields, regarded as a safe haven in the Euro Area. Borrowing costs in some countries have started to show greater divergence and volatility since 2010, reflecting increasing sovereign risk of default. Sovereign risks became a major macroeconomic issue for the global economy and financial markets following the debt crisis that has affected Greece, Ireland and Portugal in the past two years, and the credit rating downgrade of major economies such as the US and France last year. More recently, financial stress in the Euro Area rose further following a sharp hike in Spanish and Italian bond yields. In our forecast, we have assumed spreads remain at current high levels throughout 2014 and start to fall from 2015 onward.

Nominal exchange rates against the US dollar are assumed to remain constant at the prevailing rate in the second week of July 2012 for the third quarter. After that, they follow a backward-looking uncovered-interest parity condition, based on interest rate differentials relative to the US. Figure A3 illustrates the effective exchange rate projections for the US, Euro Area, Japan, Canada and the UK. The Euro Area effective exchange rate has depreciated against most major currencies since the beginning of the year amid growing concerns about growth and financial markets, shifting by about 6 per cent since mid-2011. Meanwhile, Japanese interventions to bring their currency down against the dollar brought some relief in the first half of the year. By the end of the second quarter, the Yen had stabilised around 50 per cent above its pre-crisis peak, but has started to appreciate again in recent weeks. Sterling lost nearly 20 per cent of its value between the end of 2007 and the end of 2009, then remained broadly stable until the end of 2011, and strengthened in recent months by about 4 1/2 per cent. The Canadian dollar tends to follow the oil price closely, and followed it upward in the first quarter of this year, before easing in the second quarter.

[FIGURE A2 OMITTED]

Our oil price assumptions for the short term are based on those of the US Energy Information Administration, who use information from forward markets as well as an evaluation of supply conditions. In the longer term, we assume that real oil prices will rise in line with the real interest rate. The oil price assumptions underlying our current forecast are reported in figure A4 and in table 1 at the beginning of this chapter. Annual average oil prices, based on the average of Brent and Dubai spot prices, rose by almost 40 per cent between 2010 and 2011. Tight demand and supply balances and the Libyan crisis triggered this rise. Prices increased by a further 9 per cent in the first quarter of this year, from $107.7 to $117.3 per barrel, in response to the recent standoff over Iran's nuclear plans, but have reverted back since April amid growing concerns about global economic activity. In our forecast, we assumed that oil prices would average $106.1 per barrel this year, down by $15 per barrel compared to our April 2012 baseline assumptions.

[FIGURE A3 OMITTED]

Our equity price assumptions for the US reflect the return on capital. Other equity markets are assumed to move in line with the US market, but are adjusted for different exchange rate movements and shifts in country-specific equity risk premia. Figure A5 illustrates the equity price assumptions underlying our current forecast. Global share prices dropped sharply in the third quarter of 2011 in response to the deepening of the Euro Area debt crisis and the downgrade of the US government debt. However, we have seen a rebound in most countries since October, with the exception of Greece, Portugal and Spain. In Japan, share prices have been on a declining trend since 2007, standing about 50 per cent below their pre-crisis levels, and were further exacerbated last year by the sharp decline recorded in the wake of the tsunami crisis.

[FIGURE A4 OMITTED]

Fiscal policy assumptions for 2012-13 follow announced policies. Average personal sector tax rates and effective corporate tax rate assumptions underlying the projections are reported in table A3. Government revenue as a share of GDP reported in the table reflects these tax rate assumptions and our forecast projections for income and profits, as well as our projections for consumption tax revenue. Consumption tax revenue projections reflect indirect tax cuts in Germany and Finland last year, as well as rises in Greece, Portugal, Spain and the UK. Moreover, we expect further increases in consumption taxes this year in Ireland, Italy, Netherlands and Spain. Following fiscal consolidation plans, the average income tax rates in 2012-13 are expected to rise sharply in Australia, Finland, France, Italy, Portugal and Spain. It is also expected to rise slightly in the US, where various temporary fiscal stimulus programmes have just come to an end, whilst there is not much variation in the UK as consolidation measures are mostly based on spending cuts. The effective corporate tax rate is expected to rise sharply this year in Canada, France and Italy, with more modest rises in Japan and the US. In the UK, corporate taxes are expected to continue to fall in 2012-13. Finally, government spending in 2012 and 2013 is expected to continue to fall sharply as a share of GDP in Ireland, the US, Spain, Netherlands and Japan, with more moderate adjustments planned in the majority of the remaining countries to address budget deficits.

[FIGURE A5 OMITTED]

Table A1. Interest rates Per cent per annum

 Central bank intervention rates

 US Canada Japan Euro Area UK

2009 0.25 0.44 0.10 1.28 0.65
2010 0.25 0.59 0.10 1.00 0.50
2011 0.25 1.00 0.10 1.25 0.50
2012 0.25 1.00 0.10 0.88 0.50
2013 0.41 1.25 0.10 0.75 0.50
2014 0.84 1.59 0.10 0.85 0.54
2015-19 2.23 2.81 0.37 2.11 1.56
2011 Q1 0.25 1.00 0.10 1.00 0.50
2011 Q2 0.25 1.00 0.10 1.22 0.50
2011 Q3 0.25 1.00 0.10 1.47 0.50
2011 Q4 0.25 1.00 0.10 1.30 0.50
2012 Q1 0.25 1.00 0.10 1.00 0.50
2012 Q2 0.25 1.00 0.10 1.00 0.50
2012 Q3 0.25 1.00 0.10 0.75 0.50
2012 Q4 0.25 1.00 0.10 0.75 0.50
2013 Q1 0.25 1.13 0.10 0.75 0.50
2013 Q2 0.41 1.25 0.10 0.75 0.50
2013 Q3 0.50 1.25 0.10 0.75 0.50
2013 Q4 0.50 1.38 0.10 0.75 0.50
2014 Q1 0.66 1.50 0.10 0.75 0.50
2014 Q2 0.75 1.50 0.10 0.75 0.50
2014 Q3 0.96 1.58 0.10 0.88 0.50
2014 Q4 1.00 1.77 0.10 1.00 0.67

