The industrial countries as a group are gradually emerging from their first major economic slowdown since the early 1980s. During the past decade, inflation has been reduced substantially, and growth of potential output may have strengthened in some countries. Price stability was not achieved, however, and budgetary imbalances have remained excessive in many cases and in some countries have widened again. Policymakers now face the tasks of supporting economic recovery in the short run while improving conditions for stronger growth over the medium term. A key priority should be a reduction in real long-term interest rates through a resumption of progress toward fiscal consolidation; this would stimulate capital formation and raise productive potential.
Current Stance of Monetary Policy
In the past two years, some industrial countries have been in recession, with most others experiencing a cyclical decline in output growth. The resulting moderation of price increases has alleviated earlier concerns of a re-emergence of inflationary pressures in many countries. This has allowed short-term interest rates to decline significantly in Australia, Canada, Japan, the United Kingdom, and the United States. In contrast, monetary conditions in most European countries have followed the tightening in Germany, which was made necessary by inflationary pressures in the wake of unification (Charts 18 and 19).
Major Industrial Countries: Real Interest Rates1
(In percent a year)
1Interest rates deflated by the annual increase in the GDP deflator; annual averages through 1989 and quarterly data for 1990-92:Q2.2A weighted average of yields on government bonds with remaining maturities of ten years or nearest, using 1987 GDP weights.3Three-month certificate of deposit rates for the United States and Japan: three-month interbank deposit rates elsewhere, with the following exceptions: Eurodollar rate for the United States before 1976; Gensaki rate for Japan before July 1984; money market rate for France before 1970; and the discount rate for Italy before 1978.Judging the stance of monetary policy during the past two years has proved unusually difficult, in part because movements in monetary aggregates have been providing unreliable and, at times, inconsistent signals. In the United States, M2, the broad aggregate targeted by the Federal Reserve, has grown only very slowly, whereas M1 growth has been far more robust (Chart 20). This difference can be traced to a substantial decline in small time deposits, which are included in M2 but not in M1. A similar situation has existed in Japan, where M2 plus certificates of deposit (M2 + CD), the only aggregate for which the Bank of Japan publishes projected rates of growth, increased relatively slowly in 1991, whereas M1 grew rapidly. In early 1992, however, the growth of M1 fell sharply. In Germany the situation is the reverse, with the broad aggregate that is targeted by the Bundesbank, M3, growing rapidly while M1 growth slowed during 1991 and through mid-1992.
Three Major Industrial Countries: Growth of Monetary Aggregates and Interest Differentials
(In percent a year)
1For the United States, yield on government bonds with residual maturities of ten years minus three-month certificate of deposit rate: for Japan, yield on ten-year government bonds with longest residual maturity minus three-month certificate of deposit rate: and for Germany, yield on government bonds with residual maturities of nine-ten years minus three-month interbank deposit rate.2Twelve-month growth rate of M1 less twelve-month growth rate of the broad aggregate.In all three countries, the differences between the growth of broad and narrow aggregates appear to be related to changes in the term structure of interest rates, which is itself an indicator of monetary conditions. In the United States and Japan, the yield curve has steepened as a more expansionary monetary stance has reduced short-term interest rates more than long-term rates, resulting in a portfolio shift out of the short-term time deposits included in the broad aggregates into longer-term nonmonetary instruments. In Germany, however, short-term rates have risen relative to long-term rates, increasing the attractiveness of the types of deposits that are included in M3. However, in each country there have also been special factors at work—such as the restructuring of the U.S. savings and loan industry, transitory portfolio shifts into postal deposits in Japan, and unification and the prospect of a new withholding tax on interest income in Germany-that probably indicate little about the short-term direction of the economy. At this juncture monetary aggregates in all three countries do not provide an unambiguous guide for the conduct of monetary policy; the authorities must therefore rely on a wider range of indicators.
In the United States, a recovery now seems to be under way, although its hesitancy continues to give rise to concern. The sharp decline in short-term interest rates since the end of 1990 should continue to support the economy in accordance with lags of the kind observed in the past. The decline in short-term interest rates, however, has been reflected only to a small extent in long-term rates (Chart 18), a phenomenon that is attributable at least in part to the large government borrowing requirement and related fears of higher inflation in the future. The effectiveness of lower short-term rates in stimulating interest-sensitive spending has therefore been blunted. Although the mixed signals given by the monetary aggregates make it difficult to assess the current policy stance, in view of the projected recovery of economic activity a further reduction of interest rates would not now seem necessary. In any case, as the recovery strengthens, the authorities should be prepared to allow interest rates to rise to help keep aggregate demand on a sustainable path.
In Canada and the United Kingdom, the two other major industrial countries that have been in recession, signs of recovery are generally less encouraging. In Canada, the inflation rate has fallen sharply to one of the lowest in the world, and there is now a large margin of slack in the economy. Short-term interest rates have been reduced significantly, and further easing of monetary conditions consistent with achieving price stability will depend on the pace of economic activity. In the United Kingdom, short-term interest rates also have fallen considerably since their peak in 1990, but with inflation declining and in light of the weakness of activity, they have remained at relatively high levels in real terms. Given the position of sterling in the ERM in recent months, it is doubtful that there is further scope for reducing interest rates. Moreover, earnings increases continue to outpace productivity gains, and the underlying inflation rate will have to fall further in order to attain EMS convergence.
The Japanese authorities responded to weak growth, falling asset prices, and subsiding inflation by lowering the discount rate several times. Although growth remains slow at present, activity is expected to pick up again by the end of 1992. Moreover, labor markets remain relatively tight despite the growth recession, limiting the scope for a further easing of monetary conditions. Thus, on the basis of current projections, further easing would not be warranted. The sharp decline in asset values and persistently low business and consumer confidence, however, point to the risk that economic activity may be weaker than projected.
Pressures on prices and wages have remained strong in Germany as the process of unification has strained resources and has led to demands for compensation for tax increases. To combat rising inflation and to hold down increases in monetary aggregates, the German authorities tightened monetary conditions during the course of 1991, which helped to reduce excess demand growth. However, labor markets in west Germany remain tight, recent settlements have been higher than the authorities had originally hoped, and money growth remains a cause of concern. Interest rates are therefore likely to remain high until inflation clearly begins to recede. An early reduction of the budget deficit will be essential to reduce the pressure on inflation and on interest rates.
