The economy continues to perform impressively. Output has grown strongly, the unemployment rate has fallen and core inflation has been relatively stable. All this has been achieved despite high oil prices and damaging hurricanes. Solid economic growth seems set to continue, albeit at a slightly slower pace. The projected moderation in growth reflects a lagged response to higher oil prices, higher interest rates and a cooling of the housing market. The stance of monetary policy, currently near neutral, needs to tighten slightly to keep the economy in balance. The federal government budget deficit seems likely to settle around 3% of GDP as higher spending on prescription drugs, defence and hurricane relief is offset by surprisingly strong revenue growth. Little progress has been made so far on reform of taxation, entitlements or other longstanding fiscal problems.
Japan has achieved a sustained expansion as the economy has largely overcome its post-bubble problems. Robust output growth is projected to continue through 2007, at a rate of between 2 and 3%, thanks to strong domestic demand underpinned by rising corporate profits and a reversal of the declining trend in employment and wages. The strength and duration of the upturn is expected to reduce the unemployment rate to around 3½ per cent and bring a definitive end to deflation, with the underlying inflation rate approaching 1% by the end of the 2007. The Bank of Japan should keep its short-term policy interest rate at zero until inflation is sufficiently high so as to make the risk of renewed deflation negligible. The lower limit of the 0 to 2% inflation range that was announced by the Bank in March 2006 should be increased. The medium-term fiscal plan should aim at a primary budget surplus large enough to stabilise the public debt-to-GDP ratio by the early 2010s, based on a more detailed package of spending and tax measures. Ensuring rising living standards in the face of accelerated population ageing requires effective regulatory reform to ensure strong competition and measures to improve the national innovation system.
Activity is gathering pace, especially in export-oriented manufacturing industries, and business surveys suggest that activity will be robust in the first half of 2006. However, the recovery has yet to feed through to household consumption. This may well occur soon, underpinned by employment growth and a moderate pick-up in wages. Overall, growth should average about 2¼ per cent through 2006-07. Were it not for Germany’s value-added-tax increase, inflation would be below 2% next year. With persistent oil price pressures and as evidence builds up that the recovery is firming, the need for monetary tightening should become clear. Its actual pace should be conditional, however, on unambiguous signs that economic slack is shrinking. Governments need to make greater efforts towards fiscal consolidation throughout the current economic upswing. Further reforms to enhance the Single market, including for services, would improve the euro area’s economic performance and its resilience to shocks.
With exports growing strongly, and investment and consumption firming, economic activity is projected to strengthen in 2006. The investment pick-up reflects improved profits and higher capacity utilisation while consumption should eventually respond to a gradual improvement in labour market conditions. GDP is projected to grow by 1¾ per cent (working day adjusted), slightly above potential, this year and 1½ per cent next year. The general government deficit is likely to remain slightly above 3% of GDP this year, before falling to 2¼ per cent in 2007, as revenues are boosted by an increase in the value added tax. New structural reform measures have been legislated or are being prepared, notably cuts in tax expenditures, measures to reduce bureaucracy and some simplification in federal fiscal relations. These need to be embedded within a coherent policy framework, involving further reform in labour and product markets. Fiscal consolidation should be linked to public sector reform in areas such as the system of intergovernmental revenue allocation and the social security system.
Modest economic growth in 2005 reflected a continuing weakness in export performance. The second-half recovery continued into 2006 and is likely to be maintained. Inflation should remain around 2% or lower, though some pick-up in the underlying rate is expected. The outlook for employment remains poor, even though the unemployment rate should decline slowly. The general government budget deficit shrank substantially in 2005, partly reflecting a special one-off factor. Going forward, the challenge is to step up the pace of underlying fiscal adjustment and restore public finance sustainability in the face of the pressures stemming from population ageing. Labour market reform made progress last year with the introduction of a new contract for small firms but stalled more recently on opposition to the proposed new contract for workers under 26. Over the longer run, minimising the uncertainty surrounding separation costs for employers and moving towards a single labour contract would help reduce the social exclusion and insecurity associated with labour market segmentation.
After stalling in late 2005, the economy now appears to be back on a recovery track. Average annual growth over the next two years is expected to be around potential (1¼ per cent), helped by buoyant world demand and the lagged impact of easy monetary conditions. The negative output gap will contribute to a moderating inflation rate. With employment rising by only about ½ per cent per year, there should be some recovery of productivity, in turn accentuating disinflation and facilitating export growth. Without bold structural reforms by the new government to raise the economy’s low supply potential and reverse its huge cost disadvantage -- notably via more services competition and wage flexibility -- sub-par growth is likely to persist. Reforms that reduce public spending on a permanent basis at all levels of government would increase the credibility of fiscal policy.
