Revised Forecast for the US and European Economies in FY 2009-2010
- Full-scale recovery difficult amidst continued deterioration of the employment situation and ongoing capacity adjustments -
June 18, 2009
The Lehman crisis of autumn 2008 caused turmoil in the financial markets and substantial deterioration of the real economy. Calm has returned to the financial markets and the deterioration of the real economy has begun to slow: provisionally, it seems that the worst phase — when dysfunction in the financial markets and deterioration of the real economy exacerbate each other — is over.
However, the problem of bad assets facing American and European banks, which triggered the crisis, has only been partially resolved. Especially in Europe, banks have been slow both to recognize their losses and strengthen their capital bases. With the major cause of losses shifting from securitized paper to non-performing loans, it is highly likely losses will continue to grow as the economy deteriorates.
The real economy faces a mountain of obstacles to sustained recovery. Three problem areas in the United States and in Europe are examined below.
The United States
(i) Stagnation of consumer spending set to be prolonged
With the GDP gap widening fast, the unemployment rate is expected to rise to around 11% by the end of the year. As the unemployment rate rises, pressure to curb wage growth is set to strengthen. Meanwhile, the adjustment following the housing bubble has yet to be completed. As of the first quarter of 2009, the value of housing assets in the household sector was still $3.9 trillion in excess of the theoretical value. Convergence with the theoretical value will not come before early 2010, and until then real consumer spending will be depressed by 1.3 points.
(ii) Adjustment in capital investment beginning in earnest
Banks have yet to ease their tougher stance on lending and this continues to exert downward pressure on capital investment. In the real economy, production capacity remains well above the demand trend and there is little prospect that capital investment will rise in the near future. Meanwhile, as the adjustment of excess consumption begins in earnest, a major downturn in the anticipated growth rate is inevitable and, in the short term, stock adjustments are likely to continue.
(iii) Economic stimulus measures having a limited impact
The US government has introduced an economic stimulus package worth a total of $787 billion. Most of the money released by individual tax rebates is likely to be channeled into savings or used to pay off debts. About one-third of government expenditure goes to support the finances of State governments so that the direct boost to demand will be $110 billion. The boost to real GDP is expected to be no greater than +1.0 points as compared with 2008.
(i) Consumer spending slumps as employment situation deteriorates
In the Eurozone, the unemployment rate is rising by 0.5 points for every 1.0% fall in the real GDP growth rate and by the end of the year is expected to reach a level of around 11%. The deterioration in the employment situation is expected to accelerate in Germany and France in particular. A number of countries have introduced measures to promote sales of new automobiles but, against a backdrop of continued deterioration in the employment situation, these have not led to a sustained recovery in consumer spending.
(ii) Central and eastern European economic crisis set to be a hindrance
Central and eastern European countries, which rely on investment from the major European economies, will continue to face the risk of an outflow of funds until the financial crisis affecting the major economies is resolved. Meanwhile, the economic destabilization of central and eastern Europe may exacerbate the financial instability of the major economies that provide them with funding. Austria and Sweden, which have made substantial loans to those regions, are likely to be particularly hard hit. In the real economy, central and eastern Europe is a base for exports to the major European economies and in the stagnation of demand from those economies has led to a sharp fall in exports and capital investment. The rapid deterioration of the economic situation in central and eastern Europe has also led to a fall in exports from the major European economies to central and eastern Europe.
(iii) Obstacles on the policy front
The severity of the economic crisis differs from one country to the next but the EU's common currency and monetary policy mean that governments have not necessarily been able to implement interest rate policies that suit the needs of their own country. On the fiscal side, convergence standards that call for a ratio of government borrowing to nominal GDP of 60% are impeding the introduction of further economic stimulus measures. The smaller economies in these regions have high import ratios, and fiscal stimulus measures have little attraction.
Given these conditions, the economic outlook for the United States and Europe is as follows:
In the second half of 2009, the United States is likely to escape from substantial negative growth and may return to positive growth as the effects of the economic stimulus package begin to come through. However, (i) the deterioration of employment and wages situations, (ii) household balance sheet adjustments and (iii) stock adjustments to compensate for excess capacity, among other factors, mean that the US economy is unlikely to move towards a sustained recovery.
In the Eurozone, with the employment situation still deteriorating rapidly and in the absence of an adequate policy response, the recession is expected to continue through 2010. It is also expected to continue in the United Kingdom, against a background of household balance sheet adjustments and the slump in the financial sector, which is one of the country's main industries.
The risk, given the above outlook, is that the international cooperative framework for the financing of the US fiscal deficit, which is moving towards an unprecedented level, will weaken. If long-term interest rates rise sharply in consequence, it is possible that the adjustment in the housing market will become prolonged. And if the downward trend of the dollar accelerates, the rising price of oil could lead to a sharp downturn in consumption.
For more information on the content of this report, please contact Takeshi Makita, the Japan Research Institute, Limited.