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A joint initiative of Ludwig-Maximilians-Universität and the Ifo Institute for Economic Research
Forum
SPRING
2001
Focus
WORLD AND
EUROPEAN
ECONOMIES
Ignazio Visco
Barry Bosworth
Willi Leibfritz
Pro and Contra
THE U.S. ECONOMY:
RECESSION AHEAD?
William C. Dudley
Gail D. Fosler
Special
ECONOMICS
IN
EUROPE
Assar Lindbeck
Spotlights
EAST GERMAN ECONOMY
MEASURING INFLATION
DICE Reports
TAXING CO2 IN EUROPE
Trends
ECONOMIC SURVEY INTERNATIONAL
STATISTICS UPDATE
CESifo Forum ISSN 1615-245X
A quarterly journal on European issues
Publisher and distributor: Ifo Institute for Economic Research
Poschingerstr. 5, D-81679 Munich, Germany
Telephone ++49 89 9224-0, Telefax ++49 89 9224-1461, e-mail [email protected]
Annual subscription rate: Euro 50.00
Editor: Heidemarie C. Sherman, Ph.D., e-mail [email protected]
Reproduction permitted only if source is stated and copy is sent to the Ifo Institute
CESifo Forum
Volume 2, Number 1
Spring 2001
_____________________________________________________________________________________
Focus
OUTLOOK ON THE WORLD ECONOMY AND THE EUROPEAN ECONOMY
Challenges and Risks for the World Economy
Ignazio Visco
The Outlook for the U.S. Economy: Soft or Hard Landing?
Barry Bosworth
Forecast for the European Economy
Willi Leibfritz
3
14
21
Pro and Contra
THE U.S., ECONOMY: RECESSION AHEAD?
Pro: Weakness Will Persist
William C. Dudley
Contra: Economy Rebounding
Gail D. Fosler
28
29
Special
Economics in Europe
31
Spotlights
The East German Economy Stopped Catching Up
How Inflation is Measured
33
34
DICE Reports
Taxing CO2 in Europe
35
Trends
Economic Survey International
Statistical Update
37
39
Focus
OUTLOOK
WORLD ECONOMY AND THE
EUROPEAN ECONOMY
ON THE
On 1–2 March 2001, the ifo Institute conducted an international conference in Munich at which macroeconomic forecasts and policies were discussed during the first day and the outlook and driving forces for
individual industries in various European countries were the topics of the second day. Three papers presented on the first day on the world economy, the U.S. economy, and the European economy are reproduced here.
ment of developments based on the information
currently at hand.
CHALLENGES AND RISKS
FOR THE WORLD ECONOMY
Recent developments
IGNAZIO VISCO*
The outlook for US growth has changed rapidly
since the end of last year, as the actual slowdown
occurred substantially faster than the large majority of forecasters had considered as the most likely
outcome (Figure 1). Some slowing of growth had
been expected, driven by the tightening of US
monetary policy since June 1999, the actual and
projected weakening of equity prices, and the
impact of rising energy prices on real incomes. In
addition, a sharper slowdown had been considered
(in particular in the most recent OECD Economic
Outlook), although mainly as a risk that might
result if financial market conditions (especially
equity prices and risk premia) were to deteriorate
Introduction
D
evelopments since the previous OECD Economic Outlook was finalised in autumn 2000
have brought substantial changes to the short-term
outlook for the world economy. Even if a U.S. slowdown – after some 6 percent output growth in the
first half of 2000 – was anticipated, such an abrupt
correction as appears to have taken place was only
indicated as a risk. In addition, the economic situation in Japan, while difficult to interpret, appears
poised for further deflation and disappointing
growth. Finally, some financial instability has resurfaced in emerging markets, hitting the Turkish economy. The
Figure 1
OECD is currently in the
process of producing its new
Outlook, and we are, of course,
taking these developments into
account in our projections.
While it is too early to discuss a
consistent set of short to medium-term projections, I shall, at
this point, highlight what I see
as the key issues affecting the
outlook and provide an assess-
Slowdown in the
U.S.
* OECD, Chief Economist and Head of
the Economics Department.
The views expressed in this paper are my
own and do not necessarily represent
those of the OECD or of its Member
countries.
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CESifo Forum
Focus
Figure 2: Financial Indicators in the United States
No rebound in Japan
CESifo Forum
sector and widely looked at
measures of consumer sentiment/confidence
dropped
sharply in the final months of
the year and continued to fall in
January and February.
In Japan, economic activity has
seemed unable to pick up in a
self-sustaining fashion, and
deflation has continued. While
recovery in Japan may still be
underway, the pace appears to be
slower than had been thought.
Corporate sector profits and a
weaker yen have helped, despite
higher real interest rates, to
underpin business investment,
but while, as expected, public
investment has slowed, real net
exports have started to decline
with weaker growth in the
United States and the economies
of East Asia. Moreover, the
weak income growth, due in part
to restructuring, has evidently
restrained private consumption.
Even more importantly, perhaps,
there are renewed concerns
about the financial sector in
Japan, amid indications of the
need for further significant balance sheet adjustments by banks
and some major adjustments as
well by life insurance companies.
Finally, wholesale and consumer
Source: Bloomberg; Board of Governors of the Federal Reserve System.
prices are continuing to decline
despite higher energy prices, in
further and spill over into business and consumer
part due to deregulation in a number of key sectors,
confidence.
but probably also in response to sustained weakness
in aggregate demand.
US financial market conditions did in fact deteriorate further in the fourth quarter. Equity prices fell
Economic activity in Europe also appears to be slowsharply and risk spreads on corporate bonds
ing a bit, but its performance still looks relatively
picked up (Figure 2). Real economy indicators also
good and is not much different from what was expectsoftened, driven by exceptionally weak capital
ed a few months ago. Export growth has slowed in
goods spending, a drop in real exports and a
part as the boost from the earlier depreciation of the
marked slowing in consumption (Figure 3). At the
euro ended and foreign demand dropped. The growth
same time, real inventories increased while final
of investment spending has softened as business consales of goods declined. Initial claims for unemfidence indicators have slipped slightly. Consumption
ployment compensation continued to rise throughspending has remained strong, however, with conout the quarter, and both the purchasing managers’
sumer confidence near record levels and employment
index of business conditions in the manufacturing
continuing to grow rapidly.
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Focus
Figure 3: Recent Economic Indicators in the United States
Relatively good performance in Europe
a)
Excluding aircraft. – b) Three-month moving average, percentage change from three months earlier at annual rate. – c) Level of shipments
in December relative to fourth quarter at an annual rate. – d) The average balance of opinions on production expectations, order-books and
stocks.
Source: Bloomberg, Bureau of the Census, Bureau of Economic Analysis, Datastream, Employment and Training Administration.
For most of the rest of the OECD area, develop-
price of oil does not drop sharply the economic out-
ments seem to be broadly in line with what was
look for these countries is generally favourable.
expected some months ago. Korea, however, may
be affected more than others by the U.S. slowdown
and the fall in demand of ICT products, given its
The U.S. correction
export specialisation in the ICT component producing sector. In Turkey, the situation is serious in
Against this background, much of our revised view
that it marks a significant setback in the attempt to
of the global outlook will depend on how we see
achieve stabilisation objectives.
economic activity in the United States evolving. In
this regard, the key issue is to form an assessment
The situation in the non-OECD area softened in the
on whether the slowdown since late 2000 is transi-
second half of last year, as the U.S. slowdown and the
tory and mostly due to temporary factors or
fall in demand for semiconductors and other electri-
whether it presages a protracted period of adjust-
cal goods is likely to have significantly reduced
ment. It is important, therefore, to try to under-
export growth also in dynamic Asia. South American
stand the nature of the factors behind the recent
countries, which have weaker trading ties with the
developments that have been taking place in the
United States, have been less affected than Asia by
United States. Significant pieces of data are, how-
the slowing of economic activity in the United
ever, still missing and, as a consequence, any analy-
States. Output growth in the oil-exporting countries
sis at this point can only be preliminary.
is rising in line with expectations and provided the
Nonetheless, one can tentatively identify a few key
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CESifo Forum
Focus
deepening and in the rapid rise in the equity price
of ICT producing firms. ICT expenditures were by
far the fastest growing component of investment
spending over the past two to three years and
accounted for more than a third of all business
investment in 1999 and 2000. Recently, adverse
profit movements have helped to reduce what have
appeared for some time to be clearly overvalued
stock prices of several ICT firms.
forces that likely contributed to the slowdown in
the United States and speculate about others.
Transitory factors
One element that seems to have been important
has been the exceptionally cold weather in the
United States in November and December, which
likely suppressed retail sales during that period
and also construction activity. The impact, however, on the economy is transitory and may, to the
extent that some purchases are only delayed, spur
output in coming months.
High oil prices
There also seems to have been a significant stock
adjustment taking place in the demand for durable
consumer goods in the last months of 2000, particularly in the motor vehicles sector, which had
enjoyed several years of strong growth before the
second half of the year. This downward adjustment
in the demand for automobiles as consumers work
off existing stocks was possibly influenced also by
high gasoline prices. In addition, investment
demand for trucks appears to have dropped off significantly at the end of last year, probably for similar reasons.
A related factor has been the high price of energy
(both oil and natural gas), which together with
apparently limited stocks of refined products, such
as home heating oil and gasoline, led to increased
final product prices and must have absorbed a larger-than-normal share of discretionary income.
Since December of last year, crude oil prices have
eased back a bit from recent peaks, as additional
crude oil production entered the market, heating
oil stocks began to recover and energy demand
softened. These developments were expected six
months ago when the OECD was finalising its current published set of projections, but the changes
have come earlier than anticipated. Moreover,
while oil and commodity markets are inherently
volatile, it is reasonable to believe that the risk of a
substantial additional hike in oil prices has abated.
The fourth quarter also saw a fall of U.S. exports in
nearly all categories of goods. A significant portion
of the drop was in aircraft, which are typically
volatile, and in semiconductors and ICT equipment. It is not clear, however, what factors were
behind the generalised drop-off in exports.
Even if the slowdown in investment, given signs of
over-capacity in some sectors, was to an extent
anticipated, it appears to have exceeded expectations. Rather than occurring smoothly over time, a
sharp correction has taken place. The interaction
between profit movements, stock price developments, consumer and business confidence (the
“animal spirits”) is obviously very complex.
Especially labour market consequences have to be
watched with care, as they will be crucial in determining the path of consumer expenditures. Finally,
as a result of the sharp correction in final demand,
an inventory adjustment is also to be expected,
which adds some uncertainty to the timing of the
recovery in activity growth.
Other elements, advanced by some commentators,
have been the protracted periods for settling the
outcome of the US presidential election and the
electricity utility crisis in California (one of the
world’s largest economies). These may have served
to puncture confidence. The somewhat nebulous
nature of confidence, however, makes it difficult to
assess these influences. But to the extent that these
forces did play a role, their impact is also likely to
be transitory.
