Making the most of the recovery

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After a drawn-out period of fits and starts, a palpable recovery has finally taken hold across the OECD. Yet, the persistence of very large current account imbalances at this early stage of the recovery may complicate the encouraging outlook.

The strong momentum already achieved in Asia, North America and the UK provides ample evidence of the renewed strength of the world economy. Despite lingering domestic weaknesses, continental Europe is also on its way to join the recovery.

This turn for the better stems from a variety of factors. Since the spring, the geopolitical environment has steadied, allowing oil prices to stabilise and confidence to strengthen. In the United States, this revival of “animal spirits” has taken place in a context where the underlying stimulus provided by monetary and fiscal policies was still very powerful and where past excesses in business investment had been largely worked off. As expected in the previous OECD Economic Outlook, the US economy has recovered strongly, with investment starting to take over the baton from consumption. More fundamentally, the US economy will greatly benefit from strong productivity gains and high potential growth over the next few years.

The American upswing has coincided with a marked and better-than-expected improvement in Japan, driven in large part by better investment prospects in the manufacturing sector and fast-growing markets in neighbouring Asian economies.

Looking further ahead, the most likely scenario for the next two years is one of sustained growth in the United States and progressive recovery in Europe and Japan, in a context of low inflationary pressures and with a gradual reduction in unemployment. This central scenario would be underpinned by a prolonged period of monetary ease and moderate long-term interest rates.

While encouraging, this scenario is not devoid of vulnerabilities. In Europe, balance sheet problems are still prevalent in the business sector and will continue to inhibit investment. In a variety of countries – including the United States, the United Kingdom and Australia – households remain highly indebted and may suffer large wealth losses, especially in the housing sector, should interest rates increase abruptly. Such a back-up in interest rates cannot be ruled out in a context where all large OECD countries are now suffering from historically wide public deficits which will not disappear easily given their predominantly structural nature.

The persistence of very large current account imbalances at this early stage of the recovery may also complicate the outlook. The combination of large public and external deficits in the United States could be a source of exchange rate instability, given the potentially short-run nature of much of the international capital currently flowing in. Under such delicate circumstances, a sudden weakening of the dollar could stifle a fledgling European recovery. This would exacerbate the unevenness of the global upturn, while not doing much to help reduce current account imbalances or tensions in the trade policy arena.

These various imbalances and sources of vulnerability are largely inherited from past policy mistakes. This is especially true of fiscal policies which often failed to take advantage of “good times” to replenish public coffers and have led to exceedingly large deficits after several years of economic slowdown. With ageing-related financial pressures looming larger than ever, taking advantage of the economic upswing to restore the sustainability of public finances will be crucial. The challenge will be, for many countries, to fight fiscal complacency during a period of sustained growth, in marked departure from the repeated failures of the past two decades.

To succeed in this difficult endeavour, it will be necessary to re-establish or revitalise long-term oriented fiscal frameworks and to improve fiscal institutions so as to prevent the reappearance of pro-cyclical fiscal policies and to enhance the cost-effectiveness of public expenditures in a context where competing claims are on the rise. Given the magnitude of the challenge, a special dossier is devoted to these medium-term fiscal issues in the forthcoming full edition of this Economic Outlook.

It will be equally crucial to draw lessons from the very uneven ability of OECD countries to withstand adverse economic shocks. Performance gaps are often too large to be ascribed exclusively to differences in macroeconomic policies or idiosyncratic shocks. Strikingly divergent performance within the European Union in recent years reflects unequal degrees of resilience in the face of shocks, as well as marked differences in potential growth rates. Both are clearly linked to structural policies, where a lot of work remains to be done over the coming “good years” so as to raise potential growth rates and living standards, and to strengthen OECD countries to weather the next economic slowdown.


OECD (2003), Economic Outlook, No. 74, November 2003 (preliminary edition), available at

OECD (2003), Economic Outlook, No. 73, June 2003.

©OECD Observer No 240/241, December 2003

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