Following the slowdown in activity in the first half of 2005, signs of a pick-up in momentum are emerging, and a strengthening in private consumption and investment is expected to take GDP growth to around 2½ per cent in 2006 and 3% in 2007. Headline inflation is projected to move slightly higher in the short term, in response to the recent spike in domestic gas prices; beyond that it should fall back below the 2% target, converging towards the rate of core inflation. Given the recent pick-up in inflation expectations, and the risk of spill-over of higher energy prices into core inflation, the OECD projections assume that policy interest rates remain unchanged. The general government deficit has now exceeded 3% of GDP for three years in a row, and is expected to narrow only very gradually over the forecast horizon; measures to achieve a more decisive reduction in the deficit may thus be required. Reforming the disability benefit scheme and improving workforce skills should remain priorities in order to raise potential growth.
The Canadian economy slowed at the end of last year but has since rebounded and is still operating close to full capacity. It is expected to grow at rates above potential over the projection period, driving unemployment further below its estimated structural rate. Nevertheless, headline inflation is likely to decelerate significantly in the second half of 2006, reflecting a cut in the federal Goods and Services Tax, but should steadily move up to the upper limit of the monetary policy target range next year. In the context of rising inflationary pressures and buoyant economic growth, the Bank of Canada should continue with its tightening cycle. At the same time, fiscal settings at all levels of government should remain prudent and the federal government should focus on reducing the debt burden before ageing pressures accumulate.
Following a weak second half of 2005, due to a subdued export performance and weak dwelling investment, economic activity is now strengthening again. With business investment remaining buoyant and export volumes eventually picking up, output is likely to accelerate in 2006 and 2007 to about 3 and 3½ per cent, respectively. The recent monetary tightening should be sufficient to counter emerging inflationary pressures. Despite tax windfalls related to the commodities boom, the general government surplus is expected to fall slightly. Any further unexpected windfalls through 2006-07 should be allowed to accumulate in higher surpluses rather than add to demand. The effectiveness of the welfare-to-work programme in raising labour force participation would be greatly enhanced if it was applied to the stock of beneficiaries rather than just new claimants.
GDP growth is expected to reach 2.5% in 2006 before slowing slightly to 2.2% in 2007, with the main support stemming from a strengthening of exports. Higher employment growth will be accompanied by increasing labour force participation and continuing immigration inflows so that unemployment will nevertheless remain high by historical standards. The fiscal deficit will increase in 2006 reflecting the full impact of recent tax reforms and increases in spending. To achieve the planned deficit reduction in 2007, the envisaged public administration reform should be fully implemented.
The economic slowdown came to an end in mid-2005 and activity appears ready to accelerate in 2006, thanks to the impetus coming from export market growth. In addition, consumer expenditure will benefit from the introduction of tax cuts and improved labour market trends. Even though real GDP growth will rise above potential (of nearly 2%), the output gap will remain negative by the end of 2007. Thus, core inflation is projected to remain subdued, with headline inflation falling back as energy prices stabilise. Further fiscal consolidation through expenditure restraint is required to secure a sustainable path for public finances and continued government debt reduction. The amount of required consolidation can be reduced by implementing labour market measures that stimulate job creation and increase employment rates, which are low by international standards, particularly for older workers and among the younger generations.
Real GDP growth reached 6% in 2005, with a very large contribution from net exports, and is projected to fall to 5¾ and 4¾ per cent in 2006 and 2007 respectively. While private consumption growth is expected to strengthen and exports to remain buoyant, this effect will be outweighed by accelerating imports. Higher consumption growth will add to inflationary pressures, along with increases in indirect taxation and regulated prices. The government deficit has come in below 3% for two years running but is expected to increase in 2006 and 2007. Adjustments to the budgeting system are needed to ensure appropriate treatment of windfall revenues in the Medium Term Spending Framework and changes are required to the rules on carry over spending. In addition, more progress on pension and health care reform is necessary to put government balances on a more sustainable track over the longer term.
GDP is already above potential, but growth is set to continue at 3% in 2006 and 2½ per cent in 2007, with all demand components growing solidly. However, with capacity constraints already visible and wage and price inflation set to pick up in due course, domestic firms are likely to lose market share. Expansionary monetary conditions are currently adding stimulus to the already buoyant economy. Hence, fiscal policy should be tighter and it is urgent to increase labour supply both by strengthening work incentives and by making it easier for foreigners to enter sectors like construction.