Areas of greater uncertainty
Stock adjustment in
ICT equipment and
autos
CESifo Forum
An assessment
Stock adjustment effects appear to have been present in the demand for computing and telecommunications equipment, whose growth declined
sharply at year-end. The slowdown followed a period of exceptional demand growth, which was
reflected both in the process of strong capital
Positive developments
In many respects, recent developments have been
accompanied by adjustments that appear to be
6
Focus
would have been considered reasonable macroeconomic performance.
appropriate and reasonable, even if their timing
was not well predicted. In addition, the favourable
background against which these adjustments have
occurred might ease concerns about the likely
severity of the slowdown overall.
Low inflation and stable inflation expectations
The rise in oil prices since early 1999 has had little
effect so far on underlying inflation trends.
Excluding food and energy, the four-quarter
changes in US consumer prices have increased
only slightly (Figure 4). Consumer prices in the
euro area have also remained low. In addition,
there are no signs of higher long-term inflation
expectations in the United States and a number of
other economies, based on measures of inflation
expectations derived from consumer and producer
surveys, as well as from regular and index-linked
government bonds. Market long-term inflation
forecasts also continue to be low and stable relative to current inflation in the United States and
Europe (Figure 5). These developments are all the
more remarkable given that many economies have
been either above estimated measures of potential
output (e.g. the United States, the United Kingdom
and Canada) or approaching it, in some cases
rapidly (e.g. the euro area). The exception is Japan,
where deflation is continuing.
An orderly decline in US equity prices
Equity prices, especially in the high-technology
sectors, were by most estimates too high in recent
years. It seemed almost inevitable that an adjustment would eventually occur, and the risk was that
such an adjustment, when it did occur, might overshoot its true equilibrium and destabilise economic activity. However, what we saw in the past year
was a large but reasonably orderly decline of equity prices, most notably in the high-technology sector, where it was believed that such an adjustment
was most needed. Current prices clearly reflect
more reasonable prospects for earnings growth
than those of a year ago, although valuations may
still be a bit high relative to historical norms.
Continuing productivity growth in the United
States
US labour productivity continued to grow in the
fourth quarter, at a rate similar to those of previous
quarters. This is encouraging in part because the
end of a cycle is typically accompanied by a sharp
slowdown in labour productivity growth, as firms
are less able to adjust employment when demand
for output falls.
Productivity growth
and low inflation
It is noteworthy that the general pattern of modest
inflation outcomes has been occurring for a while
and has not been well anticipated by forecasters.
For example, while OECD projection errors for
GDP have been somewhat evenly distributed
around zero over the period from 1993 to 1999,
projection errors for inflation over the past decade
have generally been negative, indicating that actual inflation outcomes have generally been below
the projections (Figure 6). This may highlight the
occurrence of an important regime change in the
state of inflation expectations, possibly linked to
the success in the setting and conduct of monetary
policy.
The productivity figures serve to reinforce the view
that there has been a structural shift in the U.S.
economy. Sustained strong increases in productivity compared with the performance of recent
decades support the conclusion that the trend rate
of growth of potential output in the United States
has improved. Indeed, OECD estimates of U.S.
potential growth have been revised up on several
occasions over the past few years. The most recent
upward revision was late last year, when potential
growth was increased to around 4 per cent. This
compares with an estimate of 23/4 per cent in 1998.
An implication of the improvement in potential,
which is consistent with temporarily subdued inflationary pressure, is a reassessment of the extent to
which cyclical imbalances need to unwind and to
which policies need to react. Furthermore, these
imbalances can now unwind while maintaining a
pace of economic growth that until quite recently
Improved employment conditions in the euro area
Labour market trends in the euro area have been
favourable in recent years. More or less comprehensive reforms have been undertaken in many
countries, with all of them adopting measures that
lower labour costs and/or raise real wage flexibility. Also, reflecting policy measures to make
European labour markets more flexible, part-time
and temporary employment has contributed very
significantly to overall employment growth. This
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CESifo Forum
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Figure 4: Actual and core inflation in major OECD areas and
world oil prices
ployment rate has declined
from a peak of 11.5 per cent of
the labour force to around 9 per
cent, even as the participation
rate improved.
High consumer confidence in
Europe
Consumer confidence, according to the European Commission Survey, remains near
record levels in Europe, even if
some signs of softening are
beginning to appear (Figure 7).
Provided that labour market
trends continue to be favourable and that equity prices
remain around their current
levels, consumption should
remain healthy. It is notable
that consumer confidence measures in Europe have remained
relatively strong overall, despite the sharp downturn in the
United States.
Job growth and
high consumer confidence in Europe
Modest adjustment of the euro
The recent period has also witnessed a reversal in the foreign
exchange value of the euro,
which until October-November
of last year had been on a
declining trend since its inception. This sustained decline
prompted renewed questions
by some commentators about
the relationship between foreign exchange market developments and economic fundamentals. The slide of the euro
elicited both verbal and, ultimately, market intervention on
the part of monetary authorities in Europe and elsewhere.
The recent turnaround of the
euro against the dollar and the
yen constitutes, at this point,
only a small reversal of its earlier slide. However, this reversal is consistent with
a shift in views about the relative strength of economic activity in the euro area in the past few
Source: OECD Main Economic Indicators.
has occurred while demand conditions have been
gradually improving, and it has been reflected in
employment growth exceeding, over the past three
years, that in the United States. The area unem-
CESifo Forum
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Focus
By most accounts, US banks are
well-capitalised.
Therefore,
banks should not be reluctant to
lend on the grounds that they
need to work down bad debts or
build up capital, as they were at
the beginning of the 1990s. Nonfinancial corporations also
appear to have reasonably comfortable balance sheet positions.
While the debt levels of these
firms have moved above previous highs, debt positions are
quite low relative to the market
value of enterprises (Figure 8).
Furthermore, with interest rates
low, net interest payments relative to cash flow are at easily
sustainable levels. The household sector, however, is perhaps
one area where some concern
over balance sheets may arise.
Debt loads are high and,
because of the high levels of
debt, debt-servicing costs have
grown to be close to the peak
levels of ten to fifteen years ago
(Figure 9). Offsetting these concerns, to some extent, are the
relatively large holdings of liquid assets, which appear to offer a substantial cushion to households, although mutual fund holdings
comprise a significant portion of this buffer, and
their values may fall with equity prices.
Figure 5: Long-term Inflation Forecasts According to
Consensus Forecasts
Source: Consensus Forecasts (October 2000).
months and may mark the beginning of a period in
which exchange rate movements contribute to the
overall adjustment towards longer-run equilibrium.
More troubling developments
U.S. household debt
in high
Figure 6
There is more uncertainty
about certain other aspects of
recent developments, which
may serve to prolong or complicate the adjustment period.
Balance sheets in the United
States
Balance sheet positions in the
United States, which were
important in prolonging the US
recession of the early 1990s, do
not appear to be restraining
activity to the same extent now.
a) Unweighted average of projection errors for inflation and real GDP growth (actual minus
projected) from 1993 to 1999. Projections are from the December Economic Outlook for the
next year. Changing the starting date of the sample does not materially change the results.
9
CESifo Forum
Focus
United States, and, combined
with an economy that seemed
already to be running beyond
the limits of its capacity, it
appeared that a period of downward adjustment would be
inevitable. The decisions by the
Federal Reserve to cumulatively
raise short-term interest rates
by 175 basis points between
June 1999 and May 2000 were
designed to help unwind this
imbalance. Tighter monetary
conditions may have started to
bite in the second half of 2000,
but that may have come too late
to prevent a significant amount
of over-investment in capital
goods and consumer durables.
How long it will take to complete this adjustment is not
obvious, although continuing
price declines for ICT equipment and software and its rapid
depreciation should work to
shorten the process to some
extent.
Figure 7: Confidence Indicators
U.S. investment
in downward
adjustment
Japan
Balance sheet problems in Japan
CESifo Forum
The chances that growth in
Japan might deteriorate again
look to have increased. If a
downturn occurred, the situation would be made all the
a) Consumer sentiment is measured as 100 plus the balance of positive minus negative opinmore difficult by the underlying
ions. Purchasing managers’ deliveries (15%) and inventories (10%). – b) Consumer sentiment
structural problems. Balance
is calculated as an average of five indicators concerning household standard of living, income
growth, commodity price increases, employment environment and optimal time for durable
sheet problems, which reflect
goods purchases. The business situation prospects is the balance of positive over negative
poor future prospects for the
replies expressed as a percentage of total replied to questions concerning the business situation, stocks of finished goods and capacity utilisation. – c) Consumer sentiment refers to the
heavily indebted parts of the
average balance of positive and negative opinions on the expected financial situation, expectcorporate sector, are continuing
ed general economic situation and advantage to make major purchases at present. The purchasing managers’ index refers to the average balance of opinions on production expectato act as perhaps the major
tions, order-books and stocks.
restraining force on growth.
Source: OECD Main Economic Indicators.
While dealing with them will
create “head winds”, delaying
U.S. over-investment
appropriate responses will only exacerbate the
problem. In addition, despite the measures taken
Fuelling the exceptional growth performance of the
in March 1999 to address pressing problems with
United States, particularly in the period from midfinancial institutions, many underlying problems
1999 through to the first half of 2000, were rapid
remain with the banking sector (particularly the
increases in investment spending. Growth during
major banks). Furthermore, as bankruptcy procethis period was well above even the upwardly
dures continue to gather pace, the recognition is
revised estimates of potential output growth for the
growing that banks will have to increase their pro-
10
Focus
banks, has also been established.
Nevertheless, the industry is
likely to come under further
stress in the period ahead.
Figure 8
Turkey
An important concern is the
risk of contagion to other
emerging market economies
from the crisis in Turkey. One
cannot predict with certainty
what kinds of spillovers might
result from the crisis in Turkey.
Certainly those with exposure
to Turkey will be affected. It is
clear, however, that the Turkish
crisis is very much linked to
specific conditions in that country; and also that widespread
international exposure to
Turkish risk is not very high.
These considerations suggest
that spillovers, if any, should be
modest and short-lived.
Outlook: positive
growth in the U.S.
Tentative outlook and risks
Our preliminary analysis leads
us to think that the US economy
is currently going through a period of needed adjustment. To be sure, it started earlier and more abruptly than all analysts and commentators had anticipated. But going forward, it appears
that two different scenarios are likely. The more pessimistic scenario calls for a recession in the United
States, which in the worst case could be protracted
and have significant spillover effects on the rest of
the world. The more optimistic scenario, which
appears to be held by most analysts and towards
which I personally lean at this point in time, is for
significantly lower but still positive growth in 2001.
