Notwithstanding higher oil prices and natural disasters, global growth has continued to exceed expectations, aided by benign financial market conditions and continued accommodative macroeconomic policies. Looking forward, the baseline forecast is for continued strong growth, although—as illustrated in Figure 1.1— risks remain slanted to the downside, the more so since key vulnerabilities—notably the global imbalances— continue to increase. With the risks associated with inaction rising with time, the principal challenge for global policymakers is to take advantage of the unusually favorable conjuncture to address these vulnerabilities. In particular, an orderly resolution of global imbalances will require measures to facilitate a rebalancing of demand across countries and a realignment of exchange rates over the medium term, with the U.S. dollar needing to depreciate significantly from current levels, and currencies in surplus countries— including in parts of Asia and among oil producers— to appreciate.

The momentum and resilience of the global economy in 2005 continued to exceed expectations (Table 1.1 and Figure 1.2). Despite higher oil prices and natural disasters, activity in the second half of 2005 was stronger than earlier projected, particularly among emerging market countries; accounting also for statistical revisions in China,1 global GDP growth is estimated at 4.8 percent, 0.5 percentage point higher than projected last September. At the same time, incoming data have been generally positive. Global industrial production has picked up markedly from mid-2005; the services sector remains resilient; global trade growth is close to double-digit levels; consumer confidence and labor market conditions are strengthening; and forward-looking indicators, notably business confidence, have risen (Figure 1.3).

Table 1.1.

Overview of the World Economic Outlook Projections

(Annual percent change unless otherwise noted)

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Note: Real effective exchange rates are assumed to remain constant at the levels prevailing during February 9–March 9, 2006. See Statistical Appendix for details and groups and methodologies.

Simple average of spot prices of U.K. Brent, Dubai, and West Texas Intermediate crude oil. The average price of oil in U.S. dollars a barrel was $53.35 in 2005; the assumed price is $61.25 in 2006, and $63.00 in 2007.

Six-month rate for the United States and Japan. Three-month rate for the euro area.

Figure 1.1.
Figure 1.1.

Prospects for World GDP Growth1


Global growth is projected to remain about 4¾ percent in 2006 and 2007, but the risks are slanted to the downside, the more so as time progresses (see text for a detailed discussion).

Source: IMF staff estimates.1 This so-called fan chart shows the uncertainty around the World Economic Outlook central forecast with the 90 percent probability interval. See Box 1.3 for details.2 Shaded areas of the same gradient above and below the central forecast add up to 10 percent.
Figure 1.2.
Figure 1.2.

Global Indicators1

(Annual percent change unless otherwise noted)

Global growth remains noticeably above the historical trend, while inflation and long-run interest rates are unusually low.

1 Shaded areas indicate IMF staff projections. Aggregates are computed on the basis of purchasing-power-parity (PPP) weights unless otherwise noted.2 Average growth rates for individual countries, aggregated using PPP weights; the aggregates shift over time in favor of faster-growing countries, giving the line an upward trend.3 GDP-weighted average of the 10-year (or nearest maturity) government bond yields less inflation rates for the United States, Japan, Germany, France, Italy, the United Kingdom, and Canada. Excluding Italy prior to 1972.4 Simple average of spot prices of U.K. Brent, Dubai Fateh, and West Texas Intermediate crude oil.
Figure 1.3.
Figure 1.3.

Current and Forward-Looking Indicators

(Percent change from a year ago unless otherwise noted)

Global industrial production has turned up, while business and consumer confidence are generally improving.

Sources: Business confidence for the United States, the Institute for Supply Management; for the euro area, the European Commission; and for Japan, Bank of Japan. Consumer confidence for the United States, the Conference Board; for the euro area, the European Commission; and for Japan, Cabinet Office; all others, Haver Analytics.1 Australia, Canada, Denmark, euro area, Japan, New Zealand, Norway, Sweden, Switzerland, the United Kingdom, and the United States.2 Argentina, Brazil, Bulgaria, Chile, China, Colombia, Czech Republic, Estonia, Hong Kong SAR, Hungary, India, Indonesia, Israel, Korea, Latvia, Lithuania, Malaysia, Mexico, Pakistan, Peru, the Philippines, Poland, Romania, Russia, Singapore, Slovak Republic, Slovenia, South Africa, Taiwan Province of China, Thailand, Turkey, Ukraine, and Venezuela.3 Japan’s consumer confidence data are based on a diffusion index, where values greater than 50 indicate improving confidence.4 Data for China, India, Pakistan, and Russia are interpolated.

From a regional perspective, the expansion is becoming more broadly based. Among industrial countries, despite a weak fourth quarter, the United States remains the main engine of growth, but the Japanese expansion is well established, and there are signs of a more sustained recovery in the euro area, although domestic demand growth remains subdued. Growth in most emerging and developing countries remains solid, with the buoyancy of activity in China, India, and Russia—which together accounted for two-thirds of the upward revision to global growth in 2005 relative to that expected at the time of the September 2005 World Economic Outlook—being particularly striking. Consistent with the strength of corporate profits and improved balance sheets, investment in major industrial countries appears to be picking up, although—with some exceptions, most importantly China—less so in emerging market countries, including many in Asia.

Oil prices remain high and volatile. After easing from Katrina-related highs, crude oil prices fluctuated in the range of $60–66 per barrel2 over the past three months, with comfortable inventory levels—particularly in the United States—counterbalancing rising geopolitical uncertainties in the Islamic Republic of Iran and in Iraq and threats to oil production in Nigeria. With crude oil consumption somewhat lower than expected in 2005, prices are being increasingly driven by concerns about future supply, with the International Energy Agency assessing both upstream and downstream investment to be significantly below desirable levels (see Appendix 1.1); futures markets suggest prices will remain close to current levels for the foreseeable future. Nonfuel commodity prices— particularly metals—rose strongly in 2005, reflecting both cyclical and supply-side factors, but are projected to moderate in 2006–07 as supply responds to higher prices. The semiconductor cycle has also turned up, particularly in Asia, and while forward-looking indicators are mixed and prices continue to decline, industry analysts expect some pickup in revenue growth in 2006.

Global financial market conditions remain very favorable, characterized by unusually low risk premiums and volatility.3 Global short-term interest rates have continued to rise, led by the United States. With tightening cycles in the euro area and Japan less advanced or yet to begin, short-term interest rate differentials have widened considerably (Figure 1.4). Despite some recent increase, long-run interest rates remain below average, and the yield curve has flattened, the more so in the most cyclically advanced countries. Interest rate spreads—in both industrial countries and emerging markets—remain close to historic lows (Figure 1.5), reflecting both improved fundamentals but also a search for yield in an environment of easy liquidity, accompanied by buoyant inflows to emerging markets (Table 1.2), with many having already prefinanced their borrowing needs for 2006. Given this favorable environment, equity prices have risen significantly, particularly outside the United States, with some markets looking increasingly richly valued; property prices have been more diverse, although signs of a slowdown have increased in some cyclically advanced countries, notably the United States.

Table 1.2.

Emerging Market and Developing Countries: Net Capital Flows1

(Billions of U.S. dollars)

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Net capital flows comprise net direct investment, net portfolio investment, and other long- and short-term net investment flows, including official and private borrowing. In this table, Hong Kong SAR, Israel, Korea, Singapore, and Taiwan Province of China are included.

Because of data limitations, “other private capital flows, net” may include some official flows.