Tight German monetary conditions have put upward pressure on interest rates in most European countries, which have in one way or another effectively coupled their currencies to the deutsche mark. For those countries with relatively high inflation, such as Italy, Portugal, and Spain, relatively high nominal interest rates are consistent with the need to reduce inflation. In contrast, the monetary spillover from Germany has posed a problem for those countries with relatively low and stable inflation, such as Belgium, Denmark, and France. Although the price performance and high unemployment in these countries would warrant lower interest rates, markets have so far been reluctant to allow rates to fall below those in Germany.
Financial Market Deregulation, Asset Prices, and Monetary Policy
Price stability is a key goal of monetary policy. However, pursuit of this goal during the past decade has been complicated in a number of countries by financial market liberalization and considerable volatility in asset prices. The liberalization of financial markets in the 1980s widened the availability of financial services and increased the efficiency of the financial sector. As Annex I points out, although there are clear benefits from increased competition in financial markets, deregulation of this sector was also associated with asset market speculation and an excessive leveraging linked to both financial and real assets. This phenomenon can be attributed to some extent to increased competition for deposit taking and lending on the part of financial institutions, which resulted in greater access to credit for households and firms.
Asset price inflation and the rapid expansion in debt also reflected country-specific factors, including tax codes, demographics, and macroeconomic policies. As a result of these factors, in combination with financial market deregulation, asset prices in some industrial countries rose to unsustainable levels. This led to the accumulation of debt and assets—particularly leveraged residential and commercial real estate—based in part on unrealistic expectations of a continued availability of financing and still further increases in the prices of these assets. The ensuing decline in asset prices seriously eroded the net worth position of financial institutions, real estate companies, and households. The extended adjustment of balance sheets and the overhang of real assets—notably commercial real estate—have been factors in the slowdown and have restrained recovery in several countries.7
In retrospect, it is apparent that monetary policy inadvertently permitted an overly rapid expansion of credit in some countries during the 1980s, and that there was not a full appreciation of the emerging balance sheet problems in both the financial and nonfinancial sectors. One lesson of this experience is that an excessive buildup of debt to finance asset accumulation in certain sectors, which may be facilitated by moving to a more competitive environment for financial institutions, can have significant adverse macroeconomic consequences. It is therefore necessary that both monetary and regulatory authorities remain alert to potential imbalances, particularly in those countries where considerable deregulation has yet to occur.
It is important to form a judgment on the extent to which asset price inflation may be a symptom of inappropriate economic policies or other imbalances, as was the case in the 1980s. It has been common practice for some time to monitor exchange rates for symptoms of underlying problems. For example, the sharp and sustained rise in the external value of the U.S. dollar up to February 1985 was reflected in large international payments imbalances. Comparable increases in other asset prices could warrant similar attention, with a view to ascertaining whether the price changes were sustainable or were likely to be reversed, imposing potentially significant strains on both the financial and nonfinancial sectors. In such cases, monetary authorities would need to take account of these developments in assessing the appropriate cost and rate of credit expansion. Seen in the light of the sharp increase in asset prices in the 1980s, it would appear that in some industrial countries the real cost of credit to finance real estate and equity purchases was too low for too long. A quicker response to the emerging imbalances would have helped to dampen the speculative excesses in real estate and equity markets, thereby moderating the subsequent downward adjustment in asset prices.
As noted above, a consequence of the changes that have occurred in financial markets and institutions is that calibrating the appropriate thrust of monetary policy has become more difficult. These changes also make it more difficult to appraise the appropriate degree of liquidity to provide to the financial system. Although there are clear efficiency gains associated with the growth of competitive and liquid financial markets, such systems may be more susceptible to liquidity strains than bank-intermediated systems. Central banks need to stand ready to supply liquidity on short notice to ensure systemic stability. At the same time, it is essential to guard against the risk of excessive liquidity growth, which would jeopardize price stability. To maintain the overall health of the system, care should also be taken to ensure that short-term liquidity support does not give rise to excessive risk taking.8
In the same way that monetary policy should not permit an overextension of borrowing and lending, regulatory policies must play their part in preventing financial imbalances from having systemic consequences. In some cases, the speed and scope of deregulation resulted in excessive risk taking or allowed financial institutions to move into unfamiliar—and, in many cases, eventually loss-making—lines of business. This placed heavy and unexpected demands on supervisory institutions, which were not fully prepared for the consequences of deregulation. A lesson of this experience is therefore that supervisory practices need to be strengthened as deregulation proceeds. Prudential regulation, oversight, and increased capital standards are needed to ensure that the gains from increased competition in financial markets are not offset by the systemic weaknesses arising from insolvency of financial institutions.
Fiscal Policy in the Current Business Cycle
In general, budget deficits have increased since 1990, in some instances indicating major setbacks in relation to medium-term objectives even though fiscal policy has necessarily played a far less active role than in past economic downturns. The slowdown in economic activity caused a cyclical deterioration in the fiscal position in all the larger countries in 1991, except for Japan (Table 5). In 1992, the adverse impact of the cycle should be relatively small as recovery takes hold, and by 1993 rising output should contribute to a modest narrowing of fiscal deficits. In addition to the effects of automatic stabilizers, the underlying budget position has also deteriorated in some cases because of policy slippages or as a result of action to stimulate activity.
Major Industrial Countries: Fiscal Impulse and General Government Budget Balances
(In percent of GDP/GNP)
The fiscal impulse estimates do not necessarily reflect only discretionary changes in policies. A positive fiscal impulse results from government expenditure growth that exceeds estimated potential output growth, or from tax growth that falls short of actual output growth. Given the mechanical nature of these calculations, the estimates are only indicative of the broad effects of fiscal policy on the economy. A positive number indicates an injection of stimulus, and a negative number a withdrawal of stimulus (see Table A17 in the Statistical Appendix). Both the “fiscal impulse” and the “implied impact of the cycle” estimates (but not the budget balances) exclude certain official international transfers associated with the Gulf war. For the United States, receipts of $4.26 billion in 1990, $42.54 billion in 1991, and $1.26 billion in 1992 are excluded. For Japan, payments of ¥61.9 billion in 1990 and ¥1,214 billion in 1991 are excluded. For Germany, payments of DM 0.44 billion in 1990 and DM 9.13 billion in 1991 are excluded. For France, FF 10.1 billion in receipts is excluded in 1991. For the United Kingdom, 2.1 billion in receipts is excluded in 1991.