 10-year government bond yields

 US Canada Japan Euro Area UK

2009 3.2 3.2 1.3 3.7 3.7
2010 3.2 3.2 1.2 3.3 3.6
2011 2.8 2.8 1.1 3.9 3.1
2012 1.8 1.9 0.9 3.4 1.8
2013 2.1 2.3 0.8 3.9 1.9
2014 2.6 2.9 0.9 4.5 2.2
2015-19 3.6 3.8 1.2 4.4 3.1
2011 3.4 3.3 1.2 3.9 3.7
2011 3.2 3.1 1.2 4.0 3.4
2011 2.4 2.5 I.0 3.7 2.8
2011 2.0 2.2 I.0 3.8 2.3
2012 2.0 2.0 1.0 3.5 2.1
2012 1.8 1.9 0.9 3.4 1.8
2012 1.6 1.7 0.8 3.3 1.6
2012 1.7 1.9 0.8 3.5 1.7
2013 1.9 2.1 0.8 3.7 1.8
2013 2.0 2.3 0.8 3.8 1.8
2013 2.2 2.4 0.8 4.0 1.9
2013 2.3 2.5 0.8 4.1 2.0
2014 2.5 2.7 0.9 4.3 2.1
2014 2.6 2.8 0.9 4.4 2.1
2014 2.7 2.9 0.9 4.6 2.2
2014 2.8 3.0 0.9 4.7 2.3

Table A2. Nominal exchange rates

 Percentage change in effective rate

 US Canada Japan Euro Germany France
 Area

2009 7.0 -3.0 15.5 6.0 2.4 1.7
2010 -3.1 9.5 4.6 -6.1 -3.6 -2.8
2011 -3.0 2.1 7.2 2.3 0.7 1.1
2012 4.4 -0.1 3.2 -3.9 -2.1 -2.2
2013 1.2 -0.7 0.5 -1.2 -0.6 -0.6
2014 0.6 -0.6 -0.4 0.5 0.2 0.3
2011 Q1 -0.8 3.1 -0.4 -0.2 -0.2 0.0
2011 Q2 -2.0 -0.8 -0.8 3.1 1.3 1.5
2011 Q3 1.1 -2.3 5.4 -0.4 -0.3 -0.4
2011 Q4 3.8 -1.1 3.0 -0.1 0.1 -0.4
2012 Q1 -0.5 3.1 -2.5 -2.9 -1.6 -1.3
2012 Q2 1.9 -1.1 0.2 -0.8 -0.3 -0.4
2012 Q3 1.3 -0.3 1.8 -2.1 -1.0 -1.0
2012 Q4 -0.1 0.0 -0.1 -0.1 0.0 0.0
2013 Q1 -0.1 0.0 -0.1 -0.1 0.0 0.0
2013 Q2 0.2 -0.2 -0.2 0.1 0.0 0.0
2013 Q3 0.2 -0.2 -0.1 0.1 0.0 0.1
2013 Q4 0.2 -0.1 -0.1 0.1 0.0 0.1
2014 Q1 0.2 -0.2 -0.1 0.1 0.0 0.1
2014 Q2 0.1 -0.2 -0.1 0.1 0.1 0.1
2014 Q3 0.1 -0.1 -0.1 0.1 0.1 0.1
2014 Q4 0.1 -0.1 0.0 0.1 0.1 0.1

 Percentage change
 in effective rate Bilateral rate per US $

 Italy UK Canadian Yen Euro Sterling
 $

2009 2.4 -10.5 1.132 93.6 0.720 0.641
2010 -3.3 -0.2 1.026 87.8 0.755 0.647
2011 1.4 0.0 0.995 79.8 0.719 0.624
2012 -2.0 4.3 1.010 79.6 0.791 0.639
2013 -0.5 1.1 1.022 79.9 0.812 0.644
2014 0.4 0.5 1.030 80.5 0.814 0.644
2011 Q1 0.0 0.8 0.977 82.3 0.732 0.624
2011 Q2 1.6 -1.8 0.977 81.7 0.695 0.614
2011 Q3 -0.3 0.2 1.002 77.7 0.709 0.621
2011 Q4 -0.1 1.5 1.024 77.3 0.742 0.636
2012 Q1 -1.4 1.2 0.994 79.3 0.763 0.636
2012 Q2 -0.3 2.6 1.010 80.1 0.780 0.632
2012 Q3 -1.0 0.7 1.019 79.6 0.811 0.644
2012 Q4 0.0 0.0 1.019 79.6 0.811 0.644
2013 Q1 0.0 0.0 1.019 79.6 0.811 0.644
2013 Q2 0.1 0.1 1.021 79.8 0.812 0.644
2013 Q3 0.1 0.1 1.023 80.0 0.813 0.644
2013 Q4 0.1 0.1 1.025 80.1 0.813 0.644
2014 Q1 0.1 0.1 1.027 80.3 0.814 0.644
2014 Q2 0.1 0.1 1.029 80.4 0.814 0.644
2014 Q3 0.1 0.2 1.031 80.5 0.814 0.644
2014 Q4 0.1 0.2 1.033 80.6 0.814 0.643

Table A3. Government revenue assumptions

 Average income tax Effective corporate
 rate (per cent)(-) tax rate (per cent)

 2011 2012 2013 2011 2012 2013

Australia 13.8 14.4 14.4 24.7 24.7 24.7
Austria 31.6 31.7 31.7 20.9 20.9 20.9
Belgium 33.1 33.0 33.0 23.9 23.9 23.9
Canada 21.4 21.8 22.2 24.3 25.1 25.9
Denmark 37.6 38.0 37.9 18.1 18.1 18.1
Finland 30.9 31.5 31.6 17.5 17.5 18.0
France 28.7 30.0 30.2 23.8 26.0 22.6
Germany 27.9 27.7 27.7 26.6 26.6 26.6
Greece 17.5 17.5 17.5 23.3 23.3 23.3
Ireland 22.3 22.5 22.5 5.8 5.8 5.8
Italy 28.5 29.5 29.4 26.2 28.6 28.6
Japan 22.7 22.8 22.8 27.2 27.6 28.0
Netherlands 33.7 34.0 34.0 25.3 25.3 25.3
Portugal 20.3 21.0 21.3 18.4 18.4 18.4
Spain 23.1 25.0 25.3 25.2 25.2 25.2
Sweden 30.3 29.8 29.7 19.3 19.3 19.3
UK 23.8 23.7 24.0 19.6 17.6 16.3
US 17.1 17.5 17.7 29.6 29.9 31.2

 Govt revenue
 (% of GDP) (b)

 2011 2012 2013

Australia 31.2 31.9 32.3
Austria 38.9 38.8 38.1
Belgium 42.4 43.7 43.1
Canada 35.5 35.6 35.7
Denmark 48.1 46.5 46.5
Finland 44.3 45.3 45.0
France 44.3 45.6 46.0
Germany 44.6 45.8 46.2
Greece 42.2 45.4 45.2
Ireland 25.6 29.5 28.5
Italy 43.4 45.6 46.0
Japan 32.0 31.6 31.5
Netherlands 40.4 40.5 40.2
Portugal 39.5 38.8 39.6
Spain 33.0 34.4 35.8
Sweden 45.5 45.5 44.7
UK 37.3 37.8 38.0
US 27.3 27.6 27.8

Notes: (a)The average income tax rate is calculated as total
income tax plus both employee and employer social security
contributions as a share of personal income. (b) Revenue shares
reflect NiGEM aggregates, which may differ from official
government figures.