A minus sign indicates an increase.

The sum of the current account balance, net private capital flows, net official flows, and the change in reserves equals, with the opposite sign, the sum of the capital account and errors and omissions. For regional current account balances, see Table 25 of the Statistical Appendix.

Historical data have been revised, reflecting cumulative data revisions for Russia and the resolution of a number of data interpretation issues.

Consists of developing Asia and the newly industrialized Asian economies.

Excluding the effects of the recapitalization of two large commercial banks in China with foreign reserves of the Bank of China (US$45 billion), net private capital flows to emerging Asia in 2003 were US$108.5 billion while other private capital flows net to the region amounted to US$36.2 billion.

Includes Israel.

Figure 1.4.
Figure 1.4.

Developments in Mature Financial Markets

While short-term interest rates have generally risen, long-run interest rates have increased more modestly, resulting in a marked flattening of the yield curve.

Sources: Bloomberg Financial Markets, LP; OECD; national authorities; and IMF staff calculations.1 Ten-year government bond minus three-month treasury bill rate.
Figure 1.5.
Figure 1.5.

Emerging Market Financial Conditions

Emerging market spreads—and borrowing costs—remain unusually low, accompanied by buoyant capital inflows. In some regions, rapid credit growth and soaring equity markets pose potential risks.

Sources: Bloomberg Financial Markets, LP; Capital Data; and IMF staff calculations.1 Average of 30-day rolling cross-correlation of emerging market debt spreads.

The flattening of the yield curve has raised questions about the durability of the current expansion, particularly in the United States. Certainly, there is a considerable body of evidence supporting the view that a flatter yield curve is a leading indicator of an economic slowdown, although the relationship has weakened noticeably since the 1980s. However, the yield curve is only one such indicator, and others— such as equity markets and credit spreads—do not suggest a slowdown (indeed, the OECD’s aggregate measure of leading indicators, which includes the yield curve slope, is rising both in the United States and elsewhere). More generally, the interpretation of the flattening of the yield curve is clearly related to the factors causing the unusually low level of long-run interest rates (see Box 1.1, p. 20), and how they will evolve over time. In this regard, as discussed below, the future behavior of the corporate sector, which is presently accumulating record net savings, appears of particular importance.

Long-Term Interest Rates from a Historical Perspective

By the standards of the last two decades of the twentieth century, long-term interest rates, whether measured in real or nominal terms, are currently very low. The British gilts market is a case in point: in January–March of 2006, the rate on ultra-long indexed gilts averaged about 70 basis points. But real long-term rates on unin-dexed government bonds are also low in the United States and Europe. In the same period, the interest rate on 10-year treasuries, deflated by the expected rate of inflation 10 years ahead, was about 2 percent.

When viewed from a historical perspective, however, the recent behavior of real government bond rates does not appear so unusual. Consider the behavior of rates in the period from 1870 to the start of the World War I. From 1870–95, nominal long-term rates, which were trending downward, averaged 3½ percent (see the figure) for the average of a group of eight countries (Australia, Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States).1 However, because the early part of this period witnessed marked deflation, which bondholders would not likely have foreseen, realized ex post real rates of return averaged 4½ percent, above what might be inferred to be their expected rate. Average real rates declined to 2.2 percent in 1895–1914, a period of prosperity and rising prices that ended with the outbreak of war. The variance of real long-term rates also declined in this period. A somewhat similar pattern is evident in the 20 years between the wars, with average realized real rates comparatively low during the 1920s, and higher during the Depression. In both the 1920s and the 1930s, however, variance was high, which reflected the well known economic instability of the period.


Real Long-Term Interest Rates

(Three-year moving averages)

Source: IMF staff calculations.1 Includes Australia, Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.

During most of the period since 1945, real long-term interest rates have been comparatively low, although real rates have fluctuated substantially in some subperiods. During the Bretton Woods era, from 1946 to 1971, real global long-term rates averaged 2½ percent.2 In the case of treasuries, after a period of comparative stability from 1956 to 1973 when the real rate averaged about 2 percent, the real rate dropped precipitously to well below zero because of the unexpected inflationary impact of the first oil shock. During the disinflation of the 1980s, the opposite occurred. During the 1990s, the average rate of inflation and its variance declined, and real rates trended down. A similar if less pronounced pattern was evident in other markets during these decades.

In general, when inflation has been both low and stable, real long-term interest rates will tend to be low and stable as well. Conversely, when inflation is high and volatile, real interest rates will be volatile, and the premium investors demand for holding fixed-interest securities will rise.

Theoretically speaking, long-run interest rates are expected to be no lower than the trend growth rate of an economy. However, the historical experience clearly shows that this general rule can be broken. In about half of the years since the 1870s (excluding the war years), the growth rate exceeded the rate of interest for the eight-country average. Moreover, the rate of growth has exceeded the rate of interest for as many as 20 years at a stretch. As discussed in previous issues of the World Economic Outlook, the outlook for long-run interest rates depends critically on economic fundamentals—notably, the extent to which the desired level of savings continues to exceed desired investment, as well as on such factors as the impact of regulatory change and aging on the demand of financial institutions for long-term assets—but other developments such as commodity price shocks, especially oil price shocks, also play a role (for econometric evidence on this point, see Catão and Mackenzie, 2006).

Should low real long-term interest rates persist, the relative positions of borrowers and lenders may be significantly affected. Governments will find it easier to attain or maintain financial stability, because the primary surplus they need to target to maintain a given debt-to-GDP ratio will decline. Lower rates of interest can also reduce the incentive to undertake needed but politically difficult fiscal consolidation. Investors, however, may need to revisit their assumptions regarding target rates of return on their portfolios. In particular, households, which in many countries are shouldering more of the risks associated with saving for retirement, may have to retire later, or increase the savings they planned to make during their working lives.

Note: The principal authors of this box are Luis Catão and Sandy Mackenzie.1 This figure was computed by deflating the nominal long bond rate by the current rate of inflation in each country and obtaining a global rate as a GDP-weighted average of the real rates thus measured in the eight countries in the sample. The median of the annual global real rates over the entire 1870–95 period is reported. Deflating the nominal rate by the 10-year-ahead inflation rate, rather than by current inflation, yields essentially the same estimate of the average real interest rate for this period.2 This measure is obtained as explained in footnote 1. For alternative measures using estimates of inflationary expectations, but telling essentially the same story, see Catão and Mackenzie (2006).

Within this favorable environment, beyond the continuing strength of oil prices, three features are particularly striking:

  • The U.S. current account deficit has continued to rise, matched by large surpluses in oil exporters, China and Japan, a number of small industrial countries, and other parts of emerging Asia. That said, partly reflecting favorable short-run interest rate differentials, as well as high net savings in corporates, oil exporters, and much of Asia, financing has not been a problem; indeed, the U.S. dollar appreciated somewhat in trade-weighted terms during 2005, with depreciations against many emerging market currencies offset by appreciations against the euro and yen (Figure 1.6). Despite the record current account deficit, initial estimates suggest that the U.S. net investment position deteriorated only moderately as—for the fourth year in succession—the United States benefited from favorable valuation changes. In contrast to previous years, these stemmed not from U.S. dollar depreciation, but rather the relatively low rate of price increase of U.S. equities relative to the rest of the world.

