Major exchange rate realignments affect macroeconomic conditions

The currencies of many advanced countries and large EMEs have depreciated noticeably against the US dollar since mid-2014, to a similar extent as in 2008-09, despite some reversal since mid-April 2015 (). In a number of economies, the depreciation vis-à-vis the dollar has been in excess of 15%, though in nominal and real effective terms the adjustment has been less pronounced, and some countries’ currencies have even appreciated in effective terms. Consequently, the real effective exchange rate of the US dollar has appreciated by nearly 10% since mid-2014 and slightly more in nominal terms. Smaller effective exchange rate adjustments than bilateral changes potentially imply muted trade effects relative to financial effects.

Many currencies have depreciated against the US dollar

Per cent depreciation between July 2014 and May 2015

A negative number implies a depreciation of the indicated country's currency against the US dollar (USD) and against a trade-weighted basket of currencies deflected with consumer prices (real effective exchange rate).

OECD Economic Outlook 97 database; Datastream; and OECD calculations.

Statlink http://dx.doi.org/10.1787/888933220606

These currency movements have been driven by differences in monetary policy stances around the world. Markets have been expecting a gradual tightening of monetary policy in the United States but easing in the euro area and Japan, leading to growing interest rate differentials (). As a result of the decision by the Bank of Japan to expand quantitative and qualitative easing and a series of measures by the European Central Bank, including the decision to purchase sovereign bonds, total assets of the major OECD central banks have continued to expand rapidly. In addition, several central banks have reduced policy rates due to easing inflationary pressures and a weakening economy.

Divergence in monetary policy stances has increased

Differences in 1 and 2-year ahead expected overnight interest rates vis-à-vis the United States

Average differences for the months indicated.

Bloomberg; and OECD calculations.

Statlink http://dx.doi.org/10.1787/888933220614

The exchange rate changes have affected financial conditions. The US dollar appreciation has contributed to a tightening of financial conditions in the United States, while the opposite holds in the euro area and Japan (). In all three areas, bond and equity prices have increased, helped by monetary policy support, boosting household wealth and lowering financing costs for corporations. Indeed, bond prices rose to record highs in the euro area in mid-April, after which they fell abruptly, with the associated increase in yields (by around 50 basis points), although bond prices still remain high. Nevertheless, corporate debt flows from all sectors have been subdued in the euro area, although loan flows now seem to be picking up, and in Japan. In contrast, debt flows have been rising in the United States.

Financial conditions and corporate debt flows have been diverging

A unit increase (decline) in the index implies an easing (tightening) in financial conditions sufficient to produce an average increase (reduction) in the level of GDP of ½ to 1% after four to six quarters. See details in Guichard et al. (2009). Based on available information up to 29 May 2015.

Non-financial corporations.

OECD Economic Outlook 97 database; OECD Quarterly National Accounts Database; Datastream; and OECD calculations.

Statlink http://dx.doi.org/10.1787/888933220628

The currency movements that have taken place since mid-2014 have had a marked impact on domestic inflation. This is especially the case in the euro area where the pass-through of exchange rates to inflation is estimated to be stronger than in the United States and Japan (Morin and Schwellnus, 2014). Taking into account the estimated pass-through rate and the import intensity of demand, the effective nominal depreciation of the euro since mid-2014 could directly account for the bulk of the increase in the core consumer price level in the area since then (). Also, the yen depreciation over the same period could have contributed somewhat to the increase in core consumer prices in Japan. By contrast, the appreciation of the US dollar may on its own have held back the recovery in US inflation.

Exchange rate and price developments since mid-2014 in the United States, the euro area and Japan

Statlink http://dx.doi.org/10.1787/888933221693

The recent exchange rate changes will affect the volume of exports and imports and reallocate demand from the United States to the euro area and Japan. The extent of the impact depends on the pass-through of currency changes into export and import prices and price elasticities of exports and imports. The pass-through is estimated to be very weak in the United States for both exports and imports compared with the euro area, and export and import price elasticities vary significantly across countries. For the United States, the dollar’s appreciation is projected to result in losses in market shares of US exporters and an increase in import penetration. Consequently, a cumulative negative net export contribution to growth over 2015 and 2016 of around 1¼ percentage point is projected. For the euro area and Japan, the opposite holds, with a positive cumulative net export contribution to growth of around ½. The contribution of net exports to growth in non-OECD economies is projected to be just below ½ percentage point ().

