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EFN Economic Outlook

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					EFN Economic Outlook
FALL REPORT 2002
Available at http://www.efn.uni-bocconi.it

The EFN Network
 The purpose of the European Forecasting Network (EFN), launched in 2001 on behalf of the European Commission by leading research institutes from EU Member States, is – to improve the understanding of euro-area economic developments and policies, – to augment the analytical basis for economic policy decisions in the euro area, and, – to increase the visibility of Economic and Monetary Union (EMU) in the Member States.

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EFN Report on the Euro Area Outlook - Autumn 2002

The network

The EFN Network
 To achieve these objectives, the EFN will produce independent, rigorous and joint assessments of the economic situation, the aim being to identify key policy challenges in the euro area.  Two reports will be produced each year, including: – A detailed analysis of the economic situation and outlook, including quantitative forecasts. – An examination of policy issues in key areas – Thematic analyses, focusing on euro-area economic characteristics

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EFN Report on the Euro Area Outlook - Autumn 2002

The network

Members of the Network
Università Bocconi - IGIER, Milano, Italy, Network Coordinator. Team Leader: Massimiliano Marcellino Centre d'Etudes Prospectives et d'Informations Internationales (CEPII), Paris, France. Team Leader: Lionel Fontagné The Halle Institute for Economic Research (IWH), Halle, Germany. Team Leader: Christian Dreger Department of Economics – Eur. Univ. Institute (EUI), San Domenico di Fiesole, Italy. Team Leader: Michael Artis Econometric Institute - Erasmus Universiteit (EUR), Rotterdam, The Netherlands. Team Leader: Dick van Dijk Anàlisi Quantitativa Regional (AQR), Universitat de Barcelona, Barcelona, Spain. Team Leader: Jordi Suriñach Instituto Flores de Lemus (IFL), Universidad Carlos III, Madrid, Spain. Team Leader: Antoni Espasa Department of Applied Economics (DAE), Univ. of Cambridge, Cambridge, UK. Team Leader: Sean Holly
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The network

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EFN Report on the Euro Area Outlook - Autumn 2002

The network

 In fact, the slow reduction of disparities during the second half of the nineties coincides with a substantial wage moderation in the European Union and with the process of disinflation experienced by most European countries during this period.

 However, if the process of wage and unit labour costs convergence continues but not in terms of productivity, countries with lower levels of productivity will lose competitiveness against their Euro-area partners.
 For this reason, previously mentioned labour market reforms should be carried out in order to improve the territorial equilibrium in economic activity.
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Part IV

The US current account deficit

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EFN Report on the Euro Area Outlook - Autumn 2002

Part V

Introduction
 In 2001 the US current account deficit reached 4.1% of GDP.  The worry is that if the deficit does not move back closer to balance of keeps widening, US external liabilities would represent a growing share of world portfolios.

 If, at some point, investors become unwilling to hold dollars, the large adjustment and fall of the external value of the dollar  How credible is this view ?

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EFN Report on the Euro Area Outlook - Autumn 2002

Part V

Objective
 Quantify the sustainable level of US Current Account deficit

 Understand the economic dynamics that led to the deficit in order to forecast the expected developments
 Evaluate the Spillover effects to Europe of a possible US$ depreciation

 Is the US like any other country ? The role of the Dollar

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EFN Report on the Euro Area Outlook - Autumn 2002

Part V

Current account sustainability
 Two approaches are examined:  In the first, an intertemporal approach to the balance of payments emphasises both the importance of domestic saving and investment decisions by both domestic residents and foreigners. With a number of reasonable assumptions, calculations suggest that a deficit of 3.5% of GDP is sustainable.  In the second, a structural VAR is used to decompose the deficit into its cyclical and structural components.