  • Inflationary pressures remain surprisingly modest. Global headline inflation has picked up in response to higher oil prices, but core inflation has been little affected (Figure 1.7) and inflationary expectations remain well grounded. This has raised questions as to whether low inflation reflects deflationary pressures from other sources, notably global-ization—the theme of this issue of the World Economic Outlook—or whether there is a danger that the inflationary impact has simply been postponed. The analysis in Chapter III, “How Has Globalization Affected Inflation?” concludes that while globalization has reduced the sensitivity of inflation to domestic capacity constraints, the direct impact of globalization on inflation has generally been quite small, except in several periods of excess global capacity when import prices suddenly plunged. In the current environment of strong global growth and diminishing excess capacity, the restraining effect of declining import prices has faded. Indeed, a cyclical upturn in import prices could contribute to stronger inflation pressures going forward, which monetary policymakers will need to remain vigilant against.

  • Emerging markets and corporations remainhighly unusually—large net savers, contributing to low long-term interest rates. In the emerging markets, as discussed in the last World Economic Outlook, this primarily reflects a combination of low investment and—increasingly—buoyant oil revenues. Chapter IV of this World Economic Outlook,“Awash With Cash: Why Are Corporate Savings So High?,” finds that record Group of Seven (G-7) corporate surpluses reflect a combination of lower tax and interest payments and low nominal investment; surprisingly, underlying profitability has barely changed. This surplus has been partly used to buy back equities, restructure debt, and build up liquid assets. While it is commonly argued that this mainly reflects a reaction to the high debt and excess investment in the late 1990s, Chapter IV argues that the underlying reasons are considerably more diverse. With some of these clearly temporary in nature, the current situation is unlikely to be sustained, suggesting that changing corporate behavior will start to put upward pressure on interest rates going forward.

Figure 1.6.
Figure 1.6.

Global Exchange Rate Developments

The U.S. dollar appreciated moderately over the last year, with appreciations in emerging market currencies—especially Latin America and parts of emerging Asia—offset by depreciations of the yen and European currencies.

Sources: Bloomberg Financial Markets, LP; and IMF staff calculations.1 Australia and New Zealand.2 Denmark, Norway, and Sweden.3 Indonesia, Malaysia, the Philippines, and Thailand.4 Czech Republic, Hungary, and Poland.5 Russia, South Africa, and Turkey.6 Hong Kong SAR, Korea, Singapore, and Taiwan Province of China.7 Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela.
Figure 1.7.
Figure 1.7.

Global Inflation

(Annualized percent change of three-month moving average over previous three-month average)

While headline inflation has increased with higher oil prices, core inflation has changed little.

Sources: Haver Analytics; and IMF staff calculations.1 Australia, Canada, Denmark, euro area, Japan, New Zealand, Norway, Sweden, the United Kingdom, and the United States.2 Brazil, Bulgaria, Chile, China, Estonia, India, Indonesia, Hong Kong SAR, Hungary, Korea, Malaysia, Mexico, Poland, Singapore, South Africa, Taiwan Province of China, and Thailand.

Against this background, global GDP growth is projected at 4.9 percent in 2006, 0.6 percentage point higher than expected last September, easing to 4.7 percent in 2007 (Figure 1.8). Continued headwinds from high oil prices are expected to be offset by a gradual pickup in investment, as increasing capacity constraints encourage corporates to reduce their net savings; very favorable financial market conditions; and continued accommodative macroeconomic policies (Figure 1.9). Looking across key countries and regions:

Figure 1.8.
Figure 1.8.

Global Outlook

(Real GDP; percent change from four quarters earlier)

Following some slowing in the first half of 2005, global growth is expected to stabilize around 4¾ percent in 2006—07.

Sources: Haver Analytics; and IMF staff estimates.1 Australia, Canada, Denmark, euro area, Japan, New Zealand, Norway, Sweden, Switzerland, the United Kingdom, and the United States.2 Hong Kong SAR, Korea, Singapore, and Taiwan Province of China.3 Indonesia, Malaysia, the Philippines, and Thailand.4 Czech Republic, Estonia, Hungary, Latvia, and Poland.5 Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela.6 Israel, Russia, South Africa, and Turkey.
Figure 1.9.
Figure 1.9.

Fiscal and Monetary Policies in the Major Advanced Economies

Real short—term interest rates are generally expected to rise in 2006—07, but—outside Germany and the United Kingdom—underlying fiscal positions show little improvement.

Source: IMF staff estimates.1 For Japan, excludes social security.2 Three-month rate for euro area countries.
  • In industrial countries, GDP growth in the United States is expected to moderate to 3.4 percent in 2006, still the highest among G-7 countries. Despite the surprisingly weak growth in the fourth quarter of 2005, incoming data suggest a relatively strong start to 2006, with a more abrupt slowdown in the housing market the most significant risk (see Box 1.2, p. 22). In Japan, activity picked up strongly in the fourth quarter while deflationary pressures continue to ease; risks are to the upside, especially if private consumption gains momentum in response to improving labor market conditions. Despite slowing fourth quarter growth, the expansion in the euro area also seems to be gaining some traction, although—with consumption remaining weak—it remains vulnerable to domestic and external shocks.

  • Activity in emerging market and developing countries remains very strong, with forecasts revised upwards in most countries and regions. In emerging Asia, GDP growth in both China and India has continued to surprise on the upside, driven by strong domestic demand and—in China—a rapidly rising current account surplus. Along with the recovery in information technology (IT), this has supported an acceleration in activity in the rest of the region, although investment growth has yet to pick up substantially. In Latin America, notwithstanding the slower pace of growth in larger economies, GDP growth remains solid, aided by booming commodity prices. While this has aided a notable reduction in debt ratios, political uncertainty remains a concern, and many countries remain vulnerable to an abrupt deterioration in the external environment. In the Middle East and Commonwealth of Independent States,rising oil prices continue to boost fiscal and external current accounts, with spending behavior generally more cautious than in past episodes of rising prices (see Chapter II, Box 2.1, “How Rapidly Are Oil Exporters Spending Their Revenue Gains?”). Inflationary pressures—while generally manageable—need to be carefully watched, and in some cases sharply rising asset prices pose risks. Elsewhere, GDP growth in Emerging Europehas proved resilient to higher oil prices, but high current account deficits and rapid credit growth in many countries remain central vulnerabilities.

  • In the poorest countries, GDP growth in sub-Saharan Africa is estimated at 5.5 percent in 2005, rising to 5.8 percent in 2006—the highest in over three decades. Within this, the pickup owes much to surging growth in oil-producing countries as new capacity comes on stream. Perhaps surprisingly, GDP growth in oil importers has slowed only modestly, reflecting both improved macroeconomic and structural policies and the offset from higher nonfuel commodity prices—particularly in metals producers—but also more limited energy price pass-through in 2005, as well as rising external aid. Notwithstanding the tendency for past IMF GDP growth forecasts for Africa to be overoptimistic (see Box 1.3, p. 24, on the accuracy of WEO forecasts), the upward trend in growth is encouraging, although achievement of the Millennium Development Goals remains far off. Donors now need to fully deliver on commitments for higher aid and debt relief, including ensuring that additional resources are indeed additional, and not offset by reductions in other forms of assistance; African countries must continue to strengthen policies and institutions to ensure that those resources—as well as those coming from higher oil and other commodities—are well used.

