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World Macroeconomic ConditionsOverview ~ G8 Summit ~ Asian Crisis ~ United Kingdom ~ Continental Europe ~ North America ~ Japan
While macroeconomic stability still eludes many Southeast Asian countries, G8 leaders have more or less managed to convince governments in this area of the need for political as well as economic action. Meanwhile, in the G8 countries themselves, the more liberal English-speaking countries of the United States, the United Kingdom and to a lesser extent Canada have posted impressive economic performances, while the continental countries struggle to maintain domestic demand, and the Japanese economy appears mired in stagnation.
Expect the G8 leaders to fully endorse the IMF sponsored reform packages in Asia, particularly the push for better corporate governance and transparency of information, greater public sector disclosure, tighter financial sector regulation and domestic market liberalization. Most of these measures are positive as well as relatively low cost reforms. With widely varying economic performance among themselves, G8 leaders will be loath to criticize any member of the group. However, the Japanese will be praised for their fiscal stimulus package but will be pressed for more tax cuts rather than increased public spending. Expect specific emphasis on the value of life-long education as a means of achieving greater economic growth and an increased living standard. Moreover, expect references to general labour and product market liberalization, as well as reductions in payroll charges as positive reforms.
A severe currency depreciation and economic slowdown affected many of the "Asian Tiger" economies starting in 1997. The general causes of this downturn are threefold. Firstly, an overheated economy produced stock and property market "bubbles". Many Southeast Asian countries were running consistent current account deficits to finance the large capital account surpluses. In other words, investment money was flowing steadily into these countries, helped by sluggish growth in the developed world. However, this inflow, combined with insufficient investment opportunities in the region, resulted in unjustifiable rises in asset prices. Restrictions on direct foreign ownership also channelled money into easily repatriated kinds of investments, facilitating large-scale outflows during the crisis.
Secondly, the policy of pegging exchange rates to the US dollar produced the illusion of risk free US$ borrowing by local firms. Indeed, the extent of private sector foreign debt exposure combined with the depreciated currencies created one of the main characteristics of this crisis - the prohibitive cost of purchasing unexpectedly expensive foreign currency with which to repay foreign creditors.
Lastly, inadequate financial sector regulation by government and poor credit assessment by financial institutions themselves, combined in many cases by "government directed" credit decisions, exacerbated the weakness in the economy.
IMF-supported reform packages in Indonesia, South Korea and Thailand have emphasized domestic structural reform, particularly in the financial sector, where more effective regulation and firm recapitalization must be introduced. Monetary policy will be sufficiently restrained in order to reduce the risk of further currency depreciation.
Strong real GDP growth combined with extremely low unemployment has materialized at the peak of Britain's economic cycle. However, the UK's economy has long been in the growth phase, leading to concerns that prices will soon begin to rise above the 2.5% government set target as the output gap lessens. Indeed, the Bank of England has raised rates a full percentage point over the past year in order to contain an overheating economy. Moreover, the real appreciation of the pound over the past year will contribute to a cooling of the economy. Britain can expect continued growth but at a lower pace than in the recent past.
Germany, France and Italy have recently experienced increases in domestic demand, leading to higher growth. Increased foreign demand has also aided in economic improvement. While these circumstances have aided all three nations to comply with the Maastricht Treaty's convergence criterion on government finances, their economies remain weak. In particular, German and French short-term interest rates have remained at very low levels for over a year. All three countries will likely continue fiscal retrenchment (per EMU and Stability Pact requirements) and easier monetary policies. However, with France and possibly Italy considering shortening the workweek without loss of pay, and Germany having identified labour market flexibility and excessive government payroll charges as a major cause of its economic difficulty, it appears that a common continental view towards an economic remedy will not evolve.
The United States continues to post strong economic performance with surprisingly (even unbelievably) low inflation. However, inflationary increases remain the most feared economic event in the US. The Federal Reserve stands ready to raise rates in order to cool an overheating economy but, as of late, has not been forced into action, partly due to the slowing effects of reduced export demand from the recent Asian crisis and dollar appreciation. Nevertheless, the Fed will maintain a "wait and see" attitude. This year's balanced federal budget is also good economic news, with the caveat that a social security crisis may loom in the near future. Canada has also experienced positive economic growth but has yet to completely narrow the output gap. While the Asian downturn will affect this country as well, the economy will undergo healthy growth in the near future. Canada's federal deficit has been eliminated and the central bank remains vigilant in keeping inflation low. Monetary policy is unlikely to change.
Japan is mired in economic stagnation. Weak domestic demand persists, in spite of below 1% interest rates. Scandals within the financial sector as well as the revered Ministry of Finance have also shaken Japanese confidence. Moreover, with monetary policy rendered ineffective, the fiscal stimulus package of Yen 16 trillion announced in March, 1998, is welcomed. A similar fiscal package launched in November, 1997, has had little effect because of the temporary nature of its tax cuts. By contrast, this most recent package is more likely to contain increased public spending rather than tax reductions. This is because reduced tax revenue must be covered through the sale of government deficit-financing bonds. However, the Hashimoto government passed a law in November, 1997, which ordered the elimination of such new issues by 2003. Nevertheless, a fiscal stimulus of any sort is clearly helpful. So too is the government's decision last December to use public funds to protect bank depositors and to recapitalize some financial institutions. Finally, continued domestic product market reform will contribute to the push for more growth.
Document prepared by: Stephen Hudovernik
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