This means that GDP growth might end up being,
overall, around 2 per cent in the current year, and
higher for 2002. This central scenario acknowledges
that a sharp slowdown has occurred, but expects also
the speed of correction to be relatively rapid, as temporary conditions pass, fuel prices stabilise or ease,
potential output growth remains strong, and capital
stock adjustment is concentrated in the rapidly
evolving ICT sector. The sharp easing of US monetary policy in January and possible further cuts in
interest rates will also serve to speed the adjustment.
visions for bad loans (and disposing of bad loans is
made more difficult by the small size of the market
for asset-backed securities as well as the lengthy
and inefficient bankruptcy procedures, which have
nonetheless improved recently).
This effect could be compounded as the true extent
of losses in the non-financial sector are recognised
(following the introduction of tighter accounting
standards) and by any additional weakness in real
estate prices that might emerge, as banks typically
value collateral at historical value and only provision against the difference. Finally, bank loans have
fallen, as major sound clients restructure their own
balance sheets, and loan margins remain low. There
are also severe problems in the life insurance industry, where firms have extensive cross holdings with
the banking sector. These problems stem from high
promised returns, which in a number of cases now
cannot be met and which can only be altered during
bankruptcy proceedings. A restructuring system is
in place, and a safety net, smaller than that for the
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Figure 9: Debt and Debt-Servicing Measures of U.S. Households
and Non-Profit Organisations Relative to Disposable
Personal Income
Solid prospects for
Europe
Few policy options
for Japan
CESifo Forum
Nonetheless, the short-term
outlook for Europe appears to
remain solid. The high level of
business and consumer confidence, the employment gains,
and the tax cuts implemented in
some countries should underpin growth in domestic demand
and without stoking inflationary pressures. Recent falls in
equity prices may detract from
private demand, but the magnitudes should be buffered by the
small proportion of European
net worth held in the form of
listed company stocks. A modest slowdown in activity with
respect to 2000 is nonetheless
the most likely outcome. As
core inflation is predicted to
remain low, there would probably be little risk to implementing some modest monetary easing relatively soon. In the event
the size of the external shock is
larger than anticipated, or if the
domestic conjuncture substantially deteriorates, there would
remain considerable scope to
counter such weakness with further monetary policy easing.
In Japan, however, the monetary
authorities may not see themselves as having the same degree
of freedom. With policy targeting
an interest rate that is already
a) Home mortgage and consumer credit. – b) Deposits, credit market instruments and mutual
close to zero, further substantial
funds.
easing to counter the decline in
Source; Federal Reserve Board, Flow of Funds.
external demand might require
alternative, quantitative meaSlower growth in the United States will obviously
sures for the injection of liquidity, such as through
bear on the economic outlook in the other major
outright purchases of government bonds or foreign
economic areas. But the impact on the rest of the
exchange. Absent such easing, Japan might suffer an
world appears at this point to be manageable in
even larger decline in aggregate demand if the yen
most countries. Simulation results from the
were to rise in reaction to the relative easing of monOECD’s Interlink model show that, considering
etary policies elsewhere. Likewise, the scope to stimthe direct trade linkages, a decline of US GDP
ulate demand through expansionary fiscal policy is
1
growth of 1 to 1 /2 percentage points – about the
severely constrained by the already large budget
magnitude of the recent adjustment to expectadeficit and rapidly growing size of outstanding govtions for US growth in 2001 – would ceteris
ernment debt.
paribus lead to declines of roughly 1/2 of a percentage point for growth rates in both Europe and
Outside the OECD area, the reduction of global
Japan.
interest rates should help in many cases to reduce
12
Focus
ments exerting a stronger influence on consumption
behaviour through fluctuations in wealth and
through confidence. As a consequence, U.S. consumption spending may be becoming more volatile
and difficult to forecast than it had been in the past.
financing costs in emerging markets. Most of these
countries are also in a position to counter the effects
of a slowdown in external demand by easing monetary policy. The impact, however, of the ICT stock
adjustment in the United States may hit some countries in dynamic Asia hard, since a sizeable share of
their output and exports comprise ICT components
and equipment.
In addition, as mentioned earlier, the relationships
among inflation, inflation expectations, labour
market pressures and fuel prices may have
changed. Perhaps because of increased flexibility
of labour and product markets and/or increased
confidence in monetary policy making, inflation
and inflation expectations seem to be responding
less, in the current environment, to wage and commodity price pressures.
Risks
One risk to the outlook, however, is a more generalised cutback in investment and consumption outlays in the United States, which would detract from
growth in domestic demand and, in time, impinge
negatively on the US economy’s growth potential. So
far disappointing returns and revised profit expectations have been concentrated among high technology
investments. And the slide in equity prices, which
persisted through to the end of the year, has been
largely in these sectors. There is a risk, however, that
equity markets continue to fall, triggering even steeper declines in consumer and business confidence.
Such declines in confidence might in turn affect consumption and investment spending for a more protracted period, generating a more negative impact on
domestic demand and larger spillover effects to the
rest of the world. However, there is still scope for further monetary policy easing, which would tend to offset some of these negative effects on growth in the
United States and elsewhere.
The increased rate of potential output growth in the
United States, which has altered the speed limit for
the economy, and the greater share of capital stock
devoted to information and computing equipment,
which depreciates more rapidly and would lead to
faster unwinding of stock adjustment imbalances,
also change key economic relationships. As a result,
policy makers will need to be prepared to come to
grips with new developments, to look for changes in
relationships and indicators, and to adapt their policies as needed to the evolving character of economic activity. The success policy makers have in understanding and adapting to the new environment will
have an important influence on the way in which the
world economy evolves.
Changed economic
relationships pose
new challenges for
policy makers
This is a very general prescription and implementing it in specific situations will, of course, be difficult. At the moment, one of the key challenges facing the United States is to avoid over-reacting to
the slowing of economic growth, which might foster more volatility in activity and risk dissipating
hard-won gains against inflation. This task is complicated by the difficulty of measuring potential
with a high degree of precision, making policy setting uncertain. For Japan, the main challenge continues to be to devise the right policy configuration
to avoid deflation and spark self-sustaining economic activity. This will likely require the rigorous
implementation of financial system reforms, vigorous structural changes and the perhaps creative
use of existing macro policy tools. For Europe, the
challenge is to continue with smooth, non-inflationary growth while at the same time to boost the
growth rate of potential, which may come with the
further diffusion of information and communication technology and a higher degree of exposure to
competition in product markets.
Another, perhaps less likely, risk to the outlook
arises if the impacts of higher energy prices are still
to be fully felt. If the increases we have seen ultimately do pass through to core inflation and inflation expectations, especially at a time when output
growth is slowing, they could complicate the policy
response to the slowdown in activity throughout
the OECD area.
Challenges for policy makers
The current economic environment, which in many
respects is quite favourable, presents at the same
time some difficult challenges for policy makers. In
part this stems from recent changes in the nature of
economic activity and the patterns of economic
behaviour. For example, equities have in recent
years become an important component of U.S.
household wealth, with equity market develop-
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CESifo Forum
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become the source of the instability that it seeks to
combat.
THE OUTLOOK FOR THE
U.S. ECONOMY:
SOFT OR HARD LANDING?
However, the most striking feature of the economy in recent years is the extent to which its performance was dominated by developments in the
high-technology sector, both during the boom
and now during the slowdown. Thus, the overall
economy is being driven by cyclical developments in the high-technology sector. During the
boom period, the growth of aggregate demand
was spurred by a surge in domestic investment,
which we can attribute to purchases of high technology products, and a binge of consumer spending which I will argue can be largely attributed
to the wealth effects of the boom in high-technology equity prices. High-technology products
also had a large impact on the supply side of the
economy, providing for a surge in productivity
growth that allowed the U.S. to accommodate
the demand side boom without inflation (see
Table 1).
BARRY BOSWORTH*
T
U.S. performance is
dominated by hightech sector
he U.S. economy performed extremely well
over the period of 1995-2000; but it appears to
have hit a wall at the end of 2000 and its poor performance in the first few months of this year has
elicited talk of recession. The slowdown also seems
to have caught policymakers unprepared: as
recently as mid-December, the Federal Reserve
professed to be leaning toward further interest rate
increases. Yet in early January the Open Market
Committee convened by telephone and decided to
cut interest rates by 50 basis points, and followed
that with another 50 basis point cut in less than a
month. The prior restrictive policy has now been
fully reversed; and when combined with a similar
set of dramatic policy changes in 1998, there should
be some concern about whether policy itself has
With the bursting of the high-technology bubble in
equity markets and the consequent loss of wealth,
consumer spending has slowed; but the most substantial change has been a sharp drop in demand
* The Brookings Institution.
Table 1
Annual Rates of Change in Prices, Wages and Productivity
December to December percent changes
1993
1994
1995
1996
1997
1998
1999
2000
Consumer Price Index
ex. Food and fuels
2.8
3.1
2.6
2.7
2.6
3.0
3.3
2.6
1.7
2.2
1.6
2.5
2.7
1.9
3.4
2.6
Producer prices
Crude
Finished
ex. Food and fuel
0.4
0.2
0.4
– 0.6
1.7
1.6
5.6
2.2
2.6
14.7
2.9
0.6
– 11.7
– 1.2
0.1
– 7.4
– 0.2
0.3
15.7
3.0
0.9
31.4
3.6
1.2
Employment cost – Private Sector
Total compensation
Wages and salaries
ex. Sales occupations
3.6
3.1
3.0
3.1
2.8
2.9
2.7
2.9
2.8
2.9
3.3
3.3
3.3
3.8
3.7
3.4
3.7
3.1
3.4
3.5
3.6
4.4
3.9
3.9
Hourly earnings
2.6
2.7
2.9
3.9
3.7
4.0
3.5
4.3
Productivity growth
Nonfarm
Manufacturing
0.1
2.2
1.3
3.1
1.0
3.9
2.7
4.1
2.0
5.0
2.8
4.8
2.9
6.4
3.4
6.5
Unemployment rate
(annual average)
6.9
6.1
5.6
5.4
4.9
4.5
4.2
4.0
Source: Bureau of Labor Statistics, U.S. Department of Labor.
CESifo Forum
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for high-technology capital.
The implosion of internet startup firms has left the industry
with excess capacity, there has
been a slowing of the pace on
new product innovations, and
financial strains have led other
firms to slow the pace of their
purchases of high-technology
capital. The result is likely to be
a transitory slowing of GDP
growth to an annual rate of
about one percent in the first
half of 2001, and a return to
growth at 3 percent or above in
the last half of the year.
However, the effect on government policy may be more longlasting, as the Chairman of the
Federal Reserve has used the
slowdown as an occasion to
actively support a previously
unpopular proposal for a large
multi-year tax reduction. Thus,
it will likely mark the end of a
policy mix of fiscal restraint
and monetary ease that was in
effect for most of the 1990s.
Figure 1
Adjustment in hightech sector leads to
growth slowdown in
the first half of 2001
In what follows, I would like to
discuss the underlying cause of
the boom in somewhat more
detail before turning to the current economic outlook. In addition, the economic boom has
Saving (NIPA) is from the national accounts; Saving (FoF) includes the net accumulation of
had a profound affect on the
consumer durables.