Table A4. Government spending assumptions(a)

 Govt spending excluding
 interest payments

 (% of GDP)

 2011 2012 2013

Australia 33.3 32.8 32.2
Austria 38.9 38.9 37.9
Belgium 42.8 43.3 42.7
Canada 36.3 35.5 35.3
Denmark 48.0 48.1 47.2
Finland 43.8 44.0 43.6
France 46.9 47.5 47.7
Germany 43.4 44.4 44.5
Greece 44.4 45.1 44.5
Ireland 35.2 34.5 32.8
Italy 42.5 42.7 42.1
Japan 39.4 38.9 38.3
Netherlands 43.0 42.6 41.5
Portugal 39.8 39.3 39.3
Spain 39.1 38.4 37.9
Sweden 44.0 44.2 43.3
UK 40.0 40.7 40.5
US 34.2 32.9 32.3

 Gov't interest Deficit
 payments projected to
 (% of GDP) fall below
 3%
 2011 2012 2013 of GDP (b)

Australia 1.8 1.9 1.8 2012
Austria 2.6 2.5 2.3 2011
Belgium 3.5 3.4 3.2 2012
Canada 3.6 3.5 3.2 2013
Denmark 1.9 1.7 1.6 2013
Finland 1.4 1.3 1.2 --
France 2.6 2.7 2.7 2016
Germany 2.2 1.9 1.6 2011
Greece 7.0 7.8 7.9 2017
Ireland 3.4 4.2 4.4 2018
Italy 4.8 5.2 5.5 2012
Japan 2.1 2.1 1.8 --
Netherlands 2.0 1.9 1.9 2013
Portugal 3.9 4.0 4.2 2014
Spain 2.4 3.1 4.0 2015
Sweden 1.2 1.1 0.9 --
UK 3.3 3.4 3.5 2017
US 2.8 2.6 2.4 --

Notes: (a) Expenditure shares reflect NiGEM aggregates, which
may differ from official government figures. (b) The deficit in
Finland and Sweden has not exceeded 3 per cent of GDP in recent
history. In Japan and the US, deficits are not expected to fall
below 3 per cent of GDP within our forecast horizon.

Appendix B: Forecast detail

[FIGURE B1 OMITTED]

[FIGURE B2 OMITTED]

[FIGURE B3 OMITTED]

[FIGURE B4 OMITTED]

Table B1. Real GDP growth and inflation

 Real GDP growth (per cent)

 2009 2010 2011 2012 2013 2014-18

Australia 1.4 2.5 2.1 3.2 3.2 3.1
Austria -3.4 2.5 3.0 0.8 1.8 2.1
Belgium -2.7 2.2 2.0 0.7 1.2 1.3
Bulgaria -5.7 0.5 1.8 1.3 2.3 3.0
Brazil -0.3 7.5 2.7 2.7 4.7 4.1
China 9.0 10.4 9.3 7.8 7.8 7.0
Canada -2.8 3.2 2.4 2.2 2.1 2.5
Czech Rep. -4.5 2.6 1.7 0.1 2.1 1.7
Denmark -5.8 1.3 0.8 0.9 1.7 1.9
Estonia -14.3 2.3 7.6 2.8 3.8 2.1
Finland -8.4 3.7 2.9 1.8 1.9 2.0
France -3.1 1.6 1.7 0.2 0.7 1.9
Germany -5.1 3.6 3.1 0.8 1.7 1.3
Greece -3.3 -3.5 -6.9 -6.6 -2.7 0.3
Hong Kong -2.6 7.1 5.0 2.5 4.5 3.2
Hungary -6.7 1.2 1.7 -0.1 2.1 2.2
India 5.7 10.3 7.0 6.6 6.7 7.1
Ireland -7.0 -0.4 0.7 -0.3 1.9 1.8
Italy -5.5 1.8 0.5 -1.8 -0.9 0.9
Japan -5.5 4.5 -0.7 2.3 1.2 1.4
Lithuania -14.8 1.4 6.0 3.7 3.6 3.9
Latvia -17.1 -1.1 5.0 3.2 3.6 3.5
Mexico -6.0 5.5 3.9 3.8 3.6 3.9
Netherlands -3.7 1.6 1.1 -0.5 1.1 1.7
New Zealand -0.2 0.9 0.3 2.6 2.8 2.3
Norway -1.6 0.6 1.5 2.9 1.7 2.2
Poland 1.7 3.9 4.3 3.4 3.0 3.1
Portugal -2.9 1.4 -1.6 -3.0 -1.8 1.6
Romania -6.6 -1.7 2.5 1.6 3.9 3.5
Russia -8.0 4.3 4.3 3.6 3.0 3.1
South Africa -1.5 2.9 3.1 3.2 4.1 3.9
S. Korea 0.3 6.3 3.6 3.3 3.6 3.4
Slovakia -4.9 4.2 3.3 2.8 2.6 3.6
Slovenia -8.2 1.3 0.2 0.0 1.2 2.5
Spain -3.7 -0.1 0.7 -1.8 -1.2 2.3
Sweden -5.0 5.9 4.0 0.7 2.2 2.7
Switzerland -1.9 2.7 2.1 1.6 1.3 1.8
Taiwan -1.8 10.7 4.0 2.7 3.8 3.2
U K -4.0 1.8 0.8 -0.5 1.3 2.6
US -3.5 3.0 1.7 2.0 2.1 2.9
Euro Area -4.4 1.9 1.5 -0.4 0.5 1.6
EU-27 -4.3 2.0 1.6 0.0 0.9 1.8
OECD -3.8 3.2 1.8 1.4 1.7 2.4
World -0.6 5.3 3.9 3.3 3.7 4.1

 Annual inflation (a) (per cent)