The Impact of Recent Housing Market Adjustments in Industrial Countries

House prices in many industrial countries have been increasing at unprecedented rates in recent years, providing a boost to economic growth. An analysis in the September 2004 World Economic Outlook, however, found that this increase in house prices had significantly exceeded the amount justified by fundamentals—such as population and income growth and interest rates— in a number of countries, raising the prospect that house prices would need to adjust in the period ahead. Further, the analysis also found that the correlation of house prices across countries was surprisingly high—particularly given that housing is a nontraded asset—raising the possibility that such a weakening in prices could be synchronized across countries, magnifying the impact on global growth.

Over the past year, house price growth has slowed in many countries, consistent with the historical cross-country synchronization in these prices. In Australia and the United Kingdom, house price inflation has declined from 20 percent a year in late 2003 (middle of 2004 for the United Kingdom) to zero to 5 percent currently, while in Ireland prices slowed through mid-2005, but appear to have accelerated more recently. In France, Spain, and the United States, house price appreciation has also slowed to some degree, although it remains in double digits on a year-on-year basis. In the Netherlands, the downturn in the housing market started much earlier—in 2000—than in other industrial countries, and price appreciation has remained subdued in recent years. The slowing in price appreciation in Australia, Ireland, and the United Kingdom has brought house prices in these countries closer to current estimates of fundamental value, although the United Kingdom still appears quite richly valued (first figure). On the other hand, house prices in the United States and Spain appear to have moved further away from estimated fundamentals over the past year.


Assessing the Global House Price Boom

(1997–2005; cumulative percent change; constant prices)

Sources: Haver Analytics; IMF, International Financial Statistics; national authorities; and IMF staff calculations.

There are now growing signs that housing activity in the United States has peaked. A key question for both the United States and the global economy is to what extent slowing house price appreciation will affect growth going forward. There are several channels through which house price movements affect aggregate demand and output. First, house prices affect households’ net wealth and capacity to borrow and spend. Bayoumi and Edison (2003), for example, find that a dollar increase in housing wealth in industrial countries raises consumption by around 5 cents, with the impact being larger in countries with market-based financial systems (such as Australia, the Netherlands, the United Kingdom, and the United States) than in those with bank-based financial systems (such as France and Spain). As discussed in the main text, this would suggest that a 10 percentage point slowing in real house price appreciation would reduce consumption growth in the United States by some ½−1 percentage point in the first year. Second, house prices alter the incentives for residential construction, although this relationship has been hard to pin down empirically. Lastly, strong housing markets generate employment in the real estate and related sectors, boosting incomes and consumption. Combining these effects and allowing for the cross-country comovement of house prices, estimates for the United States by Otrok and Terrones (forthcoming) suggest that a 10 percent slowing in the rate of real house price appreciation could slow real GDP growth by as much as 2 percentage points after one year in that country. The recent experiences in the Netherlands, Australia, and the United Kingdom also suggest that a sharp slowing in the pace of house price appreciation could put a significant dent in the growth of private consumption, residential investment, and real GDP in the United States (see the second figure).

A more abrupt adjustment in house prices would of course have more serious consequences for growth. The April 2003 World Economic Outlookfound that 40 percent of house price booms ended in busts, and that these “busts”—defined as a peak-to-trough decline in real house prices that falls into the top quartile of all such price declines—are associated with a substantial slowing in real GDP growth (for the average “bust” episode, real GDP growth was 3 percent before the “bust,” but modestly negative two years after).1 Nearly all such “bust” episodes were preceded by a significant monetary policy tightening (generally short-term interest rates increased by 400 to 500 basis points). A key question for housing markets going forward, therefore, is the extent to which interest rates increase in the period ahead.

A slowing U.S. housing market would have important implications for the world economy given that the U.S. economy has been a key engine of global growth in recent years. Should U.S. growth and imports slow, trading part-ners—particularly significant exporters of consumption goods to the United States— would be adversely affected (over the past 25 years, the correlation between output growth in the United States and the rest of the world has been 0.5). Through its likely impact on household saving and residential investment, a slowing in the rate of house price appreciation in the United States would, however, contribute to a needed rebalancing of global growth and a reduction in existing current account imbalances.


The Recent Slowdown in Housing Prices

(Percent change from a year earlier, constant prices; x-axis in quarters where zero denotes the quarter in which housing price growth reached its highest level)

Sources: Haver Analytics; Bank for International Settlements;national authorities; and IMF staff calculations.1 Simple average of Australias, the Netherlands', and the United Kingdom's recent booms and subsequent slowdowns.
Note: The main authors of this box are Tim Callen and Marco Terrones.1 The analysis in the September 2005 World Economic Outlook suggested that at least 18 states, accounting for more than 40 percent of U.S. GDP, are currently experiencing housing booms.

Looking forward, notwithstanding the greater-than-expected momentum in the global economy, a number of uncertainties remain. On the upside, corporates could run down their surpluses more rapidly than presently expected, either through higher investment or increased wages or dividends, although the impact would be partly offset by higher long-run interest rates. It is also possible that growth in some emerging market countries could continue to exceed expectations (although, particularly in China, this would also increase the risk of a more abrupt slowdown later on). But, overall, the balance of risks remains slanted to the downside, the more so as time progresses (Figure 1.1 and Box 1.3). There are four primary concerns, two of which are uncertainties related to the current conjuncture and two of which are of lower probability but potentially high-cost:

  • High and volatile oil prices. To date, the impact of higher oil prices on the global economy has been more moderate than generally expected, in part because inflationary expectations have remained well anchored, and the shock has been driven by strong global demand.4 Looking forward, however, there are three reasons for concern. First, the full effects of the recent shock may not yet have been felt, especially if producers and consumers are still treating it as temporary, rather than largely permanent in nature. Second, with excess capacity still very low, the market remains vulnerable to shocks—indeed, with the recent increase in geopolitical uncertainties in the Middle East, options market data suggest risks are slanted to the upside, with a 15 percent probability of oil prices spiking above $80 per barrel by mid-2006. Third, with prices increasingly driven by supply-side concerns, the adverse impact is likely to be greater than in the recent past, especially if feed-through to core inflation increased. This would be of particular concern for oil-importing developing countries, which would not in these circumstances benefit from an offsetting rise in nonfuel commodity prices. This underscores the need for progress in improving the medium-term supply-demand balance in oil markets, including through eliminating obstacles to upstream and downstream investment; ensuring full pass-through to domestic oil prices accompanied by a suitable safety net for the poorest; strengthening conservation efforts; and last—but not least—improving oil market data. Such measures would also help reduce price volatility in the short term, by making markets less vulnerable to shocks.

  • A tightening in financial market conditions. Current benign financial market conditions are partly due to strengthening fundamentals, but also reflect more temporary factors, including very easy monetary conditions and, related to that, the continuing search for yield. Over the coming two years, global short-term interest rates will rise further, accompanied by significant changes in short-run interest differentials, as the tightening cycle in the United States reaches completion while those in the euro area—and, recently, Japan—become more advanced (see relevant country sections below); long-run interest rates are likely to rise further; and volatility and risk premiums may pick up. If the implications of the transition to more normal financial conditions are fully anticipated, its impact is likely to be moderate; ifnot, the effect could be considerably greater. As discussed in the April 2006 Global Financial Stability Report, financial institutions and markets seem relatively well placed to manage these changes, especially given the marked strengthening in their balance sheets in recent years; emerging market countries have also taken advantage of current conditions to improve debt structures, although some remain vulnerable to a deterioration in financing conditions. The greatest risks appear to lie in the household sector, particularly in countries where housing markets are elevated, especially since recent house price slowdowns have led to a noticeable slowing in private consumption and residential investment.