The impact of the cycle on the budget is calculated as the sum of the change in the budget balance and the fiscal impulse, both adjusted for Gulf war transfers in the cases of the United States, Japan, France, Germany, and the United Kingdom; see footnote 1. A positive number indicates an improvement, and a negative number a deterioration, in the budget balance.
In percent of GNP; data for 1990 refer to west Germany.
Major Industrial Countries: Fiscal Impulse and General Government Budget Balances
(In percent of GDP/GNP)
| Budget Balance | Fiscal Impulse1 | Implied Impact of the Cycle on the Budget2 |
||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 1990 | 1991 | 1992 | 1993 | 1991 | 1992 | 1993 | 1991 | 1992 | 1993 | |
| United States | −2.5 | −3.4 | −4.6 | −3.6 | 0.2 | 0.2 | −0.5 | −1.4 | −0.2 | 0.4 |
| Japan | 3.0 | 3.0 | 2.1 | 2.1 | −0.2 | 0.9 | −0.3 | 0.1 | −0.5 | — |
| Germany3 | −1.7 | −2.8 | −3.2 | −2.5 | 1.1 | 0.4 | −1.0 | 0.4 | −0.5 | −0.1 |
| France | −1.4 | −2.1 | −2.2 | −2.1 | 0.1 | 0.2 | −0.3 | −0.7 | −0.2 | −0.2 |
| Italy | −10.9 | −10.2 | −10.4 | −9.3 | −1.0 | −0.3 | −1.4 | −0.3 | −0.4 | −0.4 |
| United Kingdom | −0.8 | −2.0 | −5.5 | −6.3 | −1.0 | 1.4 | 0.7 | −2.5 | −1.7 | −0.2 |
| Canada | −4.1 | −6.1 | −5.2 | −4.4 | −0.4 | −1.3 | −0.2 | −2.4 | 0.4 | 0.7 |
| Total | −1.6 | −2.3 | −3.3 | −2.7 | — | 0.3 | −0.5 | −0.8 | −0.4 | 0.1 |
The fiscal impulse estimates do not necessarily reflect only discretionary changes in policies. A positive fiscal impulse results from government expenditure growth that exceeds estimated potential output growth, or from tax growth that falls short of actual output growth. Given the mechanical nature of these calculations, the estimates are only indicative of the broad effects of fiscal policy on the economy. A positive number indicates an injection of stimulus, and a negative number a withdrawal of stimulus (see Table A17 in the Statistical Appendix). Both the “fiscal impulse” and the “implied impact of the cycle” estimates (but not the budget balances) exclude certain official international transfers associated with the Gulf war. For the United States, receipts of $4.26 billion in 1990, $42.54 billion in 1991, and $1.26 billion in 1992 are excluded. For Japan, payments of ¥61.9 billion in 1990 and ¥1,214 billion in 1991 are excluded. For Germany, payments of DM 0.44 billion in 1990 and DM 9.13 billion in 1991 are excluded. For France, FF 10.1 billion in receipts is excluded in 1991. For the United Kingdom, 2.1 billion in receipts is excluded in 1991.
The impact of the cycle on the budget is calculated as the sum of the change in the budget balance and the fiscal impulse, both adjusted for Gulf war transfers in the cases of the United States, Japan, France, Germany, and the United Kingdom; see footnote 1. A positive number indicates an improvement, and a negative number a deterioration, in the budget balance.
In percent of GNP; data for 1990 refer to west Germany.
Major Industrial Countries: Fiscal Impulse and General Government Budget Balances
(In percent of GDP/GNP)
| Budget Balance | Fiscal Impulse1 | Implied Impact of the Cycle on the Budget2 |
||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 1990 | 1991 | 1992 | 1993 | 1991 | 1992 | 1993 | 1991 | 1992 | 1993 | |
| United States | −2.5 | −3.4 | −4.6 | −3.6 | 0.2 | 0.2 | −0.5 | −1.4 | −0.2 | 0.4 |
| Japan | 3.0 | 3.0 | 2.1 | 2.1 | −0.2 | 0.9 | −0.3 | 0.1 | −0.5 | — |
| Germany3 | −1.7 | −2.8 | −3.2 | −2.5 | 1.1 | 0.4 | −1.0 | 0.4 | −0.5 | −0.1 |
| France | −1.4 | −2.1 | −2.2 | −2.1 | 0.1 | 0.2 | −0.3 | −0.7 | −0.2 | −0.2 |
| Italy | −10.9 | −10.2 | −10.4 | −9.3 | −1.0 | −0.3 | −1.4 | −0.3 | −0.4 | −0.4 |
| United Kingdom | −0.8 | −2.0 | −5.5 | −6.3 | −1.0 | 1.4 | 0.7 | −2.5 | −1.7 | −0.2 |
| Canada | −4.1 | −6.1 | −5.2 | −4.4 | −0.4 | −1.3 | −0.2 | −2.4 | 0.4 | 0.7 |
| Total | −1.6 | −2.3 | −3.3 | −2.7 | — | 0.3 | −0.5 | −0.8 | −0.4 | 0.1 |
The fiscal impulse estimates do not necessarily reflect only discretionary changes in policies. A positive fiscal impulse results from government expenditure growth that exceeds estimated potential output growth, or from tax growth that falls short of actual output growth. Given the mechanical nature of these calculations, the estimates are only indicative of the broad effects of fiscal policy on the economy. A positive number indicates an injection of stimulus, and a negative number a withdrawal of stimulus (see Table A17 in the Statistical Appendix). Both the “fiscal impulse” and the “implied impact of the cycle” estimates (but not the budget balances) exclude certain official international transfers associated with the Gulf war. For the United States, receipts of $4.26 billion in 1990, $42.54 billion in 1991, and $1.26 billion in 1992 are excluded. For Japan, payments of ¥61.9 billion in 1990 and ¥1,214 billion in 1991 are excluded. For Germany, payments of DM 0.44 billion in 1990 and DM 9.13 billion in 1991 are excluded. For France, FF 10.1 billion in receipts is excluded in 1991. For the United Kingdom, 2.1 billion in receipts is excluded in 1991.