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EFN Report on the Euro Area Outlook - Autumn 2002

Part V

-5.5 -5 -4 -3 -2 -1

-4.5

-3.5

-2.5

-1.5

-0.5

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CA_ACT Observed and “structural” CA_SIM current deficit account

Structural and cyclical components

EFN Report on the Euro Area Outlook - Autumn 2002

19 94 Q 19 1 94 Q 19 2 94 Q 19 3 94 Q 19 4 95 Q 19 1 95 Q 19 2 95 Q 19 3 95 Q 19 4 96 Q 19 1 96 Q 19 2 96 19 Q3 96 Q 19 4 97 Q 19 1 97 19 Q2 97 Q 19 3 97 Q 19 4 98 19 Q1 98 Q 19 2 98 Q 19 3 98 Q 19 4 99 19 Q1 99 Q 19 2 99 19 Q3 99 Q 20 4 00 Q 20 1 00 Q 20 2 00 20 Q3 00 Q 20 4 01 Q 20 1 01 Q 20 2 01 Q 20 3 01 Q 4

Part V

Structural and cyclical components
 A real business cycle interpretation of the results is that the technological shock coming from electronics and IT has been taken up much more quickly during the 1990s by the US compared to elsewhere. Since domestic savings are unlikely to rise in response, the investment boom domestically has to imply a current account deficit. The question is what the medium term outlook will be.



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EFN Report on the Euro Area Outlook - Autumn 2002

Part V

Simulations with MARMOTTE
 Two simulations have been carried out on a modified version of the MARMOTTE multicountry model:  Is it possible to replicate the most important features of the US business cycle of the recent years (the deepening of the current account and the massive real appreciation of the US dollar) by means of simple shocks?  We want to assess the likelihood of a reversal in the current account deficit in order to give some hints about the future developments of the current account and the real exchange rate.
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Part V

Replicating the US business cycle
 The combination of  a permanent increase in total factor (whose magnitude was partly unexpected by agents) as a result of the introduction of IT technology, and  a significant reduction of the US risk premium (due to sustained higher growth and profitability) reproduces quite well the dynamics of the US macroeconomic performance.

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EFN Report on the Euro Area Outlook - Autumn 2002

Part V

Future developments
 In 2001, the productivity growth in US is halted. Firms revise downwards their investment plans. This moderates permanently GDP growth and thereby imports, which stop the deterioration of the trade balance afterwards.  From 2002 onwards, such a scenario foresees investment growing slowly due to past over-accumulation. The reversion of expectations about the risk of the US economy entails a sizeable nominal depreciation of the dollar (but still remaining appreciated). The overall effect on the trade balance is a continuous but slow reduction of the deficit.

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EFN Report on the Euro Area Outlook - Autumn 2002

Part V

Effects for the euro area
 The spillovers on euro area GDP are significant until 2002 due to the increased demand stemming from the US and from the pro competitive effects of the euro’s real depreciation. This improves the trade balance.  These effects dampen over time. When the appreciation of the US dollar ends, the euro experiences a marked real appreciation with a negative impact on the trade balance and growth.  The effects on different parts of the euro area are asymmetric due to the different composition of exports and imports and greate exposure to trade outside of the euro area.

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EFN Report on the Euro Area Outlook - Autumn 2002

Part V

Questions
The US$ is, to date the only international currency  The demand for Dollar denominated liabilities is not expected to fall abruptly  Who would benefit from the falling of the Dollar ?  The problems are elsewhere...


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EFN Report on the Euro Area Outlook - Autumn 2002

6.00

Current account, private and public deficit

4.00

2.00

0.00 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

-2.00

-4.00

-6.00

-8.00 Public deficit / GDP Current account / GDP Private deficit / GDP

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EFN Report on the Euro Area Outlook - Autumn 2002

Current account and domestic desequilibrium
The current account deficit is nothing but the reflection of the huge indebtness of the provate sector  A sudden return to equilibrium would imply a sharp contraction on US domestic demand  The true risk is US exporting recession and deflation


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EFN Report on the Euro Area Outlook - Autumn 2002

FINAL REMARKS

 Compared to previous economic downturns, the downturn experienced during 2001 and 2002 has been comparatively mild and shallow.  The loosening of monetary policy by the ECB and the FED appears to have done the trick.  There is little prospect of improvement in economic performance in the next eighteen months, due to a number of major imbalances.  But a slow recovery has started in the Euro-area …  … a recovery that could be improved if policy measures pointed in this report were properly implemented.

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EFN Report on the Euro Area Outlook - Autumn 2002

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EFN Report on the Euro Area Outlook - Autumn 2002