World economic prospects are bright

Economics Department

World economic prospects are brighter than they have been for some time. OECD-wide output is projected to grow by 4% this year, the fastest pace in more than a decade, before slowing to 3% in 2001.

A tightening of monetary policy is expected to keep inflation low nearly everywhere, although a modest upward drift in consumer prices will be apparent in many countries. OECD-wide unemployment should decline by more than 2 million between 1999 and 2001 – mainly in the euro area – falling to 6% of the OECD labour force. With the strong and widespread rebound of economic activity outside the OECD, world output may rise by some 4% this year and next.

This is a welcome trend. Except in Japan, where prospects are improving but remain uncertain, there are even some upside risks to watch out for. International linkages, including through global trade, could reinforce growth beyond the OECD’s central projections. This could affect inflation. Moreover, the surge in growth across countries could also stimulate further rises in commodity prices, including oil.

Overall, the emergence of simultaneous rapid growth in many OECD countries has coincided with the absence of marked stabilising forces in global financial markets. Monetary authorities should take care not to underestimate the global strength of demand nor its potential effect on prices. If they do, the result could ultimately be a stronger monetary policy reaction and a substantially more pronounced cycle than envisaged in the OECD projections. This would lead to turbulence in equity markets and, given projected large external imbalances, a loss of confidence in the dollar.

In the United States, there is a real possibility that new technology and structural change have raised the economy’s non-inflationary potential. Nevertheless, the recent strength of demand is not sustainable and inflationary pressures are beginning to show. A further tightening of monetary policy may soon be needed, with the federal funds rate possibly having to rise to above 7% by August 2000, to ensure a soft landing.

In the euro area, the critical question now is how long the expansion can last without running into inflationary bottlenecks. The European Central Bank should continue shifting monetary policy towards a neutral stance, raising interest rates only gradually, while taking account of possible supply side improvements. Improved cyclical conditions have generated unexpectedly strong budgetary revenue growth in a number of euro area countries. Some have already announced plans to use the revenue gains to reduce tax burdens and increase government spending. To the extent that tax reductions can help boost the economies’ supply potential, they are welcome. However, given the current economic buoyancy and limited spare capacity, any major easing of fiscal policy by euro area governments would be ill-advised.

In Japan, recovery now appears to be in place, although consumer spending remains sluggish. Policy should aim to sustain the recovery in the short run, while encouraging the speedy implementation of reforms in product and labour markets as well as continuing restructuring in the corporate and financial sectors.

©OECD Observer No 219, December 1999




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