U.S. fiscal situation and transSource: Federal Reserve System, Flow of Funds (FoF) Statistics.
formed the debate in ways we
never would have anticipated
ket for home mortgages and the rise in the wealthan few years ago. Finally, the combination of a
boom in investment and a sharp drop in saving has
income ratio. Most Americans finance their homes
generated a very large current account deficit. The
with 30-year mortgages. Prior to the 1970s, these
deficit in turn has stimulated concerns, more outwere truly long-term contracts that were binding
side than inside the United States, about the suson both the borrower and the lender. But under
tainability of the expansion in future years.
political pressure from homeowners, the government eliminated prepayment penalties for borrowers who wanted to repay the loan at an earlier peri-
The Role of the New Economy
od. Thus, borrowers have both the flexibility of
short-term borrowing and the security of long-term
As shown in Fig. 1, there has been a remarkable
collapse of household saving in the United States
over the past 15 years. I believe that decline can be
traced to two phenomena: innovations in the mar-
credit. In addition, the costs of refinancing a mortgage have been dramatically reduced by other regulatory changes, innovations in the mortgage mar-
15
CESifo Forum
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ket, and expanded competition
among mortgage lenders.
Consumer spending
boosted by
mortgage borrowing
and rising wealthincome ratio
Investment in information processing
dominated investment growth
Figure 2
As a result of these innovations,
periods of decline in mortgage rates
now trigger episodes of mass refinancing of mortgages. If it were simply a roll over of debt at a lower
interest rate, it would be of little
economic consequence. But most
homeowners cannot avoid the
temptation to increase the mortgage
amount, converting gains in their
home equity to cash, and repaying
their consumer credit. Mortgage
interest is tax-deductible and the
rates are much lower than for consumer credit. Note in the charts that
consumer credit is an unchanging
ratio to disposable income, whereas
mortgage debt continues to rise.
This is a relatively new mechanism
for translating real estate gains into
immediate gains to consumer
spending; but it is also very sensitive
to variations in interest rates,
because it is only attractive when
interest rates are declining.
index in 1991, they rose 10-fold over the following eight years to the point where they represented a third of the overall index in early 2000. Nontechnology stock rose by 150 percent over the
same period.
The second factor behind the growth of consumer
spending is the rise in the wealth-income ratio; and
as can be seen in the figures, the wealth gains can be
traced to increases in equity prices. Much of this
wealth is held in retirement accounts, but with the
conversion to defined-contribution accounts whose
value goes up and down with the market, more
Americans are aware of the short-term changes in
their retirement situation, and a large proportion
borrow against those retirement accounts to finance
more immediate expenditures. In addition, the proportion of American households with equity market
investments had increased to about 50 percent by
the end of the 1990s.
Business investment has had a long and remarkable expansion during the 1990s, admittedly from
very depressed levels at the beginning of the
decade. Again, as shown in Fig. 2, investments in
information processing capital completely dominated that growth. High-technology capital is conventionally defined to include computers, computer software, and communications capital. While
these components are an increasing share of nominal investments, their spectacular growth is the
result of large reductions in quality-adjusted
prices. It is important to note that part of the differences in the reported rates of growth and investment between the United States and Europe can
be traced to differences in how we measure the
real value of such investments; but in any case the
production of high-technology capital is a more
important part of the U.S. economy.
Over the past decade, the net wealth of the
household sector has increased from 5 times disposable income to 6.5 in mid-2000. The increased
value of equity holdings, both direct and indirect
through pension funds, represented 85 percent of
that increase. The increase in equity values, in
turn, was dominated by the performance of the
technology sector. Even though technology
stocks accounted for only 10 percent of the S&P
CESifo Forum
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Focus
nated NASDAQ. Much of the
rise of the NASDAQ in late
1999 was clearly unsustainable,
as price-earnings ratios reached
absurd levels; and the U.S.
experience with internet startups seems to have been built
largely on exaggerated hype. In
any case, the resulting wealth
losses have had an impact on
consumer spending.
Figure 3
The abrupt turnaround in capital spending was more surprising. Real expenditures on information capital fell at a 5 percent annual rate in the 4th quarter, in dramatic contrast to the double-digit rates of
growth in prior years. More generally, capital good
orders also plunged in the final few months. To
some extent the NASDAQ collapse may have been
an occasion that led firms to reevaluate their budgets for high-technology products. In addition, the
lack of new developments in computer hardware
and software made it unnecessary to replace computers at the pace of past years. This is reflected in
a much slower rate of quality improvement in the
government price indexes for computers during
2000. Also, a decade of rapid growth in investment
outlays has pushed up corporate indebtedness, and
financing restrictions are becoming of increasing
importance.
On the supply side, the rate of productivity growth
has accelerated over the last five years by about
11/2 percentage points, from 1.3 percent in the
1973-95 period (see Fig. 3). We can also factor that
improvement among three components. About
one-third of the gain can be traced to productivity
gains in the production of high-technology products; another one-third is the result of the large rise
in the capital-labor ratio (as previously mentioned,
largely the result of high-technology investments.);
and one-third reflects gains in multifactor productivity outside of the high-technology sector.
The source of the last one-third of the gains remains
controversial. Some analysts want to attribute it to
supra-normal returns to information technology
(network and similar effects), while others maintain
that much of this improvement will prove to be
cyclical or transitory in its effect. Interestingly, the
current slowdown will provide a partial test of the
importance of the cyclical factor. In either case,
high-technology would appear to be the dominant
source of the improvement in productivity growth,
Just as it was the primary story behind the boom on
the demand side of the economy.
The Federal Reserve has responded to these developments in a very confusing fashion that may
reflect a lack of consensus on future policy. Rates
were cut very quickly and by large amounts, and
some of Greenspan’s remarks seemed designed to
promote recession fears. For a while, it looked like
the new Administration and the Fed were trying to
generate a recession to strengthen the case for tax
reductions. But more recently Greenspan has
backed off and argues that there is no immediate
need for further actions.
Burst of equity price
bubble depresses
capital spending
Monetary policy was
eased sharply
The Slowdown
Outside the government, there are expectations of
further interest rate cuts. Primarily, this reflects a
view that the economy is fundamentally in very
good condition, that there is no economic reason for
a recession, and therefore the Fed should do everything it can to be sure that a recession does not
occur. Certainly, the Fed has the power to prevent a
recession should it desire to do so. Thus, nearly all of
So what happened at the end of 2000? First, a
restrictive monetary policy cut the growth of residential spending and a reduction in the refinancing
of mortgages was a factor behind the growth of
consumer demand. But the rise in interest rates
also played a role in pricking the bubble of equity
prices, particularly in the high-technology domi-
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CESifo Forum
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est forecasts of the CBO, the fiscal
surplus would reach 5 percent of
GDP by 2010 and the government
would retire all of the publicly-held
debt. Most surprising, this changed
budget situation is the product of
little or no legislative action.
Figure 4
Instead the fiscal turnaround is the
result of a higher rate of projected
growth, based on a continuation of
the pickup in productivity growth,
and a sharp rise in the effective
rate of personal income taxation.
The increase in the effective tax
rate, in turn, largely caught the
budget forecasters by surprise,
with large unanticipated revenue
inflows beginning in 1997. It
reflects an unusual concentration
of the income gains of recent years
among the highest income groups
who pay the highest marginal rates
and very large revenue windfalls
from the taxation of capital gains
realizations. The income gains of
the lowest income groups have
been surprisingly modest throughout the expansion. In the short
run, the realization of capital gains will continue,
even in a declining market, but the sustainability
of the high revenue yield rate is a critical area of
conflict in the argument over the long-term fiscal
outlook. Furthermore, the projections assume
continued strong restrictions on spending that
reduce the ratio of federal government expenditures to GDP to levels not seen for the past half
century.
Large and growing
budget surpluses to
be scaled boule by
tax cuts
the forecasts show a V-shaped slowdown in which
growth is not negative for more than one quarter,
and it recovers to a trend growth rate of 3–31/2 percent. This outlook is based on a continuation of
modest inflation pressures, and as shown in the
attached table, there are still few indications of a
significant rise in the inflation indicators.
The Changing Fiscal Situation
The current argument over fiscal policy is primarily
a political dispute with little role for economic factors. Conservatives have learned over the past quarter century that deficits can serve as the most effective restraint on new expenditure proposals, and
advocacy of tax reductions is far more popular than
opposing new programs as being too costly. Thus,
they will seek to eliminate the surpluses as a means
of maintaining pressures for scaling back expenditure programs in future years. Similarly, liberals
would like to use the funds to finance new programs, particularly expanded health care for the
elderly. Advocates of saving the surplus as a means
of offsetting a portion of the decline in private sav-
Among the most dramatic developments of recent
years has been the disappearance of the budget
deficit as the dominante issue of political conflict
in Washington (see Fig. 4). In just three years, the
fiscal outlook went from large and growing deficits
as far as the eye could see to large and growing surpluses equally far out into the future. In just the
two years from March of 1997 to January of 1999,
the projected fiscal balance for the year 2005 shifted from a deficit of $200 billion to a surplus of $300
billion; and this year the projected surplus was
increased to over $400 billion. According to the lat-
CESifo Forum
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Focus
Much of the external discussion has centered
around the sustainability of the foreign capital
inflows; but the issue generates surprisingly little
concern within the United States. Because of the
improvement in public sector saving, most of the
growth of the current account deficit has been a
reflection of very positive investment opportunities in the United States, and the fact that a
booming U.S. economy has been the engine of
growth in an otherwise weak and fragmented
world economy. While Europe has been doing
fairly well with a focus on its own internal economic concerns, the countries of Asia and Latin
America have become increasingly dependent on
exports to the United States to sustain their
economies. That situation is unlikely to change in
the near future, given the continued deterioration
of the Japanese economy, financial sector weaknesses in the rest of Asia, and a decidedly mixed
situation in Latin America.
ing or to improve the financing of the old-age retirement programs are in a distinct minority.
The most reasonable projection is that President
Bush will achieve most of his tax reduction program, and that his own proposals for defense
expenditures and a compromise with the Democrats on nondefense spending will eliminate the
projected surpluses on the budget exclusive of the
public Social Security programs. I would expect
projections for the non-Social Security budget to
return to rough balance within the next two budget cycles.
The Current Account
The economic concern with these budgetary outcomes lies with their implications for rates of
national saving in future years and the pressures
that will be placed on the current account. Over
the past decade, improvements in public sector
saving have fully offset the decline in private saving. Thus, the rise in the current account deficit to
near five percent of GDP can be traced to
increases in domestic investment (see Table 2 and
Fig. 5). With the scaling back of public sector surpluses, there would seem to be a potential future
problem of inadequate national saving. Barring a
stock market collapse that would reverse the
wealth gains of the past decade, there is little
basis for projecting improvements in private saving rates. That implies, in turn, a continued large
reliance on capital inflows from the rest of the
world; or a substantial decline in the rate of
domestic investment.
