The Economic Crisis: Facts and implications for public policy

Higher Education at a Time of Crisis – Challenges and Opportunities,Copenhagen, 29-30 June 2009 Sven BlondalMacroeconomic Policy DivisonEconomics DepartmentOECD

Organisation of presentation

• The economic crisis: driving forces and key features.

• The OECD Economic Outlook projections.

• The implications of the crisis for budget policies in the medium term.

• Budget policies and public spending in the medium term.

2

The driving force in the downturn

• Abrupt shift towards risk aversion:– Collapse in asset prices– Increased cost of capital– Credit rationing

• The consequences:– Financial institutions left with bad loans and

assets; lack of confidence in counter parties– Businesses cut capital spending as financial

conditions tighten and uncertainty mounts– Households reduce consumption in response to

falling wealth3

The negative feedback loop

• The weakness of the economy is making it difficult for households and businesses to service and repay their debt …

• …creating more bad debts for banks and undermining their balance sheet …

• … which in turn weakens the real economy even further.

4

The crisis: key features

• The deepest post-war recession in the OECD area.

• The most synchronised recession on record.

• Manufacturing has been particularly hard hit.

• Employment has fallen and unemployment has risen.

• Inflation is falling but is positive in most countries.

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The recession: Depth and synchronicity

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Output declines in the 4th quarter of 2008 and the 1st quarter of 2009

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Industrial production has plungedIndex, January 2000 = 100

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Unemployment has risen significantly in many countries

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Inflation is falling

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The policy responses

– Monetary policy has been eased significantly, with interest rates close to zero in many countries and central banks have used other unconventional measures to support demand.

– Fiscal stimulus packages have been introduced in most OECD countries to increase aggregate demand.

– Financial market policies have aimed at repairing the financial system and increase confidence.

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Policy rates are very close to zero in most major OECD economies

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Discretionary fiscal stimulus programmes in most OECD countries

(2008-2010 net effect on fiscal balance, % of 2008 GDP)

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OECD Economic Outlook 85 projections to end-2010: summary

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Average 2008 2009 2010

1996-2005 2006 2007 2008 2009 2010 q4 q4 q4

Per cent

Real GDP growth12.8 3.1 2.7 0.8 -4.1 0.7 -1.7 -2.6 1.5

United States 3.2 2.8 2.0 1.1 -2.8 0.9 -0.8 -1.7 1.5 Euro area 2.1 3.0 2.6 0.5 -4.8 0.0 -1.7 -3.6 0.9 Japan 1.1 2.0 2.3 -0.7 -6.8 0.7 -4.4 -3.6 0.8

Output gap2-0.2 1.3 1.7 0.3 -5.3 -5.8

Unemployment rate36.6 6.0 5.6 5.9 8.5 9.8 6.4 9.4 9.9

Inflation43.3 2.3 2.3 3.2 0.6 0.8 2.4 0.7 0.6

Fiscal balance5-2.2 -1.3 -1.4 -3.2 -7.7 -8.8

Memorandum Items

World real trade growth 6.9 9.5 7.1 2.5 -16.0 2.1

World real GDP growth63.7 4.7 4.5 2.4 -2.2 2.3

1. Year-on-year increase; last three columns show the increase over a year earlier. 2. Per cent of potential GDP. 3. Per cent of labour force. 4. Private consumption deflator. Year-on-year increase; last 3 columns show the increase over a year earlier.5. Per cent of GDP. 6. OECD countries plus Brazil, Russia, India and China only, representing 81% of world GDP at 2005 purchasing power parities. Fixed weights based on 2005 GDP and purchasing power parities. Source: OECD Economic Outlook 85 database.

OECD Economic Outlook 85 projections to end-2010: United States

• Relatively early exit from the recession.

• The recession bottoms out in 3rd quarter and a recovery starts in 4th quarter thanks to massive policy effort.

• The recovery is weaker than consensus projections for 2010.

• Unemployment rate to reach 10% in end 2009 and stay at that level in 2010.

• Inflation falls to low levels but remains positive.

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GDP growth (s.a.a.r.)

Very high budget deficits in most OECD countries in 2010

• High budget deficits due to:– Fiscal packages introduced to support

the economy.– Budgets no longer benefitting from

revenues related to booming asset markets.

– “Automatic stabilisers”: revenues fall and spending increases when the economy is weak.

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General government net lending in 2010 (% of GDP)

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The inevitable consolidation of public finances in the medium term

• Consolidation will have to take place in the medium term and governments have to prepare credible medium-term consolidation plans now.

• Absence of credible consolidation plans risks triggering adverse reactions of financial markets, which in turn would risk the economic recovery.

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Consolidation requirements will differ across OECD countries

– Remove stimulus measures only: Most Nordic countries, Korea, Switzerland.

– Remove stimulus measures and cumulative tightening of 3 per cent of GDP: Japan, Germany, France, Italy, Canada, etc.

– Remove stimulus measures and cumulative tightening of 7 per cent of GDP: United States, United Kingdom, Spain, Ireland.

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Consolidation requirements (% of general government outlays)

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Consolidation based on tax increases?

• Historical experience suggests that tax-based consolidation is rarely successful.

• Tax increases would undermine economic performance.

• If unavoidable, tax increases should be concentrated on taxes that have the least harmful effects on economic performance, e.g. increase taxes on fixed property and indirect taxes rather than taxes on labour or corporate profits.

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Consolidation based on public spending cuts

• On unchanged policies, public spending is set to increase rather than fall due to the ageing of the population:– Old-age pension spending is set to

increase.– Health care spending will increase.

• Consolidation needs may trigger long overdue reforms in these key areas.

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Increase in ageing-related public spending

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Education spending in a time of budget consolidation

• Education spending will come under close scrutiny in the search for budgetary saving as the size of young cohorts diminishes.

• Cuts in education output could undermine economic performance in the long term.

• Scope for efficiency increases in the delivery of education services?

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Tertiary education in a time of budget consolidation: the scope for efficiency gains

and new ways of financing

• What scope is there for efficiency gains in delivery of higher education?

• Will consolidation lead to, for example, institutional rationalisation to exploit economies of scale? Restriction on numbers in high cost programmes? Growth in distance education?

• Higher education graduates appropriate most of the gains of university education: A case for raising tuition fees for university education combined with government-sponsored income-contingent study loans?

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