International Economic Outlook: Monetary Tightening in the Global Business Cycle

I. Global Assessment and Outlook Although economic growth in the major industrial countries accelerated at the end of 1999 and in the first quarter of 2000, a monetary policy induced scenario is forecast for the second half of this year and is expected to extend into 2001. In the United States, output growth was remarkably strong advancing at an average annual rate of 6.5% in the last two quarters of 1999 and 5.4% in the first quarter of 2000. The Euro Area enjoyed a robust output expansion in the second half of 1999 at an annual growth rate of 2.8%, compared with 2% in the first half of the year, and a Japanese recovery at moderate growth rates is underway. Monetary policy, however, has been restrictive in the United States and a tightening is expected in the Euro Area and to a lesser degree in Japan. The firming of monetary conditions in the industrial countries is expected to result in output growth below potential levels, maintain low inflation and improve external account imbalances. The three major economic and financial blocks have experienced uneven economic growth patterns in the current phase of the global business cycle. Monetary policies in each block reflect the reaction of policy makers to each economy' s position in the global business cycle. The global monetary policy cycle in the industrial countries has entered a tightening phase designed to generate the prospects of a soft landing. The current tightening phase of the global monetary cycle is led by the United States, where the Federal Reserve' s gradual increases in interest rates are expected to slow down domestic demand. Following easy monetary conditions in the Euro area in 1999, monetary policy is forecast to switch from its current neutral stance to monetary tightening. The European Central Bank is expected to continue raising gradually interest rates as it considers Europe to enter the experience of the US new model, according to which technology-- induced supply factors will maintain economic growth and keep down inflationary pressures. Japan, the laggard of the global monetary policy cycle, is forecast to abandon its zero interest policy as the economy is gradually improving and energy-related imported inflation builds into the overall inflation rate. The Bank of Japan seems to have started preparing the markets for a monetary tightening as officials talk about higher rates. According to this soft landing based forecast, the economic expansion in the United States will substantially slow down, while economic growth in the Euro Area will strengthen this year and slow down in 2001. In Japan, the pace of economic recovery will be accelerating during 2000-- 01 at a moderate pace. Economic growth in the United States is forecast to slip to 3.1% in 2000 and 2.6% in 2001, from 4.2% last year. Following a growth rate of 2.2% in 1999, output in the Euro Area is expected to expand 3.2% this year and 3.0% in 2001. In Japan, the economic recovery is expected to begin gaining momentum at the end of this year with output increasing by 1.4% in 2000 and 2.4% in 2001. In contrast to the expected moderation of economic growth in the major industrial countries, the developing countries are forecast to experience strong economic growth. The Asia economies have advanced rapidly in the global business cycle from their 1998-99 substantial slowdown. The newly industrialized Asian countries (Hong Kong, Korea, Singapore and Taiwan) are forecast to grow by an average annual rate of about 6.2% during 2000-01, following a 7.7% growth rate in 1999. Following a near zero output growth rate in 1999, the Latin America nations are expected to advance at an average growth rate of 5.5% per year during 2000-01. The economies in transition have recovered from their financial turbulence and are forecast to grow at an average rate of 2.6% this year and 3.1% in 2001. Consequently, world economic output is projected to increase by 3.7% this year and 3. …

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