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The Economic and Financial Outlook: Surviving Imbalances David Wyss Chief Economist 212-438-4952 [email protected] World Bank Washington April 26, 2005 The Recovery Is Finally Accelerating • • • • • • • • • • After two years of sluggish expansion Jobs are finally materializing Up to now, the recovery has run on two legs – consumer and government spending Now equipment spending is rising And nonresidential construction is starting to recover Higher interest rates will slow housing and consumer spending Tax cuts are over, and the saving rate is already low Federal deficits will come down slowly But higher oil prices could stall the expansion And world economic stagnation continues to widen the trade gap 2 Inflation Remains Mild (Percent change in CPI) 3 2 1 0 -1 US Canada Japan France 3 Germ. Italy UK Unemployment Rates Are High (Percentage of labor force, 2003) 10 8 6 4 2 0 US Canada Japan France Unemployment rate 4 Germ. Italy UK Long-term (26-week) The Fed Is Moving Toward Neutral (Percent) 8 6 4 2 0 1993 1995 1997 1999 2001 Federal Funds Rate 2003 2005 2007 10-Year Treasury Bond Yield 5 Second-Term Policies • Emphasis in second term will shift to controlling deficit – The current deficit is manageable (3% of GDP) – But few prospects for controlling it • Creating an “Ownership Society” • Social security reform is getting most attention – We have promised more than we have money to pay – Benefit cuts or tax increases – Partial privatization will be main Administration proposal • Tax reform rather than tax cuts – Changes should be revenue neutral – More consumption-based taxation – Encourage saving • Cut deficit in half by fiscal 2008 – Requires tough control of government spending – Could be derailed by international events 7 The Future Looks Bleak (Government debt as % of GDP) 400 718 350 287 300 239 250 200 221 160 150 150 100 235 108 101 65 42 50 66 66 68 98 0 US Japan UK 2005 2025 8 France Germany 2050 Where the Money Goes (Federal spending, percent of GDP, CBO estimates) 35 30 Interest 25 Other 20 Defense 15 Health care 10 Social security 5 0 2004 2050 2025 9 The Trade Gap Yawns Wider (Percent of GDP) 16% 14% 12% 10% 8% 1993 1995 1997 1999 2001 Exports 2003 2005 2007 Imports 10 Taking the Dollar Down (Real trade-weighted dollar) 1.2 1.1 1.0 0.9 0.8 0.7 0.6 0.5 1993 1995 1997 1999 2001 Industrial 2003 2005 2007 Developing 11 World Growth Is Slowing (Real GDP, % change) 8 6 4 2 0 -2 US 2002 Europe Japan 2003 2004 12 Other Asia 2005 Latin America 2006 US Deficit Balances Other Surpluses (Trade balance as percent of GDP, 2004) 6 4 2 Japan 2.8 0 -2 -4 -6 -8 US Canada Eurozone 13 UK Japan Asia ex Japan US Borrows From Abroad to Offset Weak Savings (Percent of GDP) 22% 20% 18% 16% 14% 12% 10% 1970 1975 1980 Gross saving 1985 1990 1995 Private saving 14 2000 2005 Private investment European Investment Lags US and UK 15 European Productivity Growth Trails (Output per hour, percent change) 6% 5% 4% 3% 2% 1% 0% -1% -2% 1992 1994 1996 Eurozone 1998 UK 16 2000 2002 Japan 2004 US Average Bottom Line: The Economy Recovers, But Slowly • Consumers are spending near max • Businesses will not take over the lead yet • But strong stimulus from fiscal policy • Interest rates rise gradually next year • Housing prices and starts slow • Weak recovery for stock market • Risk of recession remains if: – Further terror attacks damage confidence – War disrupts oil supplies – World deflation sucks the US into slower growth 17 Risks to the Economy (Real GDP, percent change year ago) 6% 4% 2% 0% -2% 2000 2001 Baseline 2002 2003 2004 Recession 2005 2006 Optimism 18 2007 2008 Stagnation Economic Updates • Thank you for your attention • If you would like to receive our regular economic and credit market updates, please register at: • http://info.standardandpoors.com/mk/get/ECMR_REG_FORM 19