Net exports are projected to contribute negatively to growth in the United States in contrast with other areas

Sum of contribution of net exports to annual GDP growth for indicated periods

OECD Economic Outlook 97 database.

Statlink http://dx.doi.org/10.1787/888933220634

Currency movements also have financial implications stemming from international exposures:

• In EMEs depreciating domestic currencies have been increasing the servicing cost of debt denominated in foreign currencies. Foreign currency debt has risen in several large EMEs over recent years, though such exposures appear to be lower relative to GDP than they were before the Asian crisis in 1997 (; Ollivaud et al., 2015). In particular, companies in many EMEs have increased their foreign currency borrowing (Chui et al., 2014). The impact of a US dollar appreciation on corporate balance sheets will depend on the extent to which loans are denominated in US dollars and whether these currency risks are hedged. The lack of comprehensive data precludes the drawing of firm conclusions, though in several Asian EMEs foreign liabilities are primarily denominated in US dollars. Higher debt servicing costs may not be a problem for companies with revenues primarily in foreign currencies, as is the case with many commodity exporters. However, the recent decline in global commodity prices has hit commodity producers’ revenues. Debt servicing strains would be aggravated if investors become excessively risk averse, intensifying capital outflows. However, portfolio capital continued to flow into EMEs until April (IIF, 2015), though this has reversed somewhat in May, and no significant corrections in equity and debt markets in major EMEs have been observed.*

  Debt servicing strains have also risen in Central and Eastern European countries. Their currencies depreciated strongly against the Swiss franc following the decision of the Swiss National Bank to abandon the minimum exchange rate against the euro in mid-January. Banks and households still have nonnegligible liabilities denominated in Swiss francs, which are unlikely to be hedged by households.

  Indeed, in China, the equity market has actually surged by more than 30% since the start of the year, following 60% gains in the second half of 2014, despite evidence of weakness in the economy.

• The stronger dollar has lowered US investors’ returns from foreign assets as most of them are denominated in foreign currencies. For instance, in April the annual return on world equities in local currencies was around 8 percentage points higher than in US dollars. The appreciating US dollar has also damped the earnings of US companies with large foreign operations, with implications for their equity prices. Nearly 40% of the total profits of S&P 500 companies come from abroad.

• In contrast, euro area and Japanese investors’ returns on foreign assets have been boosted in domestic currency terms. For instance, in April the annual return on world equities in the euro area and Japan was respectively around 20 and 10 percentage points higher in domestic currencies than in local currencies.

• The US dollar appreciation has important valuation effects on net foreign assets. The magnitude and direction of valuation effects depend on the relative size of assets and liabilities and their currency composition. These effects can be illustrated by estimating changes in net asset valuations (excluding derivative positions) due to a 10% appreciation of the US dollar against all currencies, assuming the currency structure of foreign assets and liabilities as estimated by Bénétrix et al. (2014) (). In the United States net foreign liabilities would deteriorate by nearly 7% of GDP as foreign assets are predominantly denominated in foreign currencies. Also, in Turkey and Indonesia, with large net dollar liabilities, net foreign liabilities would deteriorate by 2% and 1% of GDP, respectively, increasing their external vulnerability. In several other economies, primarily with net foreign assets, the external positions would improve by between 2% and 6% of GDP, with beneficial wealth and income effects for domestic firms and households.

Foreign currency borrowing has increased in several EMEs

Offshore liabilities are computed as the difference between debt securities by nationality of the issuer and by residence of the issuer and are set to zero when the difference is negative (Mexico and Turkey in 2014). 2014 denotes 2013 for South Africa.

OECD Economic Outlook 97 database; BIS, Debt Securities Statistics; and IMF, Balance of Payment Database (for bank loans and other investment liabilities).

Statlink http://dx.doi.org/10.1787/888933220641

Net foreign asset valuation effects from a 10% US dollar appreciation

In per cent of GDP

Latest available.

After a 10% appreciation of the US dollar based on the currency composition of assets and liabilities estimated by Bénétrix et al. (2014).

International Monetary Fund; Bénétrix et al. (2014); and OECD calculations.