  • Rising global imbalances. With the U.S. current account deficit being financed with little difficulty, and exchange rate movements relatively benign, there may be a temptation to put this issue on the back burner. But the fundamental arithmetic—that the U.S. current account deficit must ultimately fall substantially to stabilize its net investment position, while surpluses in other countries must fall—has not changed; and—as discussed in Chapter II, “Oil Prices and Global Imbalances”—higher oil prices are complicating the adjustment process. Looking forward, as described in detail in Box 1.4, p. 28, adjustment in the imbalances will in all circumstances require both a significant rebalancing of demand across countries, and a further substantial depreciation of the U.S. dollar and appreciations in surplus countries, notably in parts of Asia and oil producers; the issue is when and how those adjustments occur.5 While an important part of the adjustment will need to take place in the private sector, a purely market-driven adjustment will succeed only if foreigners are willing to increase their net holdings of U.S. assets substantially in the face of substantial capital losses from future dollar depreciation—which do not appear to be priced into yields on U.S. dollar assets at present—and if protectionist pressures can be held in check. If not, as illustrated in Figure 1.10, there is a risk of a much more abrupt and disorderly adjustment, accompanied by substantial exchange rate overshooting, a large increase in interest rates, and a sharp slowdown in growth worldwide.

  • An avian flu pandemic. While both the probability and potential risks are impossible to assess with any certainty, a worse-case scenario could have extremely high human and economic costs, particularly in developing countries (see Appendix 1.2 on the avian flu pandemic). This underscores the importance of moving ahead with necessary public health precautions and providing the necessary assistance to developing countries to do so; measures to ensure that essential economic infrastructure—particularly payments systems—can continue to operate should also be a priority. In particular, all major financial institutions need to have a contingency plan that addresses the consequences of the loss of key personnel.

How Accurate Are the Forecasts in the World Economic Outlook?

A recent report commissioned by the IMF’s Research Department evaluated the accuracy of the forecasts published in the World Economic Outlook (WEO), and made a number of recommendations for improving forecasting at the IMF (see Timmermann, 2006). The report— written by Allan Timmermann of the University of California, San Diego—is the fourth in a series of such evaluations (following Artis, 1997; Barrionuevo, 1993; and Artis, 1988).1 This box discusses the findings of the report and the steps that are being taken to implement the report’s recommendations.

Assessing the WEO Forecasts

As a first step, the report looked at the forecasting performance for five key variables—real GDP growth, inflation, the current account balance, and import and export volume growth— for 178 countries in seven economic regions (Africa, central and eastern Europe, the Commonwealth of Independent States (CIS) and Mongolia, Developing Asia, Middle East, Western Hemisphere, and Advanced Economies) since 1990. The analysis considered current-year and next-year forecasts published in the April and September issues of the World Economic Outlook (e.g., the April and September 2005 issues of the WEO have projections for 2005—current year—and 2006—next year). Overall, the report found that the World Economic Outlookforecasts for variables in many countries meet the basic forecasting quality standards in some, if not all, dimensions.2 The report, however, also raised important issues that are discussed below on a variable-by-variable basis.

  • Real GDP growth. WEO forecasts for real GDP growth display a tendency for systematic over-prediction. Looking at the G-7 countries, WEO forecasts systematically and significantly overpredicted economic growth for the European and Japanese economies during 1991–2003. In contrast, U.S. growth was underpredicted after 1990, although the bias was not statistically significant. In Africa, central and eastern Europe, the CIS, and the Middle East, growth in individual countries is, on average, overpredicted by more than 1 pecentage point in both current- and next-year forecasts. That said, more than four-fifths of these biases are not statistically significant, which largely reflects the high volatility in the underlying growth series. For IMF program countries, growth was, on average, overestimated by about 0.9 percentage point in April current-year forecasts and by 1½ percentage points in April next-year forecasts, often significantly so.

  • Inflation. The report found a bias toward underprediction of inflation, with these biases significant in the next-year forecasts in the case of many African, central and eastern European, and Western Hemisphere countries. The bias tends to be smaller in the current-year forecasts.

  • External current account balances. Fewer problems were found in the forecasts for current account balances, except that in some cases the April next-year forecast errors were significantly biased or serially correlated.

As well as assessing the performance of the WEO projections against standard benchmarks of forecast performance, the report also compared them to the Consensus Forecasts, a widely used source that compiles the forecasts of economists working in the private sector. The analysis covered the G-7 economies, seven Latin American economies, and nine Asian economies. Overall, the performance of the WEO forecasts was similar to the Consensus Forecasts—for example, the current year WEO forecasts of GDP growth in the G-7 economies were generally less biased than the Consensus Forecasts, but the bias in the next-year forecasts was stronger in the WEO than in the Consensus.


The report made a number of recommendations to improve the WEO forecasting process. These included: (1) WEO growth forecasts for some countries could be improved if more attention were paid to important international linkages, particularly with the United States;(2) the accuracy of the forecasts should be assessed on an ongoing basis by instituting a set of real-time forecasting performance indicators;(3) IMF forecasters should more carefully consider the historical forecast “biases” when making their forecasts; and (4) the forecast process should be broadened to more explicitly consider the risks around the key central projections. Internally, the IMF has begun taking steps to implement the first three recommendations. The rest of this box discusses the fourth recommendation—forecast risks—and how these can be incorporated in the WEO process.

The increased use of policy targets for key macroeconomic variables—especially inflation— that are not fully under the control of policymakers and advances in econometric methodology have led to a more intense scrutiny of forecast uncertainty in recent years. For example, the Bank of England uses “fan charts” to illustrate the bank’s view about the uncertainty around its central forecast path for inflation. Similarly, the Congressional Budget Office in the United States has started using fan charts to illustrate the uncertainty in its projection of the budget deficit. These fan charts are diagrams that represent forecasts of the probability distributions of variables of interest. The aim of such charts is to depict in a practical way the uncertainty that exists about future economic outcomes.

The fan chart in Figure 1.1 shows the IMF staff’s assessment of the range of uncertainty around the central WEO projection for global real GDP growth in 2006–07. Specifically, it shows the 90 percent probability interval for growth outcomes in 2006–07. Past forecast performance and judgment about the current balance of risks,3 as discussed in the main text, provide the inputs for the construction of the fan chart. In addition to uncertainty about the future course of oil prices, the U.S. housing market, corporate investment, and the future resilience of emerging market growth, two low probability, but high cost, events—an avian flu pandemic and the disorderly unwinding of current account balances—are also considered. The fan chart builds on the two-piece normal distribution used by the Bank of England in its inflation forecast. This distribution, unlike the standard normal distribution widely used in forecasting, allows for asymmetric probabilities below and above the central forecast.4 In the case of the balance of risk being tilted to the downside—which is the view of IMF staff at this juncture—the expected probability of outcomes being below the central forecast exceeds 50 percent. As shown in Figure 1.1, the downside risks are expected to increase somewhat over time, in part reflecting the gradually increasing probability of a disorderly adjustment in global imbalances in the absence of policy action.

