Modest Growth and High Price Stability Projected for the OECD Area

Following a speedy recovery in 1994, western economies have shifted towards a slower growth path in 1995. At present there is little evidence to suggest that activity may soon reaccelerate. Therefore, inflation should remain at its present low level, while high unemployment in Europe is unlikely to fall substantially. Instead of gaining further momentum according to the usual pattern, demand and output have slowed in the OECD area during the course of 1995. Aggregate GDP may have expanded by 2 1/4 percent, following the almost 3 percent annual rate in 1994. Little acceleration is projected until end-1997; with a growth rate below 3 percent output remains well below potential. Inflationary pressures are thereby kept at bay, an even further weakening seems possible. Employment prospects, on the other hand, are unlikely to become substantially brighter and jobless rates remain too high nearly everywhere. In spite of lackluster activity spreading over most of the OECD area – hardly any of the major countries except Canada is likely to attain a 3 percent annual growth rate before the end of 1997 – and overall growth differentials being small, individual countries are in rather different cyclical positions. In the U.S., the strong recovery passed its peak in 1994 and, as a consequence of preemptive monetary tightening, demand and output have staged a "soft landing". The Japanese economy, on the other hand, has been kept in a recession over the last four years which even sustained expansionary action by fiscal and monetary policy has not been able to overcome, since it is superseded by problems of structural adjustment concentrated in the financial sector. However, most disappointing has been the early faltering of the recovery in western Europe, reasons which vary from country to country. A common factor were the marked exchange rate shifts – devaluation of the dollar and of several southern European currencies – in spring 1995. These shifts, although being in part corrected subsequently, have undermined competitiveness of hard-currency countries, thereby weakening exports, the major force of expansion; in the weaker-currency countries, at the same time, they gave rise to interest rate hikes – in order to rein in further risks to price and exchange rate stability – which dampen domestic demand. With the prospects for slower growth, continued high price stability and greater resolution of governments to reduce excessive fiscal deficits, interest rates have generally come down in recent months and the trend is unlikely to reverse soon. Low interest rates and the generally good profit situation should strengthen business confidence and the propensity to invest, even if the short-term demand outlook remains fragile. In Europe, simultaneous efforts of fiscal retrenchment undertaken in many countries are likely to lead to shortfalls in demand and output, amplified by multiplier effects. To what extent this restrictive impact will be offset by low interest rates and confidence effects created by the consolidation process itself, remains to be seen.