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Keynote speech by OECD Secretary-General, Angel Gurría, on the occasion of the launch of the OECD Economic Outlook, No.85 at the OECD Forum.
Paris, France, 24 June 2009
Good morning ladies and gentlemen.
Today is an important day for the OECD. This Outlook covers over 80 per cent of the world economy and in that sense it is not so much an OECD outlook as a global outlook. It also reflects the increasing reality of the OECD. This year at the MCM we have the 40 ministries that make up for over 80 per cent of the world economy.
In my remarks this morning I will provide you with an overview of our Economic Outlook and the forces that will be driving economic prospects over the next year and a half. I will then handover to Mr. Elmeskov, the acting Chief Economist, who will elaborate on the risks around the projection and highlight the key challenges facing policymakers.
The recovery is likely to be both weak and fragile
Today’s launch of the Economic Outlook contains both good news and bad news. The bad news is that we still anticipate a deep contraction in output. For the OECD area at large, GDP is forecast to shrink by 4.1 per cent this year, as shown in the table on page 2 of the handout, which is available in the back of the room. World trade is set to fall by as much as 16 per cent, due to a host of economic influences. And unemployment will continue to rise sharply, to reach 10 per cent of the labour force by the end of 2010. That represents an increase of 25 million unemployed since the trough in late 2007. The figure on page 6 shows starkly the rise in unemployment.
The good news is that economic activity in OECD countries is reaching bottom, following the deepest decline since the Second World War. In fact, this is the first Economic Outlook in two years to revise up previous projections for OECD economic growth compared with the previous Outlook. But we should not get carried away. The upward revision is fairly modest and we foresee a recovery that will be rather slow and fragile for some time.
One reason for guarded optimism is the improvement in financial markets that we have seen in recent months. The spread between 3-month money market rates and risk-free rates has come down to levels below those prevailing after the Lehman default, as shown on page 7 of the handout, share prices have rebounded from their low points (page 8) and bond spreads have come down both for corporations and for sovereign borrowers. There has also been some slight improvement in banks’ credit standards.
We are also seeing signs that OECD activity may be approaching its lowest point. The figure on page 10 of the handout illustrates how business confidence has begun to move up across the OECD area. But it also shows that business confidence remains at a fairly depressed level. It is like that with most of the green shoots. They represent improvements compared with the really atrocious time we have been through, but they are not really anything to write home about.
It is, however, worth noting that business confidence seems to have turned the corner at different times in different regions. This relates to the staggered nature of the recovery we see across countries. Activity in the major non-OECD countries is likely to firm first, becoming supportive to OECD area growth (page 11). This partly reflects that they are not being held back by the need to undertake balance-sheet repair work the way that households and financial sectors are in many OECD sectors.
Turning to the specifics of the forecast:
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The Chinese economy is already recovering, supported by substantial monetary and especially fiscal stimuli, while Indian activity is also benefitting from policy stimulus and is likely to gain greater momentum once world trade stabilises. The rebound in commodity prices should support a modest recovery in Russia while activity in Brazil should firm in the second half of the year as domestic demand strengthens from improving credit conditions and fiscal stimulus. The figure on page 12 of the handout provides detail on our projections for Brazil, China, India and Russia.
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A US recovery from later this year is anticipated, driven by strong policy stimulus, a normalisation of stockbuilding and the bottoming out of residential construction. But rising unemployment and the need to repair their balance sheets will hold back private consumers. Thus, as the fiscal policy impulse tails off in 2010, the economy doesn’t really gather speed and does not make any headway in reducing unemployment.
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In Japan, policy stimulus and stockbuilding are also major ingredients in the recovery story and residential investment also helps. On the other hand, the level of the yen is still holding back the external side.
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The euro area recovery is being held back by a back-up in saving as households worry about rising unemployment and we therefore see only a return to modest positive growth from the beginning of 2010. Financial conditions also have improved less than elsewhere. The figure on page 13 of the handout shows the profile of GDP in the three major OECD economies.
Let me now turn to prices. A lot has been said about this, with some people worried about deflation and others being worried about high inflation. Page 14 of the handout shows the headline inflation path in our projection. Basically, the large spare capacity implies that inflation falls to low levels, with only Japan experiencing deflation. It is also the case that inflation expectations outside Japan remain firmly in positive territory. Nonetheless, we cannot fully exclude the deflation risk.
Against this background, it is necessary that monetary policy remains expansionary in order to ensure a sustained economic recovery. This means interest rates should stay at their current low level (page 15 of the handout) through the projection period. It may even be useful for central banks, as some have already done, to signal in an appropriate conditional way that rates will stay at this level for some time to come. That should help to lower rates further out on the yield curve.
I would now like to hand over to Jorgen Elmeskov, who will run through the risks attached to the outlook and the policy challenges that lie ahead.
