Organisation for Economic Co-Operation and Development
OECD ECONOMIC OUTLOOK
No. 62, December 1997
Extracts of the publication
INTRODUCTION
Tensions in financial markets, which began in Thailand in mid-1997, spread to a number of other countries in East Asia, including Japan and Korea, in the following few months. At the same time, volatility in other OECD stock markets also increased considerably. Nevertheless, by 10 November – which corresponds to the cut-off date for information underlying the projections reported in this issue of the OECD Economic Outlook – developments since the summer did not appear to call for a fundamental reassessment of the relatively favourable outlook for the OECD area as a whole, although, compared with six months ago, they entailed important revisions to the distribution of output growth among the major OECD regions. Prospects for 1998-99 looked on average better for both the United States and Europe, but significantly worse for Japan.
Since then, however, financial problems have intensified in Japan and Korea. In the first instance, this has undoubtedly clouded the short-term outlook for Asia, but, more broadly, this may have increased the risks of spillover effects on other regions. However, provided appropriate actions are taken rapidly in the countries directly affected to deal with the fundamental causes of their current problems, in the absence of further significant shocks and with suitable international co-operation, developments during the past three weeks are unlikely to modify the overall picture substantially:
The main task facing governments in the countries most affected by financial turmoil is to ensure that adjustment policies to tackle problems at their roots be implemented as rapidly and effectively as possible. In Korea, banking sector difficulties have been exacerbated by the high indebtedness, as well as the deterioration in the cash-flow positions, of many large businesses, which to a large extent reflect fundamental governance problems. The immediate priority is for authorities to provide adequate liquidity to avoid systemic risks. Policy actions to speed up financial market liberalisation while strengthening prudential measures, restructure the corporate sector and improve governance structures are also essential to restore the soundness of the financial sector. Measures announced recently, as well as the Korean request for assistance from the International Monetary Fund, represent an important step in addressing these issues and, if reforms to make better use of market discipline are implemented rapidly, they should contribute to improve confidence and increase efficiency, and to prepare the grounds for the next stage of development of this dynamic economy.
In Japan, recent events have highlighted the underlying weaknesses of the financial sector. Already fragile balance sheet positions of some banks have been affected by falling equity prices, reinforcing the need for authorities to act promptly and effectively to restore confidence in the financial sector. This should require the use of government funds, as was the case in other OECD countries confronted with banking crises during the 1980s and early 1990s. More needs to be done, however. In particular, it will be important that efforts be made to increase transparency by strengthening accounting standards and by improving reporting and disclosure procedures.
Beyond policies to address financial sector problems, the accent in Japan must also be put on macroeconomic policies to secure the present recovery. The fragility of the expansion, which had been evident for several months before the financial turmoil affected Japan, was already calling for a more supportive stance of overall macroeconomic conditions. The potential negative consequences of more recent financial turbulence have now reinforced this need. On the monetary policy side, there is little or no scope for providing any further stimulus to domestic demand in the near term, in view of the historically low levels of interest rates that prevail. Given the possibility that banks’ balance sheet problems may hinder the effectiveness of monetary policy, a continuation of the current easy stance is likely to be required for some time to come. On the other hand, some adjustment might be envisaged on the fiscal side. This, however, represents a particularly difficult challenge for Japan in the present situation. An ambitious approach to fiscal consolidation is required over the medium term given the rapid ageing of the population. Nevertheless, in the short run, greater consideration should be given to possible ways to ease the fiscal stance without loosing sight of medium-term objectives. This might best be achieved through the implementation of budgetary measures that are also desirable on structural grounds. Reductions in the level of taxation, to be seen as part of a more comprehensive fiscal reform, offset at a later stage by cuts in subsidies and other inefficient public expenditure, may provide an example of such measures. However, it is important that any tax cuts be seen as permanent; otherwise they may well be saved rather than reflected in higher domestic demand.