Statlink http://dx.doi.org/10.1787/888933220652

The oil price fall is boosting global growth and no longer depressing inflation

Following four years of broad stability at around USD 105 per barrel, oil prices have declined sharply since June 2014 and have been trading in the USD 50 to USD 70 range since the beginning of 2015 (). While much of the recent price decline seems attributable to supply factors, the simultaneous decline in the price of many other commodities, though generally by less than oil prices, suggests that demand factors also played a role. In 2014 global food prices fell to their lowest level in four years, while agricultural commodities and metals and minerals prices are also down more than 15% since last June.

Commodity prices have fallen

OECD Economic Outlook 97 database; and Datastream.

Statlink http://dx.doi.org/10.1787/888933220664

The fall in oil prices reallocates income between oil producers and consumers, both within countries that produce oil and between net oil-exporting and net oil-importing countries. This is reflected in major changes in current account balances (). The net impact of these transfers on global activity should in itself be positive given that consumers typically have a higher spending propensity than producers. The resulting boost in global demand is a positive development in the context of an overall deficiency of demand. The growth benefits to net oil-importing countries will be offset to some extent by lower exports to oil producers, as these countries have less income.*

In the 2002-08 period, re-spending rates of higher oil revenues by oil exporters are estimated to have been around 40% for the OECD area as a whole (Wurzel et al., 2009). However, this differed significantly across economies, with relatively low rates in the United States and Japan and relatively high ones in the euro area countries (up to 80% in Germany).

World trade will strengthen gradually

Statlink http://dx.doi.org/10.1787/888933221702

Lower oil prices will add about ¼ percentage point to both global and OECD growth in each of 2015 and 2016. The impact is estimated to be larger in Japan (about 0.6 percentage point per year) and in the United States (about 0.4 percentage point per year including investment effects) than in the euro area (about 0.2 percentage point per year). Despite the positive global impact, countries differ greatly in the extent to which they are affected, given different oil consumption intensities, net oil balances and trade exposures to energy producers ().

• OECD oil-importing economies with little or no oil production, such as the euro area and Japan, receive a real income boost similar in effect to a tax cut.

• In the United States, still a net oil importer, the growth benefits will accrue gradually over this and next year, but are tempered in the short term by a fall in oil sector investment.

• For net oil-exporting OECD economies – such as Canada, Norway and Mexico – lower oil prices are weighing on growth through significant losses in export and fiscal revenues and lower investment. But currency depreciation and energy cost savings to consumers provide a partial offset.

• In non-OECD net oil-exporting economies, in particular Russia but also some Latin American countries, the fall in oil prices is dragging growth down substantially with associated currency weakness. Declining import demand provides some offset to growth, as does the income gain to energy consumers, given that these countries typically have relatively high oil consumption intensities.

• Non-OECD net oil-importing economies, especially those in Asia such as India and Indonesia, may be the greatest beneficiaries from lower oil prices as energy figures more prominently in consumption baskets and production methods and negative net oil balances are thus relatively large. This is also true of China, which makes greater use of coal, whose price also tumbled.

The oil price decline has different effects across country groups

The OECD net importers group includes the Euro area, Australia, Czech Republic, Hungary, Japan, Korea, New Zealand, Poland, Sweden, Switzerland and United Kingdom. The OECD net exporters group includes Canada, Denmark, Mexico and Norway. The non-OECD net importers group includes China, India, Indonesia, Singapore, South Africa, Taiwan and a few other small countries depending on the panel, mostly in East Asia. The non-OECD net exporters group includes Russia as well as African and Middle Eastern producer countries, the precise list varying slightly between panels.

The results are from simulations on the National Institute of Economic and Social Research's NiGEM model, except OECD net exporters and the United States which are OECD estimates. The simulations use the observed oil price up to the end of 2015 Q1 and assume USD 65 per barrel as of 2015 Q2. The world effect is a weighted average of the five other groups.

International Energy Agency; International Monetary Fund; and OECD calculations.

Statlink http://dx.doi.org/10.1787/888933220675

Looking ahead, even if oil prices may come under renewed downward pressure in the short term, supply-demand projections from the International Energy Agency suggest that prices are likely to rise in the longer term, although remain below USD 100 ().

