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Chapter II. The World Economy
Published online by Cambridge University Press: 26 March 2020
Abstract
In the ‘overall outlook’ section we focus on the influence of the Group of Five (G5) ‘accord’ on exchange-rate prospects, and compare the expected impact of an appreciating currency on growth prospects in Japan and Germany. The short-term forecast is then discussed in more detail in sections covering the six major economies, commodity prices and trade. In the second half of the chapter we examine economic prospects in the world economy over the next five years, focusing particularly on the outlook for current balances. In our central medium-term forecast exchange rates move sufficiently to bring about a large, if not total, reduction in the present level of trade imbalance. Our forecast for a substantial fall in the US deficit is unusual, and we examine the key issues involved as well as looking at associated changes in the Federal budget deficit. Finally, we present two simulations which represent alternative routes to removing current account disequilibrium. The first involves substantial, and as yet unannounced, fiscal reflation in Japan and Germany, which is sufficient to broadly maintain current exchange-rate parities. By contrast, a second simulation illustrates a collapse in the dollar, and the consequences of exchange-rate overshooting.
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- Copyright © 1987 National Institute of Economic and Social Research
Footnotes
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In preparing this forecast we had helpful discussions with various members of the Institute, and in particular Andres Drobny, Andrew Britton and George Ray.
References
Notes
(1) We have not, however, assumed any significant effects from recently-imposed US tariffs on Japanese electronic exports.
(2) ‘Productivity, wages and prices inside and outside of manufacturing in the US, Japan, and Europe’, Centre for Economic Policy Research, Discussion Paper no. 134.
(3) This underprediction occurs even if we allow for the unusual level of gold imports.
(4) The historical figures for some of the commodity price indices quoted below and in table 16 will differ from those published in the February Review because of changes in our data source. Current definitions are given in the Appendix. This change, together with re-estimated equations, will also influence the forecast compared to February.
(5) Our econometric results suggest that agricultural non-food prices are heavily influenced by earlier movements in food prices, perhaps reflecting a degree of substitution between crops.
(6) In considering the US deficit in absolute terms, we also need to bear in mind likely measurement errors, as reflected in the fact that when the world's current accounts are added up we get a deficit of nearly $100 billion. In the forecast this total deficit is kept roughly constant.
(7) See Bryant and Hoitham, ‘The extarnai deficit: why? where next? what remedy?’, The Brookings Review, Spring 1987; and associated Discussion Papers, nos. 55, 58 and 59.
(8) Tests show that neither competitiveness variable is I(0). A moving average was taken for the competitiveness terms because equations without any lags performed badly in terms of test statistics. This may reflect a combination of long average lags in the relationship estimated by conventional means (e.g. the equation in February's Review) and problems of small sample bias when one of the dependent variables is more like a random walk than a trend.
(9) If GEM's expenditure or asset demand equations contained wealth terms, then the model would automatically provide this consistency. This is planned as a future development of the US sector of the model.
(10) The absence of a DM appreciation compared to the base influences all EMS currencies, so they gain competitiveness in relation to the US.
(11) An example is contained in Economic Policy, April 1987, involving a debate between G. Fels, H. Froelich, O. Blanchard and M. Miller.
(12) See, for example, Gavyn Davies, The German Growth Conundrum, Goldman Sachs.