WORLD OUTLOOK

The strength of US domestic demand is exerting a very strong pull on the world economy. Japan in particular is benefiting from soaring export demand, but the effects on European exports have been offset by weak domestic demand and, in the case of West Germany and the UK, by damaging industrial disputes which have interrupted supply. Over the next 12 months we expect the US economy to slow down under the weight of the financial and external balance pressures, which two years of very rapid but unbalanced growth have built up. For the world economy, however, we expect the slowdown in the US to be counterbalanced by expanding domestic demand in Europe and Japan, especially if a lower dollar permits reductions in interest rates. We forecast world output growth of about 3 per cent next year, well below the near-5 per cent projected for 1984 - the cyclical peak. By the second half of 1985 the world recovery will be three years old and we expect a pause in the growth of output. Against a background of stable monetary growth we expect world inflation in the 5–6 per cent range over the medium term. This is consistent with some increase in US inflation, low and stable inflation in Japan and West Germany and further progress in reducing inflation in countries such as France and Italy. Our forecast is based on the assumption that the dollar falls next year. If it does not fail we believe there is a significant risk of slower growth.     

The London Business School with Gover Publishing

The world economy is in poor shape. OECD industrial production fell 0.5per cent in both 1991 and 1992 arid though it may now have stopped falling it is still, on our estimates, below year-earlier levels. The US recovery continues to disappoint; recession persists in Japan and Europe; inflationary pressures, already weak, are waning. Next month's UK forecast would normally be based on the world forecast published in June's International Economic Outlook, when we were looking for G7 output to rise 1.2 per cent this year, 2.5 per cent next. But this now looks on the high side and although a detailed revision to the world forecast mist wait until the December IEO, as at1 input to the UK forecast we are shading our G7 growth forecasts - to I per cent this year and 2.25 per cent in 1994. Similar downward revisions are also in train at the OECD arid IMF, according to recent press reports. The more sluggish output performance is already having mi impact on the oil price, which has fallen below £16 a barrel. Together, these developments imply lower world inflation and, particularly in post-ERM Europe, a faster easing of monetary policy than we had allowed for in June.     

WORLD OUTLOOK

The world recovery, which began at the turn of the year, gathered pace in the second quarter. We have again revked our forecast upwards and predict an increase of 2 1/2 per cent in OECD GNP in 1983 and a further 3 1/2 per cent in 1984. In its early stages the recovery was centred upon North America, though more recently it has spread to West Germany and Japan. France and Italy, however, remain in recession. Over the next 12 months this pattern is unlikely to change significantly-in the approach to the Presidential election the US is expected to grow quite rapidly, but domestic demand will remain a restraining factor in Europe/Japan where, by historical standards, modest growth is expected. Reflecting this some inflationary pressure could re emerge in the United States towards the end of next year, though not, in this forecast, elsewhere. We continue to expect therefore that world inflation will settle in the 6–7 per cent range and that this will enable the world recovery to be sustained over the medium term.     

Forecast Summary

In themselves the drop in interest rates and the fall in the exchange rate following the ERM débâcle of "Black Wednesday" will have an expansionary effect on demand in the UK economy. But because of the way in which the policy shift was handled, any positive impact is likely to be offset by lower business and consumer confidence with the result in our forecast that recession continues well into next year. It is another six months before output stops falling and a rise of as little as 0.9per cent is in prospect for 1993 as a whole. Such a weak recovery will, however, limit the inflationary impact of a lower pound and, helped by lower mortgage interest rates, retail price inflation is forecast to be almost unchanged over the next 12 months. In 1994 and beyond, the inflationary effects of devaluation are more evident and we assume that the Government will tighten its monetary stance, raising interest rates back above 10 per cent to stabilise the pound, possibly re-entering the ERM at a new central parity of DM2.40. On this policy stance, output rises 3 per cent in 1994 but slows thereafter and the peak in inflation is held to 6 per cent late in 1994. The J-curve effects of devaluation enlarge the current account deficit to f20bn next year- The weakness of output over the next 12 months is the main factor behind a rise in unemployment to 3.2 million and a steady increase in the PSBR, which reaches a high of f43bn in 1995-6, equivalent to 6per cent of nominal GDP.     

Forecast Summary

The lower exchange rate offers UK industry a remarkable competitive advantage in world markets which, we believe, will be expanding rapidly over the next two years. As domestic demand is also likely to be strong in the run-up to the General Election, output is forecast to rise 3 per cent both next year and in 1988. But, even so, the short-term supply response is not expected to be sufficient to prevent the current account from recording a large deficit next year. Excess demand pressures also point to a higher rate of inflation from now on. We forecast a steady increase in inflation to 3¾ Aper cent by the end of next year and a peak of 4½ per cent in late 1988.     