Potential oil price developments in the medium and longer term

The 60% oil price drop in the second half of 2014 was not unprecedented, as similar drops happened in 1986, 1998 and 2008 (Figure below). The recent decline was both supply and demand-driven and it took place while energy markets have been undergoing fundamental changes. The International Energy Agency (IEA) expects the market rebalancing to be quite swift, but relatively limited in scope. Oil prices are expected to stabilise above current levels, but substantially below the average price of USD 110 per barrel seen in the three years preceding the drop, under the assumption that no unexpected supply disruption or major policy change takes place.

The major factors behind these price development expectations are the following:

• Demand growth is expected to outpace the growth of supply over the next six years (Figure below). Oil demand is expected to grow by 1.1 mb/d per year by 2020 (an increase of about 1.1% per annum), but this is a much slower pace compared with the pre-crisis period (by about 0.2 percentage point) as the global economy has been gradually becoming less oil intensive. This trend is also spreading to EMEs, with the oil intensity of China projected to fall 20% by 2020. China’s oil demand will grow at a similar pace as the aggregate of non-OECD economies (2.4% p.a.). India stands out with annual growth of 3.4%, reflecting its rapid population and economic growth. Nevertheless, the EMEs aggregate will no longer provide as big an offset to the projected decline of demand of the OECD economies (by 0.2% p.a.) as was the case before the crisis. Among the OECD economies, the United States is the only country for which demand growth is projected (0.3% p.a.), while Japanese demand is projected to decline by 1.4% p.a. and that of OECD Europe by 0.7% p.a. in the medium term. Across all economies, fuel switching to natural gas, nuclear, coal and renewables is expected to cut global oil demand by about 2% by 2020.

• Supply capacity is projected to increase by 0.86 mb/d by 2020 (about 0.9% p.a.), but at a slower pace than in the past and compared with demand, mainly due to the scaling back of investment following the drop in prices. Despite OPEC’s decision to defend its market share, almost all of its production growth by 2020 (0.5% p.a.) is projected to come from Iraq, despite security risks, reflecting its high endowment with resources. The capacity of the United Arab Emirates and Libya is also projected to grow (by about 2% p.a.) but other OPEC producers with higher costs, lower financial reserves, and social and budgetary pressures will see stagnation or even declines. Among non-OPEC countries, the United States will remain the top source of global supply growth in barrel terms. Supply is projected to grow around 3% p.a. in the United States and Canada and 5% p.a. in Brazil. Russia’s output is expected to decline by about 0.9% p.a. by 2020, as low prices, international sanctions and a depreciating currency exacerbate the effect of natural declines at the country’s brownfields. Several other smaller producer countries – including Norway, Egypt, Colombia and Indonesia – are also expected to see declines in production over the medium term.

• Over a shorter term, the timing of a lifting of sanctions on Iran will affect market rebalancing. Iran would be able to restore its full supply capacity quickly and then raise it, to about 4 mb/d by 2020 from the current 2.8 mb/d. Moreover, other producers might lift their supply as well, in an attempt to preserve market share. This would lead to a considerably less tight market which would probably rebalance at an even lower price.

In addition, the following factors could affect the volatility of the oil price over the short to medium term:

• Non-OPEC supply has become more price elastic. North American Light Tight Oil (LTO) has become the single largest source of global supply growth, with projected growth of about 0.3 mb/d (6%) p.a. by 2020. OPEC’s decision not to cut production in November 2014 has turned LTO into a critical market-balancing factor. LTO is more responsive both to higher and lower prices, with short lead times, faster payback and lower upfront costs, and will thus limit global under and overshooting of market corrections.

• On the other hand, North America’s growing supply means that an increasing portion of its demand will be sourced locally. This will contribute to the decline in international crude trade, in particular inter-regional trade, which will also be affected by increasing volumes of crude being refined locally before being exported. Global oil trade will thus shift from crude oil to oil products, with a contraction and fragmentation in crude markets mirrored by expansion and globalisation in oil product markets. This might add to crude price volatility over the short to medium term.

Past and projected developments in the oil market

Values for 2014 episode from June 2015 onwards are Brent futures as of 27 May 2015. Futures prices are not price projections.

OPEC is not included in the non-OECD supply aggregate.