In an increasingly global capital market, national
balances seem less relevant as long as countries,
like the United States, are unconcerned about
foreign ownership of their production facilities.
At present, we can see no evidence of a rising
risk premium for investments in the United
States, and U.S. governments and corporations
still find it advantageous to borrow in their own
currency.
Inadequate national
saving offset by
foreign capital
inflows
Even if foreign investment capital should find
alternative outlets, the implication for the United
States would seem to be a declining real
exchange rate and improved export opportunities. Only if the capital outflow should generate a
Table 2
Net Saving and Investment by Sector, 1960–2000
Percent of net national product
Sector
1970–79
1980–89
1998
1999
2000
Saving
Private
Household
Government
1960–69
12.0
10.9
6.4
1.1
9.6
10.9
7.6
– 1.3
6.7
10.2
7.6
– 3.5
1990–95
4.7
8.6
6.1
– 3.9
1996
5.7
7.4
4.0
– 1.7
1997
6.7
7.0
3.5
– 0.3
7.5
6.3
3.4
1.2
6.9
4.7
1.8
2.1
6.7
3.2
0.1
3.5
Investment
Private
Government
Net foreign
12.5
9.4
2.6
0.4
10.7
9.0
1.4
0.2
7.3
7.5
1.5
– 1.7
5.4
5.1
1.3
– 1.0
6.2
6.7
1.1
– 1.6
7.1
7.6
1.1
– 1.7
7.2
8.6
1.2
– 2.6
6.0
8.5
1.3
– 3.8
5.7
9.2
1.4
– 4.8
Statistical discrepancy
0.6
1.0
0.5
0.7
0.5
0.4
– 0.3
– 0.9
– 1.0
Capital consumption
10.9
12.3
14.2
14.1
13.9
13.9
14.0
14.3
14.4
2000 is average of three quarters. – Net saving excludes capital consumption allowances.
Source: Bureau of Economic Analysis, Department of Commerce, National Income and Product Accounts.
19
CESifo Forum
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Figure 5
The current economic expansion
will contiune
precipitous decline in the dollar, with resulting
inflation pressures, would the implications be
particularly negative for growth. While a current
account adjustment may be an important issue in
the long-term outlook for the U.S. economy, it
does not seem to be determining the near-term
outlook. I would conclude that the United States
still has room to continue the current economic
expansion; and, while there are some signs of
increasing strains, they do not signal a recession
in the near term.
CESifo Forum
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Focus
is still an open economy, more open than the US or
the Japanese economies. Last year the share of
exports of goods and services of the Euro area
(excluding intra-area trade) was around 19% of
GDP compared to export shares of around 12% in
the United States and in Japan.
FORECAST FOR THE
EUROPEAN ECONOMY
WILLI LEIBFRITZ*
Another important driving force of the cyclical
development in Europe is the economic policy
stance with respect to both, fiscal policy and monetary conditions.
At an economic growth rate of around 31/2%, the
Euro area and Western Europe as a whole
achieved the best growth performance since 1990.
But the year 2000 was exceptional. Most forecasters agree that growth will be lower this year, but
views differ on how pronounced the slowdown will
be and also on the medium-term growth path of
Europe.
With these three factors, i.e. world trade growth,
fiscal policy and monetary conditions (the latter
comprise interest rates and the exchange rate) one
can fairly well explain the business cycle in the
Euro area in past years, reflected in changes in the
output gap, i.e. the difference between actual GDP
and trend-GDP (Figure 3).
Current situation
The Euro area passed the cyclical peak at the middle of last year. Since then the business climate
indicator collected by the ifo institute from experts
in these countries (Economic Survey International) has declined (as has the Ifo business climate
indicator for Germany) and economic growth in
the Euro area decelerated (Figures 1 and 2).
There is, first, the growth of the global economy. It
is true that foreign trade is less important for the
Euro area as a whole than it is for its individual
member countries as a good part of their trade is
intra-Euro area trade. Nevertheless, the Euro area
• The boom in the early 1990s, which was greatly
affected by German unification and expansionary fiscal policy, was followed by the recession
of 1993 which was caused by a combination of
slowing world trade growth and restrictive
macro policies in Europe. Fiscal policy became
restrictive when countries started to cut back
their structural deficits which had gone out of
control. Monetary policy was tight until the
recession began because the inflation rate
exceeded the inflation target.1
• In the period between 1994 and 1999 cyclical
recoveries remained moderate and short-lived.
During the entire period governments were cutting budget deficits to meet the Maastricht criteria and abide by the Stability and Growth
Pact. Monetary conditions tightened in 1995
when the deutschmark (and the currencies
which were linked to it) appreciated sharply
against the dollar. World trade growth was also
unstable during this period: strong growth in
1994/95 helped Europe to recover from the
recession. The temporary slowdowns in the
* Willi Leibfritz is Head of the Department of Economic
Forecasting and Financial Markets at the Ifo Institute.
1 But during the recession in 1993 the Bundesbank reduced the discount rate in five steps from 8% in February to 53/4% in October.
Main driving forces of the European business cycle
There are many supply side and demand side factors which affect economic developments. In
analysing the cyclical fluctuations of the European
economy one can, however, identify a few factors
which in the past played an important role and
which will also be of key importance this year and
next.
21
The Euro area business cycle is well
explained by world
trade growth, fiscal
policy and monetary
conditions
CESifo Forum
Focus
the deficit (if tolerated by the policymakers)
would then provide an automatic stabiliser
effect. By contrast, during past slowdowns (like
that of 1993) European fiscal policy often
restrained aggregate demand.
• With the increases in interest rates last year the
European Central Bank tightened monetary conditions in the Euro area. The level of the monetary conditions index constructed by Ifo for the
Euro area by weighting together the real shortterm interest rate and the real effective exchange
rate of the euro is, however, still above its medium-term average. This implies that monetary
conditions are currently not restraining aggregate demand. But a further appreciation of the
euro would continue to depress the monetary
conditions index unless the ECB cuts interest
rates (Figure 7). The growth of the money stock
M3 has decelerated from a high rate and is now
close to the reference value (4 1/ 2%) which
reflects a neutral policy stance. By contrast, the
monetary policy stance (excluding the exchange
rate) is found to be restrictive if instead it is
assessed by the Taylor rate and assuming that the
ECB is currently aiming to keep the core inflation rate below 2% rather than to push the actual inflation rate below 2% which is currently
above this target because of the oil price effect
(Figure 8). The yield gap, i.e. the difference
between long and short-term interest rates, also
indicates a tight monetary policy stance. In our
forecast we have assumed that the ECB will cut
interest rates by 50 basis points this year and that
the euro will strengthen from currently 0.91 to
around 0.97 dollars towards the end of the year.
• The actual inflation rate is still above the ECB
target but this is due to the oil price increase
which we assume to have been temporary.
Headline inflation has come down somewhat but
core inflation has picked up. One reason is the
effect of higher oil prices on the cost of domestic
production. As we assume no further rise in oil
prices, this second round effect should also be
temporary. Most recently European food prices
have increased in the wake of the spreading
mad-cow disease, but this should also be temporary. The big question, however, is if and how
wages in the Euro area will respond to higher
headline inflation. So far wage increases have
been moderate and in many cases they have a
term of two years. Hence next year’s wage round
will be of key importance for the sustainability
of price stability. The greater (the smaller) the
expansion of world trade in 1996 and in 1999
dampened growth in Europe.
• In the year 2000 there was a combination of
booming world trade and very favourable monetary conditions which were also a result of the
weak euro. These two positive factors outweighed the higher oil prices so that economic
growth could reach a new peak.
Forecast for 2001 and 2002
The Ifo indicators (as well as other indicators) for
the global economy show a significant slowdown in
economic activity in all major regions of the world
with the biggest decline in the United States
(Figure 4). Obviously Europe cannot be insulated
from the slowdown in the United States and in the
world economy. Given the sharp decline of some of
the indicators one cannot preclude a hard landing
scenario for both the United States and Europe,
although this is not our most likely forecast. A hard
landing scenario for Europe would require:
Hard landing of
European economy
unlikely
• that the United States enter a recession and that
this will be accompanied by
• significant losses in confidence all over the
world including Europe, and
• a fall in the exchange rate of the dollar and a
sharp appreciation of the euro.
In such a pessimistic scenario, growth in Western
Europe would decline from 3.4% last year to
around 11/2% this year. In the United States,
growth would decline from 5% last year to around
1% or lower this year. There are various reasons
why this is not our most likely forecast. First, there
are good chances that the slowdown of the US
economy will remain moderate, in particular as
monetary policy was eased quickly and may be
eased further. In addition, in Europe macroeconomic policies are currently better suited to prevent a severe downturn than in past recessions.
• Fiscal policy will stimulate demand in 2001
because of tax-cutting programmes in some
countries like Germany, France, and the
Netherlands (Figure 5). Furthermore, as the
average budget deficit in the Euro area is now
relatively small (Figure 6), there is room for an
increase in the cyclical component of the deficit
in case of a more severe downturn without violating the 3% deficit ceiling. Such an increase in
CESifo Forum
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Focus
mainly driven by consumption. At average rates
of around 21/2% this year and next, growth will
be lower than last year and similar to that
achieved in 1999 and also similar to the rate of
potential (or trend) output.
• As the slowdown will be more pronounced in
the United States (13/4%), economic growth in
the Euro area (and also in Western Europe as a
whole) will be higher than in the U.S. The
United States is, however, assumed to recover in
2002 when it may again achieve slightly higher
growth than Europe. In the forecasting period
there will be no growth differential in favour of
the United States which is an important difference to the second half of the last decade
(Figure 9).
• Employment in the Euro area will continue to
rise and unemployment will fall to under 8%
next year. Compared to a peak unemployment
rate of almost 12% this may be considered an
achievement. However, while it takes only a
short time in Europe to increase unemployment
during a recession it takes a very long time to
reduce it to its pre-recession level (Figure 10).
This points to major structural rigidities in
European labour markets which differ, however, among the various countries. Furthermore,
some European countries have made more
progress to reduce structural unemployment
than others.
Table 1
Euro Area
Key Forecast Figures
1999
(*)
2000
(*)
2001
(s)
2002
(s)
Percentage change over previous yeara)
Private consumption
Government consumption
Gross fixed capital formation
Domestic expenditure
Exports
Imports
Gross domestic product (GDP)
Employmentb)
(% change over previous year)
2.8
1.6
5.3
3.1
4.7
6.7
2.5
2.6
1.6
4.6
2.8
11.7
10.4
3.4
21/4
11/2
31/2
21/4
71/2
7
21/2
21/4
11/4
4
21/2
71/2
71/2
21/2
1.8
2.0
11/4
11/4
10.0
9.1
81/2
73/4
Consumer pricesd)
(% change over previous year)
1.1
2.3
31/4
13/4
Public sector financial deficite)
– in % of GDP
– 1.3
0.3
– 3/4
– 1/2
memo item:
Real GDP in USA
(% change over previous year)
4.2
5.0
13/4
23/4
Real GDP in Japan
(% change over previous year)
0.8
1.7
1
11/2
Unemployment ratec) (in %)
a)
* Preliminary. – (s) Forecast by the Ifo Institute. – At 1995 prices. –
b)
Domestic employment. – c) Unemployment as a percentage of civilian labour force (employed and unemployed). – d) Harmonised
index of consumer prices (HICP). – e) On national accounts definition (ESA 1995), in 2000 including revenue from the auction of
UMTS licenses.