Activity rebounded in the second half of 2005 after the labour dispute in the forestry industry was resolved. Growth is expected to pick up to an average of around 3% this year and next, driven by household consumption and exports. Wage and price inflation will remain moderate, despite a positive output gap, because of the moderate central wage agreement in place until the end of 2007. Employment growth picked up strongly raising the probability that the government will reach its goal of increasing employment by 100 000 between 2003 and 2007, but it is less likely that the medium-term target of increasing the employment rate to 75% in 2011 will be reached. Achieving this target is important to mitigate the shock to both living standards and fiscal sustainability from rapid ageing. Further reforms to early retirement schemes and unemployment benefits are needed. Measures are required to raise productivity in the sheltered sectors of the economy.
Activity slowed in 2005, as the waning of the Olympics-related stimulus and, to a lesser extent, higher oil prices weighed on domestic demand. The positive growth differential with the euro area, however, remained substantial. GDP growth should continue at around 3¾ per cent over the next two years, helped by a rebound in investment activity. Although inflation is set to diminish to around 3% by 2007, it will continue to exceed the euro area average — a trend that will at some point undermine competitiveness if it is not reversed. Wide-ranging reforms of the pension and health care systems are needed to ensure the sustainability of the public finances. Recent measures to improve the operation of public enterprises are welcome. The rigorous implementation of the National Reform Programme, which sets as priorities restoring sound public finances, improving the business environment and boosting productivity and employment, would create room for continued strong growth.
Sustained by strong exports and domestic demand, real GDP growth is expected to strengthen somewhat further this year, and remain close to 4½ per cent in 2007. However, employment has disappointed and the unemployment rate is not projected to fall below 7% despite moderate wage inflation. The new government should set more realistic fiscal targets and implement them rigorously. Otherwise there is a risk of financial turbulence that could prove costly for the economy. A stronger commitment to fiscal consolidation would not only reduce short-term risks but also help growth prospects over the longer term.
Very strong growth over the past two years has led to serious overheating, as evidenced by inflation well above the official target and a soaring current account deficit. With financial markets increasingly focusing on tensions and imbalances in the economy, the currency has dropped abruptly and the Central Bank has accelerated interest rate hikes to fend off ensuing inflation pressures. Further substantial interest rate increases are needed to put inflation on a downward track toward the official target. Although government finances are in surplus, the expansionary effect of income tax cuts this year and next should be offset by spending restraint -- in particular on public-sector wages -- until there are clear signs that inflation subsides.
Despite a marked slowdown in exports, growth was strong in 2005 as government consumption and investment picked up. With private consumption firming, domestic demand is projected to continue to underpin rapid economic growth at 5% in 2006 and 2007. The current pattern of real wage increases in excess of productivity growth could compromise future economic performance and entails inflationary risks. It is important that wage settlements in the current bargaining round reflect productivity developments. Rolling back anti-competitive regulation in services should be a priority as it would spur productivity growth and restrain inflation.
A further recovery in domestic demand, led by private consumption, is projected to boost economic growth to around 5% in 2006-07. Export growth is also picking up, led by exports to China, despite the significant appreciation of the won during the past 18 months. The stronger currency will help contain inflation within the central bank’s medium-term target zone. Monetary policy should focus on the medium-term inflation target, while concerns about rising housing prices in some regions should be addressed through tax measures and policies to increase supply. With domestic demand accelerating, fiscal policy should aim at the medium-term objective of a balanced budget by 2009. Regulatory reform, including greater labour market flexibility, is needed to improve the environment for business investment.
Economic activity has been growing near its trend rate during the past two years (about 4%). This has been helped by rising exports of financial services, reflecting improved confidence in financial markets. With growth broadening to other sectors, including business services, employment gains have been substantial. Nominal wages, underlying inflation and headline inflation are all growing faster than in neighbouring countries. The budget deficit increased to 1.9% of GDP in 2005. The authorities are determined to restore budget balance by the end of the legislature (in 2009). The focus should be on the reduction of the rapid growth of public expenditure, including social benefits. Fiscal consolidation would be helped by measures to moderate the levels of income replacement benefits, which would also strengthen residents’ work incentives.