WORLD OUTLOOK

The slowdown in the world economy, which followed last year's oil price collapse and which awakened fears that the world was on the threshold of a new recession, is coming to an end. Output growth in the first half of the year was stronger than we had previously expected and a gentle acceleration is forecast over the next eighteen months. In contrast to this improvement on output, there has been little or no progress on the major problems of the world economy, including the USA's twin structural deficits, budget and trade, and the international debt crisis. Moreover, with the US facing elections in just over a year's time, no economic initiative is likely until 1989. Hence the prevailing view that the US and world economies will "muddle through" for another year. But in 1989 a new US administration is likely to face up to the trade and budget imbalances and many US forecasters believe that the required fiscal tightening will lead to recession. As we explain below, this is not our view and the forecast embodies steady 3 per cent growth in the world economy over the medium term. Inflation has now passed the low point brought about by the oil price collapse. On our forecast of output, inflation is expected to remain close to its present underlying rate of 4 per cent.     

World Economic Prospects

Overview: Dollar surge brings mixed consequences

• The strengthening dollar is now becoming a significant factor for global growth and our forecasts. The tradeweighted dollar is up 2.5% over the last month and over 12% on a year ago.
• Driving the latest rise are growing expectations of US rate hikes while monetary policy in many other major economies is headed in the opposite direction.
• The beginning of ECB QE has prompted a further slide in bond yields and the euro – which at 1.06/US$ is on course to fulfill our forecast of near‐parity by year‐end. Weak data in Japan also raises the chance of a further expansion of QE there later this year.
• We remain relatively positive about the advanced economies: we forecast G7 GDP growth at 2.2% for 2015 and 2.3% next. This month we have revised up German growth for 2015 to 2.4% – a four‐year high.
• Robust US growth and a strong dollar are good news for the advanced economies. US import volume growth firmed to over 5% on the year in January, while the dollar surge potentially boosts the share of other advanced countries in this growing market.
• But for the emerging economies the picture is mixed. A stronger US may boost exports, but rising US rates are pulling capital away: there has been a slump in portfolio inflows into emergers in recent months. Emerging growth may also suffer from higher costs of dollar funding and a rising burden of dollar debt as currencies soften – the more so if US rates rise faster than markets expect.
• Moreover, emergers are also under pressure from a slowing China. Chinese import growth has been weak of late and commodity prices remain under downward pressure. A notable casualty has been Brazil, which we have downgraded again this month – GDP is expected to slump 1.1% this year.
• Emerging GDP growth overall is expected to slip to 3.7% this year, the lowest since 2009. And excluding China, emerging growth will be only 2.2% – the same as the G7 and the worst performance relative to the advanced economies since 1999.

     

The London Business School with Gower Publishing

Over the lastfive years events in the United States have been repeated throughout the OECD area, with a lag of 6–12 months. A repeat of this pattern in I982 would mean that the recovery in Europe and Japan, which has been progressing slowly since the middle of last year. would not last into 1983. The present forecast excludes this possibility. The argument, which we have put previously, is that the US recovety of 1980 was premature and that the current recession Jollows a renewed attempt by US policy-makers to reduce inflation. There are already signs that they will be succes & Consequently we do not expect the US recession to be prolonged In the second haIfof the year we expect an expansion of output to be in progress, both in the US and elsewhere; in the next few months, however, world activity is likely to remain subdued.     

WORLD OUTLOOK

The world recovery, now three years old, has proved more resilient than many expected and will be sustained in 1986 by lower oil prices. Fears that the early-1985 slowdown would turn into renewed recession have proved unfounded, as output in both the United States and Europe picked up in the second half of the year. The improvement stemmed from lower interest rates, falling inflation and weak commodity prices and was further helped by the sharp correction to the value of the dollar following September's G5 agreement. To these factors, which will remain supportive this year, is now added a lower oil price. The recovery in world output has not produced an increase in oil demand and, as the oil price rise of 1979-80 gave a further boost to supply from non-OPEC sources, a severe imbalance has emerged in the oil market. To maintain a £26 marker price (itself cut from £29 last July) has required a cutback in production of ever-increasing magnitude from Saudi Arabia in its role as OPEC's swing producer. Now that Saudi Arabia has abandoned this role in favour of stabilising its market share, oil prices have fallen sharply. We assume that the oil price will fall to £20 by the end of this year, a fall in real terms of 30 per cent. As a result the world recovery is given renewed impetus and output accelerates over the next twelve months. A cyclical peak in activity emerges in 1987, after which output growth settles at 2%-3 per cent and inflation at 4–5 per cent.     

