Currency Realignment and Productivity Sustain Global Growth

INTERNATIONAL ECONOMIC OUTLOOK I. Global Assessment and Outlook Although global economic growth is expected to moderate from its 2004 peak, the pattern and the speed of the slowdown in output will differ appreciably among the major economic blocs. Higher oil prices, currency realignments and high-tech driven productivity improvements have reshaped the global economic landscape leading to economic policies, particularly monetary policies, unparallel to past experiences. After easing at the end of 2004, oil prices headed gradually up again this year reaching above the 50 dollar mark per barrel in early March. This is the result of interplay between increasing demand -particularly from the U.S. and China - the realignment of currencies and the reaction of central banks to overall inflation instead of focusing on energy-pushed inflation like in the past. The weakness of the dollar has effects not only on trade and financial transactions but also on the oil markets. oil is priced in U.S. dollars and a falling dollar means less oil revenue for oil producing countries which induces OPEC to set higher oil prices. Most important, last year increases did not disrupt economic growth in the technology-driven economy of the United States and the fast growing trade-driven Asian countries, implying that the global economy could endure higher oil prices in the long-term. In strong currency countries such as Canada, Australia, Europe and Japan, the fall in the US dollar has dampened down import prices, most important oil prices. The euro appreciation has played an important role in cushioning the shock of rising - dollar denominated - oil prices in the Euro Area. Because of its relation to unit labor costs, productivity is the third key player - along with oil prices and currency realignments - in the global triangle of market forces in shaping worldwide economic growth. When growth in labor productivity - measured by output per hour of work - is above the growth in wages, it reduces the cost of labor per unit of output and hence output prices in competitive markets. As global competition has increased in the last ten years, countries with higher productivity growth experience deflation in technology goods which counterbalances inflationary pressures caused by higher oil prices and increases in other commodity prices driven by worldwide demand as a result of the global recovery. A recent productivity study on the Eisbon Strategy by the European Commission concluded that the post-1995 differences in EU-US productivity patterns are fundamentally driven by the US' superiority in terms of its capacity to produce and absorb new technologies. According to the findings of the study, EU labor productivity per hour is estimated to deteriorate to around 88 percent of US levels in 2005, after having peaked in the mid-1990s at around 97 percent. In the early 1990s, annual EU labor productivity growth was averaging 2.5 percent, compared with 1.5 percent for the US. Since that time there has been a dramatic reversal in productivity trends, with the EU's labor productivity growth rate declining by a full 1 percentage point to 1.5 percent, compared with an acceleration of labor productivity growth in the US to 2.5 percent. This implies that the solid gains in labor productivity in the United States could absorb rising oil prices without derailing economic growth. In the European Union, only the combination of a rising euro with moderate gains in productivity is able to soak up the adverse effects of higher oil prices and retain positive economic growth. Looking at the latest indicators in the world economy, there are signs that the global recovery has entered a phase of somewhat slower growth compared to the brisk pace recorded early in 2004. Recent evidence from quarterly national accounts confirms that the major economic blocs, led by the United States, entered a slower growth pace in the fourth quarter of 2004. …

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