Prospects for individual economies.

Holland, Dawn ; Barrell, Ray ; Delannoy, Aurelie 等

United States

Our estimates indicate that the US economy regained pre-crisis levels of output in the final quarter of 2010, with a full recovery in the levels of consumer spending as well as both exports and imports (see figure 2 above). Investment and inventory levels, however, remain well below pre-crisis levels, offset by higher government spending. The pace of recovery moderated in the second and third quarters of 2010, when annualised growth averaged 2.1 per cent per quarter, somewhat below potential. However, the slowdown was more a reflection of a recovery in import penetration and correction to the level of world trade than a sign of global slump. Domestic demand expanded at an average annualised rate of 4.7 per cent per quarter, pulling in imports and allowing the net trade position to worsen. In the final quarter of the year import growth appears to have moderated, and we expect the current account balance to have stabilised at 3 1/2 per cent of GDP. We estimate that GDP expanded by 2.9 per cent in 2010 as a whole.

The outlook for 2011 reflects the negative impact of higher oil prices on the economy, which are expected to reduce growth by 0.6 percentage points, as discussed by Barrell, Delannoy and Holland elsewhere in this Review. This is largely offset by the additional fiscal and monetary stimulus introduced at the end of 2010. The Federal Reserve introduced a new round of quantitative easing in November 2010 (QE2), in response to the rise in long-term interest rates, weaker GDP growth and little evidence of import prices stoking inflation. Our estimates suggest that the stimulative impact of QE2 is comparable to a 1 point cut in short-term interest rates, although actual interest rates remain restrained by the zero lower bound (see Barrell, Delannoy and Holland in this Review). This was followed by an agreement to prolong expiring tax cuts and extended unemployment benefits into 2011, which can be expected to boost consumer spending this year. We forecast consumer spending growth of 3 per cent this year, moderating to 2 1/4 per cent in 2012 as the stimulus is withdrawn.

We forecast GDP growth of 2.6 per cent this year and 2.7 per cent in 2012. While these rates of growth are probably somewhat above potential, they are unlikely to be sufficient to see a significant decline in the unemployment rate, which stood at 9.4 per cent in December. Average hours of work are still below pre-crisis levels, so there is scope for firms to increase labour input without taking on the added costs and commitment of additional staff. The collapse of the US construction sector leaves the economy with a mismatch of skills. The construction sector has declined from 5.7 per cent of total employment in 2006 to 4.3 per cent in 2010, reflecting a loss of 2 million jobs, as illustrated in figure 7. In addition to a skills mismatch, the US economy suffers from a location mismatch. Labour mobility is hampered by the 20 per cent of homeowners with negative equity in their homes. Given these new rigidities, the unemployment rate is not expected to fall below 9 per cent until the second half of 2012.

The high unemployment rate has held back inflation, despite the rise in commodity prices, a weaker exchange rate and the economic stimulus programmes. The year-on-year rise in the consumer expenditure deflator decelerated to just 1.1 per cent in the final quarter of 2010. We forecast some rise in inflation in 2011, to 2.2 per cent. Over the medium term, US inflation is expected to exceed that in Canada and Europe, reflecting the weaker dollar and the looser approach to inflation targeting recently discussed by the Federal Reserve.

[FIGURE 7 OMITTED]

Canada

Canada's exports are highly dependent on US consumption and dropped by 14.2 per cent in 2009 as US consumption declined. This decrease of exports was a major contribution to the GDP decline of 2 1/2 per cent in that year. The recovery in US consumption last year supported a revival in Canadian exports, which rose by an estimated 6 per cent in volume terms. The value of exports rose by more than 20 per cent, reflecting the sharp appreciation of the Canadian dollar and the rise in the oil price at the end of the year. We expect export volumes to rise by a further 6 per cent in 2011, with more moderate rates of growth forecast in subsequent years.

The Canadian dollar is a commodity-linked currency. The effective exchange rate is highly correlated with the movement of oil prices, as illustrated in figure 8. The recent rise in the oil price and exchange rate will raise the income from exports in value terms, allowing the current account to approach balance by 2012.