The London Business School with Gower Publishing

The world economy is just starting to emerge from the second trough of a "W-shaped" recession. Compared with the experience after the first oil shock, when industrial production fell by 12 per cent, bringing inflation quickly down from 14 per cent into single figures. the 1980 world recession was mild. Between the first and third quarters industrial output fell 5 per cent; it recovered in the fourth quarter and inflation stopped falling. As a result governments - and this is especially true of the United States - look "another bite at the cherry": monetary policy was tightened and interest rates rose. The effect over the last six months has been to produce a second dip in output. The renewed attack on inflation has, however, been successful and inflation is now well in single figures and falling. Consequently a general easing of policy is evident and a recovery of output in the second half of 1982 and into 1983 remains our forecast.     

Forecast Summary

Even if output recovers in the second quarter (as we expect), it looks as if there will be no increase in GDP this year in comparison with 1991. This reflects the weak start to the year, in which non-oil output registered its seventh successive quarterly decline. Through the year (fourth quarter to fourth quarter), however, we expect GDP to rise 1.5 per cent, laying the basis for a stronger recovery in 1993. Even so, it is not until late next year that output returns to its previous peak Paradoxically, we have raised our forecast of domestic demand from February (on a milder stock rundown) but imports are taking a disproportionate amount of the extra demand, holding back domestic output and aggravating the current account deficit. From nearly £9bn this year, we see the deficit rising to over £14bn by the middle of the decade, equivalent to 1³/4 per cent of GDP. While this is disappointing, it should be relatively easily financed even with lower interest rates providing the pound is held at its present DM 2.95 parity. we assume no ERM realignment which underpins a further drop in inflation to 4 per cent later this year and to 3-3 1/2 per cent by the mid 1990s. The weakness of output means that unemployment continues to rise for another 12 months, peaking in the middle of 1993 at three million, and that public sector finances will move still further into deficit - we project a PSBR this year of £30bn and a peak of £34bn in 1993-4, equivalent to 5 1/4 per cent of GDP.     

The London Business School with Gower Publishing

Output has stagnated in the main industrialised countries this year but we expect the benefits of lower oil prices to show up in rapid growth from now on. The present weakness in the world economy stems from tighter US fiscal policy and the oil price shock itself. These have combined to reduce domestic demand in the United States, and hence to cut the market for Japanese exports in particular, and also to reduce expenditure by energydependent countries and companies. A further factor is that, with prices of oil-based products falling, there is an incentive to delay expenditure. We expect this impact effect of OPEC III to be short-lived and to give way to its positive effects in the second half of this year. Specifically, we expect consumer spending to lead the recovery as real incomes will be boosted by the terms of trade gain from lower oil prices - equivalent to 3 per cent of GNP in the OECD area as a whole. On the basis of oil prices holding at $15. we forecast OECD output growth of 3 per cent this year, rising to 41/2 per cent in 1987. Additionally, we expect lower oil prices to produce a significant reduction in world inflation. Zero growth of producer prices is forecast on average this year arid consumer price inflation is expected to fall to wards 2 per cent in the course of the year.     

WORLD OUTLOOK

In the course of 1984 growth rates in the major economies came together. This reflects a slowdown in the United States, and to a lesser extent Japan, from the middle of the year and continuing recovery in Europe. This convergence is expected to continue in 1985 when total output in the OECD area is forecast to increase by 3 per cent. Within this total it is likely that the US, West Germany and the UK all achieve about 3 per cent; Japan should grow more quickly, France more slowly. In spite of a rapid recovery in output from the late-1982 trough, inflationary pressures remain weak. Measured in dollar terms, non-oil commodity prices have fallen and the oil price is under considerable down wards pressure. We expect inflation to stay at about its preset level in the US, West Germany, Japan and the UK and decline further in France, Italy and other countries where policy reaction to the 1979-80 oil price shock was delayed. In the medium term we expect the world economy to experience steady growth combined with a constant or slightly increasing inflation rate. This reflects a stable policy environment and falling real oil prices. After the excesses of the 1970s and early 1980s it is possible that the rest of the decade will experience u greater stability than at any time since the 1960s.     

A long dollar fall: likelihood and consequences

• ? The dollar has tended to move in long swings over the last forty years, raising the risk that the recent decline could extend considerably further. This is not our base case, but risks do look skewed towards additional dollar weakness. Our modelling work suggests that a large further dollar slide would have significant effects on the pattern of world growth – the US and some emerging markets would gain, with other advanced economies the main losers.
• ? There have been several large multi‐year swings in the dollar over the last four decades. We identify seven such episodes since 1971 including three long declines averaging 31%, the last being in 2002‐08. Since 2017 the dollar has fallen 10%, implying a possible further considerable drop.
• ? Our dollar strength indicator, which covers a range of economic variables associated with dollar moves in the past, does not currently point to a re‐run of the dollar weakness of the 2000s. But we do expect some further near‐term dollar losses and risks to our baseline forecast look skewed to the downside, especially given the emergence of large twin deficits in the US.
• ? Should a further large dollar slump nevertheless occur, our modelling suggests large effects on the pattern of world growth. The main gainers would be commodity‐producing emerging markets (EM) benefitting from improved terms of trade, positive balance sheet and external liquidity effects and scope to ease local interest rates. Rising US yields would erode some of these gains in later years.
• ? The main initial losers would be advanced economies outside the US which would lose competitiveness. In the case of the Eurozone and Japan, undershoots of inflation targets would be likely. There could also be some other negative consequences such as stoking protectionism and creating financial bubbles in some EMs.