 2009 2010 2011 2012 2013 2014-18

Australia 2.4 2.8 2.6 1.5 2.4 2.8
Austria 0.4 1.7 3.6 2.7 1.8 2.2
Belgium 0.0 2.3 3.5 3.1 2.2 2.5
Bulgaria 2.5 3.0 3.4 2.8 5.2 4.1
Brazil 4.9 5.1 6.6 5.6 5.9 5.0
China -0.7 3.3 5.4 3.0 2.6 2.0
Canada 0.5 1.3 2.0 1.8 2.2 1.8
Czech Rep. 0.6 1.2 2.1 3.7 2.0 2.0
Denmark 1.1 2.2 2.7 2.9 2.6 2.7
Estonia 0.2 2.7 5.1 3.9 3.4 5.8
Finland 1.6 1.7 3.3 3.6 2.4 2.6
France 0.1 1.7 2.3 2.6 1.7 1.5
Germany 0.2 1.2 2.5 2.3 2.1 2.4
Greece 1.3 4.7 3.1 1.5 1.8 1.6
Hong Kong -1.6 0.9 4.1 4.3 3.1 2.9
Hungary 4.0 4.7 3.9 5.7 3.4 3.3
India 10.9 12.0 8.8 8.3 7.6 5.1
Ireland -1.7 -1.6 1.2 2.2 2.0 1.8
Italy 0.8 1.6 2.9 3.3 2.4 2.2
Japan -2.5 -1.7 -1.1 -0.3 -0.3 0.4
Lithuania 4.2 1.2 4.1 3.9 5.1 5.3
Latvia 3.3 -1.2 4.2 3.0 3.6 3.9
Mexico 5.3 4.2 3.4 4.0 3.2 2.4
Netherlands 1.0 0.9 2.5 3.0 2.4 2.4
New Zealand 2.6 1.7 3.4 1.6 1.5 3.2
Norway 2.7 2.2 1.3 1.1 2.3 2.7
Poland 4.0 2.7 3.9 3.9 3.0 2.7
Portugal -0.9 1.4 3.6 2.9 0.8 1.8
Romania 5.6 6.1 5.8 3.7 5.6 1.4
Russia 11.7 6.9 8.4 5.8 6.6 4.7
South Africa 6.5 4.0 5.0 5.2 4.8 4.3
S. Korea 2.8 2.9 4.0 2.3 2.4 2.8
Slovakia 0.9 0.7 4.1 3.6 3.6 4.0
Slovenia 0.9 2.1 2.1 2.3 1.8 1.4
Spain -0.2 2.0 3.1 2.7 3.4 2.3
Sweden 1.9 1.9 1.4 1.2 1.8 1.6
Switzerland -0.5 0.7 0.5 0.4 0.8 2.6
Taiwan -1.2 0.6 0.8 1.2 1.8 2.1
U K 2.2 3.3 4.5 2.5 1.5 1.9
US 0.2 1.8 2.5 2.1 2.1 2.2
Euro Area 0.3 1.6 2.7 2.7 2.2 2.1
EU-27 1.0 2.1 3.1 2.8 2.2 2.2
OECD 0.3 1.7 2.3 2.0 2.0 2.1
World 2.8 4.1 5.2 4.4 3.8 3.2

Notes: (a) Harmonised consumer price inflation in the EU economies
and inflation measured by the consumer expenditure deflator in the
rest of the world.

Table B2. Fiscal balance and government debt

 Fiscal balance (per cent of GDP) (a)

 2009 2010 2011 2012 2013 2018

Australia -4.5 -4.7 -3.9 -2.8 -1.7 -1.2
Austria -4.1 -4.5 -2.6 -2.5 -2.1 -1.6
Belgium -5.7 -3.9 -3.9 -3.1 -2.8 -2.1
Bulgaria -4.3 -3.1 -2.1 -1.4 -0.4 -0.9
Canada -4.9 -5.5 -4.4 -3.4 -2.8 -1.6
Czech Republic -5.8 -4.8 -3.1 -3.7 -3.8 -3.1
Denmark -2.7 -2.5 -1.8 -3.3 -2.3 -2.2
Estonia -2.0 0.2 1.0 0.9 0.4 -0.9
Finland -2.7 -2.9 -0.9 -0.1 0.2 -0.9
France -7.5 -7.1 -5.2 -4.6 -4.3 -2.3
Germany -3.2 -4.3 -1.0 -0.5 0.0 -0.9
Greece -15.6 -10.5 -9.1 -7.5 -7.1 -2.5
Hungary -4.5 -4.3 4.2 -3.2 -2.8 -1.1
Ireland -14.0 -31.2 (c) -13.0 -9.2 -8.7 -3.0
Italy -5.4 -4.6 -3.9 -2.3 -1.6 -1.8
Japan -8.8 -8.4 -9.5 -9.4 -8.6 -5.5
Lithuania -9.4 -7.2 -5.5 -4.0 -3.4 -1.6
Latvia -9.9 -8.2 -3.5 -2.3 -2.4 -1.2
Netherlands -5.5 -5.0 -4.6 -4.1 -3.2 -2.1
Poland -7.4 -7.8 -5.1 -3.0 -2.7 -1.7
Portugal -10.2 -9.8 -4.2 -4.5 -3.8 -1.2
Romania -9.0 -6.8 -5.2 -3.3 -2.4 -1.7
Slovakia -8.0 -7.7 -4.8 -3.4 -2.4 0.0
Slovenia -6.1 -6.0 -6.4 -5.6 -4.6 -0.9
Spain -11.2 -9.3 -8.5 -7.1 -6.0 -1.9
Sweden -0.7 0.3 0.3 0.2 0.5 -0.6
UK -11.5 -10.2 -8.2 -7.2 (d) -8.5 -1.6
US -11.6 -10.7 -9.7 -8.0 -7.0 -5.1

 Government debt (per cent of GDP, end year) (b)

 2009 2010 2011 2012 2013 2018

Australia 22.1 28.0 30.7 32.1 32.2 29.0
Austria 69.6 71.8 72.2 72.6 69.7 60.7
Belgium 95.7 96.0 98.1 98.7 96.1 87.4
Bulgaria -- -- -- -- -- --
Canada 80.5 82.1 82.1 82.2 81.6 73.4
Czech Republic 34.4 38.1 41.2 44.7 47.6 55.4
Denmark 40.6 42.9 46.5 48.5 48.8 50.3
Estonia -- -- -- -- -- --
Finland 43.5 48.4 48.6 48.9 48.3 46.7
France 79.3 82.7 86.2 88.7 90.5 90.4
Germany 74.4 83.0 81.2 79.6 77.2 67.7
Greece 129.4 145.0 165.4 163.9 173.7 130.6
Hungary 79.8 81.4 80.6 78.8 74.1 62.1
Ireland 65.1 92.5 108.2 116.3 119.7 119.6
Italy 116.0 118.7 120.0 122.9 121.9 109.4
Japan 187.5 193.0 205.0 211.0 216.8 223.5
Lithuania -- -- -- -- -- --
Latvia -- -- -- -- -- --
Netherlands 60.7 62.9 65.1 69.1 69.2 65.5
Poland 50.9 54.8 56.3 55.1 55.9 52.4
Portugal 83.1 93.4 107.8 113.3 116.5 105.7
Romania -- -- -- -- -- --
Slovakia -- -- -- -- -- --
Slovenia -- -- -- -- -- --
Spain 53.9 61.2 68.5 82.4 87.9 81.9
Sweden 42.6 39.4 38.4 37.8 35.9 30.4
UK 67.8 75.6 82.5 88.0 94.1 93.5
US 88.7 96.8 101.2 105.6 108.0 108.2

Notes: (a) General government financial balance; Maastricht
definition for EU countries. (b) Maastricht definition for EU
countries. (c) The deficit for Ireland in 2010 includes outlay on
bank recapitalisation amounting to 20 per cent of GDP. The outlays
are in the form of promissory notes and do not require upfront
financing. (d) Includes the impact of the transfer of the Royal Mail
pension fund to central government in April 2012.

