When growth depends on a lack of interest
OECD economies need a gentle touch from the central bankers, says Richard Freeman
Sunday 25 August 1996
Economists have claimed that the slowdown in growth is merely a pause as the industrialised world catches its breath before accelerating again. The episode has been compared with the growth pause in 1986. The main difference this time round is that stock levels were much higher at the start of this pause than in 1986. Also, this pause has lasted longer.
But the comparison is wrong for two other reasons. First, the 1986 pause affected only industrial production and not the whole OECD economy as it has this time round. In 1986 OECD GDP rose by a solid 2.8 per cent. Second, with the exception of 1994, OECD GDP has grown well below its longer-term trend since 1990.
Since 1990, the OECD area has grown at an average annual rate of only 1.5 per cent which is a particularly dismal performance. With such weak growth it is no surprise that unemployment in the OECD area has risen to unacceptably high levels.
To a large extent, the slowdown in growth, particularly severe in Europe, reflects the emphasis of policy in many OECD countries on both fiscal rectitude and stable prices. Both are very desirable aims but it is reasonable to query whether the quest for stability hasn't gone too far, too quickly. Most important, I query whether monetary policy in some major countries has been too much focused on stability against a setting of restrictive fiscal policies.
In answer to this question, most forecasters and financial markets are saying it hasn't. So are the leading international organisations such as the IMF and the OECD.
Almost universally, the experts are saying the pause in growth in the OECD is over. With the strong growth of the US economy in the second quarter, the emergence of Japan from a major recession and increasing indications of recovery in Germany, both the IMF and the OECD area are forecasting a stronger performance in the second half of this year and an acceleration into 1997. Trends in the UK add weight to this assessment.
The predicted acceleration in growth is admittedly not strong but it is nevertheless significant, with the OECD economy expected to expand at a rate of around 2.5 per cent from mid-1996 to the end of 1997. Many private forecasters are more bullish than the IMF or the OECD, especially for the UK.
There is no doubt that the outlook in the OECD area is looking brighter in the second half of this year than it has over the last year. But will the forecast pick up in demand, will activity be sustained into 1997 and will 1997 see near or above trend growth rates? I would not put a great deal of money on it.
With fiscal policies mostly remaining restrictive, a great deal depends on what central banks in the major economies do in the next few months. What happens to monetary policies is the major uncertainty in the outlook.
My hesitation about the strength of the acceleration into 1997 in the OECD area stems from the obsession with inflation of, mainly, central banks in Europe and Japan. I believe central bankers have mostly been concerned about inflation for far too long. The one possible exception is the Federal Reserve.
The main culprit in my view is the Bundesbank which, after all, dictates monetary policy throughout Europe. With inflation under 2 per cent and no signs of inflationary pressures for a long time ahead, it is unclear why the Bundesbank continues to fight a war it has long won. It is more than time to call a halt.
Without a significant reduction in the appropriate German interest rates in the near future, there is a real risk that the Bundesbank will kill off the fragile recovery now under way in Germany. A move in Germany away from what is essentially a hard-money policy would certainly be good for the rest of Europe as well as for Germany itself.
An easing of German monetary policy would help the weak southern European countries, particularly as they could follow suit without any inflationary concerns. It would also be a tonic for France whose recovery is still very much in the balance.
The odd man out in Europe is Britain where the Bank of England is calling for a pre-emptive rise in interest rates against future inflation. This call seems to me to be somewhat premature. Inflation is well under control and the economy is growing at a rate of under 2 per cent. A rise late in the year may be in order but it would be premature to act now.
In Japan there is also central bank pressure to raise interest rates. Low as rates are in Japan, a tightening of monetary conditions is the last thing the Japanese economy needs. As in much of Europe, the recovery in Japan is still fragile and any early move against phantom inflationary pressures could easily push the economy back into recession.
The major uncertainty is the US. Increasingly, the commentators are calling on the Federal Reserve to make a pre-emptive strike against inflation. The balance between raising rates and leaving them where they are is a fine one. For the time being I would take the risk of leaving them where they are.
My confidence in the strength of the upswing in the major economies would be very much strengthened if central bankers act along the lines I have suggested.
Richard Freeman is corporate chief economist at ICI.
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