The broad-based expansion is expected to continue, with GDP growth around 4% in both 2006 and 2007 and employment in the formal sector expanding. Inflation is set to be on target and the current account deficit should remain close to 1% of GDP. In the context of uncertainty related to the 2006 elections, the government’s prudent macroeconomic policy has reduced the economy’s vulnerability to shocks. Faster growth of living standards requires a tax reform to finance development needs on a stable and predictable basis, while reducing distortions. Measures are also needed to improve the education system and the functioning of the labour market and to increase competition.
Economic growth continues to accelerate in the first half of 2006. Export growth is being pulled along by improved competitiveness and fast-growing export markets. Business investment is benefiting from buoyant corporate profits. The recovery should broaden as private consumption gains strength on the back of higher employment, reaching 2.8% next year. Inflation is low, but should move towards the euro area level by the end of 2007. The fiscal position has improved considerably in the last two years and is set to remain balanced in cyclically-adjusted terms in 2006-07. However, in view of the large unfunded pension liabilities falling due in the long term, efforts should be undertaken to achieve larger structural surpluses.
Activity is projected to pick up gradually as the economy responds to the sizeable exchange rate depreciation by switching to tradeables production. But the lower exchange rate along with fiscal stimulus will slow the dissipation of inflationary pressures as output falls below potential. Investment is projected to fall further before levelling out, while employment is expected to remain flat and unemployment to rise. Significant monetary easing from the second half of this year onwards should underpin the recovery, although the economy will still have spare capacity at the end of the projection period. Judgements around the timing and speed of interest rate cuts may be difficult: easing either too early or too late could carry significant costs.
Mainland Norway has been growing above potential for almost three years. Growth is projected to slow to 3¼ per cent in 2006 and decline somewhat further in 2007 in response to a slowing in petroleum sector investment. With the output gap nonetheless remaining positive, inflationary pressures are likely to build up. In the current period of robust growth and fast rising oil export receipts, a tighter fiscal stance is required. This should lead to a lesser utilisation of oil revenues by the government, in line with the symmetry requirement of the fiscal rule. Barring adverse variation in the exchange rate, a rapidly disappearing slack calls for a return to a more neutral monetary stance.
Driven by domestic demand, economic activity should gain strength in 2006 and 2007. Employment is projected to continue to grow and unemployment to fall. Productivity growth may also recover somewhat but not to the rates achieved earlier in the decade. Inflation is likely to increase but remain below the central bank’s target of 2½ per cent. With low inflation expected until 2007, monetary policy could be eased further. Despite a narrowing of the budget deficit in 2005, fiscal consolidation remains a key challenge. Structural reforms are needed to contain social spending, to enhance productivity gains and to ensure that they will be coupled with strong economic growth.
The Portuguese economy grew by only 0.3% in 2005. With buoyant export markets, a recovery in exports and GDP is expected in 2006 and growth should reach 1½ per cent in 2007. The large negative output gap should allow a decline in price inflation towards the euro area average; and high unemployment is projected to lead to moderation in wage growth, which will help to improve Portugal’s competitiveness. The high level of the fiscal deficit means that it is crucial to sustain on-going consolidation efforts. Besides tax increases and current measures to control the public sector wage bill in the short term, decisive action should continue to better control primary spending. Further efforts to raise Portugal’s human capital, modernise the economy and increase competition are essential for a return to sustained economic growth.
Economic growth is expected to remain strong, reaching more than 6% per year in 2006 and 2007, with some shifting of the stimulus from domestic to external demand. While strong growth is projected to generate employment gains, unemployment is likely to remain relatively high. Further tightening of monetary policy is likely be necessary to ensure that the inflation target is met in 2007, while further labour market reforms would improve the capacity of the economy to generate more employment without raising inflation. Greater fiscal consolidation would help damping inflation while reducing the risk of deteriorating competitiveness.
Driven by strong domestic demand, output growth reached 3.4% in 2005 and once again outpaced the European Union average. The dynamism of activity should moderate somewhat in 2006 and 2007, even though growth will remain robust at a level slightly above potential rates. In the absence of further oil price hikes, inflation could decelerate, but the differential with the euro area is likely to persist, further weighing on competitiveness. A tighter fiscal policy is desirable not only to moderate domestic demand pressures, but also to prepare for the fiscal consequences of ageing. Overcoming the inflation differential will require fostering competition, in particular in the retail distribution sector, and correcting current deficiencies in the wage-bargaining system. Reducing the segmentation of the labour market would also contribute to enhancing productivity performance, which remains poor.