Table B3. Unemployment and current account balance

 Standardised unemployment rate

 2009 2010 2011 2012 2013 2014-18

Australia 5.6 5.2 5.1 5.5 5.9 4.5
Austria 4.8 4.4 4.1 4.1 3.9 4.5
Belgium 7.9 8.3 7.2 7.3 6.9 7.2
Bulgaria 6.9 10.2 11.3 11.6 8.9 8.1
Canada 8.3 8.0 7.5 7.2 7.0 6.7
China -- -- -- -- -- --
Czech Rep. 6.7 7.3 6.7 6.7 6.8 7.5
Denmark 6.1 7.4 7.6 7.6 7.5 7.0
Estonia 13.8 16.8 12.4 11.0 10.2 9.5
Finland 8.1 8.4 7.8 7.8 7.9 6.5
France 9.5 9.8 9.7 10.1 10.3 9.9
Germany 7.8 7.1 5.9 5.9 5.9 5.8
Greece 9.5 12.6 17.7 22.1 24.0 21.3
Hungary 10.0 11.1 10.9 11.1 12.1 12.0
Ireland 11.9 13.7 14.5 15.1 15.6 13.2
Italy 7.8 8.4 8.4 10.3 11.0 8.9
Japan 5.1 5.1 4.6 4.3 4.5 4.3
Lithuania 13.7 17.8 15.4 14.7 14.3 13.9
Latvia 18.1 19.8 16.3 15.4 14.3 12.7
Netherlands 3.7 4.5 4.4 5.2 5.7 4.4
Poland 8.2 9.6 9.7 9.8 9.7 8.4
Portugal 10.6 12.1 12.9 15.4 16.2 11.5
Romania 6.8 7.3 7.4 7.0 6.5 6.4
Slovakia 12.1 14.5 13.6 13.4 12.3 10.7
Slovenia 5.9 7.3 8.2 8.2 7.9 7.6
Spain 18.0 20.1 21.6 24.9 26.8 17.8
Sweden 8.3 8.4 7.5 7.5 6.4 6.7
UK 7.6 7.9 8.1 8.2 8.5 6.9
US 9.3 9.6 8.9 8.0 7.3 6.3

 Current account balance (per cent of GDP)

 2009 2010 2011 2012 2013 2014-18

Australia -4.3 -2.9 -2.3 -5.1 -4.2 -3.1
Austria 2.7 3.1 1.9 1.2 3.2 5.2
Belgium -1.6 1.4 -0.8 -4.0 -3.0 0.0
Bulgaria -10.1 -1.1 1.2 -8.9 -3.0 -2.4
Canada -3.0 -3.1 -2.8 -2.3 -2.2 -1.8
China 5.6 5.7 3.0 3.7 4.8 3.1
Czech Rep. -2.4 -3.9 -2.9 -3.7 -6.5 -8.1
Denmark 3.3 5.5 6.6 3.9 2.4 0.4
Estonia 3.7 3.0 2.2 -6.0 -2.9 -2.5
Finland 1.8 1.4 -0.7 -2.8 -1.8 -1.3
France -1.5 -1.7 -2.2 -1.0 -1.3 -1.8
Germany 5.9 6.0 5.7 6.7 6.7 5.2
Greece -11.1 -10.1 -9.8 -4.4 -2.4 1.9
Hungary -0.2 1.2 1.4 0.5 5.6 2.1
Ireland -2.9 0.5 0.1 -0.3 1.3 2.8
Italy -2.0 -3.5 -3.3 -2.4 -2.0 -0.5
Japan 2.9 3.7 2.0 1.1 1.2 1.8
Lithuania 4.6 1.5 -1.5 -7.7 -6.6 -7.3
Latvia 9.4 3.3 -1.3 -4.8 -6.7 -11.6
Netherlands 4.1 7.0 9.1 12.9 12.0 12.3
Poland -4.0 -4.7 -4.3 -2.7 -2.4 -3.7
Portugal -10.9 -10.0 -6.4 -2.6 -1.1 0.9
Romania -5.9 -6.4 -6.4 -4.7 -1.2 1.4
Slovakia 1.6 -4.6 -0.1 0.5 -0.6 -1.9
Slovenia -1.3 -0.8 -1.1 -1.7 1.5 4.8
Spain -4.8 -4.5 -3.5 -0.1 -0.1 -1.1
Sweden 7.4 6.6 7.1 6.8 6.7 7.8
UK -1.3 -2.5 -1.9 -1.9 -1.4 -0.9
US -2.7 -3.0 -3.1 -3.0 -2.4 -2.5

Table B4. United States Percentage change

 2008 2009 2010 2011

GDP -0.3 -3.5 3.0 1.7

Consumption -0.6 -1.9 2.0 2.2
Investment: housing -23.9 -22.2 -4.3 -1.3
 : business -0.8 -17.9 4.4 8.8
Government: consumption 2.2 2.0 0.9 -1.2
 : investment 4.6 0.3 -0.3 -6.7
Stockbuilding (a) -0.5 -0.8 1.6 -0.2
Total domestic demand -1.5 -4.5 3.4 1.7

Export volumes 6.1 -9.4 11.3 6.7
Import volumes -2.7 -13.6 12.5 4.9

Average earnings 3.9 2.7 1.9 2.0
Private consumption deflator 3.3 0.2 1.8 2.5
RPDI 2.7 -2.2 2.2 1.4
Unemployment, % 5.8 9.3 9.6 8.9

General Govt. balance as % of GDP -6.6 -11.6 -10.7 -9.7
General Govt. debt as % of GDP (b) 77.1 88.7 96.8 101.2

Current account as % of GDP -4.7 -2.7 -3.0 -3.1

 Average
 2012 2013 2014-18

GDP 2.0 2.1 2.9

Consumption 1.9 1.7 2.0
Investment: housing 8.4 5.2 10.1
 : business 6.6 5.2 7.3
Government: consumption -1.3 1.2 1.9
 : investment -3.9 1.2 2.1
Stockbuilding (a) 0.1 0.0 0.0
Total domestic demand 2.0 2.1 2.9

Export volumes 4.3 5.4 5.4
Import volumes 3.7 4.9 4.8

Average earnings 1.4 3.2 3.5
Private consumption deflator 2.1 2.1 2.2
RPDI 0.7 1.8 2.2
Unemployment, % 8.0 7.3 6.3

General Govt. balance as % of GDP -8.0 -7.0 -5.6
General Govt. debt as % of GDP (b) 105.6 108.0 109.0

Current account as % of GDP -3.0 -2.4 -2.5

Note: (a) Change as a percentage of GDP. (b) End-of-year basis.