With the expectation of growing export volumes and strong private consumption, we forecast the Canadian economy to expand by about 2.6-2.7 per cent per annum between 2011 and 2017. The steady expansion of the economy will facilitate job creation and the unemployment rate is expected to return to a pre-recession level of about 6 per cent by 2013. The budget deficit in 2010 is estimated to have widened to 5 per cent of GDP. However, the gradual withdrawal of fiscal stimulus will allow the deficit to decline to 4.3 per cent of GDP in 2011 and 3.7 per cent in 2012.

[FIGURE 8 OMITTED]

Mexico and Brazil

Output in Brazil stood 5 per cent above its pre-crisis peak level in the third quarter of 2010, while the level of output in Mexico remained 1.5 per cent below pre-crisis levels (see figure 9). Rapid growth in Brazil has been supported by the rise in commodity prices and an expansionary fiscal policy, with domestic demand up 8.3 per cent relative to pre-crisis levels. Mexico is far more reliant on the US economy, as over 80 per cent of Mexican exports are sent to the US compared to just over 15 per cent of Brazilian exports. We estimate that output in Mexico increased by 5.4 per cent last year, while Brazil saw growth of 7.8 per cent. The economies are forecast to grow by 4 and 4 3/4 per cent, respectively, this year.

The exchange rates in Brazil and Mexico have both appreciated significantly against the dollar in recent months. The Brazilian appreciation partly reflects the capitalisation programme of the state-owned oil company, while the Mexican appreciation is largely a correction following a sharp depreciation in 2009. Real effective exchange rates have appreciated by more than the nominal exchange rates, reflecting a significant inflation differential relative to their primary trading partners. Brazil recorded annual inflation of about 5 per cent last year and Mexico 4 per cent, compared to a 1.7 per cent average in the OECD economies. We expect that high food prices, the higher oil price and a tight Brazilian labour market will keep inflation above 5 per cent in Brazil and 4 per cent in Mexico this year.

[FIGURE 9 OMITTED]

Japan

Output in Japan expanded by 1.1 per cent in the third quarter of 2010, following strong growth in the first half of the year. The year-on-year growth rate for 2010 as a whole is likely to be about 4 1/2 per cent, one of the fastest rates of growth in the OECD. Nonetheless, the government became concerned about deteriorating prospects as the yen appreciated sharply and price deflation deepened, and two supplemental fiscal packages were introduced in the final quarter of 2010 worth about 1 per cent of GDP, in addition to intervention in foreign exchange markets in September and additional monetary easing measures.

The fiscal multiplier in Japan is relatively large compared to other countries, reflecting both the closed nature of the economy that limits import leakages and price inertia, which allows output to rise with limited impact on the yield curve in the short term. Figure 10 illustrates the expected impact of a fiscal expansion in Japan worth 1 per cent of GDP, with half of the expansion enacted through tax cuts and half through spending increases. GDP rises by 1.1 per cent in the first year, and then gradually falls below base by 2014. The price level is only marginally affected in the first year, but rises by 0.2 per cent in 2012 and slightly further in 2013. Our forecast for Japan should be viewed in light of these factors. We forecast GDP growth of 2.1 per cent this year, receding to 1.4 per cent in 2012 as the impact of the stimulus recedes. The price level is expected to stabilise by the end of this year, with modest inflation of 0.2 per cent forecast for 2012.

[FIGURE 10 OMITTED]

With a gross debt stock expected to exceed 200 per cent of GDP this year, there is some risk that further fiscal expansion will raise pressure on government bond yields, leading to a crisis such as that seen in Greece. However, this would appear to be a remote risk, as bond yields in Japan are among the lowest in the world and have shown little inclination to rise in line with other OECD economies since last August.

In the medium term, GDP growth is unlikely to meet the government target of more than 2 per cent per annum. Labour productivity has averaged about 1.8 per cent per annum in the past decade, while the labour force is expected to decline by about 0.9 per cent per annum over the next decade. While some rise in participation may be possible, labour force participation and average hours of work in Japan are already high by international standards. Even if the unemployment rate were to come down to the targeted rate of 3 per cent, compared to our forecast of 4 per cent, employment would be expected to decline on average over the decade and we are unlikely to see output growth exceeding productivity growth.