Economic growth in Sweden remains dynamic with domestic demand increasingly complementing net exports. With growth accelerating in 2006 to close to 4%, the output gap turns positive. At the same time, inflation remains very low despite the cyclical upswing, partly reflecting productivity gains but probably also factors related to global competition. Fiscal policy will add stimulus to an already vibrant economy in 2006. An expansionary monetary policy is fuelling the boom in investment and is also driving increases in property prices. Over the projection period, the central bank should increase policy rates to at least neutral levels and the fiscal stimulus should be withdrawn.
GDP, which rose by 1.9% in 2005, should accelerate in 2006 thanks to the impulse provided by the European recovery. Despite some easing in 2007, growth will probably remain fairly robust and above potential. This cyclical improvement should help reduce unemployment in a context of low inflation pressures. With activity firming, the gradual tightening of monetary policy towards more neutral conditions is appropriate. The improved economic situation and the fiscal outturn should not, however, lead to a relaxation of efforts to control public spending, especially in the social sector, nor of the reform process in product markets aimed at strengthening potential growth, which remains weak.
Strong activity in the private sector continues to boost the economy and GDP growth is expected to remain above 6% in 2006 and 2007. While the public deficit is projected to shrink further, the current account deficit is likely to stay at historically high levels. To maintain growth on a sustainable path, domestic and international confidence must be preserved. Policies should ensure the credibility of macroeconomic policy institutions; make sure that the regulatory framework can cope with potential financial risks; and improve enterprises’ competitiveness by accelerating the programme of microeconomic reforms.
Economic growth disappointed in 2005, but recovery is now under way, underpinned by resilient private consumption and strong net exports. Investment is set to bounce back. Disinflation is ongoing. External vulnerability indicators have improved markedly, and the trade and current account balances continue to post robust surpluses. The policy mix remains tilted towards monetary restraint, despite the steady decline in interest rates. The consolidated primary budget surplus target is likely to be met, but the fiscal stance will become expansionary in 2006. There is growing concern that further reform is needed to arrest the increase in current expenditure commitments.
The economy has continued to grow very rapidly, with GDP expanding by close to 10% in 2005. Demand is being sustained by further increases in exports and investment, underpinned by strong corporate profitability. Consumer price inflation declined to 2%, as increases in world oil prices were not passed on to users. Import growth slackened, bringing a marked increase in the current account surplus to over 6% of GDP. With fiscal and monetary policies close to neutral, and only a modest appreciation of the currency, robust growth of about 10% should continue. In this context, the current account surplus may decline only slightly relative to GDP. The new budget puts great emphasis on improving public services in rural areas, yet the expenditure implications appear to be relatively modest and the fiscal deficit remains low. More shares of state-owned listed companies can now be traded, improving the functioning of the capital market, but there is a need for more private companies to be allowed to list. Greater use should be made of interest rates to stabilise demand and to reduce the reliance on non-market quantitative lending controls, and this will require freer movement of the exchange rate.
The economy has experienced extremely rapid growth in demand over the three years to 2005 that is to a certain extent cyclical. While GDP growth picked up to 8½ per cent over this period, supply has not been able to match demand, despite impressive increases in investment. As a result, the current account deficit has widened to around 3% of GDP, though inflation has remained below 5%. Some slowing of output growth seems likely in 2006 and 2007 as the impact of higher interest rates, tighter fiscal policy and a possible unwinding of petroleum products subsidies is felt. The government has continued a policy of gradual reform of product markets with further unilateral reductions in tariffs, reductions in the preferences given to small companies and the beginnings of a rationalization of indirect taxation by moving towards the introduction of national value-added tax. Further progress in the area of energy policies (both for electricity and petroleum), privatization and labour market reform will be needed to sustain longer-term growth.
Real GDP growth is projected at 6.2% in 2006 and 5.7% in 2007. This gradual moderating of growth rates will primarily reflect emerging capacity constraints. Consumption growth will remain robust, sustained by high revenues from commodity exports and further improvements in the terms of trade. While the stabilisation fund is likely to capture -- and thus neutralise -- the bulk of windfall revenues, a significant share of commodity windfalls will still feed into domestic demand. Disinflation will therefore remain difficult. Maintaining fiscal discipline will be critical if the authorities are to rein in inflation while limiting the speed of exchange-rate appreciation. The recent decision to put off consideration of a large cut in indirect taxation until 2009 is thus a welcome development. However, more needs to be done to strengthen the legislative framework governing the stabilisation fund and to insulate not only the budget but the economy as a whole from fluctuations in commodity prices.
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