Table B5. Canada Percentage change

 2008 2009 2010 2011 2012

GDP 0.7 -2.8 3.2 2.4 2.2

Consumption 3.0 0.4 3.3 2.4 2.0
Investment: housing -3.2 -8.0 10.2 2.3 7.4
 : business 2.6 -20.5 8.5 12.9 4.9
Government: consumption 4.4 3.6 2.4 0.8 0.2
investment 7.7 8.8 17.9 -3.1 -8.3
Stockbuilding (a) -0.2 -0.8 0.7 0.3 -0.3
Total domestic demand 2.7 -2.9 5.3 3.4 1.7

Export volumes -4.7 -13.8 6.4 4.6 6.0
Import volumes 1.5 -13.4 13.1 7.0 4.1

Average earnings 2.6 2.1 2.6 2.9 2.5
Private consumption deflator 1.6 0.5 1.3 2.0 1.8
RPDI 4.1 0.9 3.5 1.2 1.3
Unemployment, % 6.2 8.3 8.0 7.5 7.2

General Govt. balance as % of GDP -0.4 -4.9 -5.5 -4.4 -3.4
General Govt. debt as % of GDP (b) 72.7 80.5 82.1 82.1 82.2
Current account as % of GDP 0.3 -3.0 -3.1 -2.8 -2.3

 Average
 2013 2014-18

GDP 2.1 2.5

Consumption 2.4 2.4
Investment: housing 7.2 7.3
 : business 6.1 3.3
Government: consumption -0.5 2.1
investment 0.0 2.2
Stockbuilding (a) 0.0 0.0
Total domestic demand 2.6 2.8

Export volumes 5.0 5.0
Import volumes 5.2 4.9

Average earnings 3.2 4.2
Private consumption deflator 2.2 1.8
RPDI 1.9 2.8
Unemployment, % 7.0 6.7

General Govt. balance as % of GDP -2.8 -1.8
General Govt. debt as % of GDP (b) 81.6 76.9
Current account as % of GDP -2.2 -1.8

Note: (a) Change as a percentage of GDP. (b) End-of-year basis.

Table B6. Japan Percentage change

 2008 2009 2010 2011 2012

GDP -1.1 -5.5 4.5 -0.7 2.3

Consumption -0.9 -0.7 2.6 0.1 1.5
Investment: housing -7.0 -16.3 -4.5 5.4 1.2
 : business -2.9 -14.3 0.9 1.0 2.8
Government: consumption -0.1 2.3 2.1 1.9 1.8
 : investment -7.6 7.8 -0.1 -3.0 6.0
Stockbuilding (a) 0.2 -1.5 0.7 -0.4 0.6
Total domestic demand -1.3 -3.8 2.7 0.1 2.5
Export volumes 1.6 -24.4 24.4 -0.2 5.0
Import volumes 0.4 -15.8 11.1 5.9 6.9
Average earnings 1.3 -0.4 -1.1 0.5 -1.5
Private consumption deflator 0.3 -2.5 -1.7 -1.1 -0.3
RPDI -1.2 1.4 2.1 0.9 1.0
Unemployment, % 4.0 5.1 5.1 4.6 4.3
Govt. balance as % of GDP -1.9 -8.8 -8.4 -9.5 -9.4
Govt. debt as % of GDP (b) 175.5 187.5 193.0 205.0 211.0
Current account as % of GDP 3.3 2.9 3.7 2.0 1.1

 Average
 2013 2014-18

GDP 1.2 1.4
Consumption 1.1 0.7
Investment: housing 3.0 3.0
 : business 3.7 4.2
Government: consumption 0.2 0.8
 : investment -6.0 0.4
Stockbuilding (a) 0.2 0.0
Total domestic demand 1.2 1.2
Export volumes 5.3 5.2
Import volumes 6.4 4.6
Average earnings 0.3 1.5
Private consumption deflator -0.3 0.4
RPDI 0.6 0.3
Unemployment, % 4.5 4.3
Govt. balance as % of GDP -8.6 -6.5
Govt. debt as % of GDP (b) 216.8 223.1
Current account as % of GDP 1.2 1.8

Note: (a) Change as a percentage of GDP. (b) End-of-year basis.

Table B7. Euro Area Percentage change

 2008 2009 2010 2011 2012

GDP 0.3 -4.4 1.9 1.5 -0.4

Consumption 0.4 -1.1 0.9 0.2 -0.4
Private investment -1.6 -14.3 0.2 2.4 -3.5
Government: consumption 2.3 2.6 0.7 -0.3 -0.8
 : investment 0.6 1.1 -3.9 -2.2 -4.3
Stockbuilding (a) -0.1 -0.9 0.7 0.1 -0.4
Total domestic demand 0.3 -3.7 1.2 0.5 -1.5

Export volumes 0.8 -12.7 11.0 6.3 1.8
Import volumes 0.7 -11.4 9.4 4.1 -1.0

Average earnings 3.1 2.1 0.7 1.9 1.5
Harmonised consumer prices 3.3 0.3 1.6 2.7 2.7
RPDI 0.8 0.4 -0.1 -0.4 -1.3
Unemployment, % 7.7 9.6 10.1 10.2 11.3

Govt. balance as % of GDP -2.1 -6.4 -6.2 -4.1 -3.2
Govt. debt as % of GDP (b) 70.1 79.9 85.3 87.2 92.4
Current account as % of GDP -1.6 -0.2 -0.1 0.0 1.6

 Average
 2013 2014-18

GDP 0.5 1.6

Consumption -0.1 0.9
Private investment 0.8 3.3
Government: consumption -0.5 1.3
 : investment -2.1 2.8
Stockbuilding (a) 0.0 0.0
Total domestic demand -0.1 1.4

Export volumes 2.9 3.7
Import volumes 1.8 3.8

Average earnings 2.3 2.8
Harmonised consumer prices 2.2 2.1
RPDI -0.2 1.3
Unemployment, % 11.8 9.7

Govt. balance as % of GDP -2.6 -1.9
Govt. debt as % of GDP (b) 92.2 87.9
Current account as % of GDP 1.9 1.8

Note: (a) Change as a percentage or GDP. (b) End-of-year basis.
Maastricht definition,