In continental Europe, the most pressing issue is to ensure a smooth transition process towards European Economic and Monetary Union (EMU) while also taking the necessary adjustments to make the monetary union fully successful, once it is established. At this stage, there remains a somewhat uncomfortable degree of divergence in the cyclical positions of countries that might participate in EMU, notably between the three largest economies, where the expansion has been lagging, and most smaller countries that are at a more advanced stage of the recovery. The common level to which short-term interest rates in countries of the prospective euro area will converge during the run-up to EMU may in some cases imply unwelcome adjustments and create potential tensions. A smooth transition will require an increasingly co-ordinated approach to setting monetary policy in these countries. Once EMU is established in early 1999, there will be a single monetary policy for the area as a whole which will be conducted, within the European System of Central Banks, by the new European Central Bank (ECB). It will thus be the responsibility of the ECB to ensure that the level of interest rates is appropriate for the area as a whole, even if conditions are not identical in all countries. The loss of autonomy of national monetary policy will restrain its use to address country-specific developments in the group of countries committed to joining in the first round of EMU. Moreover, exchange rate adjustments will no longer be possible within the area once EMU is established. Countries will therefore have to rely to the extent possible on fiscal policy to respond to adverse shocks that may affect their economies. In order to be able to do so, it will be essential for these countries to restore sound budget positions as rapidly as possible to allow for some flexibility within the obligations of the Stability and Growth Pact and to ensure longer term fiscal stability.
A further important way to enhance the adjustment ability of countries aspiring to EMU is to actively pursue the structural reforms that are needed to make labour and product markets more competitive and efficient. Many of these countries have already made some progress in the priority areas identified in the OECD Jobs Strategy, but much remains to be done in order to ensure the smooth absorption of potential shocks while avoiding increases in the inequality of wages and family incomes as well as poverty that risk hampering progress in the implementation of the strategy. Within the framework of the social welfare states that characterise European economies, firm actions across a broad front are still needed: promotion of wage bargaining outcomes consistent with adequate profitability to stimulate investment and job creation; actions to reduce segmentation of labour markets into ‘‘insiders’’ and ‘‘outsiders’’; expanding the scope at enterprise level to negotiate the flexible working arrangements needed to strengthen competitiveness; careful attention to the parameters of tax-benefit systems to assure adequate incentives to work, while protecting those who are unable to do so; active policies to improve the labour-market position of the least skilled and long-term unemployed; more effective education and training policies; and liberalisation of sectors where competition remains inadequate to promote efficiency and stimulate entrepreneurship. Such a broad programme, the main lines of which developed in the OECD Jobs Strategy, can significantly improve employment outcomes without posing a threat to the social consensus and equity objectives. To meet these goals, it is important that care be taken in the design and implementation of specific schemes and policies aimed at promoting job creation and reducing inequalities, to avoid disemployment effects and excessive rigidities, as well as increases in labour costs.
The focus of the policy debate in several countries where growth has been robust and expansions are becoming mature, has increasingly been the extent to which excess demand pressures are already emerging or are an imminent risk. Macroeconomic policy priorities in this group of countries, which includes the United States, the United Kingdom, Canada and some smaller countries, vary in terms of the immediacy of the need for restraint and the reliance that should be placed on monetary policy. But all need to be vigilant to the possibility that inflation could soon rise. The difficult judgement that must be made in these countries concerns the extent of spare capacity in circumstances where historical relationships appear to offer uncertain guidance as to the effects of technological change, structural reform and increasing internal competition in product markets. These questions have been widely debated in the United States, where the economy has been growing at rates above most estimates of the growth of potential output for some time and the unemployment rate has fallen to levels below most current estimates of the structural rate of unemployment. While in the past, such levels of activity have been associated with a rise in inflation, this has not, as yet, been the case, leading some observers to conclude that a new era of prosperity has dawned. At this stage, it still remains unclear whether recent developments reflect fundamental changes in the economy as opposed to temporarily favourable factors, such as an appreciating dollar and falling import prices. It is clear, however, that the current expansion is putting increasing pressure on the labour market. Unless weakness in export markets in Asia and volatility in equity prices slow the pace of activity to a more sustainable rate very soon, some monetary policy tightening would be both prudent and desirable.
To sum up, financial turbulence has increased uncertainty and, in the absence of prompt and adequate policy actions to restore confidence, it could create serious economic difficulties. However, if authorities in the countries directly affected take this opportunity to implement policies that, in some cases, were long called for, there would be no basis for any wholesale revision of the relatively favourable near-term economic prospects embodied in the OECD’s present projections. Nevertheless, increased uncertainty, and the significant adjustments in trade and financial flows that are likely to follow from recent developments, serve to emphasise the importance for all countries of taking the actions necessary to increase the adaptability of their economies and their resilience to unpredictable shocks. Domestically, the reform agenda in this regard remains substantial for most OECD countries. Internationally, there is a heightened premium on close co-operation both to contain undesirable financial spillovers and to assure that the foundations of the international economy are not eroded by short-sighted protectionist responses.