China

Consumer price inflation in China is expected to exceed the declared target of 3 per cent this year for the second year running. China is relatively sensitive to global commodity prices, as food prices have a relatively high weight in the consumption basket and it is the world's second largest energy consumer after the US. The energy intensity of purchasing power parity-adjusted production in China is roughly 4 times that in North America. Monetary policy was tightened gradually over the course of 2010. This has been at odds with US monetary policy since August. The modest 2 1/2 per cent rise in the yuan against the dollar over this period has been insufficient to allow an appreciation of the effective exchange rate in China, adding to domestic inflationary pressures. This has intensified pressure from authorities in the US and in emerging economies, such as Brazil, that have experienced strong upward pressure on their exchange rates to allow a more significant realignment of the yuan.

We have argued on several occasions that the impact of a nominal realignment of the exchange rate on current account balances will be short-lived if it is not matched by policies to support domestic demand and raise import penetration (see for example National Institute Economic Review, 212, April 2010, pp. F15-17). The sharp rise in domestic demand in China in 2009, supported by a substantial fiscal stimulus, and a collapse in domestic demand in China's primary trading partners, allowed a painful correction to global imbalances, and China's current account surplus receded from 11.4 per cent of GDP in 2007 to 6 1/2 per cent of GDP in 2009. The current account surplus is expected to have narrowed further last year. The rise in the oil price should continue this trend in 2011, as the higher oil price pushes the value of imports up further this year. China is a highly oil intensive economy and sources about 50 per cent of its oil from abroad. The resulting rise in imports in value terms is unlikely to be matched by either the volume or price of exported goods.

Import penetration in China is also expected to edge up over the next few years. Figure 11 illustrates import penetration ratios in China, compared to those in the US, Japan and Germany. Import penetration in the US and Japan has been fairly stable since 1995, while it has more than doubled in China. Import penetration in China far exceeds that in the US or Japan, but remains significantly below that in Germany, although this largely reflects the high level of intra-Euro Area trade. Strong GDP growth of 9 per cent this year and over 8 per cent in 2012, coupled with a further increase in import penetration, should allow the current account surplus to remain below 5 per cent of GDP until at least 2015.

[FIGURE 11 OMITTED]

Other Asia

Output in Asian economies exceeds pre-crisis levels for the most part. China and India did not suffer declines in output during the global financial crisis, and recovery has been rapid in Taiwan, Hong Kong and Korea, as illustrated in the figure below. Japan is the only major Asian economy where output has yet to regain pre-crisis levels. The recovery in world trade has originated to a large extent in the rapidly expanding economies of Asia. India stands out as having yet to recover import penetration ratios, illustrated by the persistent weakness of imports relative to pre-crisis levels. Thanks to strong domestic demand and exports, we forecast GDP growth of over 7 per cent per annum in India for the next two years, while Hong Kong and Korea should grow by more than 4 1/2 per cent per annum, and Taiwan by 3 3/4 per cent per annum.

Rising commodity prices have intensified inflationary pressures in India in particular, as well as Korea, where price pressures are compounded by low unemployment and a relatively weak exchange rate. The Taiwanese exchange rate has appreciated sharply in effective terms, offsetting the impact of high commodity prices, and inflation is expected to average about 1 per cent per annum over the next several years. Inflation in India averaged nearly 12 per cent last year, and is expected to remain above 10 per cent this year. Inflation in Korea is expected to slightly exceed the central bank's target of 2-4 per cent per annum this year, while inflation in Hong Kong remains moderate and is unlikely to rise much above 2 per cent.

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Australia and New Zealand

We estimate that the Australian economy expanded by 2.6 per cent in 2010 due to strong private consumption and exports. Immense flooding affected large parts of the country in the last weeks of the year. The state most affected by flooding, Queensland, is Australia's major exporter of coal and an important producer of agricultural goods. At a macroeconomic level, the initial negative effect on economic growth in the first quarter of the year is likely to be partly offset by rebuilding and restoration work in the latter part of the year. We have revised our forecast for GDP growth in 2011 down to 2.3 per cent, compared to 3.3 per cent forecast in October 2010, although this slowdown also reflects the impact of a higher oil price. Due to the additional costs of reconstruction and emergency payments to victims, the budget deficit will remain close to 3 per cent of GDP this year.

