The global recovery has been marking time, as the adverse effects of higher and more volatile oil prices worked their way through. This is in line with the numbers published in November 2004 in our Economic Outlook. The slight deceleration witnessed in the United States has also been consistent with the gradual return to a more neutral policy stance. In the euro area, exchange rate appreciation has been taking a toll, with some lag. In Japan, activity has contracted over the past three quarters, only partly reflecting slowing exports. Going forward, however, the conditions are in place for the global recovery to pick up momentum, including as concerns enterprise balance sheets and profits, which have strengthened markedly.
Domestic demand has held up well in the third year of the US recovery, with buoyant household consumption and business fixed investment. Despite dollar depreciation, imports have risen rapidly, but exports less so, exerting a drag on GDP and worsening an already wide current account gap. Employment creation, whilst cyclically sub-par, has gathered pace, and unemployment has shrunk further, although participation in the labour force has continued to decline. Confidence and other forward-looking indicators point to growth at around potential in the near-term.
Growth in the euro area at large has been far less impressive and unemployment has failed to retreat from comparatively high levels. Performance has also been somewhat dispiritingly uneven across countries. In some, the modest expansion in GDP was pulled mainly by external demand. Nevertheless, domestic demand which was still weak in the 4th quarter seems poised to gather strength, including where it has long languished. Business confidence slightly exceeds historical means and there are scattered signs of investment revival, notably in Germany. Consumer sentiment is creeping up towards long-term averages, despite the ambient labour market gloom. Against this backdrop, GDP growth can be expected to inch back up towards potential.
Statistical fog has traditionally obscured developments in Japan more than elsewhere. The new national accounts, resting on a sounder methodology, suggest that real GDP declined in each of the past three quarters, owing in equal measure to weakening export growth and faltering household consumption. Other indicators are more encouraging, however, and foreshadow a pick-up. Business investment has continued to expand and corporate profitability has improved. So have labour market conditions, with unemployment down to levels not seen since 1998, a high job-offers to applicants ratio and regular employment growth becoming less reliant on part-time jobs. Wage growth, however, remains in negative territory, casting some doubt on how rapidly household consumption may regain strength.
With some cyclical slack enduring in most large OECD economies, wage growth generally remains moderate and core inflation low or broadly on target. Against this background, and as productivity growth seems to revert to a more sustainable pace, the US Federal Reserve’s steady and well-anticipated march towards neutrality is gradually withdrawing the exceptionally ample stimulus injected earlier on. Greater cyclical slack in the euro area and persisting underlying deflation in Japan would warrant continued, if vigilant, patience before a return to a less accommodative posture is initiated.
Fiscal positions remain precarious in most OECD countries, both in headline terms and, more worryingly, when adjusting for the cycle and for various types of one-offs or omissions. Meanwhile, demography is starting to weigh on tax revenue and to boost public spending in some countries – most notably in Japan – or will shortly do so. The ongoing pension and health care system reforms, and more, are therefore needed to put public finances back on a sustainable course. More immediately, while in some countries cyclical conditions may call for incremental rather than abrupt fiscal adjustment, spreading it out too much could lead to an unexpectedly sharp back-up in long-term interest rates, with far more deleterious effects on activity.
©OECD Observer February 2005