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The Economic and Financial Outlook: Surviving Imbalances
David WyssChief Economist
212-438-4952David_Wyss@standardandpoors.com
World BankWashington
April 26, 2005
2
The Recovery Is Finally Accelerating
• After two years of sluggish expansion • Jobs are finally materializing• Up to now, the recovery has run on two legs – consumer and
government spending• Now equipment spending is rising• And nonresidential construction is starting to recover• Higher interest rates will slow housing and consumer spending• Tax cuts are over, and the saving rate is already low• Federal deficits will come down slowly• But higher oil prices could stall the expansion• And world economic stagnation continues to widen the trade gap
3
Inflation Remains Mild
-1
0
1
2
3
US Canada Japan France Germ. Italy UK
(Percent change in CPI)
4
Unemployment Rates Are High
0
2
4
6
8
10
US Canada Japan France Germ. Italy UK
Unemployment rate Long-term (26-week)
(Percentage of labor force, 2003)
5
0
2
4
6
8
1993 1995 1997 1999 2001 2003 2005 2007
Federal Funds Rate 10-Year Treasury Bond Yield
(Percent)
The Fed Is Moving Toward Neutral
7
• Emphasis in second term will shift to controlling deficit– The current deficit is manageable (3% of GDP)– But few prospects for controlling it
• Creating an “Ownership Society”
• Social security reform is getting most attention– We have promised more than we have money to pay– Benefit cuts or tax increases– Partial privatization will be main Administration proposal
• Tax reform rather than tax cuts– Changes should be revenue neutral– More consumption-based taxation– Encourage saving
• Cut deficit in half by fiscal 2008– Requires tough control of government spending– Could be derailed by international events
Second-Term Policies
8
The Future Looks Bleak
65
150
4266 68
101
287
66108 98
239
718
160
235 221
0
50
100
150
200
250
300
350
400
US Japan UK France Germany
2005 2025 2050
(Government debt as % of GDP)
9
Where the Money Goes
0
5
10
15
20
25
30
35
2004 2025 2050
Interest
Other
Defense
Health care
Social security
(Federal spending, percent of GDP, CBO estimates)
10
8%
10%
12%
14%
16%
1993 1995 1997 1999 2001 2003 2005 2007
Exports Imports
(Percent of GDP)
The Trade Gap Yawns Wider
11
0.50.60.70.80.91.01.11.2
1993 1995 1997 1999 2001 2003 2005 2007
Industrial Developing
(Real trade-weighted dollar)
Taking the Dollar Down
12
World Growth Is Slowing
-2
0
2
4
6
8
US Europe Japan OtherAsia
LatinAmerica
2002 2003 2004 2005 2006
(Real GDP, % change)
13
US Deficit Balances Other Surpluses
-8
-6
-4
-2
0
2
4
6
US Canada Eurozone UK Japan Asia exJapan
(Trade balance as percent of GDP, 2004)
Japan 2.8
14
10%
12%
14%
16%
18%
20%
22%
1970 1975 1980 1985 1990 1995 2000 2005
Gross saving Private saving Private investment
(Percent of GDP)
US Borrows From Abroad to Offset Weak Savings
15
European Investment Lags US and UK
16
European Productivity Growth Trails
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
1992 1994 1996 1998 2000 2002 2004 Average
Eurozone UK Japan US
(Output per hour, percent change)
17
Bottom Line: The Economy Recovers, But Slowly
• Consumers are spending near max• Businesses will not take over the lead yet• But strong stimulus from fiscal policy• Interest rates rise gradually next year• Housing prices and starts slow• Weak recovery for stock market• Risk of recession remains if:
– Further terror attacks damage confidence– War disrupts oil supplies– World deflation sucks the US into slower growth
18
Risks to the Economy
-2%
0%
2%
4%
6%
2000 2001 2002 2003 2004 2005 2006 2007 2008
Baseline Recession Optimism Stagnation
(Real GDP, percent change year ago)
19
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