New Zealand also suffered from a natural disaster in 2010, the Canterbury Earthquake in September. Initially, the earthquake was estimated to have decreased GDP by 0.5 per cent. However, much of this will have been recovered through subsequent reconstruction. New Zealand regained pre-recession levels of output in the second quarter of 2010. Following an estimated economic expansion of 2.1 per cent in 2010 as a whole, we forecast an even stronger recovery in 2011 with an increase of about 3 per cent in GDP.

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Russia

Alongside China, India and Brazil, Russia is regarded as one of the emerging markets that will drive world economic growth in the near future. Following a severe recession in 2009, Russia's economy is estimated to have expanded by 3 1/2 per cent in 2010. Growth was driven by strong domestic demand and growing exports. Russia is one of the world's biggest exporters of oil, natural gas, wood and metals and benefits from the rising demand and increasing prices for raw materials. In 2010, export volumes grew by an estimated 8 1/2 per cent. We predict Russian export volumes to increase by a strong 11.3 per cent in 2011.

The strong performance of Russian exports is particularly impressive in light of the recent loss of competitiveness, as the real effective exchange rate appreciated by 9.4 per cent last year. A rise in the nominal exchange rate has helped reduce the rate of inflation in 2010 to an estimated 6.7 per cent from an average rate of 14 per cent per annum over the previous decade. A recent rise in the unemployment rate limits domestic inflationary pressures, and we forecast inflation of about 5 per cent per annum for the next several years.

South Africa

Following a contraction in 2009, the South African economy is estimated to have expanded by 3.1 per cent in 2010, due to increased domestic demand of 4.1 per cent and a 4.6 per cent rise in export volumes. Real economic growth was supported by a sharp deceleration in inflation, which fell from 7.3 per cent in 2009 to an estimated 3.9 per cent in 2010.

The host nation of the first African Soccer World Cup was very optimistic that it would yield significant economic benefit due to construction and preparation works and the tourism accompanying the event. However, estimates suggest that the tournament raised output by just 0.1 per cent, significantly less than anticipated. The longer-term effects of the World Cup on the South African economy are likely to be positive. The event has put the nation on the map, which could boost tourism, and demonstrated its ability to cope reliably with such a mammoth task of organisation, which could attract more foreign investment. In our forecast, we project GDP growth of 3.6 per cent in 2011 and about 3 per cent per annum for the next several years.

Europe

The recovery in the European Union is proceeding. Its speed, however, remains very uneven across countries. Among old member states the main engine of growth is Germany, which in the third quarter of 2010 recorded growth of 0.7 per cent in quarterly terms. Among new member states Poland grew most rapidly, expanding at a quarterly rate of 1.3 per cent. The weakest member of the Euro Area remained Greece with a quarterly decline of 1.3 per cent, while among the new member states Bulgaria contracted by 0.8 per cent.

At the current juncture Europe is facing two short-term challenges: sizeable budget deficits and rising inflation. One of the crucial long-term challenges, which relates also to the five key targets of the Europe2020 growth strategy for the coming decade, remains maintaining global competitiveness.

Sizeable budgetary consolidations are required in most members of the EU (the only exceptions remain Sweden and Estonia). Members to face the gravest consolidation efforts this year include Ireland, Portugal, Greece and Spain, where consolidation measures worth 2-4 per cent of GDP have been introduced (see Euroframe, 2010). At the Euro Area level, policy measures introduced in 2011 to correct fiscal deficits amount to a fiscal contraction of about 1 1/4 per cent of GDP.

Inflation is rising. The HICP inflation in the Euro Area exceeded the ECB target and settled at 2.2 per cent in December last year. The only countries where inflation remained (only slightly) below 2 per cent are Germany, Cyprus, the Netherlands and Slovakia (and Ireland which is experiencing deflation). Key factors behind the rise in consumer prices are rising oil prices that translate into producer prices, and food prices. The gravest risks may result from a rise of core inflation. Monitoring possible wage-price spirals is thus crucial.

The crisis has left a long-term scar of about 3 per cent on productive capacity in major European economies (see Barrell, 2009). The Europe2020 strategy has recommended a package of structural reforms aimed at improving the functioning of product and labour markets in order to raise employment and productivity and raise the potential growth rate in the medium term. One of the targets of the strategy concerns increasing investment in innovation to 3 per cent of GDP. (3) One of the main long-term challenges for Europe remains maintaining a sufficient level of competitiveness against other global players. Higher public and private expenditures on R&D in the economy, in combination with more efficient use of resources, could make Europe more competitive relative to China and the US, stimulating European exports and contributing to higher growth. Of particular importance remains maintaining competitiveness in the area of high tech production and exports. Figure 14 shows world shares of high tech exports in four major economies: EU-27 (excluding intratrade), US, Japan and China.

