World Economic Outlook--October
1997
A Survey by the Staff of the International
Monetary Fund
I. Global Economic Prospects and
Policies
Chapter I in PDF (105k)
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With world output expected to expand by some 4¼ percent in both 1997 and 1998, the
strongest pace in a decade, the global economy is enjoying the fourth episode of relatively
rapid growth since the early 1970s (Figure 1). The expansion is
underpinned by continued solid growth with low inflation in the United States and the United
Kingdom; a strengthening recovery in Canada; a broadening of recovery across continental
western Europe, notwithstanding persistent weakness in domestic demand in some of the
largest countries; robust growth trends in most of the developing world, particularly in China
and much of the rest of Asia even though some countries are likely to experience a setback
associated with recent turmoil in financial markets in Southeast Asia; and evidence of an end
to the decline in output, and perhaps a beginning of growth, in Russia and in the transition
countries as a group. It is worth recalling, however, that each of the three previous episodes
of relatively rapid growth was followed by widespread slowdown and even recession in many
countries. Taking account of this earlier experience, is there a danger that the present
expansion may soon run out of steam and give way to a new global downturn?
Data for Figure 1
Although a moderation of world growth is indeed likely to occur at some point, there are
reasons to believe that the current expansion can be sustained, possibly into the next decade.
First, there are relatively few signs of the tensions and imbalances that have usually presaged
significant downturns in the business cycle: global inflation remains subdued and
commitments to safeguard progress toward price stability are perhaps stronger than at any
other time in the postwar era; fiscal imbalances are being reduced with increasing
determination in many countries, which is helping to contain inflation expectations and real
interest rates; and exchange rates among the major currencies, taking account of relative
cyclical conditions, are generally within ranges that appear to be consistent with
medium-term fundamentals. Second, cyclical divergences have remained sizable among the
advanced economies, and there are still considerable margins of slack to be taken up in Japan
and continental Europe. Stronger growth during the period ahead in these countries should
help support global demand and activity as growth slows to a more sustainable pace in those
countries that have already reached a mature stage in their expansions, especially the United
States, the United Kingdom, and several of the smaller advanced economies. Third, the
recovery that is in progress in the transition countries seems likely to continue to strengthen
at the same time as the growing number of successful economies in the developing world are
also providing both new markets and increased production capacities; these developments are
stimulating trade and growth worldwide while helping to dampen price pressures. Taking into
account the combination of the strong catch-up potential of the developing and transition
countries and the beneficial effects on productivity of technological advances and increasing
globalization, the sustainable rate of world output growth may now in fact be somewhat
stronger than in the quarter century since the first oil shock. This view is embodied in the
IMF staff’s medium-term scenario, which points to a trend growth rate of world GDP
of about 4½ percent between 1996 and 2002 compared with an average rate of
expansion of 3¾ percent since 1970.
This generally positive assessment of the global outlook should not lead to complacency
because there is a wide range of risks and fragilities that confront individual countries and
may affect regional and world economic and financial conditions. The main areas of concern
relating to prospects over the short to medium term include the following:
- Risks of overheating. Although world inflation has subsided to the lowest rates
seen since the early 1960s, inflationary pressures could reemerge, especially in countries that
have reached high levels of resource use. Effective policy to prevent inflation rising requires
vigilance not only against overheating in product and labor markets but also in asset markets,
and it requires preemptive action when warning signs appear. Problems stemming from large
swings in asset prices emerged in the late 1980s and the early 1990s in a number of countries,
most notably in Japan but also in Australia, Sweden, the United Kingdom, and the United
States, with repercussions on the soundness of financial systems in some cases. More
recently, several emerging market countries, especially in Southeast Asia, have experienced
similar difficulties in their real estate sectors. Despite some correction in August, there is also
reason for concern about the strength of world stock prices, which may to some extent be
based on unrealistic expectations about prospects for future profit growth and low interest
rates. A more substantial correction in stock prices, were it to occur, could adversely affect
confidence and economic activity.
- Uncertainties about the Economic and Monetary Union (EMU) in Europe. The
marked convergence of interest rates among the prospective members of the monetary union
seems to suggest that financial markets expect the project to go ahead in accordance with the
agreed timetable, which calls for the new currency, the euro, to be in place by January 1999.
Investor sentiment may still change, however, if the feasibility of the timetable was perceived
to be threatened. In that case, interest risk premiums might again widen for some countries,
while the currencies of others might be subject to unwelcome upward pressure. Also, should
growth prove insufficient to permit progress in reducing record levels of unemployment in
much of Europe, confidence would remain weak; in some cases there might be a risk of resort
to counterproductive fiscal policies incompatible with the requirements of EMU.
- Sustainability of capital flows to emerging market countries. Several factors have
contributed to record capital inflows into many emerging market countries and an associated
compression of yield differentials in recent years, including the trend toward a more open
global financial system and the increasingly successful economic policies pursued in many
recipient countries. But the availability of these flows and their costs are also influenced by
global cyclical conditions and are vulnerable to higher interest rates in world financial
markets as well as to perceptions that large current account deficits—the counterpart to
capital inflows—may not be sustainable in all cases. The crisis in Mexico late in 1994
and more recently the financial pressures that have affected Thailand and a number of
countries in Southeast Asia underscore the importance of disciplined macroeconomic policies
and robust financial sectors. They also have highlighted the risk and costs of potentially
disruptive changes in market sentiment, including the danger of very strong reactions in
financial markets and serious spillovers to other countries when critical policy weaknesses
are not addressed in a timely manner.
The rest of this chapter summarizes the IMF staff’s near-term projections and policy
assessments and identifies some key policy concerns that need to be addressed in order to
strengthen medium-term economic prospects in all countries in accordance with the
guidelines set out by the Interim Committee in its September 1996 "Declaration on
Partnership for Sustainable Global Growth."1 Other
issues discussed include the prospects for EMU and its potential longer-term implications for
Europe and the world economy, the critical need for labor market reforms in Europe, lessons
from recent exchange market crises and the trend toward greater flexibility of exchange rate
regimes in developing countries, the challenges facing monetary policy in the transition
countries in safeguarding progress toward macroeconomic stability, and the need for
so-called second-generation reforms to sustain high quality growth in all regions.
1See World Economic Outlook, October 1996, p.
xii.
©1997 International Monetary Fund
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