Source: Bureau of Economic Analysis, Economic and Social Research
Institute, European Central Bank, Eurostat, calculations by the Ifo
Institute.
risk of higher wages and increased inflation
expectations perceived by the ECB, the more
(the less) it will hesitate to cut interest rates.
Based on these assumptions on the global economy and on macro policies we expect (see Table 1)
that in the Euro area
Growth of Euro area
GDP projected to
accelerate in the
first half of 2001, but
to be lower than in
2000
Medium-term outlook
• exports will increase by 71/2% this year and next
year (the major slowdown in export growth
occurring in the first half of the year) (broadly
in line with the growth of world trade), following a 11.7% expansion last year;
• growth of fixed investment (equipment and construction) will decelerate from 43/4% last year to
33/4% this year and 4% next year;
• private consumption will increase by around
21/2% this year and next. In view of the fact that
taxes are being cut in major countries, this
rather conservative outlook may be surprising.
It follows from a low starting base due to the
negative oil price effect and the assumption of a
recovery of consumer spending during the
course of this year.
• GDP growth in the Euro area will – after a
deceleration in the second half of last year –
accelerate during the first half of this year,
There is a good chance that the growth path in
Europe will be higher than it has been in the past.
Several reasons may be put forward:
• Given fewer fiscal problems and lower inflation,
both fiscal policy and monetary policy could be
less restrictive than they have been in the second half of the 1990s.
• Structural reforms in product and labour markets could make the European economy more
dynamic. There are clear signs for such effects
already. But structural reforms in labour markets are still lagging in particular in the large
continental European countries.
• The spread of new economy effects could also
help Europe achieve a higher medium-term
growth path. But some caution is in order here.
First, measuring any new economy effects is not
an easy task as it is difficult to separate the tem-
23
CESifo Forum
Focus
Table 2
Determinants of Growth 1990–1999
Comparison between the United States and Europea)
Change in productivity
caused by:
GDP Labour Capital
Labour
Capital
input stock productivity deepening TFP
United States
1990–1995
1996–1999
1990–1999
2.4
4.4
3.4
1.4
2.1
1.8
1.9
3.7
2.8
1.0
2.3
1.7
0.2
0.5
0.4
0.9
1.8
1.4
Western Europeb)
1990–1995
1996–1999
1990–1999
1.4
2.2
1.8
– 0.4
0.9
0.3
2.3
2.2
2.3
1.9
1.3
1.6
1.0
0.5
0.8
0.9
0.8
0.9
Finland
1996–1999
5.5
2.3
0.9
3.1
– 0.5
3.7
Ireland
1996–1999
9.9
5.8
4.7
4.0
– 0.4
4.5
of which:
high growth countries:
a)
b)
Average annual percentage change, in constant prices. – Weighted average of following countries: Germany (1992–95, 1996–99), Finland, France, Ireland, Italy, Netherlands,
Norway, Sweden, Spain, United Kingdom.
Source: C. Gust and J. Marquez, Productivity Developments Abroad
(http.//www.federalreserve.gov) and own calculations.
Europe to achieve a
higher medium-term
growth path
porary cyclical effects from overall productivity
growth to find the rate of growth which is sustainable over the medium and longer term. So
far no significant new economy effects can be
detected in overall growth and in productivity
growth in Western Europe (as officially measured). But in a few European countries like
Finland and Ireland such effects are noticeable
(Table 2).
• Further integration of Europe could also provide positive effects on medium-term European
growth. Here much will again depend on how
structural policies in Europe will be adjusted to
these new challenges.
Figure 1
CESifo Forum
24
Focus
Figure 2
Figure 3
Figure 4
25
CESifo Forum
Focus
Figure 5
Figure 6
Figure 7
CESifo Forum
26
Focus
Figure 8
Figure 9
Figure 10
27
CESifo Forum
Pro and Contra
THE U.S. ECONOMY:
RECESSION AHEAD?
Moreover, this is all happening at a time that consumers are stretched. The household saving rate is
currently in negative territory, the lowest rate since
the Great Depression. In contrast, in 1987, the
household saving rate was around 7% of disposable income.
PRO:
WEAKNESS WILL PERSIST
WILLIAM C. DUDLEY*
This suggests that the economy will remain weak
for some time to come. As households try to save
more, consumption will have to grow more slowly
than income. This, in turn, will erode income gains,
reinforcing the softness in consumer spending. It
will take time for consumers to retrench, especially when there is no other global economic locomotive.
I
s this the beginning of the end or the end of the
beginning of this bout of economic weakness in
the United States? There are some signs that the
worst of the slump is over. The factory sector
appears to be contracting more slowly; factory
inventories are being brought under control.
Moreover, consumer confidence, after falling
sharply, may be stabilizing. This has caused some
observers to argue that we are at the beginning of
the end. The economy will rebound sharply in the
second half of the year.
But what about monetary policy? Won't that turn
the economy around? After all, the Fed has aggressively been cutting interest rates.
I, however, am much more pessimistic. That is
because, from my vantage point, all that we are
close to is the end of the beginning, the first stage
of what will be a continuing slump in U.S. economic performance. It is the end of the beginning
because it is now widely recognized that an investment bust is fully underway. The factory sector is
contracting sharply. But we are nowhere near the
end because we have just begun to see the impact
of the investment bust on the consumer sector.
The answer is no. The problem is that the Fed has
not accomplished much yet. Financial conditions
have not eased. The decline in interest rates has
been fully offset by a weaker stock market and a
strengthening dollar. Our Goldman Sachs
Financial Conditions index is tighter now than it
was at the beginning of the year before the Fed
starting cutting its federal funds rate target.
This does not mean that monetary policy does not
work, just that the easing lever will have to be
pushed much more aggressively to have the
desired effect. The Fed needs to get the dollar
down and the stock market back up. To do this,
they are going to have to ease monetary policy
much more aggressively over the next six months.
Put simply, the virtuous circle has turned vicious. It
is going to take time and monetary and fiscal
accommodation to engineer a reversal of the current trend.
Although consumer spending has held up reasonably well to date, there is little reason to expect
that this is sustainable. First, layoff announcements will soon translate into job losses that will
push the unemployment rate higher and create
more anxieties about job insecurity. Second, the
wealth effect is now powerfully negative. More
than $5 trillion of stock market wealth has been
destroyed in about one year's time. This is far
larger than at any other time in U.S. history. Scaled
by the size of the economy, the wealth destruction
is about 21/2 times as big as in the 1987 stock market crash.
* Chief U.S. Economist, Goldman Sachs, New York.
CESifo Forum
28
Pro and Contra
that are, at best, rare. A cyclical recovery in 1996
was prolonged by the effects of the Asian crisis on
U.S. inflation and interest rates, and strong productivity provided a degree of inflation control in near
boom conditions. Now, and looking ahead, many of
these forces are unwinding, placing stress on prices,
profits, and U.S. financial markets not seen since
the early 1990s. As was the case in 1987 – the last
time the Fed moved from an inflation bias to an
outright rate cut in an effort to restore confidence
– the Fed will find itself again reversing course, as
the dominant economic concern returns to inflation.
CONTRA:
ECONOMY REBOUNDING
GAIL D. FOSLER*
D
espite the recent spate of negative economic
reports, the bulk of the economic and financial data suggests that the U.S. economy is not in,
nor is it about to enter, a recession. Rather, the U.S.
economy is in the weak phase of a growth cycle
marked by economic growth rates that are below
recent rate trends. While the economy can exhibit
recession-like characteristics during this phase –
excess capacity, declining investment, layoffs, and
weak profits, for example – the slowdown lacks the
dynamics, severity, and duration of a recession, and
is largely self-correcting.
The U.S. economy continues to improve from
month to month. Retail activity in January and
February turned in good showings. Led by auto
sales that rose from December lows in each successive month, this improvement in consumer
spending is fed by the surge in mortgage refinancings that is adding significant liquidity to the consumer sector. Based on January and February performance, consumer spending could advance 4 to
5 percent this quarter.
In terms of historical analogies, the industrial sector is immersed in a deep, though brief, adjustment
process very much like 1998, while events in the
financial sector this year will harken back to 1987.
This adjustment process, which began in July 2000,
is motivated by a desire to realign demand and
supply to restore margins after a period of unsustainable growth. While the swiftness and intensity
of the adjustment is instructive as to what might
happen in a genuine recession, rising backlogs over
the past six months suggest that production is
being cut faster than orders, and will soon recover.
The Conference Board’s Index of Leading Economic Indicators also rebounded in January –
although in no way erasing all of the weakness of
recent months. While a rebound of this magnitude
is not likely to be repeated in February, the trend
does suggest that December was the low point for
industrial activity, and that a steady improvement
can be expected as the spring unfolds.
U.S. data for January and February appear consistent with The Conference Board’s forecast of
about 3.4 percent growth for this year. However,
the business cycle is well advanced, and the favorable inflationary conditions that have permitted
the Fed to cut interest rates are not likely to prevail
in the future.
The U.S. economy strengthened on other fronts as
well. Construction spending rose sharply in
January, and, given housing and commercial activity, this strength should continue in February. The
January durable orders numbers offered hints of a
pickup in computer and electronics orders, and the
February National Association of Purchasing
Managers (NAPM) report posted small improvements across the full spectrum of activity measures.
Indeed, vendor performance (the percentage of
firms experiencing slower deliveries) and the price
index (share of firms paying higher prices) contin-
Until very recently, the United States has enjoyed
a near perfect set of macroeconomic conditions
* Vice President and Chief Economist, The Conference Board,
New York.
29
CESifo Forum
Pro and Contra
ue the strong pattern of recent months and are
very much at odds with the weakness in the rest of
the NAPM survey.
Overall, the current picture is one of relatively
robust demand that is drawing down inventories at
significant rates. Given the magnitude of the drop in
orders and production in the auto sector alone (e.g.
over 25 percent), total production – led by autos –
should begin to pick up sharply in March and April.
Thus the combination of both demand and production moving in the same direction in the second
quarter will, in the second half of the year, add
income stimulus to the Fed’s interest rate stimulus.
CESifo Forum
30
Special
ECONOMICS
IN
in many European university systems. Professors
still favor their own students rather than allowing
open competition among students regardless of
country of origin and country of training. Newly
graduated Ph.D.s from other countries, such as the
United States, are often not welcome to take up
academic positions, even in their country of origin.