The figure shows that since 2001 China has been steadily increasing its share in world trade of high tech products, predominantly at the cost of Japan and the US. The share of EU-27 high tech exports has remained relatively stable. However, the latest data (as of 2006) suggest that the stable trend could have been disturbed.

Trends, as depicted in the figure, may prevail in the years to come. China recently introduced restrictions on the export of rare metals (of which China controls 97 per cent of supply), which are particularly important in high tech production, potentially reflecting an aim to increase their dominance in this area. A good long-term competitiveness policy in Europe is therefore essential to raise medium-term growth prospects.

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Germany

After the crisis the German economy has recovered extraordinarily rapidly. In the third quarter of 2010 the economy expanded by 0.7 per cent in quarterly terms, which marked the sixth consecutive quarter of rapid growth. We forecast that after phenomenal growth of 3.6 per cent recorded in 2010, the German economy will moderate somewhat this year. The rate of the expansion of the economy, at 2.6 per cent, will, however, continue to be above the potential of 1.5-2 per cent per annum.

Exports, the main driver of growth in 2010, are expected to moderate this year. The economic upswing is, however, assumed to maintain momentum. Domestic demand will fuel the recovery in the years to come. Both private consumption and investment growth are expected to accelerate. The scale of decline in consumption during the crisis was much lower than that of GDP, reflecting consumption smoothing, which was supported by a large fiscal stimulus and a strong labour market. The vibrant labour market is projected to continue to boost private consumption.

Investment is expected to rise swiftly adding to the positive trends in domestic demand. The level of capacity utilisation has increased and investors have started to implement projects put on hold during the crisis, as the performance of the economy has turned out to be much better than expected. The key challenge for the economy, which remains the industrial heart of the EU, is to maintain competitiveness in its export markets.

One of the main global competitor of Germany is China, which in 2009 overtook Germany as the world largest exporter of merchandise. Germany is the biggest trade partner of China in Europe and the scale of their bilateral trade has been intensifying. It is worth mentioning that the automobile sector, which suffered severely during the crisis, recovered swiftly due in part to Chinese demand for German cars.

Germany remains a model example of consistent and successful fiscal consolidation. Current plans envisage that Germany will bring down its budget deficit to below 3 per cent of GDP this year, which is a year earlier than the target set by the European Commission (see discussion in the October 2010 Review). Credible consolidation efforts in the biggest member of the Euro Area acts as a positive signal concerning the future of the Euro Area, offsetting difficulties in the Southern European countries.

France

Output growth in France softened in the third quarter of 2010, reaching about 0.3 per cent, after 0.6 per cent in the previous quarter. The current trend in international trade continues to have a detrimental effect on economic growth, despite an acceleration in domestic demand. Imports remain very strong, whilst export growth has weakened, notably as a result of a slowdown in trade with Asian economies. Investment is also on a sluggish path. Housing investment accelerated from 0.2 per cent growth in the second quarter to 0.9 per cent in the third, but compensated only partially for the loss from government and business investments. While the higher oil price will weigh on growth this year, we forecast a modest acceleration in GDP growth from 1 1/2 per cent in 2010 to 1 3/4 per cent in 2011.

In its 2011 budget, the French government hopes to achieve a reduction of the public deficit from 7.7 per cent of GDP in 2010 to 6 per cent in 2011, based on 2 per cent GDP growth. Policies include stabilising public spending, reducing various tax credits, replacing only half of the retired workforce in the public sector, and reforming the state's efficiency. Our estimates for 2011 show that this target may prove challenging. Fiscal tightening across Europe, along with decelerating growth in Asian economies, will limit external demand. Moreover, rising prices of basic commodities such as oil could substantially push inflation and restrain economic growth.

