After reaching 4.25% this year – the fastest pace in more than a decade – OECD-wide output growth is projected to slow to about 3.25% in 2001 and 3% in 2002. Core inflation is likely to remain low in most OECD countries, against a background of modest tightening in monetary policy in the United States and in the euro area. OECD unemployment may remain close to its present level, at about 6% of the labour force. After a sharp rebound in activity outside the OECD area, world output may rise by some 4.75% this year, before slowing in 2002.
This broadly favourable outlook assumes that world oil prices will ease back from their recent high levels. The low stock situation, and the prospect of continuing political tensions in the Middle East, point to an unusually volatile market. This is not a crisis of the same dimension as the oil shocks in the 1970s, but the situation may change if oil prices continue to rise.
The optimism over technology stocks at the beginning of the year has waned and risk premia in high-yield corporate bond markets have widened. If these developments were to intensify or spread, it would undermine confidence and discourage private spending, especially in the United States.
Attractive rates of return and buoyant economic conditions in the United States have ensured that the record high current account deficit could be financed without difficulty. Ultimately, however, the current account deficit will require adjustment. A sudden reversal could have inflationary consequences, leading to a more abrupt slowing in the US economy.
A continuing fall in equity prices, higher oil prices and the projected slowdown in the OECD area could inhibit growth in a number of non-OECD emerging economies. This risk would increase if interest rates rose significantly in OECD countries.
Monetary policy in the United States will depend on how rapidly pressure on capacity eases. The slowdown underway in the US economy should help reduce excess demand and inflationary risks. A further modest increase in the federal funds rate may be necessary in 2001 to check inflationary pressures but there should be scope for the Federal Reserve to start reducing interest rates during the course of that year.
As regards fiscal policy, the structural budget surplus is officially projected to continue to rise steadily. For 2002 and beyond, however, be prepared for a policy agenda that appears likely to involve tax cuts and spending increases.
In the euro area, the challenge for policy is to avoid inflationary bottlenecks and prolong the expansion. The rise in oil prices and less supportive monetary conditions have already contributed to a moderate deceleration. Core inflation is projected to move up as spare capacity is exhausted. Provided the euro does not rise significantly, the ECB may have to raise interest rates by about 50 basis points to keep core inflation in check.
The Japanese economy has started a moderate recovery. Output is projected to grow at a rate of 2 to 2.25% and deflation should subside. Employment may increase modestly, though unemployment is likely to remain high. A re-balancing of policy is needed, with monetary policy continuing to support growth and fiscal consolidation starting gradually during 2002. Priority will be given to improving the efficiency of the public expenditure system, while continuing to restructure and liberalise the economy.
Sustained strong growth in the United States and a few other OECD economies has prompted much talk of a “new economy”, with arguments emphasising the role of information and communications technology. The evidence suggests that “old economy” mechanisms are still crucial to understanding the growth process. In particular, the accumulation of various kinds of capital – especially human – as well as research and development are important for growth, and differences here help explain the variations in growth patterns across countries.
©OECD Observer No 224, January 2001