It is clear that academic training and research in
Europe has much to gain from tearing down this
archaic, hierarchical and protectionist organization.
EUROPE
ASSAR LINDBECK*
As the result of evil political forces in the 1930s
and 1940s, research and qualified academic education in economics nearly disappeared from the
European continent. To a considerable extent, this
loss of competence took the form of a brain drain
to the United States. The damage to academic
research and teaching was particularly pronounced
in the field of “technical economics”, i.e., formalized economic theory and econometrics, since the
role of teachers and course programs is particularly important in these fields.
Nevertheless, considerable progress has been made
in academic training and research in Europe during recent decades, as witnessed by the emergence
of new generations of technically well-trained
economists. But as often happens when one problem is solved, others rise to the surface. In particular, there is the delicate issue of balance between
technical-analytical skills and basic (“intuitive”)
understanding of economic problems. There are at
least two serious enigmas in this context. First, the
increased emphasis in graduate programs on mathematical methods and abstract theoretical analysis
influences the recruitment of students to economics. It is valuable that a number of students from
mathematics, natural sciences and technology
enter Ph.D. programs in economics. But it is also
important that less technically trained students
with a genuine interest in social, economic and
political issues join these programs and that they
find the dicipline interesting enough to continue
their studies. Second, many graduate students
today have to devote so much effort to acquiring
technical-analytical skills that they do not have
time to develop a good and intuitive understanding
of important economic, social and political problems. Many do not follow the general discussion
about economic, social and political issues in the
media. In some cases, they hardly know whether
there is a boom or recession in their country of residence or for that matter in the world.
I saw the mirror image of this development quite
clearly while studying in the United States in the
late 1950s. At Yale University I could not avoid
noticing the unmistakably European accents in the
lectures of Gerard Debreau, William Fellner,
Tjalling Koopmans and Robert Triffin. I had a similar experience during a subsequent stay at
University of Michigan, where I listened to and
learned from George Katona, Richard Musgrave
and Wolfgang Stolper.
It took a long time for academic research and graduate training on the European continent to recover from the collapse. One reason, of course, is the
roundaboutness of production in academia: while
students need good teachers, the latter have to be
recruited from well-trained students, as in a
Leontieff input-output model – constructed by
another escaped European economist. A further
reason for the slowness of the recovery has been
the archaic and hierarchical organization of universities in most continental European countries.
Only a very few universities in Europe today have
first-class graduate programs in economics.
Moreover, intellectual protectionism still abounds
One risk with this situation is that young economists learn their field rather mechanically. The
responsibility for this, of course, lies with academic
* Professor at Institute for International Economic Studies,
Stockholm University.
Improvised dinner speech in connection with the celebration of
Richard Musgrave’s 90th birthday at Munich University.
31
CESifo Forum
Special
technical economics has improved in recent
decades. Perhaps the increased interest in empirical research in recent years, including experimental
economics, will contribute to improve the situation
in the future. Indeed, these new tendencies may be
seen as a reaction to the problems that I have just
described.
teachers, many of whom squeeze innumerable formal models into their lectures and reading lists.
They often do not have time (or the ability) to
demonstrate the intuitive content and the relevance, or irrelevance, of the models they survey.
One unfortunate side effect of all this is that we do
not educate enough “two-legged economists”, who
both master analytical techniques and have a feeling for real-world problems. This may be a reason
for the receding role of academic economists in the
general discussion of economic and social problems in several European countries. The role abandoned by economists tends instead to be taken up
by others. For instance, other social scientists,
including sociologists, political scientists and economic historians, increasingly take part in the general economic and economic policy discussion. It is
fine, of course, that researchers with training in
these fields participate in the public debate about
important problems in society. But they can never
replace competent broadly trained economists. The
void created by “retreating” economists, in particular in the mass media, is also filled by spokespersons for various organizations – for instance, banks
and interest groups. Again, they simply cannot fully
fill the role of academic economists.
What can be done about this? Basically, university
teachers and researchers have to assume a greater
responsibility for transmitting knowledge and
understanding of real-world problems, including
common sense, to their students. By this I mean a
feeling for proportions and, and hence a realistic
view of what is worth modeling. It is my experience
that this is indeed possible – if we try hard enough.
Do these views simply reflect an aging economist’s
inability to catch up with contemporary research?
I would, of course, resist this interpretation. I
believe that there is a genuine risk that simple
classroom exercises, with oversimplified and often
unrealistic assumptions, become the end product
rather than just an introductory step in the transmission of competence in economic analysis to new
generations. This risk was pointed out a long time
ago by the most influential economic theorist in
the 20th century, Paul Samuelson, in his
Foundations of Economic Analysis (1947, p. 4):
Economists “are like highly trained athletes who
never run a race”. There are many more such economists around today than in 1947 – both in Europe
and in other parts of the world, where training in
CESifo Forum
32
Spotlights
THE EAST GERMAN
ECONOMY STOPPED
CATCHING UP
The standard of living of east
Germany is approaching that of the
west. The average net income of an
east German household already
equals 80% of the west German
level in nominal terms. This net
income includes welfare payments,
transfers to the unemployed and old
age pensions. Because of lower
goods prices and rents, in real terms
this household has at least 90% of the west
German net income at its disposal. The east
German economy was modernised at a rapid pace;
investment boomed during the 1990s. Whereas the
share of investment in GDP amounted to 20% in
west Germany, it was at least 40% in the east,
peaking at 50% in 1994. This hides the fact, however, that the financial means available in east
Germany by far exceed the output produced.
Every third deutschmark which is spent in the east
comes from the west. Public transfers amount to
about 4.5% of west German GDP. And there is no
end in sight.
process. Economic growth depends on capital
accumulation. Capital is not only a factor of production as such, it also embodies technical knowledge. That is why in east Germany investment per
capita should be higher than in the west over a considerable period of time. Although this has been
the case during most of the 1990s – albeit with a
declining trend in recent years – net investment
has primarily gone into construction and not into
machinery and equipment. Thus building investment per employable person at times exceeded the
west German level by up to 80%, while equipment
investment (per employable person) was higher
than in west Germany only in 1995 and 1996 and
has declined since to 88% in 1999. No wonder then
that convergence is not proceeding at the aggregate level.
Since 1997 the economies of eastern and western
Germany have drifted apart as east German
growth has fallen below that of the west. A comparison of east and west German states (excluding
city states) shows that even in the boom year 2000
the eastern states grew by a meagre 1.1% whereas
the western states achieved growth of 3.2%. As a
result, relative output per employable person in
the former GDR which in 1996 – according to a
recent revision of the national accounts data of the
federal states – had amounted to 60.4% of the west
German level, declined further, to 57.6% in 2000
(see Figure). The latest unemployment figures also
confirm that east German states do much worse
than those in the west. Whereas unemployment in
west Germany declined to 7.7%, it remained at
18.6% in the east.
To be sure, economic catching-up is occurring in
individual sectors. Thus, real gross value added in
the manufacturing industry has increased by an
average 6.6% p.a. since 1996 – and thus faster than
in western Germany (including Berlin; 2.4% p.a.).
The construction industry, however, is mired in
deep crisis; its output shrank by an average 7.1%
p.a. during the past four years (west Germany:
– 0.7% p.a.). Even the tertiary sector grew more
slowly in east Germany: an average increase of
2.6% p.a. since 1996 compares to growth of 3% in
the west.
H.W.S.
It is the output side of the east German economy
with its poor supply conditions which remains the
main problem. The level of investment spending
points to a major reason for lower productivity
growth and the stoppage of the convergence
33
CESifo Forum
Spotlights
HOW INFLATION
IS MEASURED
In the past year, German consumer prices increased noticeably, mainly due to the cumulative effects of a weak euro and
the oil price explosion.
Measured in terms of the price
index for the cost of living of all
private households, prices rose
by 1.9% in 2000; in terms of the
harmonised consumer price
index (HCPI) by about 2%; but
measured by the deflator for
private consumer spending by only 1.4%. How do
these three carefully watched indices differ?
other private households (e.g. used cars) are not
taken into account.
To monitor price stability in the euro area,
Eurostat, the EU statistical office, has published –
since May 1998 – a harmonised consumer price
index for members of the Monetary Union (HCPIEMU) based on individual country results. The
Federal Statistical Office determines the German
HCPI for Eurostat every month. Harmonised consumer price indices were developed in order to
determine, on the basis of uniform standards,
whether the price stability criteria were met for
EMU membership. In the meantime, HCPI-EMU
has become one of the most important economic
indicators for the euro area. Differences in the
national consumer price indices have historical
reasons but they also reflect the differing social
conditions in the member countries or different
structures in the statistical systems. Because of the
differences in the consumer price indices of the
member states (as a result of diverging commodity
baskets or weighting schemes), a complete harmonisation has not yet been achieved.
W.N.
Since June 1948 changes in the prices of goods and
services at the consumer level have been measured by the price index for the cost of living of all
private households. This index registers the
monthly price changes of a representative sample
of domestic consumer goods (commodity basket)
on the basis of the average consumption behaviour of private households in 1995 (constant
weighting scheme). Currently, the Länder statistical offices decentrally collect data in 118 west
German and 72 east German municipalities on
about 350,000 individual prices for ca. 750 goods.
The overall results are calculated by the Federal
Statistical Office. This Laspeyres type index leaves
out interim changes in consumer behaviour as the
result of changed prices or preferences as well as
the money spent by German tourists outside the
country. The money spent by foreign tourists in
Germany, however, is taken into account (domestic concept).
In the context of the national accounts, the Federal
Statistical Office also calculates a quarterly price
index for private consumer spending. This index
differs from the price index for the cost of living in
that it refers to total consumption of private households (i.e. including non-profit organisations) and
in that current changes in the composition of consumption are taken into account (Paasche price
index). In addition, the consumption deflator
includes the tourist expenses abroad of domestic
households (domestic citizen concept). However,
domestic purchases by foreign tourists as well as
domestic purchases by private households from
CESifo Forum
34
DICE Reports
DICE REPORTS1
sources of energy (Fig. 1). Demands for identical
taxation of the pollutants from each energy source
are based on the desire to have the substitution
processes and savings efforts carried out in an economically and ecologically meaningful way. Even
taxation of pollutants is of practical relevance only
if energy savings and substitutions actually do or at
least could occur. This is indeed the case within
types of energy use (road traffic, heating, industry,
electricity generation) but rarely between these
sectors. This implies that demands for an even CO2
taxation is of practical economic and ecological
relevance only within sectors of energy use but of
less relevance between the sectors. Even great differences in taxation between the sectors would
have few harmful effects as hardly any tax-induced
substitution is possible.
TAXING CO2 IN EUROPE
The importance of greenhouse gases, especially
carbon dioxide (CO2) for the world climate was
again highlighted at last year’s World Climate
Conference in the Hague. Whether nations will
achieve the targeted reduction of the emission of
theses gases depends on how these pollutants are
taxed.
Many countries in Europe tax the emission of CO2.