The impact of the cycle on the budget is calculated as the sum of the change in the budget balance and the fiscal impulse, both adjusted for Gulf war transfers in the cases of the United States, Japan, France, Germany, and the United Kingdom; see footnote 1. A positive number indicates an improvement, and a negative number a deterioration, in the budget balance.
In percent of GNP; data for 1990 refer to west Germany.
The federal budget deficit in the United States deteriorated sharply in 1991 and 1992, in large part because of the response of automatic stabilizers during the recession. To this extent, the deficit should narrow as the economy recovers. Nevertheless, the underlying deficit remains unsustainably large: even after the economy has fully recovered from the current recession, the federal deficit excluding social security and deposit insurance is expected to be of the order of 4 to 5 percent of GDP, with the general government deficit at about 2 percent of GDP (the difference reflects the social security surplus and state and local government surpluses). This unfavorable situation rules out discretionary fiscal expansion, which under current circumstances would only put more pressure on interest rates and undermine confidence further. At the state and local level, the budgetary situation deteriorated during the last half of the 1980s, leaving those governments with very little room to maneuver as activity slowed. Indeed, all U.S. states but one have constitutional limitations on debt accumulation, which have led to a procyclical improvement in the state and local government surplus from late 1990 onward.
The costs of unification entailed a sharp increase in German federal government expenditures, causing the budget deficit to deteriorate by over 3½ percent of GNP since 1989. The deficit is expected to decline beginning in 1993 because of tight ceilings on expenditure growth and the projected recovery in east Germany. There are also substantial “off-budget” liabilities, in part the legacy of the former German Democratic Republic but also a result of the operations of the privatization agency, the Treuhand. Better control of the budgetary situation in Germany—including deficits at the state and local levels, and “off-budget liabilities”—would allow interest rates to fall. It would also ease interest rate pressures in the rest of Europe, which is currently experiencing some of the crowding-out effects from the large German deficit.
The budgetary situation has also deteriorated in several other countries. In the context of a relatively mild slowdown in economic activity and a relatively strong fiscal position in 1990, the French authorities were able to allow automatic stabilizers to operate. However, with a deficit slightly above 2 percent of GDP in 1992, and in view of signs of a pickup in activity, the fiscal position should remain stable in the near term. Over the medium term, the deficit should fall as revenues grow because of economic expansion, and as adequate control is maintained over the growth of expenditures. In the United Kingdom the deep and prolonged recession led to sharply higher deficits in both 1991 and 1992. In addition, discretionary measures were adopted in late 1991 and early 1992, and a further deterioration in the deficit is expected in 1993 despite the expected economic expansion. Even though a substantial proportion of the deficit is attributable to the current weakness of activity, a cautious fiscal stance will clearly be required to redress the budgetary position over the medium term.
In Canada, the recession also sharply increased the deficit, although the program of fiscal restraint put in place by the federal government has reduced the structural deficit in 1992. Efforts made at the federal level to reduce spending despite the slowdown in activity are appropriate, given the large and long-standing structural deficit and a rising debt-GDP ratio, although they have been somewhat offset by higher deficits at the provincial level.
Italy has been far less successful at deficit control. In the absence of new measures, the deficit had been expected to approach 12 percent of GDP in 1992, compared with an initial target of 8.4 percent, and the debt-GDP ratio, which is already extremely high, will continue to rise in the absence of decisive action during 1992-93. For several years budget outcomes have systematically fallen short of initial targets, and this is expected to be the case in 1992 as well, although the shortfall will be limited by a deficit-control package introduced by the government in July and adopted by Parliament shortly thereafter. The government has recently adopted a fiscal plan to reduce the deficit sharply in the 1993-95 period. The proposed deficit reduction is a minimum that is urgently required if Italy is to proceed with its efforts to reduce inflation. The 1993 budget will be the critical first step in carrying out this plan; it is important that the plan be implemented with effective, permanent measures to secure a structural improvement in public finances. On the assumption that such measures are fully implemented, and that they succeed in generating the projected savings, a significant reduction in the deficit after 1992 is projected. Nonetheless, further action would still be needed to meet the Maastricht criteria.
In Japan, the central and general government deficits (excluding the social security surplus) were about ½ of 1 percent of GDP in 1991, the debt-GDP ratio has been on a downward trend for five years, and the social security system is running a surplus of about 3 percent of GDP. The authorities decided to front-load public works projects in 1992, a move that will affect the timing, but not the size, of expenditures. In August, the government announced an economic package to boost confidence and stimulate activity. Fiscal expenditure measures included in the package amount to 2¼ percent of GDP, of which increases in public expenditure on goods and services will probably amount to 1¼ percent of GDP. The direct impact of these latter expenditure measures could raise GDP by about ¾ of 1 percent, with the main effect being fell in 1993.
The general government balances of the smaller industrial countries are also in deficit, at least in part because of the weakness in economic activity (Table 6). Some countries, such as Austria, Denmark, Ireland, and Switzerland, have relatively small deficits that are not expected to widen through 1993. Others, however, have relatively weak underlying fiscal positions. Finland, Norway, and Sweden, which are all experiencing economic downturns accompanied by severe problems in their financial sectors (see Annex I), saw sharply widening deficits in 1991 and 1992. Deficits also increased in Australia, New Zealand, and Spain in 1991 but are expected to fall somewhat by 1993 in these countries.