     

WORLD OUTLOOK

The world economic recovery, which began in the late summer of 1980, can now be seen as premature, in as much as 1980's short, sharp recession had achieved only a limited reduction in the rate of inflation. Economic policy, particularly in the United States, is once more geared to a reduction in the inflation rate even if this imposes costs in terms of lost output and higher unemployment. The consequent appreciation of the US dollar against the European currencies has - in spite of weakening oil and non-oil commodity prices in dollar terms - produced a further boost to European inflation and a subsequent tightening of policy in some countries, notably West Germany. In these circumstances we expect little or no growth in output in the world economy until the summer of 1982.     

WORLD OUTLOOK

In the second quarter of 1980 recession spread from the United States to other OECD countries. We estimate that this process continued in the third quarter and forecast that it has a further six months to run. The latest US indicators suggest that some recovery may have taken place in the third quarter. We do not believe at this stage that any such recovery is currently sustainable. Our forecast of the world economy implies continuing US recession and some further drop in output in Europe and Japan.     

World Economic Prospects Monthly

Overview: Market falls overstate loss of momentum

• ? Financial market moves in recent months suggest that there is increasing concern about a substantial global growth slowdown or even a recession. But we continue to see this as an over‐reaction to the weakening economic data; while the downside risks to the global GDP growth outlook have clearly risen, our baseline forecast for 2019 is little changed at 2.7%, down from 3% in 2018.
• ? Recent economic news confirms that the Q3 economic soft patch appears to have spilled over into Q4, particularly in the industrial sector which has seen a broad‐based loss of momentum in many economies coinciding with a further slowdown in global trade growth. But while surveys of service sector activity have also moderated, the falls have been rather less abrupt, suggesting that overall global GDP growth is slowing albeit not alarmingly so.
• ? On balance, we think that the weaker data do not provide compelling evidence that global growth is slowing more sharply than our December forecast. Although the financial market sell‐off and associated tightening in financial conditions will impinge on growth, this may at least be partly offset by weaker inflation in response to lower oil prices, now seen at US$61pb in 2019. This, combined with the continued strength of labour markets and the likelihood of further moderate wage growth, points to a further period of solid household spending growth.
• ? Nonetheless, the risk of a sharper slowdown has risen. Cyclical risks have increased over the past couple of years as spare capacity has diminished. And uncertainty over the economic and financial market impact of the unwinding of central balance sheets have added to the risk of policy mistakes.
• ? Although our central view is that the recent financial market correction will not morph into something rather nastier, further sustained weakness (particularly if accompanied by dollar strength) would have more significant implications for activity and could see world growth falling below the 2016 post‐crisis low of 2.4%.

     

(5) Focus: Forecast Revisions

In this section we examine the current forecast together with its immediate predecessors to see how the forecast itself has changed over the last year. The conclusion is that we have become progressively more optimistic in the last 12 months about prospects for both output and inflation. The two are connected: the lower inflation outturn has contributed to higher consumers' expenditure and hence to output. On the PSBR and the current account of the balance of payments, given the large margins of error attached to these forecasts, we have not changed the main thrust of the forecast: in the next four years a declining PSBR and approximate current account balance remain the most likely outturn.     

The next hundred years of growth and convergence

World gross domestic product per capita is forecast to grow at 2.6% annually over the next 100 years. Convergence of less-developed countries toward output levels of the world frontier accounts for much of the forecast. Projecting recent growth in China and India accounts for much of the forecast convergence. The forecast differs from the earlier literature because the facts of convergence have changed in recent decades. A Markov-switching model is estimated for each country, allowing each country to switch on or off a path of convergence to the world output frontier. Bayesian estimates of the historical process and posterior forecasts are offered.     

Forecast Summary

In comparison with our February forecast, we are more optimistic on the prospects for output and unemployment both this year and into the medium term. But in consequence we have raised our forecast for the current account deficit. GDP growth, nearly 5 per cent last year, falls back to 3½ per cent this year and 2½ per cent in 1989; from 1990 onwards output is expected to increase at its underlying trend of 3 per cent. Inflation is currently rising but, as output decelerates, it peaks at 5 per cent and drifts gradually lower over the medium term. The current account deficit is projected at £5bn both this year and next; helped by a steadily depreciating exchange rate, which boosts exports, the deficit narrows from 1990 onwards.