Note: The main authors of this box are Nicoletta Batini, Tim Callen, and Thomas Helbling.1 Other studies of the World Economic Outlook forecasts include Batchelor (2001), Beach, Schavey, and Isidro (1999), and U.S. GAO (2003).2 These dimensions are that the forecast should be unbiased and serially uncorrelated, that no current information should be able to predict future forecast errors, and that the variance of forecast errors should decline as more information becomes available.3 Recent current-year and next-year forecast errors provide important information about the extent of forecast uncertainty.4 See Britton, Fisher, and Whitley (1998); and Wallis (2004).

How Much Progress Has Been Made in Addressing Global Imbalances?

This box updates the analysis of global imbalances and policy actions designed to facilitate their resolution presented in the September 2005 World Economic Outlook. Since then there has been no significant shift in the trend of external imbalances: the U.S. current account deficit is estimated to have reached the record level of 6.4 percent of GDP in 2005, and—at current exchange rates—is projected to remain at record levels in subsequent years (see the first figure). Capital flows to the United States remain strong, with an increase in purchases of U.S. bonds by the private sector offsetting a decline in official flows. As has been the case for the past four years, the deterioration of the U.S. net external position in 2005 has once again been contained by sizable net capital gains on its external portfolio despite the real appreciation of the dollar, thanks to the stronger performance of non-U.S. stock markets relative to the U.S. market.

As a matter of simple arithmetic, the global imbalances remain on an unsustainable trend over the long run, as—unless returns on U.S.-issued financial instruments continue to substantially underperform those issued in other countries, thus generating large further capital gains for the United States—they would lead to an ever-accumulating stock of emerging Asian and oil exporters’ assets and U.S. external lia-bilities.1 Therefore, the issue is not whether but how and when they adjust. As described in Appendix 1.2 of the September 2005 World Economic Outlook, the current configuration of external imbalances arises from a combination of shocks and economic trends across several countries and regions, with both the public and private sector contributing. It is possible that there will be an orderly private-sector led adjustment in imbalances even without policy action, with U.S. private savings rising gradually as interest rates increase and the housing market slows, accompanied by substantial real exchange rate adjustment, including through rising inflation in Asia (see Figure 1.10). This benign scenario assumes that foreigners will continue to purchase U.S. assets (with no significant interest rate premium, notwithstanding the risk of large capital losses) and that protectionist pressures can be avoided. If this does not happen, the figure also illustrates the implications of a much more abrupt and disorderly adjustment, characterized by a substantial overshooting of exchange rates; a large increase in interest rates; and a sharp contraction of global activity.


Current Account Balances and Net Foreign Assets

(Percent of world GDP)

Sources: Lane and Milesi-Ferretti (2006); and IMF staff estimates.1 Algeria, Angola, Azerbaijan, Bahrain, Republic of Congo, Ecuador, Equatorial Guinea, Gabon, I.R. of Iran, Kuwait, Libya, Nigeria, Norway, Oman, Qatar, Russia, Saudi Arabia, Syrian Arab Republic, Turkmenistan, United Arab Emirates, Venezuela, and the Republic of Yemen.2 China, Hong Kong SAR, Indonesia, Korea, Malaysia, the Philippines, Singapore, Taiwan Province of China, and Thailand.

The question then becomes how public policy can best assist an orderly rebalancing. The World Economic Outlook has long argued that the key actions in this regard include measures to increase savings in the United States; exchange rate appreciation in the context of greater exchange rate flexibility, along with measures to boost domestic demand in emerging Asia; structural reform to boost domestic demand and growth in the euro area and Japan; and measures to increase demand in oil exporters (see Box 1.6 in the September 2005 World Economic Outlookfor a detailed description of these policies). As shown in the “strengthened policies” scenario in Figure 1.10, this would essentially bring forward adjustment, but in an orderly way. Net external positions would be stabilized earlier, thus reducing the risk of abrupt and disruptive adjustment, and world growth would be more balanced. In addition, the proposed policies are advisable on domestic policy considerations, being in each country’s and region’s best interest.

Over the last year, how much progress has been made in implementing these policies?

  • In the United States, there are modest signs of an improvement in savings(see the second figure), with the general government deficit falling to 4.1 percent in 2005. However, IMF staff projections suggest little improvement thereafter, with the deficit remaining above 4 percent of GDP in 2006–07 and close to 3 percent of GDP over the medium term, substantially higher than the broad balance envisaged in the adjustment scenario. Recent budget proposals envisage only modest fiscal improvements and are based on an ambitious compression in nondefense discretionary spending. A more determined fiscal retrenchment, which would help prepare for the inevitable aging-related increases in spending, is likely to require revenue-enhancing measures, such as eliminating tax exemptions; raising energy taxes; or introducing a federal VAT or sales tax. The private savings rate would remain relatively stable, as a higher household savings ratio—partly reflecting a slowdown in the housing market—would be offset by a fall in the (currently very high) savings rate of firms.

  • In Asia, exchange rate adjustment remains limited, although there are some signs of a strengthening in domestic demand.More specifically:

    On exchange rates, China’s July 2005 exchange rate reform was a welcome step, and the authorities have taken further measures to liberalize and develop the foreign exchange market, including an increase in the number of financial institutions licensed to participate in the interbank foreign exchange market (including foreign banks), and the introduction of over-the-counter (OTC) trading of spot foreign exchange with 13 banks designated as market makers. However, the ren-minbi continues to move closely with the U.S. dollar, and the additional flexibility the reform permits needs to be used more aggressively to allow the renminbi to respond to market pressures and appreciate. Elsewhere in Asia, current account surpluses have declined in some countries, under the weight of higher oil prices, while currencies have generally appreciated, most notably in Korea and Thailand. Nevertheless, surpluses remain large in a number of countries, suggesting that further exchange rate appreciation would be required over the medium term.

    On the demand side, priorities differ across countries. In China, where investment is already high, the key is to strengthen private consumption. IMF staff projections suggest a stabilization but very little increase in the share of private consumption to GDP over the next two years, despite measures to boost rural incomes. Allowing for higher consumption over the medium term will require a number of structural reforms, including strengthening the financial sector, requiring state-owned enterprises to pay dividends to the state, rebalancing public expenditure toward higher spending on health and education, and reforming the pension system. Elsewhere in Asia, there are some signs of a pickup in investment since 2003, as corporate restructuring has advanced, bankruptcy rates have fallen, and debt levels have declined below pre-crisis levels in many countries. Nevertheless, further reforms are necessary to improve the investment climate, including financial sector reforms that deepen capital markets and thereby broaden the sources of corporate financing.

  • In Japan, where the expansion is now well grounded, the current account surplus has begun to narrow against the backdrop of strengthening domestic demand, and is set to decline further from its current high level over the medium term. With fiscal policy needing to tighten significantly, boosting productivity in the nontradable sector is key. Further reforms can be pursued to improve labor market flexibility, as well as to enhance competition—especially in retail, agriculture, and other domestically oriented sectors. Such steps can promote more robust domestic demand that, along with population aging, will work to narrow the external imbalance over the medium term. Over time an appreciation of the yen is likely to make a contribution as well.

  • In the euro area, the key contribution—in some ways similar to Japan—is through measures to boost growth and domestic demand.While there are signs that the recovery—primarily in investment—is becoming better grounded, further progress is needed on structural reforms at the national and European level. In recent months, the EU Services Directive has been approved by the European parliament, but in a much weaker form. In Germany, the recent package—while containing welcome measures in other areas—was relatively weak on product market reform and further labor market deregulation. For the area as a whole, past structural reform efforts have increased wage flexibility and strengthened employment resiliency, but have not delivered sufficient job creation, productivity, and output growth. Thus, comprehensive strategies to foster product market and financial sector competition, as well as a better integration of labor, product, and financial market reforms remain key priorities.