Smaller Industrial Countries: General Government Fiscal Balances
(In percent of GDP/GNP)
Smaller Industrial Countries: General Government Fiscal Balances
(In percent of GDP/GNP)
| Projections | ||||
|---|---|---|---|---|
| 1990 | 1991 | 1992 | 1993 | |
| Australia | 0.3 | −2.4 | −3.9 | −3.2 |
| Austria | −2.2 | −2.1 | −1.9 | −1.9 |
| Belgium | −5.5 | −6.3 | −5.5 | −5.1 |
| Denmark | −1.4 | −2.0 | −2.0 | −1.1 |
| Finland | – | −6.4 | −8.6 | −9.0 |
| Greece | −17.6 | −17.5 | 14.9 | −12.0 |
| Ireland | −2.3 | −2.8 | −1.8 | −1.8 |
| Netherlands | −5.3 | −3.3 | −3.6 | −3.4 |
| New Zealand | 2.0 | −3.3 | −2.6 | −3.2 |
| Norway | 2.0 | −1.1 | −3.7 | −3.7 |
| Portugal | −6.4 | −6.8 | −5.8 | −4.5 |
| Spain | −4.0 | −4.4 | −4.5 | −2.8 |
| Sweden | 3.9 | −1.5 | −3.9 | −4.8 |
| Switzerland | — | −1.7 | −1.8 | −1.6 |
Smaller Industrial Countries: General Government Fiscal Balances
(In percent of GDP/GNP)
| Projections | ||||
|---|---|---|---|---|
| 1990 | 1991 | 1992 | 1993 | |
| Australia | 0.3 | −2.4 | −3.9 | −3.2 |
| Austria | −2.2 | −2.1 | −1.9 | −1.9 |
| Belgium | −5.5 | −6.3 | −5.5 | −5.1 |
| Denmark | −1.4 | −2.0 | −2.0 | −1.1 |
| Finland | – | −6.4 | −8.6 | −9.0 |
| Greece | −17.6 | −17.5 | 14.9 | −12.0 |
| Ireland | −2.3 | −2.8 | −1.8 | −1.8 |
| Netherlands | −5.3 | −3.3 | −3.6 | −3.4 |
| New Zealand | 2.0 | −3.3 | −2.6 | −3.2 |
| Norway | 2.0 | −1.1 | −3.7 | −3.7 |
| Portugal | −6.4 | −6.8 | −5.8 | −4.5 |
| Spain | −4.0 | −4.4 | −4.5 | −2.8 |
| Sweden | 3.9 | −1.5 | −3.9 | −4.8 |
| Switzerland | — | −1.7 | −1.8 | −1.6 |
Medium-Term Fiscal Outlook in the United States, Canada, and Japan
As noted above, the cyclical downturn has contributed to a worsening of the fiscal balances of the industrial countries, although some already had large structural deficits, or their structural deficits have widened. Several countries are therefore entering the 1990s with budgetary gaps that are larger than in the early 1980s. Rapid implementation of policy measures to reduce those imbalances is necessary to permit stronger growth and a lasting decline in real interest rates, especially in light of the decline in world saving during the past two decades (Box 1 and Chart 21), the risk of a further fall in the private saving rate in industrial countries over the medium term, and the prospective rising demands for resources in other regions.
Trends in World Saving
In 1991, gross world saving amounted to some $5 trillion, about 22 percent of world income. Since 1970, the world saving rate has declined by 3½ percentage points (see Chart 21), implying a concomitant decrease in the share of investment in world output.1 Among the industrial countries, the United States and Canada have experienced a secular decline in their national saving rates over the last decade that is attributable to the emergence of large government deficits and to a decline in the private saving rate.2 In Japan, which stands out as a particularly thrifty society, there has been an increase in the national saving rate since the mid-1980s because of a rise in public sector saving, although the private sector saving rate has declined somewhat since 1986. In the EC, the saving rate has been relatively steady, although it fell in 1990, in part because of the impact of German unification.
In the developing countries, the contraction in the supply of saving in industrial countries as well as the debt crisis resulted in a marked decline in the availability of external funds during the past decade. In many cases, the difficulties that resulted from the deterioration in the external environment were compounded by a reduced domestic saving rate. In the early 1980s, countries with debt-servicing difficulties experienced a significant decline in their saving ratio because of rising budgetary imbalances, higher interest payments on external debt, and falling terms of trade. Countries that were able to maintain their saving rate did not encounter debt-servicing difficulties in most cases.
Net creditor countries experienced particularly large movements in their saving ratio, registering sharp increases in the wake of the two oil shocks in 1973-74 and 1979-80.3 Over the past decade, however, their saving rate has fallen close to the level in the early 1970s.
The aggregate national saving ratio in the former centrally planned economies remained fairly stable, at a relatively high level, until the late 1980s. The subsequent decline reflects the establishment of market-clearing prices and an end to forced saving related to shortages of consumer goods.
Beginning with this issue of the World Economic Outlook, the Statistical Appendix has been expanded to include a table showing the sources and uses of world saving (Table A51). The concepts included in this table are national saving and investment, net lending (equivalent to the current account balance), and three components that sum to the current account balance: unrequited transfers, factor payments, and the resource balance.4 For industrial countries, saving and investment are disaggregated into public and private. For developing countries, two memorandum items are shown, acquisition of foreign assets and change in reserves.
1World saving and investment differ by the world current account discrepancy, which is relatively small–only about ½ of 1 percent–as a share of world output. 2Some of the factors contributing to the decline in private saving in the industrial countries include improvements in the relative position of older groups in the population; the revaluation of the stock of wealth, in particular equities and housing; and financial liberalization. For further analysis of developments in the national saving rate for industrial and developing countries, see Bijan B. Aghevli, James M. Boughton, Peter J. Montiel, Delano Villanueva, and Geoffrey Woglom, The Role of National Saving in the World Economy, Recent Trends and Prospects, Occasional Paper 67 (IMF, March 1990). 3This group includes Taiwan Province of China. 4The resource transfer is defined as a country’s deficit on merchandise trade and nonfactor services. See “Box: Net Resource Transfer,” in the October 1989 World Economic Outlook, p. 50.In the case of the United States, the World Economic Outlook has repeatedly emphasized the need for strengthening U.S. national saving. To make visible progress in this area, the administration had set a goal in its January 1990 budget of eliminating the deficit on a unified budget basis by FY 19939 and of attaining a surplus in FY 1995 that approximated the projected social security cash-flow surplus. In November 1990, in the face of a continuing deterioration in the fiscal situation, the goal set in the January 1990 budget was replaced by the provisions of the Budget Enforcement Act, which projected a balanced budget (including the social security surplus) by 1995. The Act introduced caps on discretionary spending and pay-as-you-go requirements for changes to mandatory programs and revenues but, unlike earlier legislation, did not set specific deficit targets.