1 December 1997
SUMMARY OF PROJECTIONS FROM ECONOMIC OUTLOOK No. 62
Summary of projectionsa
Seasonally adjusted at annual rates
1997 1998 1999 1997 1998 1999 I II I II I II Percentage changes from previous period Real total domestic demand United States 4.1 3.3 2.1 4.4 4.1 3.5 2.2 2.0 2.2 Japan -0.5 1.5 2.0 -0.8 -1.1 2.6 1.7 2.0 2.3 Germany 1.3 2.3 2.4 0.9 1.9 2.5 2.4 2.5 2.4 European Union 2.1 2.7 2.7 2.1 2.8 2.6 2.7 2.6 2.6 Total OECD 2.8 3.0 2.6 3.0 2.9 3.2 2.7 2.6 2.7 Real GDP United States 3.8 2.7 1.9 4.3 3.3 2.8 2.0 1.9 2.0 Japan 0.5 1.7 2.1 0.8 -0.7 2.9 1.9 2.1 2.3 Germany 2.4 3.0 2.9 1.8 3.1 3.1 2.9 3.0 3.0 European Union 2.6 2.8 2.8 2.6 3.1 2.7 2.7 2.8 2.8 Total OECD 3.0 2.9 2.6 3.3 2.8 3.0 2.6 2.6 2.7 Per cent Inflationb United States 2.0 1.9 2.2 2.1 1.6 1.9 2.0 2.3 2.3 Japan 1.1 0.8 0.5 1.6 1.7 0.7 0.3 0.8 0.3 Germany 0.9 1.2 1.5 1.3 1.0 1.3 1.3 1.5 1.5 Total OECD less high inflation countriesc 1.7 1.7 1.9 1.8 1.7 1.8 1.8 2.0 1.9 European Union 1.8 2.0 2.0 1.8 1.8 2.0 2.1 2.0 2.0 Total OECD 3.8 3.4 3.3 3.9 3.5 3.4 3.3 3.4 3.1 Per cent of labour force Unemployment United States 5.0 4.7 5.0 5.1 4.8 4.6 4.7 5.0 5.1 Japan 3.4 3.4 3.3 3.4 3.4 3.4 3.3 3.3 3.3 Germany 11.4 11.4 10.9 11.2 11.6 11.5 11.3 11.1 10.7 European Union 11.3 10.9 10.5 11.3 11.2 11.0 10.8 10.6 10.3 Total OECD 7.3 7.0 6.9 7.3 7.2 7.0 7.0 6.9 6.9 Per cent of GDP Current balances United States -2.1 -2.5 -2.6 -2.0 -2.2 -2.5 -2.6 -2.6 -2.7 Japan 2.2 2.4 2.5 2.0 2.4 2.4 2.5 2.5 2.5 Germany -0.3 0.5 1.1 -0.6 0.0 0.3 0.6 1.0 1.2 European Union 1.4 1.6 1.9 1.5 1.4 1.6 1.7 1.8 2.0 Total OECD 0.0 0.0 0.0 0.1 0.0 0.0 0.0 0.0 0.0 Per cent Short-term interest ratesd United States 5.1 5.6 5.6 5.1 5.1 5.5 5.6 5.6 5.6 Japan 0.6 0.6 1.1 0.6 0.6 0.6 0.7 1.1 1.1 Germany 3.3 4.1 4.6 3.2 3.4 3.8 4.3 4.5 4.6 Major 4 European countriese 5.1 5.2 5.2 5.0 5.1 5.2 5.2 5.2 5.2 Percentage changes from previous period World tradef 9.2 8.2 7.4 10.7 8.5 8.4 7.7 7.3 7.3
a) Assumptions underlying the projections include:
- no change in actual and announced fiscal policies,
- unchanged exchange rates from 3 November 1997; in particular $1 = Y 121.04 and DM 1.742;
- the cut-off date for other information used in the compilation of the projections was 10 November 1997.b) GDP deflator, percentage changes from previous period. c) High inflation countries are defined as countries which have had, on average, 10 per cent or more inflation in terms of the GDP deflator during the 1990s on the basis of historical data. Consequently, the Czech Republic, Greece, Hungary, Mexico, Poland and Turkey are excluded from the aggregate. d) United States: 3-month Treasury bills; Japan: 3-6 month CD; Germany, France, United Kingdom: 3-month interbank rates; Italy: interbank deposit rate. e) Unweighted average of Germany, France, Italy and the United Kingdom. f) Growth rate of the arithmetic average of world import volumes and world export volumes.
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