[FIGURE 15 OMITTED]

Italy

The Italian economy slowed in the third quarter of 2010 with output growth of 1/4 per cent. The deceleration primarily reflects a negative contribution of the external sector to growth, due to an increase in import demand. In the third quarter of 2010, import volume growth rose to 4 3/4 per cent while exports volumes grew by 2 3/4 per cent over the same period. However, domestic demand grew by 0.9 per cent in the third quarter and sustained positive growth in output overall. A sharp rise in inventories and modest consumption growth compensated for a contraction in government spending and stagnant investment. Overall we estimate that output rose by I per cent on an annual basis in 2010, while for this year and 2012 we forecast growth of 1 and 1 1/2 per cent, respectively. While domestic demand was the main engine of growth in 2010, external demand is forecast to be the main force behind the modest growth in Italy over the next two years as world trade reverts to its pre-crisis level.

The Italian budget deficit has performed marginally better than the Euro Area average over the past two years. Nevertheless, the government debt stock as a per cent of GDP is one of the highest in Europe, second only to Greek government debt. Figure 16 decomposes the deficit into the primary component and interest payments. The picture is quite distinct from that shown for Spain in figure 17. The primary budget was approximately balanced in 2010, but interest payments account for about 5 per cent of GDE Contagion from the sovereign debt crisis could prove very costly for Italy.

[FIGURE 16 OMITTED]

Spain

Prospects for the Spanish economy are gloomy, given the pressure of the sovereign debt crisis and an unemployment rate of over 20 per cent. Output growth stagnated in the third quarter of 2010, due to weak domestic demand. All components of domestic demand contracted in the third quarter of 2010. Private consumption, the biggest component of domestic demand, contracted by 1 per cent. Government investment and expenditure contracted by 1 1/2 per cent due to austerity measures. Private investment contracted by 2 per cent, due to a further collapse of housing investment. Overall domestic demand contracted by 1 1/2 per cent. We estimate that GDP declined by 1/4 per cent in 2010, while for this year GDP growth is forecast to be 1/2 per cent per annum. The modest expansion in 2011 is mainly attributable to external demand, while domestic demand is expected to continue to contract. Export volume growth is forecast to be 3 3/4 per cent on an annual basis while import volume growth is projected to be 1 per cent in 2011.

The budget deficit in Spain for 2010 is estimated to be 10 1/4 per cent of GDP, the third biggest in Europe. It is expected to revert to 6 per cent of GDP this year as result of tightening fiscal policy. Figure 17 decomposes the budget deficit into the primary balance and interest payments. While the primary deficit is expected to decline rapidly, interest payments are forecast to become an increasing burden on the deficit. Any further rise in government bond spreads over Germany would exacerbate this burden.

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New Member States

The recovery in new member states has gathered speed. We expect that in 2011 on average the EU8+2 block will expand by 3.7 per cent annually. The best performers in the region remain Poland, which came out of the crisis in very good shape and is expected to grow by 4.2 per cent this year, and Slovakia, which, as a small and open economy, gained from an increase in global, and especially German, demand and may record growth of 3.9 per cent.

The Baltic economies, having experienced double digit declines in output in 2009 and stagnation in 2010 (with the exception of Estonia which recovered by 2.7 per cent), are expected to grow by about 3 1/2-4 per cent this year. The pace of their recovery may, however, accelerate significantly in the years to come. The performance of Southern European economies will remain rather moderate this year. Figure 18 shows the level of GDP in the third quarter of 2010 relative to its pre-crisis peak. Output in the Baltic economies remains some 15-20 per cent below pre-crisis levels, and only in Poland is output higher than it was at the end of 2008.

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DOI: 10.1177/0027950111401133

ACKNOWLEDGEMENTS

We would like to thank Simon Kirby, Dilly Karim and Rachel Whitworth for helpful comments and their contribution to the forecast.

REFERENCES

Barrell, R. (2009), 'Long-term scarring from the financial crisis', National Institute Economic Review, 210, pp. 36-8.

Euroframe, 2010, 'Economic assessment of the Euro Area', Winter Report 2010. IMF (2010), Fiscal Monitor, November.

NOTES

(1) We exclude the new Euro Area members Slovenia, Slovakia and Estonia, as they joined part-way through the sample period and their bond spreads may reflect specific additional factors.

(2) With the exception of Ireland in 2010, but this reflects exceptional factors that do not require upfront financing.

(3) The other four relate to employment, climate change, education, poverty reduction.

The forecast is based on data available to 25 January 2011.