The US recovery is, by and large, unfolding as projected in the OECD Economic Outlook published last April. In Japan, growth has surprised on the upside. In the euro area, the expected recovery has not yet materialised.
The recovery may gain momentum in the remainder of 2003, backed by policy stimulus, notably in the United States. The pattern of recovery seems likely to continue unevenly among the major OECD regions, however, with the euro area being the weak spot. Despite the projected pick-up in output, it will be some time before unemployment falls and output reaches its potential. Downward pressure on inflation should therefore continue for a while, but, further ahead, the risk of deflation now appears very remote. Assuming that oil prices do not increase and that exchange rates remain broadly unchanged, it is clear that the global recovery will continue to be largely driven by the United States, where large injections of monetary and fiscal stimulus are coming through. But Japan has also been supporting, rather than dragging down, global activity. Performance in the euro area has been disappointing so far in 2003.
According to the OECD’s forecasting models, this pattern of growth is likely to continue in the second half of 2003. This outlook is foreshadowed by recent business confidence indicators and purchasing manager surveys, and by highfrequency data on production, sales and housing. In the United States, most of these indicators are pointing up and surveys suggest buoyancy in both manufacturing and services. With consumer confidence improving since the Iraqi war, retail sales and durables orders indicate a strengthening of final demand. Furthermore, inventory rebuilding is likely, following a recent rundown in stocks.
In Japan, for which we have not yet developed an indicator model, there has been some recent improvement in business confidence, helped by a rebound in corporate profits, progress in corporate restructuring, better US and Asian growth prospects and reduced global uncertainty, while household confidence is also higher. By contrast, in the euro area, only the first signs of a bottoming out can be detected. Improvements in business confidence, if any, largely concern firms’ expectations of their own future production, while their assessment of the current business environment remains downbeat against the backdrop of shrinking order books and inventories judged to be too heavy. The economics department at the OECD has not been through a complete new forecasting round. However, putting the data for growth in the first half of 2003 together with our estimates of what third and fourth quarter GDP growth is likely to be, it would seem that US real GDP growth may approach 2.5% in 2003 as a whole. In contrast, figures imply annual euro area growth of only around 0.5%. For Japan, if growth in the second half of 2003 were to match that of the first, full-year growth would exceed 2%.
Near-term inflation prospects also diverge across the OECD area. In the United States, core inflation (which excludes food and energy) will continue to drift down, since even with growth picking up rapidly, it will take some time to eliminate the existing slack in the economy. Given the momentum of the recovery, it appears nonetheless that the risk of deflation has now become very remote. In Japan, core inflation has been negative for half a decade, but we project it to gradually move towards zero, helped by strengthening activity and more active monetary policy. With a widening output gap and rising unemployment, core inflation has now fallen significantly below 2%. But the process of disinflation may be slowing down. So far in 2003, headline inflation has continued to hover around the 2% European Central Bank threshold, reflecting in part the recent surge in energy and food prices. The relaxed monetary policy should be maintained across the OECD area until the recovery is firmly established.
In the United States, with core inflation still falling, the current expansionary stance of monetary policy can be maintained. Also, in Japan, unconventional monetary policy is starting to work and should be pursued vigorously until deflation is eliminated. But in the euro area, further monetary relaxation would be needed if clear signs of recovery failed to materialise in the near future. Meanwhile, a determined effort should be made to stem the current slide in public finances. Many large OECD economies now suffer from large and deteriorating public deficits in a context where medium-term strategies are either absent or under pressure. This worrying trend calls for vigorous corrective action as soon as the recovery achieves some momentum.
* The next edition of the OECD Economic Outlook, No. 74, will be issued in December, with a preliminary online edition in late November. For the previous Economic Outlook, No. 73, see www.oecd.org/eco or read “Unspectacular recovery” at www.oecdobserver.org, linked below.
©OECD Observer No 239, September 2003