OECD National Accounts Database; International Energy Agency; Wall Street Journal Markets Data Center; and OECD calculations.

Statlink http://dx.doi.org/10.1787/888933220794

This box is based on IEA (2015) and monthly IEA Oil Market Reports from 2015.

The direct impact of oil price movements on global inflation is estimated to be essentially a one-off, peaking after three to five months, before fading gradually. In light of the arrest to the very large fall in commodity prices that took place in the second half of 2014 and early 2015, and the partial rebound in oil prices since March, this implies that headline inflation rates have already troughed. Indeed, monthly global consumer price inflation has picked up to 0.2-0.3% in recent months. The second-round effects, via wages or the use of oil as an input into the production of other goods and services, of the oil price drop appear to have been modest so far. Medium-term inflation expectations have either been little affected, particularly in the case of survey-based measures, or their initial decline after the beginning of the oil price fall has since partly reversed, notably those based on the prices of financial instruments in Japan ().

Inflation expectations have picked up

Expected average annual inflation based on inflation swaps. For instance, for 5-10 years ahead, this is the difference between 5-year and 10-year inflation swaps.

Expected inflation implied by the yield differential between 10-year government benchmark bonds and 10-year inflation-indexed bonds.

Average of 6-10-year ahead inflation forecast by professional forecasters from Consensus Economics.

Datastream; FactSet; and Consensus Economics.

Statlink http://dx.doi.org/10.1787/888933220680

Labour markets are gradually healing

Conventional indicators suggest that slack in labour markets in advanced economies is diminishing ( and ). At the level of the OECD as a whole, the unemployment rate has fallen to 7%, a level not seen since 2008 and close to the estimated structural rate. This is particularly true in the United States and Japan, although in the United States involuntary part-time work is still high and some of those now out of the labour force might return if job prospects improve. In the euro area, by contrast, unemployment is still quite high, with the notable exception of Germany, and involuntary part-time work is pervasive. Narrowing gaps between actual and trend participation rates in many countries, partly reflecting population ageing, which pushes down trend rates, is another sign of lower labour market slack.*

Pension reform in a number of countries may offset the effect of ageing on trend participation rates to some extent. Already legislated reforms are taken into account in OECD long-term projections of participation rates (see Box 4.6 in OECD, 2014a) although the offsets may be stronger than projected and more reforms may occur.

OECD labour market conditions are likely to improve slowly

Statlink http://dx.doi.org/10.1787/888933221711

Labour market slack indicators

The unemployment rate gap is the difference between the actual and estimates structural unemployment rates. The participation rate gap is the difference between actual and estimated trend participation rates.

OECD Economic Outlook 97 database.

Statlink http://dx.doi.org/10.1787/888933220691

The improvement in labour markets has so far not been accompanied by a significant pick-up in wage growth (). Subdued wage growth has encouraged producers to use more labour, but has also pushed up the profit share in some economies, including the United States. With labour markets now getting tighter, the pendulum seems set to swing gradually away from profits and toward wages. In the United States, compensation growth is projected to rise from about 2½ per cent now to 3⅓ per cent by end-2016. Surveys show expectations of increasing compensation, a few high-profile and large employers have announced wage increases, and minimum wages have been raised in some states. In Japan the annual spring negotiations point to rising base pay, and wages are projected to be rising 2¾ per cent by end-2016, a rapid rate by Japanese standards. In Europe, however, persistently high unemployment will prevent wages from accelerating markedly. An exception is Germany where wages are already rising at a healthy clip and recent wage negotiations point to continued increases.

Labour compensation

OECD Economic Outlook 97 database.

Statlink http://dx.doi.org/10.1787/888933220706

Gains in real disposable income have had a limited impact on personal consumption

Despite tepid nominal wage growth up to now, real disposable income received a fillip from the collapse in oil and other commodity prices, which produced a large but temporary disinflationary impulse in the global economy. From July 2014 to January 2015, the average monthly change in the global CPI was zero. Consumer prices in advanced countries even saw outright declines in November and December 2014 and January 2015 (). Together with slowly improving labour markets, this negative price impulse inflated real wages and real disposable income. In the United States modest and stable average hourly wage growth of around 2% at the turn of the year still translated into an acceleration in real wages. By March 2015 real personal disposable income was up 3.3% from a year ago. The benefit to US consumers from lower energy prices is estimated to be equivalent to a tax cut in excess of USD 500 per household, with the impact concentrated on lower-income households, who have a higher marginal propensity to consume. The purchasing power lift to euro area or Japanese households is more modest than in the United States, given euro and yen weakness and lower oil consumption intensity, but it is still significant.