The budget projections in the administration’s July 1992 mid-session review showed a sharp deterioration in the medium-term fiscal position relative to the Budget Enforcement Act’s projection. This shortfall appears to have been due to a more pessimistic economic outlook, downward revisions to expected tax revenue (for a given level of income), and higher-than-expected demands on mandatory spending programs. Although the recession accounted for most of the deterioration of the budget position in FY 1991 and FY 1992, estimates of the underlying or cyclically adjusted balance indicate that the underlying medium-term situation has also deteriorated, suggesting that a sizable fiscal adjustment will be needed even after the recovery is complete. On the basis of estimates of potential growth, the structural component of the deficit will rise from 3¾ percent of GDP in FY 1991 to about 4 to 5 percent of GDP in the medium term.
Dealing with a fiscal imbalance of this magnitude is likely to require measures on both the revenue and expenditure sides. Among the former could be higher energy taxes and the introduction of a consumption tax. For example, it has been estimated that a 5 percent value-added tax (VAT) and a carbon tax sufficient to reduce carbon dioxide emissions modestly by the turn of the century would each yield revenue of about 1 percent of GDP in 1997.10 In addition, revenue could be increased by limiting distortionary tax expenditures—for example, by taxing employer-paid health care insurance premiums. On the expenditure side, much of the recent growth can be attributed to entitlement outlays, particularly for health care, where there is a need for fundamental reforms. There would also appear to be some room for reducing discretionary spending. For example, cutting defense expenditures to a level that the Congressional Budget Office believes is consistent with the administration’s defense goals would generate savings of over ½ of 1 percent of GDP by 1997.
The impact on the U.S. economy and on the rest of the world of an illustrative package of such deficit-reducing measures has been estimated using MULTIMOD, the econometric model maintained by the IMF. The simulation results are described in detail in Annex II. Half of the yield of the stylized package is assumed to consist of cuts in government expenditures, and the other half is split equally between indirect tax increases and cuts in entitlements. The package is phased in evenly over the period 1993-97 and amounts to 5 percent of GDP by 1997. The fiscal measures have a short-run adverse effect on the level of output, which reaches a maximum of about ½ of 1 percent of GDP in 1997. By 2000, however, output rises nearly ¾ of 1 percent above the level it would have been in the absence of the measures, as lower real interest rates and a depreciation of the dollar “crowd in” investment and real net exports.11 This higher output level is sustained in subsequent years as the fiscal package raises national saving, thereby providing room for higher investment and a larger capital stock. In other industrial countries output rises above the level it otherwise would have been because the impact of lower world interest rates more than offsets the decline in exports to the United States. Output in the developing countries is also higher than it would have been in the absence of fiscal consolidation in the United States, mainly because of lower debt-servicing costs and stronger exports.12
The federal deficit in Canada, which fell from 6½ percent of GDP in 1985 to less than 4 percent of GDP in 1989, is expected to narrow further over the medium term. To strengthen the process of budget consolidation, the February 1990 budget introduced an ambitious deficit reduction path for FY 1990/91 and subsequent years, which was reaffirmed in the February 1991 budget. However, because economic activity was weaker than expected, the deficit rose despite efforts to offset the operation of the automatic stabilizers in 1991 and 1992. The February 1992 budget sought to keep to the medium-term strategy of achieving a continuous reduction in the deficit through expenditure restraints, including cuts in defense expenditures. If the authorities continue to address the budgetary imbalance with the consistency implied by current policies, the fiscal situation will be on its way to being corrected.
For Japan, projections show a gradual reduction over the medium term in the general government deficit (excluding social security), resulting in approximate balance in the general government account by 1997.13 The surplus in the social security system is projected to remain at about 2½ percent of GDP, which appears appropriate in view of the prospective aging of the population. The firm pursuit of fiscal consolidation and the accumulation of a persistent surplus in the social security accounts is designed to deal explicitly with the prospect of rising demands on the budget in the future.
Fiscal Policy and Convergence in the European Community
A high degree of economic convergence is a recognized condition for exchange rate stability in the EC and for economic and monetary union (EMU) as envisaged in the Maastricht agreement. Rapid progress in the implementation of the criteria for convergence in the agreement is essential to reduce exchange market tensions, permit lower real interest rates, and improve the Community’s medium-term growth prospects.14 Indeed, in the absence of efforts to reduce excessive budget deficits and contain inflation it is unlikely that a satisfactory pace of growth can be maintained in many countries.
Currently only France, Denmark, and Luxembourg meet the fiscal criteria for convergence (Table 7). Germany and the United Kingdom are expected to satisfy them without major changes in underlying fiscal policy; they already meet the debt criterion, and their deficits are expected to decline as temporary factors—unification and a deep recession, respectively—are unwound. All other EC countries will need to take significant measures to reduce their deficits, debt ratios, or both to qualify for EMU. Given that Italy, Greece, Ireland, Belgium, and the Netherlands currently have high debt ratios, they cannot realistically be expected to achieve the debt criterion by 1996. Satisfying the deficit criterion could allow these countries to qualify, however, since this would bring their debt-GDP ratios onto a sustainable downward path. In most cases, satisfying the deficit criterion would also permit the inflation target to be met.
European Countries: Convergence Indicators for 1991 and 1992
(In percent)
Debt data are from national sources. They relate to the general government but may not be consistent with the definition agreed at Maastricht.
Debt on fiscal year basis.
Average weighted by 1991 GDP shares.
The debt-GDP ratio would be below 60 percent if adjusted in line with definition agreed at Maastricht.
Long-term interest rate is 12-month treasury bill rate.
Debt is central government only. General government balance excludes capital deposits in state enterprises.