  • In oil exporters, adjustment is—understandably given the size of additional revenues relative to domestic economies—relatively gradual.

    In oil exporters, scope remains for boosting expenditures in areas where social returns are high (education and health; infrastructure; private sector employment; and strengthened social protection schemes). To date, oil-exporting countries have, on average, spent 30–40 percent of their additional oil revenues on imports, with relatively significant variation across countries—see Box 2.1 for details.

    Exchange rates have appreciated noticeably in real terms in a number of oil exporters and more modestly in Cooperation Council of the Arab States of the Gulf (GCC) countries, whose exchange rates remain tied to the dollar in the runup to GCC monetary union. In these latter countries, real effective appreciation can only take place through inflation as spending adjusts.


Global Imbalances: Macroeconomic Indicators

(Percent of GDP, unless otherwise indicated)

Source: IMF staff estimates.1 Newly industrialized Asian economies (NIEs) refers to Hong Kong SAR, Korea, Singapore, and Taiwan Province of China.2 Marginal propensity to import out of oil revenues (See Chapter II, Box 2.1 for details).3 Cooperation Council of the Arab States of the Gulf (GCC): Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates.4 See footnote 1 in previous figure excluding GCC countries.

Finally, it is important to stress that adjustment will require both a rebalancing of demand and exchange rate adjustment, with currency depreciation in several deficit countries and currency appreciation in several surplus countries—there is not a choice between one or the other. The longer adjustment is delayed, the larger these exchange rate adjustments will ultimately need to be, and the greater the risk of overshooting. Policymakers and private sector decision makers need to recognize that— although the timing is difficult to predict— exchange rate adjustment will eventually take place and to ensure that national economies, financial institutions, and corporations are as resilient to it as possible.

Note: The author of this box is Gian Maria Milesi-Ferretti.1Hausmann and Sturzenegger (2006) have recently argued that since U.S. net investment income is still positive and changed little over the past 25 years, the “effective” net external position of the United States must also have changed little, and as of end-2004 the U.S. must still have been a net creditor. The main flaw in this argument is the assumption that all investments should earn the same rate of return (even though the risk characteristics of the U.S. asset and liability portfolio are very different). Allowing for this, there is no reason why net investment income cannot be positive even when a country is a net debtor (see “Why Is the U.S. International Income Account Still in the Black, and Will this Last?” Box 1.2, World Economic Outlook, September 2005).
Figure 1.10.
Figure 1.10.

How Will Global Imbalances Adjust?1

In the absence of policy adjustment, an orderly adjustment may take place, but only if investors are willing to hold substantially higher levels of U.S. assets (despite large capital losses) and if protectionist pressures are avoided. If these conditions are not met, there is a clear risk of a disruptive adjustment and a global recession. However, strengthened policies—along the lines described in the text—would sharply reduce imbalances, with a modest short—xterm slowdown offset by stronger medium-term growth.

Source: IMF staff estimates.1 See Appendix 1.2, September 2005 World Economic Outlookfor a detailed discussion of these projections. Since the no policies baseline includes significant short-term real appreciation in Asia through higher inflation, it may overestimate the adjustment in current accounts in the initial period.

Looking forward, policymakers face three main challenges:

  • Making more rapid progress in addressing global imbalances. As the World Economic Outlookhas argued for some time, a coordinated package of policies across major regions—including measures to reduce the budget deficit and spur private savings in the United States; structural and other reforms to boost domestic demand in surplus countries; and greater exchange rate flexibility in China and some other countries to allow necessary appreciations to take place—could significantly reduce risks (see Box 1.4 for a detailed description). To date, however, only modest progress has been made in implementing these policies. As shown in the “strengthened policies” scenario in Figure 1.10, such a package would lead to a significantly earlier adjustment in imbalances, correspondingly reducing the risk of a more abrupt adjustment; while GDP growth would slow somewhat in the short term, over the medium term it would be both stronger and better balanced. Given the strong global conjuncture, and that these policies are in the national as well as the international interest, the cost of such insurance against a disorderly adjustment appears relatively modest.

  • Ensuring sustainable medium-term fiscal positions, not least among many major industrial countries where—outside of Canada and Japan— underlying fiscal positions have improved only modestly since 2003 and—except in Germany and the United Kingdom—IMF staff projections suggest little further improvement over the next two years (Table 1.3). This is of particular concern since, despite some progress in Europe and Japan, pension and health systems across the globe remain unsustainable, with the difficulties associated with implementing even modest reforms being well illustrated by recent experience in the United States. A failure to accelerate progress will increasingly limit the scope for a fiscal response to future shocks, put upward pressures on long-run interest rates, and—over the longer term— pose risks to macroeconomic stability.

  • Putting in place the preconditions to take advantage of globalization and support global growth in the future. At the multilateral level, the most important issues are to resist protectionist pressures—which have been on the increase in a number of countries—and ensure an ambitious outcome to the Doha Round. While the World Trade Organization (WTO) Ministerial Meetings in Hong Kong SAR made some progress (Box 1.5, p. 32), wide differences in country positions remain; given the limited flexibility so far displayed, the risks that the very tight negotiating schedule will not be met are high. An unambitious out-come—or failure—of the Doha Round would have major costs both for the global economy and the multilateral trading system. The challenge at the national level is to advance the structural reform agenda, which in some areas appears to be in retreat—for instance on cross-border takeovers. While the priorities vary across countries, as described below, common themes included the need for greater labor market flexibility in the face of rapid technological change and global competition; improvements to the business climate and increased competition in emerging markets; and the strengthening of financial systems.

The Doha Round After the Hong Kong SAR Meetings

The World Trade Organization (WTO) Ministerial Conference, held in Hong Kong SAR during December 13–18, 2005, was the second such conference since the Doha Round of multilateral trade negotiations was launched in the Qatari capital in 2001. In contrast to the failed Cancún Ministerial Conference in September 2003, the Hong Kong SAR meeting largely met its objectives—though these were disappointingly modest—and succeeded in instilling the Doha Round with some renewed political momentum. Ministers in Hong Kong SAR focused heavily on agriculture and development—the two most politically sensitive issues under discussion—largely leaving aside negotiations on nonagricultural market access (NAMA), services and rules.

In agriculture, the most tangible outcome of the Hong Kong SAR Ministerial Conference was an agreement to end all forms of export subsidies in agriculture by 2013, with an accelerated end date of 2006 for cotton. This was a welcome achievement, given the highly distortionary nature of export subsidies in OECD countries. Only marginal progress was achieved in the other dimensions of the agriculture negotiations, namely the need to discipline or eliminate trade-distorting domestic support and to increase market access in agricultural products.

On development issues, ministers outlined a “package” of trade and aid for least-developed countries (LDCs) and other poor developing countries in the form of market access privileges, less stringent disciplines (“special and differential treatment”), and assistance in trade-related capacity building. In particular, industrial and developing countries that declared themselves in a position to do so, agreed to provide duty- and quota-free market access for at least 97 percent of export items originating from LDCs by 2008. However, the 3 percent exception will allow highly protected products of significant export interest to LDCs to be exempted.