Monthly inflation rates

Month-on-month percentage changes at annual rates

OECD Economic Outlook 97 database; Statistics Bureau of Japan; and OECD calculations.

Statlink http://dx.doi.org/10.1787/888933220714

Consumers have responded unevenly to their increased purchasing power. A strong consumer response began to build in the last quarter of 2014, with global retail sales volumes jumping 6.6% at an annualised pace in the three months to December, including more than 3% in the euro area (). Strong consumer spending in the euro area was also supported by a surge in consumer confidence, lower bank lending rates for households and an easing in credit conditions. In the United States real consumer spending growth also accelerated strongly in the second half of 2014 to an annual rate above 4%. But while retail sales volumes in the euro area look set to post a similar 3% annualised gain in the first quarter of 2015, globally they have decelerated sharply, with barely any growth estimated in the first quarter of 2015. In the United States real consumer spending grew only 1.8% on an annualised basis in the first quarter despite a 5.3% gain in real disposable income. Some of the early-year weakness in the United States can probably be attributed to bad weather effects rather than a permanently higher saving rate. Consumer spending should thus pick up in the coming months, supported by robust labour income, low interest rates, strong sentiment and the gradual pass-through of the stronger dollar into consumer prices. The early-year slowdown in consumer spending in other parts of the world represents more of a puzzle but is also expected to reverse following relatively strong fundamentals in labour markets, wealth effects, purchasing power and sentiment.

Retail sales

Index June 2014 = 100

OECD, Main Economic Indicators Database.

Statlink http://dx.doi.org/10.1787/888933220720

Sustained consumption growth depends on rising wages, so the prospect of cyclical increases in real wages is a welcome sign. Wages constitute the core of household income, especially of low-income households with high spending propensities, and other types of income, such as pensions, are tied to wage dynamics. Higher wages would boost sales, hiring and investment and in turn lead to higher employment and more income in a virtuous circle. But for higher wage growth itself to be sustainable and not eaten up by inflation, labour productivity growth must also rise.

Productivity growth needs to accelerate

It would be worrying if productivity growth remained weak once economies have returned to full employment. Between the end of the early 1980s recessions in advanced countries and the global economic and financial crisis that started in 2007, aggregate OECD labour productivity growth averaged just below 2% (). From 2011 to 2014, however, it averaged only 0.7% per year and was less than that in the United Kingdom, Japan, the United States and the euro area, including Germany and France. Labour productivity growth can be unusually weak during or just after recessions when firms prefer hoarding labour and resorting to part-time and shift work to reducing employee counts. In contrast, strong job growth is often seen as a recovery gains speed and it becomes necessary to rehire unemployed workers.

Labour productivity and investment

OECD Economic Outlook 97 database.

Statlink http://dx.doi.org/10.1787/888933220736

Faster labour productivity growth will require a boost in investment, because much of the disappointing productivity performance of the last few years is due to weakness in capital spending, rather than slower technical progress (). Some of this recent weakness is cyclical and due to a sharp slowdown in tangible investment during the financial crisis. But the subsequent investment recovery has been sluggish compared with past recessions, although in line with the weakness in output according to accelerator-type models (; ; IMF, 2015a). Still, the tepidness of investment is not a new trend. Except in countries like Canada and Australia, which ramped up mining sector investment in the 2000s as commodity prices increased, the contribution of capital deepening to productivity and GDP growth in the United States, Europe, Korea and Japan had been slowing for many years prior to the financial and economic crisis.

Real business investment growth has been weak compared with previous cycles

Peak in OECD real investment = 100

Data are for OECD countries for which the breakdown of investment is available. For the March 2008 series, the dotted line is based on projections.

OECD Economic Outlook 97 database; and OECD calculations.

