The economy is gradually recovering from a long and severe recession. Real GDP is likely to grow by 1¼ per cent in 2004 and 2005, accelerating to 2¼ per cent in 2006, which would still leave a large negative output gap. Modest wage growth, needed to restore international competitiveness, and only gradually accelerating employment account for the delayed return of private consumption to trend growth. The unemployment rate will increase temporarily as a consequence of supply-side reforms, helping core inflation to edge down further. There is a risk that the additional labour supply resulting from the current social benefit reforms may not be fully absorbed at current wage rates. Hence, the government should complement these reforms with measures increasing wage flexibility, aimed at enhancing employment prospects for low-skilled workers. ...