Table B8. Germany Percentage change

 2008 2009 2010 2011 2012

GDP 0.8 -5.1 3.6 3.1 0.8
Consumption 0.5 0.0 0.6 1.3 2.0
Investment: housing -4.2 -2.3 3.2 6.4 1.9
 : business 2.6 -16.9 7.2 7.5 1.4
Government: consumption 3.1 3.3 1.7 1.1 1.0
 : investment 5.1 5.6 -1.9 1.0 -5.1
Stockbuilding(a) 0.0 -1.0 0.7 0.3 -0.5
Total domestic demand 1.1 -2.6 2.4 2.6 1.1
Export volumes 2.1 -13.6 13.4 8.4 1.0
Import volumes 3.0 -9.2 11.5 7.9 1.7
Average earnings 2.3 2.9 0.4 2.6 1.9
Harmonised consumer prices 2.7 0.2 1.2 2.5 2.3
RPDI 1.4 -0.8 0.8 1.0 2.9
Unemployment, % 7.5 7.8 7.1 5.9 5.9
Govt. balance as % of GDP -0.1 -3.2 -4.3 -1.0 -0.5
Govt. debt as % of GDP (b) 66.3 74.4 83.0 81.2 79.6
Current account as % of GDP 6.2 5.9 6.0 5.7 6.7

 Average
 2013 2014-18

GDP 1.7 1.3
Consumption 2.0 1.6
Investment: housing 3.5 4.0
 : business 3.3 1.5
Government: consumption 1.3 1.2
 : investment -0.7 2.7
Stockbuilding(a) 0.0 0.0
Total domestic demand 2.0 1.6
Export volumes 2.2 4.0
Import volumes 3.0 5.0
Average earnings 3.0 3.5
Harmonised consumer prices 2.1 2.4
RPDI 1.2 1.4
Unemployment, % 5.9 5.8
Govt. balance as % of GDP 0.0 -0.3
Govt. debt as % of GDP (b) 77.2 70.8
Current account as % of GDP 6.7 5.2

Note: (a) Change as a percentage of GDP. (b) End-of-year basis;
Maastricht definition.

Table B9. France Percentage change

 2008 2009 2010 2011 2012

GDP -0.2 -3.1 1.6 1.7 0.2

Consumption 0.2 0.2 1.4 0.2 0.0
Investment: housing -3.2 -12.1 -0.3 3.2 1.0
 : business 2.6 -12.9 4.4 5.1 -0.9
Government: consumption 1.2 2.6 1.7 0.2 0.7
 : investment -3.2 2.5 -8.2 -1.9 0.4
Stockbuilding (a) -0.3 -1.2 0.5 0.9 -0.6
Total domestic demand 0.2 -2.6 1.9 1.7 -0.5

Export volumes -0.6 -11.8 9.2 5.5 2.7
Import volumes 0.6 -9.5 8.4 5.2 -0.8

Average earnings 2.3 1.9 1.5 2.9 2.9
Harmonised consumer prices 3.2 0.1 1.7 2.3 2.6
RPDI 0.3 1.8 1.3 1.1 -0.2
Unemployment, % 7.8 9.5 9.8 9.7 10.1

Govt. balance as % of GDP -3.3 -7.5 -7.1 -5.2 -4.6
Govt. debt as % of GDP (b) 68.3 79.3 82.7 86.2 88.7

Current account as % of GDP -1.7 -1.5 -1.7 -2.2 -I.0

 Average
 2013 2014-18

GDP 0.7 1.9

Consumption 0.5 1.3
Investment: housing 2.1 4.7
 : business 1.5 2.9
Government: consumption 0.2 1.4
 : investment -1.1 1.5
Stockbuilding (a) -0.2 0.0
Total domestic demand 0.3 1.7

Export volumes 2.7 4.7
Import volumes 1.3 3.8

Average earnings 2.3 2.5
Harmonised consumer prices 1.7 1.5
RPDI 0.8 1.4
Unemployment, % 10.3 9.9

Govt. balance as % of GDP -4.3 -3.1
Govt. debt as % of GDP (b) 90.5 91.6

Current account as % of GDP -1.3 -1.8

Note: (a) Change as a percentage of GDP.
(b) End-of-year basis; Maastricht definition.

Table B10. Italy Percentage change

 2008 2009 2010 2011 2012

GDP -1.2 -5.5 1.8 0.5 -1.8

Consumption -0.8 -1.6 1.2 0.2 -2.9
Consumption -1.3 -8.4 -2.1 -2.3 -7.7
Investment: housing -4.8 -15.3 5.4 -0.1 -10.0
 : business 0.6 0.8 -0.6 -0.9 -0.9
Government: consumption -5.4 -3.3 -5.9 -5.1 -14.0
 : investment 0.0 -1.3 1.3 -0.6 -0.4
Total domestic demand -1.2 -4.4 2.2 -0.8 -4.1

Export volumes -2.8 -17.7 11.4 6.3 0.4
Import volumes -2.9 -13.6 12.4 1.0 -7.4

Average earnings 3.8 1.7 1.6 0.2 -1.0
Harmonised consumer prices 3.5 0.8 1.6 2.9 3.3
RPDI -1.3 -3.0 -0.8 -0.5 -4.1
Unemployment, % 6.8 7.8 8.4 8.4 10.3

Govt. balance as % of GDP -2.7 -5.4 -4.6 -3.9 -2.3
Govt. debt as % of GDP (b) 105.8 116.0 118.7 120.0 122.9

Current account as % of GDP -2.9 -2.0 -3.5 -3.3 -2.4

 Average
 2013 2014-18

GDP -0.9 0.9

Consumption -2.1 -0.6
Consumption -3.2 0.2
Investment: housing -0.1 3.3
 : business -1.1 0.7
Government: consumption -4.6 7.7
 : investment 0.3 0.0
Total domestic demand -1.6 0.3

Export volumes 1.6 3.2
Import volumes -1.0 1.6

Average earnings 0.5 2.3
Harmonised consumer prices 2.4 2.2
RPDI -1.6 0.4
Unemployment, % 11.0 8.9

Govt. balance as % of GDP -1.6 -1.8
Govt. debt as % of GDP (b) 121.9 114.4

Current account as % of GDP -2.0 -0.5

Note: (a) Change as a percentage of GDP.
(b) End-of-year basis; Maastricht definition.