All countries have a general consumption tax on
energy. In addition, several countries have supplemental taxes explicitly labelled “environmental”,
“energy” or “eco” taxes and in some cases a tax earmarked for financing reserves of certain energy
sources. All of these taxes on the consumption of
energy are also indirect taxes on the substances that
burning releases, including CO2. A few European
countries have, in addition, introduced specific taxes
on certain pollutants. Thus Denmark, the
Netherlands, Norway and Sweden place a direct tax
on the CO2 content of energy sources.
A comparison of the tax burden on CO2 discharge
within each of the four sectors of energy use
(Fig. 2) shows that especially in road traffic the
unevenness of CO2 taxation is much less than in
the other observed sectors. Thus, at 27%, Germany
has the lowest coefficient of variation, whereas
Norway has the highest, at 93%. In heating/households and industrial use, the size of the variation of
CO2 taxation is very different. Some countries like
Sweden, Denmark, Belgium and the Netherlands
have relatively low figures, whereas in Germany
From an economic and ecological perspective, the
tax burden on pollutants should not only be noticeable but should also be even. In other words, the tax
on a tonne of CO2 should be independent of the
energy source that releases it.
Only in this case do the substiFigure 1
tution effects and savings
efforts go in the right economic
and ecological direction. The
reasoning is that a tax on pollutants is not primarily aimed at
raising revenue, but is to force
companies to include the social
cost of a by-product in the production process in their cost
accounting.
CO2 emissions differ greatly
between countries and between
1
DICE = Database of Institutional
Comparison in Europe (www.cesifo.de).
35
CESifo Forum
DICE Reports
Figure 2
for industrial use and in the United Kingdom for
heating the differences in CO2 taxation are large.
In no European country and in no sector does an
even taxation of CO2 emissions exist, although
within end-use sectors even taxation would make
sense because of the possible substitutability. A
reasonable evenness of European CO2 taxation
may be found in the road traffic sector, with
Germany displaying the greatest evenness and
Norway and Switzerland the greatest unevenness.
Finally, taxation of a tonne of CO2 is higher in
those countries which have a specific CO2 tax than
in the others. Whereas the differences are small in
road traffic and electricity generation, they are
considerable in heating and industrial use. The
variation in the taxation of the individual energy
sources within sectors is lower in countries with
specific CO2 taxes overall and in the individual sectors than in the other countries.
In the long run, a rational and more effective economic/ecological policy will not get around a convergence of the marginal (not overall average) taxation of pollutants among the various sources of
energy. Toward this end, taxes on specific pollutants are needed like those already applied by
some European countries. The importance of such
instruments which are able to achieve the targeted
CO2 reduction at the lowest possible cost will
increase all over Europe and especially in those
countries which plan to get out of nuclear energy
and increase the number of conventional CO2intensive power plants.
Rigmar Osterkamp
CESifo Forum
36
Trends
ECONOMIC SURVEY
INTERNATIONAL
In its latest, the 71st Economic Survey International (ESI), the ifo Institute polled 717 economic experts in 78 countries in January 2001.
income taxes. This may be offset, however, by weaker consumption growth in Portugal, Spain,
Switzerland and Sweden. In Asia, assessments of the
current situation slipped further below the “satisfactory” level. This negative trend is expected to
continue during the coming six months. The economic climate was relatively positive in Singapore,
Hong Kong and China and most negative in the
Philippines. In Latin America the current economic
situation was assessed as slightly better than in the
previous survey when this indicator hit the “satisfactory” level for the first time in more than two
years. Expectations for the next half year, though
lower, are still slightly positive.
The world economic climate continued to cool off
(from 107.4 in October 2000 to 94.0 in January 2001.
It had peaked in April 2000, at 117.2 (1995=100).
The fact that assessments of the current situation
were more pessimistic than the business outlook for
the next six months indicates that the slowdown of
the world economy may be rather temporary. The
steepest drop in the current assessment was displayed by North America, where expectations have
already been rather poor for some time. In Western
Europe the upswing is losing momentum. Both the
assessments of the current situation and the business outlook have deteriorated. This despite the fact
that in Germany and France, in particular, private
consumption is expected to be boosted by cuts in
There is a growing belief that short-term interest
rates and long-term bond yields will decline during
coming months. This trend is most pronounced in
the United States where despite several cuts in key
Present and Expected Economic Situation
Source: ESI 71, 1/2001.
37
CESifo Forum
Trends
interest rates, the level of rates remains relatively
high. A steep downward trend in interest rate
expectations is also visible in the United Kingdom.
Expectations of rate cuts in the euro area have
been disappointed so far. In most of Latin America
and in Eastern Europe, short-term interest rates
seem to have peaked and are expected to decline
in the next six months.
Inflation is expected to decline world-wide from
the 3.6% average rate in 2000 to 3.3% in 2001. In
the euro area, the expected inflation rate is moderately lower than in 2000 (2.4% vs. 2.5%), whereas
it is expected to stay at 2.7% in the United States.
In Eastern Europe expected inflation is around 8%
in 2001 compared with 12% in 2000. In Latin
America consumer prices are expected to rise by
7% which compares to 9% in 2000.
Despite some correction in foreign exchange markets, the euro is still seen to be undervalued
against practically all currencies. Overvalued are
the dollar, the pound sterling and the Japanese yen
in the view of most experts. A downward correction of the dollar exchange rate is expected during
the next six months, especially against the euro and
the Canadian, Australian and New Zealand currencies. In Asia the dollar is likely to remain unchanged vis-à-vis most currencies. In Latin America,
Eastern Europe and Africa the dollar is expected
to appreciate in the course of the next six months.
CESifo Forum
38
Trends
MONETARY CONDITIONS
IN THE EURO-R EGION
In its recent meetings, the Governing Council of the ECB decided to
leave the key interest rates unchanged, reflecting the Council’s assessment of the risks to price stability in the medium term based on the two
pillars of monetary policy.
The first pillar, growth of the money supply, showed a continued moderation in the annual growth of M3. Its three-month moving average declined to 5.0% in the period from November 2000 to January 2001, from
5.1% recorded in the period from October to December 2000. Overall,
the risks to price stability from the monetary side are viewed to have
become more balanced during recent months.
As regards the second pillar, euro area real GDP growth appears to
have slowed last year, but the ECB’s outlook for this year is positive, as
conditions on the domestic side, like long-term financing costs have
remained favourable. Nominal long-term government bond yields continued to decline in the first quarter of 2001. The decline has been more
pronounced in real terms since the peak in early 2000.
39
CESifo Forum
Trends
EU SURVEY RESULTS
According to the latest revised estimate, quarter-to quarter
growth of EU gross domestic product amounted to 0.7% in the
fourth quarter of 2000 compared to 0.6% in the third quarter.
Year over year, growth in the fourth quarter was 2.9%, following 2.5% in the third quarter. During the full year 2000 EU
GDP increased by 3.3%, after 2.5% in 1999.
* The indicator of economic sentiment is a weighted average of the industrial confidence indicator, the construction confidence indicator, the consumer confidence
indicator and the share-price index. 1995 = 100.
The economic sentiment indicator declined by 0.5 points in
March, reaching 102.2. The Netherlands with – 0.9, followed
by Belgium, France and Finland, with – 0.8 points, displayed
the largest decreases. Spain and Austria were the only countries not to show a decrease in March.
* The industrial confidence indicator is an average of responses (balances) to the
questions on production expectations, order-books and stocks (the latter with
inverted sign).
** The consumer confidence indicator is an average of responses to the questions
on the financial situation of households and their assessment of the general economic conditions, both in the past and future twelve months, and the question on
big-ticket purchases.
The industrial confidence indicator declined by 3 points as a
consequence of a deterioration in production expectations, higher levels of stocks and a lower level of order books. Increases
were displayed by Ireland and Denmark, whereas significant
decreases were recorded by Finland, the UK and Italy.
Consumer confidence, after decreasing slightly in February,
remained steady in March at levels that can be considered
historically quite high. Consumer confidence increased in Italy,
the UK, Austria and Greece, less so in Germany, Spain and
Portugal.
CESifo Forum
Capacity utilisation in the manufacturing industry of the 15 EU
countries has remained stable in March, whereas the decline in
order books accelerated from – 1 in January, – 2 in February to
– 6 in March. The largest March decreases were recorded by the
UK (– 21), Austria (– 12) and Germany (– 9).
40
Trends
EURO AREA INDICATORS
Estimates (OECD Outlook December 2000) for euro area fiscal balances show a surplus of 0.3% of GDP for the general
government financial balance in 2000, but projected deficits of
0.5 and 0.3% in 2001 and 2002 respectively. The more important
structural balances are estimated at – 0.6% in 2000 and projected to rise to – 0.8% in 2001 and decline again to – 0.6% in
2002.
The seasonally adjusted unempoyment rate of the euro area
was unchanged, at 8.7%, in February 2001. A year earlier it had
amounted to 9.4%. The EU 15 countries also had an unchanged
unemployment rate, at 8%, compared to 8.7% in February
2000. The lowest unemployment rates were registered by
Luxembourg (2%), the Netherlands (2.6%), Austria (3.7%),
and Ireland (3.8%). At 13.7%, Spain continued to have the highest unemployment rate in the EU.
41
a)
BIS calculations; to December 1998, based on weighted averages of the euro area
countries’ effective exchange rates; from January 1999, based on weighted averages
of bilateral euro exchange rates. Weights are based on 1990 manufactured goods
trade with the trading partners United States, Japan, Switzerland, United
Kingdom, Sweden, Denmark, Greece, Norway, Canada, Australia, Hong Kong,
South Korea and Singapore and capture third market effects. Real rates are calculated using national CPIs. Where CPI data are not yet available, estimates are used.
The real effective exchange rate of the euro which, at 90.3, had
been approaching its year earlier peak in January 2001, declined again in February to 89.4, a – 1.1 percentage change against
the previous month. In February, the bilateral euro exchange
rate declined by 6.3% year-on-year against the dollar and by
4.4% against the Swiss franc, but rose by 3.1% against sterling.
The harmonised index of consumer prices (all items) rose from
a low of 2.4% in January to 2.6% in February 2001. It remained above the EU-15 average of 2.3%. Euro area core inflation
continued its rise to 1.6% in January and an estimated 1.7% in
February.
CESifo Forum
29–30 June 2001
Area Conference on Employment and Social Protection
15–22 July 2001
3. Industrial Organisation
CESifo-Delphi Conferences
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Labour Market Institutions and Public Regulation
13–14 December 2001
11–14 September 2002
26–27 October 2001
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2. Environmental Economics and the Economics
of Congestion
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15–22 July 2001
1. Financial Crises and Recovery
CESifo Venice Summer Institute (3 workshops)
15–16 June 2001
Redistribution and Employment – New Social Policies for
the New Millennium
19–20 May 2001
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CESifo Growth and Inequality Conferences
4–5 May 2001
Date
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Conference Title
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