The risks are now more evenly balanced
Thank you Secretary General. Let me start with the general point that the risks around the current set of projections are more balanced than around previous ones. In particular, a really disastrous outcome seems to have become a much more remote risk. We discuss a number of concrete risks in the Outlook, including oil and commodity prices and the effect of reduced uncertainty.
Here I will just focus on the risk related to financial conditions. As the Secretary General said financial conditions have improved and we assume that they will stay broadly unchanged through the rest of this year before gradually normalising through next year. This assumption could be too cautious.
Box 1.4 in the Outlook looks at the effect of better outcomes in this area. For example, if financial conditions continue to improve from now through to the end of the projection, instead of only beginning to improve from the end of the year, growth in 2010 could be between ½ and ¾ point higher.
But things could also get worse. One risk would be higher bond rates given the amount of debt governments are running up. As you can see on page 16 of the handout, bond yields have already backed up though the reasons are not so clear.
Many policy challenges lie ahead
Let me shift to policies. As the Secretary General has made clear we think that conventional monetary policy needs to remain expansionary through the projection period. We also think the unorthodox policies to boost liquidity and credit should be continued for some time to come.
So we are not so concerned about the swelling of central bank balance sheets that you see on page 17 of the handout. One reason is that there is so much near-term slack in OECD economies that a strong bounce-back in inflation seems unlikely. Another reason not to be too worried is that a lot of the liquidity measures are explicitly temporary or are designed so that they automatically become less attractive as conditions in financial markets normalise. Third, it should be possible for central banks to mop up the remaining excess liquidity. It is obviously important that central banks have the right tools for this task.
Scaling back the unorthodox measures will be part of an exit strategy from the extraordinary policy interventions over the past year. In the handout on page 18 there is a table which gives an overview of government interventions to stabilise financial institutions. These measures will eventually need to be unwound. Doing so is likely to be more difficult if countries act alone and may call for international co-ordination.
But before focusing on exit, there are some areas where more may need to be done. The US stress tests have given a boost to confidence. Other regions may also find it useful to not only pursue such tests but also make both the assumptions and results public and press for recapitalisation where banks are found to be insufficiently solid. You can also see in the table showing government interventions on page 18 of the handout and in Box 1.6 of the Outlook which gives details for individual countries, that so far it is only fairly few countries that have taken action to remove impaired assets from bank balance sheets.
Over to fiscal policy. As you can see on page 19 of the handout we project some large government deficits. So consolidation will be necessary. But withdrawing stimulus too early could jeopardise the weak recovery. How the balance is struck will depend on country specific factors such as the strength of the recovery, the size of the deficit and the level of existing debt.
But wherever a country stands on this near-term balance, it is important to give a credible commitment that consolidation will be undertaken when the economy is strong enough. Many governments have already announced consolidation plans. Box 4.5 in Chapter 4 of the Outlook describes these medium-term plans.
Chapter 4 also presents some stylised scenarios out to 2017, under the assumption that by that date economies are back to their long-term equilibrium with output gaps closed. Depending on the size of the projected 2010 budget deficit, different degrees of consolidation are built in across countries as shown on page 20 of the handout.
The good news is that with assumed consolidation which is large in some cases but not without precedent, countries either get back to budget balance or at least a good part of the way. What is without precedent, though, is the simultaneity of fiscal consolidation across countries.
Budget consolidation is made harder by the permanent output losses as a result of the crisis. As you can see on page 21, we estimate that the crisis will permanently reduce the level of trend output in the OECD area by almost 3 per cent. That is partly because we expect the crisis to permanently increase the cost of capital which again will lead to a less capital-intensive production. It is also because we expect structural unemployment to go up. We estimate, for example, that structural unemployment in the euro area will rise by almost 2 percentage points as you can see on page 22.
The way to offset the crisis effects on unemployment and trend output is of course through structural reform. We think we know some of what needs to be done in that area. But in the short term the focus may be more on avoiding that things go in the wrong direction. I will finish by mentioning two concerns in that area.
First, a number of government interventions to rescue domestic enterprises have been harmful to international competition. The same where fiscal stimulus packages have come with side-conditions on using local suppliers. And high and rising unemployment of course makes this a dangerous time in the trade area.
Second, fiscal consolidation could further hit potential output unless it is done the right way. Expenditure cuts are generally preferable to revenue hikes. And higher revenue should preferably come from base broadening and from broad-based taxes such as general consumption taxes, with a useful supplement possibly coming from green taxes or revenue from auctioning emission permits.
So to sum up, it looks as if OECD economies are now nearing the bottom. Even if the coming recovery may be slow, such an outcome is a major achievement of economic policy, given the risk that an even worse scenario might have materialised. But this is no time to relax – economic policy needs to ensure that the recovery stays on track and leads towards a long-term sustainable growth path.
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