Table B11. Spain Percentage change

 2008 2009 2010 2011 2012

GDP 0.9 -3.7 -0.1 0.7 -1.8

Consumption -0.6 -4.3 0.8 -0.1 -1.0
Investment: housing -9.1 -22.1 -9.9 -4.9 -11.7
 : business -0.4 -14.8 -4.3 -7.5 -15.6
Government: consumption 5.9 3.7 0.2 -2.2 -7.1
 : investment 2.5 1.5 0.3 -0.1 -0.1
Stockbuilding (a) 0.1 0.0 0.0 0.0 0.0
Total domestic demand -0.5 -6.2 -1.0 -1.7 -4.5

Export volumes -1.0 -10.4 13.5 9.0 2.2
Import volumes -5.2 -17.2 8.9 -0.1 -7.1

Average earnings 6.0 4.5 -0.1 0.7 -0.6
Harmonised consumer prices 4.1 -0.2 2.0 3.1 2.7
RPDI 2.6 3.9 -2.1 -3.1 -6.4
Unemployment, % 11.4 18.0 20.1 21.6 24.9

Govt. balance as % of GDP -4.5 -I 1.2 -9.3 -8.5 -7.1
Govt. debt as % of GDP (b) 40.2 53.9 61.2 68.5 82.4

Current account as % of GDP -9.6 -4.8 -4.5 -3.5 -0.1

 Average
 2013 2014-18

GDP -1.2 2.3

Consumption -1.9 0.6
Investment: housing -9.6 5.6
 : business -2.9 9.9
Government: consumption -4.5 4.0
 : investment -1.2 2.7
Stockbuilding (a) 0.0 0.0
Total domestic demand -3.1 2.6

Export volumes 7.3 3.7
Import volumes 1.6 4.8

Average earnings 0.6 2.6
Harmonised consumer prices 3.4 2.3
RPDI -4.1 2.2
Unemployment, % 26.8 17.8

Govt. balance as % of GDP -6.0 -2.8
Govt. debt as % of GDP (b) 87.9 86.4

Current account as % of GDP -0.1 -1.1

Note: (a) Change as a percentage of GDP.
(b) End-of-year basis; Maastricht definition.

ACKNOWLEDGEMENTS

We would like to thank E. Philip Davis, Simon Kirby and Jonathan Portes for helpful comments.

This forecast was completed on 25 July, 2012.

Exchange rate, interest rates and equity price assumptions are based on information available to 10 July 2012. Unless otherwise specified, the source of all data reported in tables and figures is the NiGEM database and NIESR forecast baseline.

REFERENCES

Bundesbank (2012), Monthly Report, 64, 5, May.

Buiter, W.H. and Rahbari, E. (2012), 'The ECB as lender of last resort for sovereigns in the Euro Area', CEPR Discussion Paper No. 8974

Coudert, V., Couharde, C. and Mignon, V. (2012), 'On currency misalignments in the Euro Area', CEPII Working Paper No. 2012-07.

Holland, D., Kirby, S. and Orazgani, A. (2011), 'Modelling the sovereign debt crisis in Europe', National Institute Economic Review, 217, pp. F37-F45.

IMF (2012), India: Staff report for the 2012 Article IV consultation.

Tarr, D. and Volchkova, N. (2010), 'Russian trade and foreign direct investment policy at the crossroads', World Bank, Policy Research Working Paper 5255.

NOTES

(1) Of course simple redenomination will not be as clearcut as suggested here, due to cross-border holdings and multinational corporations, which would no doubt lead to protracted legal disputes.

(2) Some of these policies, such as what are know as the Bush Tax cuts, have been in place since 200 I, and so to describe them as temporary may be misleading.

(3) Foreign claims are on consolidated - ultimate risk basis by domestically owned banks. End of year quarter foreign claims are divided by Japan's GDP in a corresponding year, GDP is converted to US dollars by applying end of year exchange rates.

(4) Regional outlook, Asia and Pacific Managing Spillovers and Advancing Economic Rebalancing, IMF 04/2012.

(5) IMF Survey Magazine: Countries & Regions, 2012.

(6) See I MF (2012) and selected issues paper for a summary of the literature.

(7) Based on 2010 GDP.

Table 1. Forecast summary Percentage change

 Real GDP (a)

 World OECD China EU-27 Euro USA Japan
 Area

2008 2.8 0.1 9.8 0.2 0.3 -0.3 -1.1
2009 -0.6 -3.8 9.0 -4.3 -4.4 -3.5 -5.5
2010 5.3 3.2 10.4 2.0 1.9 3.0 4.5
2011 3.9 1.8 9.3 1.6 1.5 1.7 -0.7
2012 3.3 1.4 7.8 0.0 -0.4 2.0 2.3
2013 3.7 1.7 7.8 0.9 0.5 2.1 1.2
2002-07 4.4 2.6 10.8 2.3 2.0 2.6 1.6
14-18 4.1 2.4 7.0 1.8 1.6 2.9 1.4

 Private consumption deflator

 OECD Euro USA Japan Germany France Italy
 Area

2008 2.9 2.7 3.3 0.3 1.7 3.0 3.1
2009 0.3 -0.4 0.2 -2.5 0.1 -0.7 -0.1
2010 1.7 1.7 1.8 -1.7 1.9 1.1 1.5
2011 2.3 2.5 2.5 -1.1 2.1 2.1 2.7
2012 2.0 2.3 2.1 -0.3 1.9 2.2 2.4
2013 2.0 2.3 2.1 -0.3 2.3 1.7 2.4
2002-07 1.9 2.1 2.4 -0.8 1.3 1.8 2.5
20 14-18 2.1 2.1 2.2 0.4 2.4 1.5 2.2

 Real GDP (a)
 World
 trade (b)
 Germany France Italy UK Canada

2008 0.8 -0.2 -1.2 -1.0 0.7 2.9
2009 -5.1 -3.1 -5.5 -4.0 -2.8 -10.7
2010 3.6 1.6 1.8 1.8 3.2 12.6
2011 3.1 1.7 0.5 0.8 2.4 5.7
2012 0.8 0.2 -1.8 -0.5 2.2 4.1
2013 1.7 0.7 -0.9 1.3 2.1 5.8
2002-07 1.4 1.8 1.2 3.0 2.7 8.0
14-18 1.3 1.9 0.9 2.6 2.5 5.3

 Private
 consumption
 deflator Interest rates (c) Oil
 ($ per
 UK Canada USA Japan Euro barrel)
 Area (d)

2008 3.4 1.6 2.1 0.5 3.9 95.7
2009 1.4 0.5 0.3 0.1 1.3 61.8
2010 3.7 1.3 0.3 0.1 1.0 78.8
2011 4.5 2.0 0.3 0.1 1.2 108.5
2012 1.9 1.8 0.3 0.1 0.9 106.1
2013 1.4 2.2 0.4 0.1 0.8 99.5
2002-07 2.0 1.6 2.9 0.2 2.7 45.6
20 14-18 1.9 1.8 1.8 0.2 1.7 110.1

Notes: Forecast produced using the NiGEM model. (a) GDP growth at
market prices. Regional aggregates are based on PPP shares.
(b) Trade in goods and services. (c) Central bank intervention
rate, period average. (d) Average of Dubai and Brent spot
prices.