After the attacks

World economic prospects and policy challenges after the 11 September events in the United States.
Chief Economist, OECD

The OECD's chief economist, Ignazio Visco, gives his views on the outlook of the world economy in an interview with the OECD Observer.

OECD Observer: The OECD is in the throes of finalising its twice-yearly Economic Outlook* for the global economy in an unusual time of uncertainty. What repercussions do you think the terrorist attacks in the United States on September 11 will have on overall economic prospects? 

Ignazio Visco: The impacts will be significant, but, as you say, uncertain. The tragic events in the United States had an immense human toll. The direct economic impact on persons, properties and some firms is tragic, but relatively moderate for the US economy, certainly smaller than the Kobe earthquake in Japan. The indirect impact, on confidence, financial markets, and investors is very uncertain, but potentially quite large.

The fact is, this indirect impact is difficult to assess because there are no close historical precedents with which parallels can be drawn. We believe that it might be large in the short run. Stock markets have already fallen. Consumer confidence in the United States plunged in September. Employment, housing starts, retail sales and output will all be affected. There will be more profit warnings, and large companies in the travel industry, insurance, and leisure will face serious difficulties. How long this will last depends to a large extent on the political developments.

Observer: You mention the indirect impact on confidence. To what extent will psychology play a role? 

IV: The effect might be considerable. There are questions on the speed of return to a world where businesses feel safe enough to engage in large international operations and borders are open as usual to flows of goods, capital and persons. Perhaps the current fears will be dispelled quickly thanks to a credible international co-ordinated effort to combat terrorism. In such a case, our economies, which had been generally performing well, will rebound strongly and return to healthy growth. But there are also downside risks of a long drawn-out process, punctuated by setbacks. Businesses could decide to repatriate investments, costly security measures could multiply, and governments could re-erect borders to protect themselves from a more uncertain environment. This could mean the return to slow and uncertain growth patterns, but it is really too early to speculate about this.

Observer: How do you prepare your projections against this background of uncertainty?

IV: We start by laying out a "central" scenario. This contains a normative assessment of the political developments, one that necessarily excludes dramatic events. In this central scenario, we take into account both the current state of economic fundamentals (and their interaction with highly uncertain expectations) as well as the monetary and fiscal policy responses. Accordingly, we will assume that oil prices will remain broadly stable, exchange rates unchanged, and that stock markets will not be subject to a wave of panic selling. This may turn out to be wrong, but at this stage it is impossible to make other predictions realistically.

Observer: So, what does this central scenario tell us? 

IV: The short-term outlook could unfold in four successive stages. First, activity in the third quarter will be directly affected by the direct disruptions associated with the terrorist attacks: activity in the United States is lowered by temporary (hopefully recoverable, at least partially) loss of activity, especially in the sectors of financial intermediation, air travel, tourism and retail trade. The direct impact on other countries is minimal. Transatlantic flights from Europe were cancelled for a few days, and disruptions may be expected for some time yet, but except for that there was no direct impact.

Second, consumer and business confidence will fall in the United States and most other countries around the world. The sharp stock market decline (by 8-12% in the US and Europe, and 5% in Japan) hint to what may be coming. Confidence will initially be affected by the events, then by the stock market fall and by the rise in unemployment. Judging from the reaction to the Gulf conflict over a decade ago, and from the recent global stock market decline, it is likely that confidence will be sharply eroded around the world. Following the Gulf crisis, confidence plunged sharply in the US and in Europe (although not in Japan), and there was a global adverse reaction to the South East Asian crisis in 1998. This could affect economies at least until the end of the fourth quarter, with negative effect on demand, including household consumption. Growth in the second half of this year will be negative in the US – the sign of a recession – and very low in the EU. Conditions in Japan are already quite dismal, and the reduction in world trade will make matters worse.

Third, a "wait-and-see" attitude will prevail among consumers and investors, perhaps through the first half of next year. Faced with large uncertainties, businesses will keep deferring investment decisions, households postponing large purchases, and the real estate market could slow down sharply. There will be a global stagnation during this period. Spending decisions will also be affected by the decline in financial wealth, which by now probably exceeds the gains in housing wealth.