Statlink http://dx.doi.org/10.1787/888933220744

The contribution of weaker investment to slower potential growth

The growth rate of OECD potential output per capita, proxying the trend growth rate of living standards, slowed from just below 1½ per cent per annum in the years preceding the crisis, to below 1% in the years immediately following it, before recovering to about 1% more recently (Figure below). The slowdown can be split into contributions from potential employment and trend productivity. The growth contribution from potential employment has slowed gradually due to the effect of ageing populations and more abruptly in the years following the crisis as structural unemployment rates is some countries rose. The slowdown in trend productivity is, however, much more important in explaining the decline in potential growth, with prolonged weakness in investment an important part of the story.

The decline in trend productivity growth can be split into contributions from total factor productivity and capital per worker, assuming an underlying Cobb Douglas production form for potential output. On this basis OECD total factor productivity growth slowed following the crisis, but has since recovered close to pre-crisis growth rates. Conversely the contribution from capital per worker slowed during the crisis and has remained subdued due to the prolonged weakness in investment. Indeed, the slower growth in capital per worker explains more than half, or about 0.3% per annum, of the slowdown in trend living standards for recent years compared to pre-crisis averages. This contribution from the slowdown in capital has become more apparent with the recent revision of capital stock data to be consistent with the new system of national accounts and the associated revision to the definition of investment, which now includes expenditures on research and development.

The foregoing analysis relates to the aggregate OECD, but nearly all OECD countries have experienced a prolonged post-crisis slowdown in the contribution of capital per worker to trend productivity growth, the only exceptions being Australia, Canada and Chile, which experienced strong mining-related investment in the wake of booming commodity prices.

• The slowdown in capital per worker was greatest among those countries most severely affected by the crisis. For Estonia, Greece, Iceland and Portugal the slowdown in capital per worker contributed to a slowdown in post-crisis potential growth averaging between ½ and 1 per cent per annum.

• Other countries for which the post-crisis slowdown in capital per worker contributed between ¼ and ½ per cent per annum to lower potential growth are Austria, Denmark, Hungary, Italy, Japan, Korea, Luxembourg, Slovenia, Switzerland, the United Kingdom and the United States.

Decomposition of the growth rate of OECD potential output per capita

Contribution to potential per capita growth

Assuming potential output (Y*) can be represented by a Cobb-Douglas production function in terms of potential employment (N*), the capital stock (K) and labour-augmenting technical progress (E*) then y* = a (n*+ e*) + (1 - a) k, where lower case letters denote logs and a is the wage share. If P is the total population and PWA the population of working age (here taken to be aged 15‑74), then the growth rate of potential GDP per capita (where growth rates are denoted by the first difference, d(), of logged variables) can be decomposed into the five components depicted in the figure: d(y* - p) = a d(e)* + (1 - a) d(k - n*) + d(n* - pwa) + d(pwa - p).

Potential employment rate refers to potential employment as a share of the working-age population (aged 15-74).

Active population rate refers to the share of the population of working age in the total population.

Percentage changes.

OECD Economic Outlook 97 database.

Statlink http://dx.doi.org/10.1787/888933220800

Private investment spending, excluding housing, is generally projected to strengthen only mildly until end-2016 as compared with previous cyclical recoveries. This is consistent with the projected modest acceleration in domestic and global activity, lingering uncertainty, the remaining excess capacity in many areas and the drag on investment engendered by lower oil prices in some large economies like the United States and Canada. As economies continue to recover, consumption growth accelerates in line with wages and incomes, and confidence in future economic prospects strengthens, firms can be expected to increase the pace of investment spending. A number of OECD countries have also implemented sizeable structural reforms in the wake of the economic crisis. On average across the OECD, countries have made progress in abolishing price controls or improving their design, streamlining administrative procedures for start-ups, simplifying rules and procedures and improving access to information about regulations. As these reforms bear fruit, output and investment should accelerate. Moreover, the boost to investment and growth in one country spills over to support investment and growth in others. Hence revived growth prospects, particularly in the euro area and Japan, could disproportionately boost global growth relative to the last several years when these areas have lagged. Such a collective response could boost the current low-level growth equilibrium to a higher sustained growth equilibrium.