European Countries: Convergence Indicators for 1991 and 1992
(In percent)
| 1991 GDP Weights | Consumer Price Inflation |
General Government Balance/GDP |
Gross Government Debt/GDP1 |
Long-Term Interest Rates |
|||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| In EC | In world | 1991 | 1992 | 1991 | 1992 | 1991 | 1992 | 1991 | 1992 | ||
| EC countries | |||||||||||
| France | 19.7 | 5.1 | 3.1 | 2.7 | −2.1 | −2.2 | 47.1 | 47.6 | 9.2 | 8.5 | |
| Germany | 25.5 | 6.5 | 3.5 | 3.9 | −2.8 | −3.2 | 41.7 | 42.7 | 8.5 | 7.9 | |
| Italy | 17.7 | 4.5 | 6.4 | 5.3 | −10.2 | −10.4 | 103.5 | 108.0 | 13.0 | 12.2 | |
| United Kingdom2 | 16.8 | 4.3 | 5.9 | 3.7 | −2.1 | −5.1 | 34.4 | 34.2 | 9.9 | 8.9 | |
| Largest four countries3 | 79.5 | 20.4 | 4.6 | 3.9 | −4.1 | −5.0 | 55.2 | 56.6 | 10.0 | 9.2 | |
| Belgium | 3.2 | 0.8 | 3.2 | 3.0 | −6.3 | −5.5 | 134.4 | 133.4 | 9.3 | 8.7 | |
| Denmark4 | 2.2 | 0.6 | 2.4 | 2.5 | −2.0 | −2.0 | 66.7 | 65.9 | 9.6 | 8.7 | |
| Greece5 | 1.1 | 0.3 | 19.5 | 15.2 | −17.5 | −14.9 | 115.5 | 118.0 | 23.3 | 21.0 | |
| Ireland | 0.7 | 0.2 | 3.2 | 3.7 | −2.8 | −1.8 | 98.0 | 96.0 | 9.2 | 9.1 | |
| Luxembourg | 0.1 | — | 3.1 | 3.1 | 1.5 | 1.5 | 6.2 | 5.8 | 8.2 | 7.9 | |
| Netherlands | 4.6 | 1.2 | 3.9 | 3.3 | −3.3 | −3.6 | 79.6 | 80.0 | 8.7 | 8.1 | |
| Portugal | 0.9 | 0.2 | 11.4 | 8.5 | −6.8 | −5.8 | 65.3 | 62.5 | 18.5 | 16.0 | |
| Spain | 7.7 | 2.0 | 5.9 | 5.8 | −4.4 | −4.5 | 46.0 | 47.3 | 12.8 | 10.9 | |
| Smallest eight countries3 | 20.5 | 5.3 | 5.5 | 5.0 | −4.9 | −4.6 | 75.7 | 76.0 | 11.7 | 10.4 | |
| All EC3 | 100.0 | 25.7 | 4.7 | 4.1 | −4.3 | −4.9 | 59.4 | 60.6 | 10.3 | 9.5 | |
| Maastricht convergence criteria | … | … | 4.5 | 4.2 | −3.0 | −3.0 | 60.0 | 60.0 | 11.2 | 10.5 | |
| Non-EC countries | |||||||||||
| Austria | … | 0.7 | 3.3 | 3.8 | −2.1 | −1.9 | 56.5 | 55.8 | 8.6 | 8.0 | |
| Finland | … | 0.6 | 4.1 | 3.5 | −6.4 | −8.6 | 16.0 | 25.0 | 12.2 | 12.4 | |
| Norway6 | … | 0.5 | 3.4 | 2.5 | −0.4 | −2.6 | 39.7 | 48.5 | 9.9 | 9.0 | |
| Sweden | … | 1.0 | 9.4 | 2.5 | −1.5 | −3.9 | 44.8 | 45.8 | 10.7 | 9.5 | |
| Switzerland | … | 1.0 | 5.8 | 4.5 | −1.7 | −1.8 | 32.1 | 33.0 | 6.4 | 6.4 | |
| Five non-EC countries3 | … | 3.8 | 5.8 | 3.6 | −2.4 | −3.7 | 37.2 | 38.9 | 9.3 | 8.7 | |
Debt data are from national sources. They relate to the general government but may not be consistent with the definition agreed at Maastricht.
Debt on fiscal year basis.
Average weighted by 1991 GDP shares.
The debt-GDP ratio would be below 60 percent if adjusted in line with definition agreed at Maastricht.
Long-term interest rate is 12-month treasury bill rate.
Debt is central government only. General government balance excludes capital deposits in state enterprises.
European Countries: Convergence Indicators for 1991 and 1992
(In percent)
| 1991 GDP Weights | Consumer Price Inflation |
General Government Balance/GDP |
Gross Government Debt/GDP1 |
Long-Term Interest Rates |
|||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| In EC | In world | 1991 | 1992 | 1991 | 1992 | 1991 | 1992 | 1991 | 1992 | ||
| EC countries | |||||||||||
| France | 19.7 | 5.1 | 3.1 | 2.7 | −2.1 | −2.2 | 47.1 | 47.6 | 9.2 | 8.5 | |
| Germany | 25.5 | 6.5 | 3.5 | 3.9 | −2.8 | −3.2 | 41.7 | 42.7 | 8.5 | 7.9 | |
| Italy | 17.7 | 4.5 | 6.4 | 5.3 | −10.2 | −10.4 | 103.5 | 108.0 | 13.0 | 12.2 | |
| United Kingdom2 | 16.8 | 4.3 | 5.9 | 3.7 | −2.1 | −5.1 | 34.4 | 34.2 | 9.9 | 8.9 | |
| Largest four countries3 | 79.5 | 20.4 | 4.6 | 3.9 | −4.1 | −5.0 | 55.2 | 56.6 | 10.0 | 9.2 | |
| Belgium | 3.2 | 0.8 | 3.2 | 3.0 | −6.3 | −5.5 | 134.4 | 133.4 | 9.3 | 8.7 | |
| Denmark4 | 2.2 | 0.6 | 2.4 | 2.5 | −2.0 | −2.0 | 66.7 | 65.9 | 9.6 | 8.7 | |
| Greece5 | 1.1 | 0.3 | 19.5 | 15.2 | −17.5 | −14.9 | 115.5 | 118.0 | 23.3 | 21.0 | |
| Ireland | 0.7 | 0.2 | 3.2 | 3.7 | −2.8 | −1.8 | 98.0 | 96.0 | 9.2 | 9.1 | |
| Luxembourg | 0.1 | — | 3.1 | 3.1 | 1.5 | 1.5 | 6.2 | 5.8 | 8.2 | 7.9 | |
| Netherlands | 4.6 | 1.2 | 3.9 | 3.3 | −3.3 | −3.6 | 79.6 | 80.0 | 8.7 | 8.1 | |
| Portugal | 0.9 | 0.2 | 11.4 | 8.5 | −6.8 | −5.8 | 65.3 | 62.5 | 18.5 | 16.0 | |
| Spain | 7.7 | 2.0 | 5.9 | 5.8 | −4.4 | −4.5 | 46.0 | 47.3 | 12.8 | 10.9 | |
| Smallest eight countries3 | 20.5 | 5.3 | 5.5 | 5.0 | −4.9 | −4.6 | 75.7 | 76.0 | 11.7 | 10.4 | |
| All EC3 | 100.0 | 25.7 | 4.7 | 4.1 | −4.3 | −4.9 | 59.4 | 60.6 | 10.3 | 9.5 | |
| Maastricht convergence criteria | … | … | 4.5 | 4.2 | −3.0 | −3.0 | 60.0 | 60.0 | 11.2 | 10.5 | |
| Non-EC countries | |||||||||||
| Austria | … | 0.7 | 3.3 | 3.8 | −2.1 | −1.9 | 56.5 | 55.8 | 8.6 | 8.0 | |
| Finland | … | 0.6 | 4.1 | 3.5 | −6.4 | −8.6 | 16.0 | 25.0 | 12.2 | 12.4 | |
| Norway6 | … | 0.5 | 3.4 | 2.5 | −0.4 | −2.6 | 39.7 | 48.5 | 9.9 | 9.0 | |
| Sweden | … | 1.0 | 9.4 | 2.5 | −1.5 | −3.9 | 44.8 | 45.8 | 10.7 | 9.5 | |
| Switzerland | … | 1.0 | 5.8 | 4.5 | −1.7 | −1.8 | 32.1 | 33.0 | 6.4 | 6.4 | |
| Five non-EC countries3 | … | 3.8 | 5.8 | 3.6 | −2.4 | −3.7 | 37.2 | 38.9 | 9.3 | 8.7 | |
Debt data are from national sources. They relate to the general government but may not be consistent with the definition agreed at Maastricht.