Although the Doha Round was dubbed the Doha Development Agenda (DDA), the “development dimension” of the Round has remained controversial. In Hong Kong SAR, there was a tendency to equate “development” with “policy space”—that is, the right to exemptions from global commitments and disciplines. Yet this understanding is at odds with the experience of successful development, which suggests that active trade integration offers the best hopes for spurring economic growth. Weak commitments may also reduce developing country leverage in achieving desired outcomes in their own areas of interest.

The conference set specific deadlines for intermediate steps in the negotiations, but made no headway on several central issues, and much uncertainty remains as to whether an ambitious outcome can be reached. Work subsequent to the Davos World Economic Forum has seen a serious engagement at the technical level and a cooling of the political rhetoric that had been encumbering the negotiations. The key parameters for liberalizing agriculture and nonagricul-tural trade are to be agreed by April 30, 2006, and final draft schedules of commitments in services are to be submitted by October 31, 2006. The aim is to conclude the Round by the end of 2006.

These timelines appear very ambitious in view of the remaining differences and the pace of the negotiations so far, but they may help focus decision makers’ attention on the Round. A successful outcome to the negotiations is needed to strengthen the multilateral trading system and provide impetus to global economic growth.

Note: The author of this box is Jean-Pierre Chauffour.

China’s GDP Revision: What Does It Mean for China and the Global Economy?

China recently revised its production-side GDP estimates, showing higher nominal and real GDP growth rates over 1993–2004. This revision is based on the data collected from a recent economic census, which showed much larger output from the services sector than previously estimated; nominal GDP in 2004 is now about 16.8 percent higher than before. The highlights of the revision are:

  • The services sector’s share of GDP rose 5 percentage points on average and reached around 41 percent of GDP in 2004, largely offset by a lower share of GDP of the manufacturing sector. The rise in the share reflected better statistical recording of private businesses, especially in new areas such as computer and Internet services, and logistics support to the manufacturing and construction sectors. It should be noted that the economic census only covered 2004, and the historical data were backfilled by applying a statistical method that assumes a smooth path of the increase in services. Thus, the revision does not provide any information regarding when the newly uncovered activities emerged and expanded.

  • As a result of the revision, the annual average real growth during 1993–2004 climbed to close to 10 percent, about ½ percentage point higher than before (see the figure). Annual growth rates of GDP deflators are also higher in the revised data, reflecting both the upward revision of services deflator and the larger share of services in GDP.

The 2005 nominal GDP under the new methodology has recently been released. It makes China the fourth-largest economy in the world in U.S. dollar terms, and the second-largest in PPP adjusted terms. Nevertheless, China’s per capita income (US$7,204, PPP adjusted) remains very low. The revision has also added about 0.1 percentage point to global GDP growth estimates in recent years.


China’s Real Production-Based GDP Growth

Sources: National Bureau of Statistics of China; and IMF staff calculations.

The nominal expenditure side GDP was also revised for 2004, bringing the expenditure side estimate for this year very close to its revised production-side counterpart. The new data imply shares of consumption and investment in GDP very similar to those prior to the revision, belying the speculation that the upward revision of the services sector would lead to a significantly higher share of consumption in GDP. In fact, private consumption as a share of GDP declined, while the share of government consumption rose, which could reflect better reclassification of government spending between consumption and capital goods. While a fully revised historical series from the expenditure side has not yet been published, the basic assessment of China’s economic situation remains unchanged.

China: GDP and Components

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Sources: National Bureau of Statistics of China; and IMF staff calculations.

Ratios based on expenditure side GDP data.

Note: The main author of this box is Li Cui.
Table 1.3.

Major Advanced Economies: General Government Fiscal Balances and Debt1

(Percent of GDP)

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Note: The methodology and specific assumptions for each country are discussed in Box A1 in the Statistical Appendix.

Debt data refer to end of year. Debt data are not always comparable across countries. For example, the Canadian data include the unfunded component of government employee pension liabilities, which amounted to nearly 18 percent of GDP in 2001.

Percent of potential GDP.

Beginning in 1995, the debt and debt-service obligations of the Treuhandanstalt (and of various other agencies) were taken over by general government. This debt is equivalent to 8 percent of GDP, and the associated debt service, to 1/2 to 1 percent of GDP.

Excludes one-off receipts from the sale of mobile telephone licenses (the equivalent of 2.5 percent of GDP in 2000 for Germany, 0.1 percent of GDP in 2001 and 2002 for France, and 1.2 percent of GDP in 2000 for Italy). Also excludes one-off receipts from sizable asset transactions, in particular 0.5 percent of GDP for France in 2005.

With the global economy set for its fourth consecutive year of 4 percent plus GDP growth, the current conjuncture is the strongest for many years. Current policymakers can take considerable credit for this outcome; past policymakers can perhaps take even more. The global economy would not have been so resilient to recent shocks without the strengthening of monetary frameworks since the 1980s, which helped anchor inflationary expectations, and the improvements in fiscal positions in the 1990s, which allowed room for policy easing in 2001–02; nor would global growth and trade be as strong as they are without the successful completion of the Uruguay Round in 1994. But behind today’s rather favorable short-term conjuncture lie major risks and challenges that have yet to be fully addressed. From an economic viewpoint, there is unlikely to be a more favorable environment in which to tackle them; if progress cannot be made now, it will surely be even more difficult later on. In those circumstances, the risks of adverse shocks will rise, and the scope to react to them will decline, making the prospects of achieving the sustained medium-term global growth envisaged in the World Economic Outlookbaseline increasingly remote. From that perspective, 2006 may prove a watershed year, both in terms of the outlook for the global economy itself, and the legacy that today’s policymakers pass to their successors.

United States and Canada: Robust Growth Set to Continue, but the U.S. Housing Market Is a Key Uncertainty

The U.S. economy slowed sharply in the fourth quarter of 2005, growing at its slowest rate since early 2003. Private consumption was weak—largely due to a sharp drop in auto sales as buyer incentive programs ended and gasoline prices surged in the aftermath of Hurricane Katrina—corporate fixed investment was subdued, and net exports exerted a substantial drag on growth. Monthly indicators, however, suggest that this weakness was concentrated early in the quarter and that the economy has subsequently bounced back. In particular, industrial production has strengthened, capital goods orders are firm, nonfarm payrolls increased by an average of 220,000 a month during November–March, and consumer confidence has rebounded from its post-Katrina slump.

Consequently, real GDP growth is expected to rebound in the first quarter of 2006 and to average 3.4 percent for the year as a whole (Table 1.4). Strong corporate profits and comfortable financing conditions imply a positive outlook for business investment. Further, a pickup in growth in trading partners should mean that the external sector is less of a drag on growth, while in the near term there is likely to be higher government spending associated with rebuilding in the aftermath of Hurricane Katrina. Consumption growth, however, is expected to slow this year— by about ¾ percentage point—as a cooling housing market and elevated energy prices more than offset any acceleration in disposable incomes from employment and wage growth. With corporate profits expanding robustly and balance sheets in good shape, business investment and employment growth could be stronger than expected, but overall risks to the outlook are slanted to the downside. Specifically, the large current account deficit—6.4 percent of GDP last year (Table 1.5)—makes the United States vulnerable to a swing in investor sentiment that could put downward pressure on the dollar and see a spike in long-run interest rates. Even more importantly, against a background of low household saving and high energy prices, a weaker housing market could trigger a more abrupt withdrawal of consumer demand than anticipated.