International Economic Update

Private Demand Still Weak in the Advanced Economies
December 21, 2009

While emerging markets enjoyed robust growth in the third quarter, private demand is still lagging in the advanced economies, whose positive growth was mainly due to government spending and net exports. Despite the recovery in oil prices, inflation is expected to remain mild over the next few years. Monetary policy rates are low for now; quantitative-easing measures are expiring in some countries and expanding in others.

GDP Growth

Third-quarter real GDP was positive in the advanced economies, with the U.K. the notable exception (Table 1). Even in the U.K., growth is expected to turn positive in the fourth quarter, while third-quarter GDP was revised up from an initial estimate of –1.6 percent. Much of the growth we are currently seeing is driven by fiscal and monetary stimulus, with private demand yet to take hold.

Table 1
Positive Growth Expected to Continue into 2010 for Advanced Economies
Real GDP*
2009:Q1
2009:Q2
2009:Q3
2009:Q4
2010:Q1
2010:Q2
2010:Q3
2010:Q4
Canada
–6.2
–3.1
.4
2.9
2.6
2.5
2.7
2.8
France
–5.5
1.1
1.1
1.4
1.4
1.6
1.3
1.5
Germany
–13.4
1.8
2.9
.8
1.0
1.0
1.8
2.1
Italy
–10.4
–1.9
2.3
.7
1.2
1.4
1.0
1.2
Japan
–11.9
2.7
1.3
1.3
.8
1.4
1.7
1.9
U.K.
–9.6
–2.3
–1.2
2.2
1.5
2.4
1.8
2.0
U.S.
–6.4
–.7
2.8
2.7
2.5
2.5
2.5
2.6
Euro area
–9.4
–.6
1.5
.6
.8
1.0
1.3
1.5
*Quarter/quarter, seasonally adjusted annualized rates.
SOURCES: National statistics offices; OECD Economic Outlook, November 2009.

Organization for Economic Cooperation and Development (OECD) projections suggest that private consumption and investment will remain weak in the advanced economies over the next two quarters, with growth sustained primarily through government spending and net exports (Chart 1). Consumption and investment are expected to strengthen starting in the second quarter of 2010, bringing more robust and sustainable growth.

This shift toward private demand will be important as mounting government debt is starting to prove problematic for some nations. The cost of insuring sovereign debt has risen considerably for a number of European countries over the past eight weeks, with financial markets concerned about their ability to pay off debt. Annual deficits in Greece, Ireland and the U.K. are expected to surpass 12 percent of GDP this year, and Spain’s deficit is expected to reach 11 percent. The credit rating on Greek government debt was recently cut by rating agencies Fitch and S&P down to BBB+. Spain is at risk of having its government debt downgraded. Ireland is cutting wages for public-sector employees to try to control debt. Meanwhile, the U.K. is adjusting tax laws to generate more revenue over the next few years to try to keep its deficit at manageable levels.

Inflation and Monetary Policy

Though inflation remains low in the advanced economies, it has been climbing since July due to recovering global demand and oil prices (Chart 2). Still, recent forecasts show inflation staying within a very modest range of 1 to 3 percent for most advanced economies, with the exception of Japan.

None of the major central banks has begun to raise policy rates yet. There is some divergence, however, in their use of quantitative-easing measures. On Dec. 16, the European Central Bank ended its unlimited offer on 12-month loans to financial institutions. Conversely, the Bank of Japan is introducing ¥10 trillion ($110 billion) of new lending to try to combat deflation and the risk of a double-dip recession.

The Dollar and the U.S. Trade Sector

The U.S. dollar has been depreciating since 2002. At the height of the financial crisis earlier this year, investors sought refuge in relatively safe dollar assets, but since March, the dollar has continued on its previous trajectory, depreciating 11.6 percent against U.S. trade partners (Chart 3)[1].

The long-term depreciation of the dollar had been expected to help correct current account imbalances in the U.S. The nominal and real trade balances tell differing stories in this respect (Chart 4). Looking strictly at the nominal trade balance, one might conclude that the dollar's value had little impact on trade and that the only reason for the improvement in November 2008 was that imports fell at a faster rate than exports. According to this line of thinking, as trade recovers we may expect to see imports rise at a faster rate than exports, which is already panning out in the data.

The real trade balance, in contrast, shows a steady improvement since 2006 that suggests the dollar's depreciation has had a significant impact. The reason that does not show up in the nominal trade balance is that the run-up in import prices, particularly petroleum products, masked any improvements (Chart 5). The oil price collapse beginning in July 2008 would explain the dramatic reversal in the nominal trade balance, and the subsequent recovery in oil prices beginning in February of this year helps explain why the trade deficit has widened again recently.

It is difficult to say with any degree of certainty which viewpoint better explains the current behavior of the trade balance or better anticipates its near-term future. Strong growth in the emerging markets relative to the U.S. should support an improvement in the trade balance, as should the continued decline of the dollar. The strength of the U.S. economy relative to other advanced economies, however, supports a further deterioration.

Summary

Emerging-market economies are generally performing well and growing at a strong pace. Most advanced economies had positive growth in the third quarter; however, growth mostly seemed to come from fiscal and monetary stimulus measures, which are unsustainable. Some advanced economies are already feeling the strains of mounting public debt. Fortunately, forecasts show private demand recovering in mid-2010, which should provide for more sustainable growth and allow policymakers to ease off of stimulus measures.

—Patrick Roy

Note
  1. Based on the nominal broad trade-weighted value of the dollar as calculated by the Federal Reserve Board of Governors using the top 30 trade partners for the U.S.
About the Author

Roy is a research analyst in the Research Department at the Federal Reserve Bank of Dallas.

 

Federal Reserve Bank of Dallas Seal
Federal Reserve Bank of Dallas

2200 N. Pearl St., Dallas, Texas 75201 | 214.922.6000 or 800.333.4460
Disclaimer / Privacy Policy

Federal Reserve Centennial