Debt on fiscal year basis.
Average weighted by 1991 GDP shares.
The debt-GDP ratio would be below 60 percent if adjusted in line with definition agreed at Maastricht.
Long-term interest rate is 12-month treasury bill rate.
Debt is central government only. General government balance excludes capital deposits in state enterprises.
Successful economic convergence would substantially strengthen output growth in the EC over the medium term because it would result in lower interest rates and less financial uncertainty. Although those countries with large fiscal adjustment requirements need to put in place a stronger fiscal policy that could entail a transitional decline in aggregate demand, the short-term effects of fiscal consolidation could be significantly attenuated. Smaller deficits would allow lower interest rates, and interest rate differentials vis-à-vis the deutsche mark would narrow as convergence is achieved. The decline in interest rates would “crowd in” interest-sensitive spending and reduce public sector debt-servicing costs. Such positive effects on interest rates and confidence highlight the desirability of early and convincing action by these countries.
Structural Policies
The sustained implementation of appropriate macroeconomic policies is essential for achieving durable growth. The adoption of appropriate structural policies would complement these macroeconomic initiatives by increasing the efficiency of resource use over the medium term. During the 1980s significant progress was made in certain areas, notably tax reform and financial deregulation. But in two other important areas, labor markets and international trade, progress has been noticeably slower.
Structural problems in labor markets have been most evident in Europe, where unemployment fell only slightly during the long expansion of the past decade and has recently risen again. This increase is due in part to the weakness in economic activity, but the projected recovery is not expected to result in any significant reduction in unemployment rates. A lasting and significant reduction in the number of unemployed workers will require far-reaching policies intended to reduce or eliminate rigidities, improve the structure of collective bargaining, reform unemployment benefits systems, reduce labor turnover costs, and achieve a better match between labor demand and supply by occupation and by region. The planned move toward a single common currency in the EC underlines the crucial importance of achieving greater flexibility in labor markets.
In several countries a reduction in minimum wages would facilitate the hiring of younger, inexperienced workers, thereby providing more scope for these workers to improve their skills through on-the-job training. Changes in collective bargaining may also be necessary in some countries to achieve greater responsiveness of wages to labor supply, particularly where unionization and other features of the labor market have made it difficult for outsiders to influence outcomes dictated by insiders. In addition, relatively open-ended benefit systems with weak control mechanisms and high replacement rates have increased the level of unemployment and the incidence of long-term unemployment. A restructuring of unemployment benefits to encourage job search—for example, by limiting the duration of benefits or by making them conditional on undertaking training—could have a favorable impact. Finally, there is considerable scope for expanding training programs to develop the job-related skills of the unemployed.
Progress in reducing trade restrictions has been limited. Tariffs remain at historically low levels, but nontariff barriers have generally intensified over the past decade. Although such barriers to trade have been reduced in some countries—for example, in Australia, New Zealand, and Sweden—the share of trade covered by such measures increased in the United States and the EC during the 1980s. This increase has been marked by a widening of sectoral coverage and a shift to the use of selective instruments, mainly voluntary export restraints and antidumping and countervailing duties. Government subsidization of industry also remains a problem, although its focus has shifted in recent years from support for declining industries to attempts to establish new ones. Measures have been taken to liberalize agricultural trade in some countries, but this sector remains among the most protected in the global economy. High agricultural support levels continue to impose large costs on consumers, on taxpayers, and on efficient producers worldwide.
As of mid-summer, the central outstanding issues in the Uruguay Round of multilateral trade negotiations appear to have been narrowed to agricultural export subsidies and market access, the “free rider” problem and sectoral coverage in services trade, and the length of the transitional period in intellectual property. During the extended negotiations, the public perception of the gains from the Round has risen; the business sector, in particular, has begun to voice increasing support for a settlement. The lackluster economic recovery in several countries has highlighted the importance of foreign markets to firms’ profitability. There is also a growing fear that the improvements in the rules governing international trade—such as a streamlined dispute settlement mechanism—would be in jeopardy if the Round were to fail.
In light of the substantial welfare and efficiency gains that can be achieved by trade liberalization, the repeated slippages in the completion of the Uruguay Round have been a major setback. Failure of the Round would keep many important areas—agriculture, services, intellectual property rights, and trade-related investment measures, for example—outside the realm of multilateral rules. Worse still, protectionist pressures could intensify, and there could be greater recourse to bilateral or regional trading blocs. These developments would limit opportunity for improved market access, in particular for many developing countries and for the former centrally planned economies.
