Sustained Global Recovery

I. Global Assessment and Outlook While global economic recovery is still under way, it has been impeded by enormous lingering geopolitical uncertainties, a hike in oil prices, financial market volatility and anemic business investment. As a result, the overall setback in the business cycle of the major industrial countries has turned out to be somewhat deeper and longer than hoped for the first quarter of 2003. Monthly economic indicators and quarterly national accounts suggest that the recovery in the United States remains broadly on track. Business activity in the Euro Area is weaker than anticipated and several countries are flirting with recession. Despite a positive output gain of 0.3% in 2002, economic growth in Japan is currently flat. After slowing sharply in 2001, the world economy grew by 2 percent in 2002, which is below the 3.2 percent long-term trend of world's output growth. Last year's modest acceleration in global economic growth was largely driven by a 2.4 percent recovery in the United States economy, a more vigorous rebound in Asia - fuelled by a recovery of the area's exports to the United States - and sustained strong growth in the populous countries of China and India. Among the industrial countries, Canada, Australia and New Zealand recorded strong, above-trend, economic growth, where rates ranged between 3.4 and 3.9 percent in 2002. The contributions to global growth from Japan and the Euro Area in 2002 were desultory as in 2001. Japanese output increased just 0.3 percent and Euro Area's growth decelerated to 0.8 percent from 1.5 percent in 2001. Deep recessions in Argentina and Venezuela resulted in negative growth for Latin America as a whole. The outlook for the world economy during 2003-04 is shaped by two broad factors. First, in our central forecast, we assume that the crisis in Iraq will be overcome fairly soon without major economic disruptions. Specifically, we place a very low probability of a protracted conflict involving higher oil prices for a long period. We expect a U.S. victory in three weeks with no major damage to oil facilities. Iraqi oil is expected to be off-line for four weeks and then production will gradually recuperate to pre-war standards within six months. The rest of the OPEC countries will make up the shortfall in the global supply during the war and rebuilding periods. Oil prices will stabilize around $23 per barrel. The 'quick war' scenario will eliminate geopolitical uncertainty once the conflict is over but terrorism and North Korea will remain as important risks. The impetus to growth from lower oil prices, an expected recovery in consumer confidence and an anticipated rebound in stock prices are estimated to be smaller than in the aftermath of the 1991 Gulf War. Second, the design of economic policies are, for the most part, highly stimulative. Interest rates are at very low levels by historical standards in nearly all of the world's major economies. In 2002, liquidity in the major industrial countries expanded by 10 percent. Specifically, the growth in the broadly-defined supply of money advanced by 8 percent in the United States, 7.4 percent in Canada, and 6.8 percent in the European Union. As monetary policy works with about a year lag and under conditions of excess capacity, expansionary monetary policies will mostly affect economic growth this year, with minimum effects on demand-pull inflation. In addition, expansionary monetary policies are being backed by substantial fiscal stimulus in the United States, the United Kingdom and Asia. History suggests that sustained, across-the-board, policy stimulus eventually works to help economies move out of stagnation. This is not thecase in the Euro Area, where the structural government deficit decreased in 2002 to 1.3 percent of GDP from 1.5 percent in 2001 and it is expected to continue its decline during 2003-04 reaching 0.8 percent of GDP. These restrictive fiscal policies, combined with slower than in the United States monetary growth, are expected to result in anemic output growth in the Euro Area. …

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