Fourth, recovery and return to growth. Once the aftermath of the attacks has vanished, activity in the OECD should turn around. The precise timing is difficult to predict. Hopefully, it will take place around the middle of next year, when a sentiment that "business is back to normal" starts to prevail and the expansionary stance of monetary and, in a number of countries, fiscal policy will be fully felt. If everything goes well, growth could gather momentum in 2003.

Observer: This is the central scenario, but what if the situation develops differently, if those dramatic events you mention come into play? 

IV: Our assessment is subject to change as information becomes available and events keep unfolding. So we must approach this exercise with substantial humility. There is no doubt, however, that the United States will be affected by the recent events. How much this effect will spread to other countries is a source of uncertainties. Trade linkages play a crucial role, and there is also some evidence that suggests that global linkages might have become more important – for instance stock market fluctuations, confidence, foreign direct investment flows are more correlated – even if this is still a subject of debate. Europe was already slowing down significantly before the terrorist attack, and this might be reflected in low growth also next year. The situation in Japan can only become more complicated as a result of the attack – an issue, for example, is whether the government will launch a massive clean-up of banks’ portfolios in these uncertain times? Some emerging countries will be hit by the “flight to quality”, especially the most vulnerable ones, but it seems that countries in Central Europe and Russia have so far been relatively protected.

Observer: Is there anything that can be done to manage this difficult period? Hardly a time of business-as-usual for policymakers, is it? 

IV: To a large extent, the prospect for recovery depends on actions by policymakers around the world to restore confidence and support demand. These actions have so far been impressively appropriate. Central banks have already eased aggressively in nearly all member countries (the Fed, European Central Bank, Bank of Japan, Bank of England, etc) and (small) additional rate cuts are possible. Large amounts of liquidity have been injected in the financial system to reduce the risk of insolvency. Public resources have been allocated in the United States for the reconstruction effort, to bail out airlines, and to step up the military and security efforts. In Europe, most governments will probably let automatic stabilisers play freely.

Observer: All important steps, but are there specific policy messages you would like to emphasise to improve the situation further? 

IV: I see three key areas. The first is the quality and effectiveness of action, the second is preparedness for the unforeseen, and the third is to keep the eye on the long term. On the first issue, It is important that governments do not overreact to recent events. As the Federal Reserve Chairman has said, “it is more important to do the right thing than to react quickly”. Large injections of liquidity and sharp increases in spending would support demand immediately, but they could rekindle inflationary pressures and require a sharp policy tightening in 2003. Similarly, recent initiatives to bail out airlines, or to help insurance companies, have to be followed with care. There are risks that the progress painfully made in recent years to level the playing field, establish clear competition policies, and refrain from state interventions might be threatened. Hence, governments should avoid measures that they may regret subsequently.

On the second point, it is important that OECD countries be prepared for the uncertainty that is likely to prevail in the next few months. Unforeseen developments may occur, and it is essential to have contingency plans as well as room for manoeuvre if the situation gets more difficult. We will help in this respect by providing a toolbox of standardised shock scenarios (inter alia on oil prices, stock markets, exchange rates).

Finally, long-term risks should not be neglected. We are thinking about briefly considering in the context of the forthcoming Economic Outlook some longer-term risks concerning reductions in trade, capital flows and the movement of people and if possible, try to shed some light on the outcomes of such possible trends.

Observer: Could less economic openness be one of those risks? 

IV: Clearly, the closing of borders – whether formally or not – to goods, capital and persons would mean that the world economy would become less efficient. This might impact negatively not only on advanced countries, but also on emerging economies, which have a lot to lose. So it is important that the international community does not retreat on its progress towards a more open world. The future world summits on trade (Doha) and sustainable development (Johannesburg) should be seen as opportunities to reaffirm the commitment to an open world. The progress towards a more open world would be facilitated by the recognition that large groups of people have been left behind and have not enjoyed improvements in living standards. The global economy should stay open, but ambitious actions are also needed to fight poverty and support growth in the developing world.

* Economic Outlook, No. 70, OECD, December 2001. Electronic copies will be available from November 20 at 11.00am Central European Time. Subscribers to the EO will get access to the online preliminary edition via SourceOECD ( Non-subscribers can subscribe plus download the preliminary version via the OECD Online Bookshop ( The media can obtain copies via OECD Media Relations.

©OECD Observer No 229, November 2001  

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