Structural policy along a number of dimensions is essential to ensuring an increase in potential growth that is equitably shared. In this regard, the pace of structural reforms has slowed across the OECD in the past two years, in particular as concerns product market regulation, even as it has accelerated in large non-OECD economies (Koske et al., 2015; OECD, 2015a). Recent performance notwithstanding, a number of economies still suffer from structural impediments and would thus benefit from further policy action:

• Within the euro area, completing the Single Market with reference to the network infrastructures of telecommunications, energy transport and digital technology would boost investment and growth, as would further progress on banking and capital markets unions.

• Boosting competition and innovation and facilitating the entry of new firms would smooth the reallocation of labour and capital across firms and sectors and would help raise productivity growth. In the euro area periphery, product market reforms, especially in services, are needed to reap the full benefits of the labour market reforms introduced in recent years.

• Better integration of social protection and active labour market policies would facilitate job creation and matching and thus accelerate the elimination of labour market slack and the pick-up in wage growth. It would also reduce labour market duality and informality.

• In EMEs better physical and legal infrastructure can help address growth bottlenecks, reduce financial sector vulnerabilities and improve resource allocation, ultimately helping to narrow the gap in material living standards with advanced economies.

• In advanced and emerging market economies alike, the ultimate drivers of productivity gains are skills and knowledge-based human capital, underscoring the importance of raising the quality and inclusiveness of education systems.

Monetary policy

While remaining supportive, monetary policy stances are set to become increasingly divergent across the key economies, as is appropriate. The gradual disappearance of slack in the United States, and the associated prospect of inflation moving to its target, calls for gradual increases in policy rates. The timing and pace of this withdrawal of stimulus will depend on the outlook for inflation, which in turn will depend on the strength of the economy. In the euro area and Japan, very low inflation warrants continued supportive monetary policy, as planned.

Large commodity and exchange rate movements complicate monetary policy setting at the current juncture as their persistent effects on inflation and output are uncertain. With little signs of second-round effects of oil price falls or de-anchoring of medium-term inflation expectations, and headline inflation already recovering, monetary authorities should look through these movements and need not respond. However, should significant second-round effects materialise, extra measures will be needed. This would particularly be the case for the euro area and Japan, where risks of deflation are still not negligible and second-round inflationary effects proved to be important in the past.*

Indirect and second-round effects of past oil price shocks accounted on average for around a third of total changes in inflation rates (ECB, 2010).

To the extent that financial markets may not have accurately incorporated the effects of a future tightening of US monetary policy, the actual tightening may lead to financial market volatility and global bond yield spillovers (see above). The need for policy response would largely depend on the relative effects of the induced currency turbulence and of higher interest rates, and on prevailing inflation and the monetary policy stance.

• In areas where inflation is below target and GDP growth is weak, more monetary policy easing would be desirable if the negative effects of higher bond yields materialise faster and exceed any positive effects from currency depreciation. In the euro area and Japan, with very low interest rates and already large asset purchases, the scope for further monetary accommodation is, however, limited. Expanding asset purchases is feasible but may lead to still more market distortions and be constrained in practice by the availability of bonds.*

  In particular in the euro area, the self-imposed 25% issue limit and 33% issuer limit are likely to constrain asset purchases for some countries, resulting in a shortfall of around EUR 40 billion by September 2016 compared with the envisaged total amount (Claeys et al., 2015). These constraints would be even more biding if asset purchase increased.

  Similarly, taking policy rates well into negative territory could lead to costly market distortions.

• In countries with high inflation and inflation expectations poorly anchored, monetary policy should be tightened to limit capital outflows. This has already been the case in Brazil and Russia. In some countries, concerns regarding exchange rate effects have led to easing even as inflation remains above target. If short-lived foreign currency liquidity problems arise, threatening system-wide financial stability, countries could apply for multilateral facilities, if they have strong policy frameworks and track records in economic performance. Transparent and temporary exchange rate interventions could also be considered to address short-term volatility, when sufficient foreign exchange rate reserves are available. Introducing controls on capital flows is likely to be counterproductive.

Fiscal policy

Fiscal policy is estimated to be roughly neutral in the United States and the euro area and mildly restrictive in Japan (). Consideration of the near-term effects of the fiscal stance, in light of needed growth to service debt obligations, is key. A medium-term commitment to fiscal consolidation appears to appropriately balance the near and long term objectives. Public debt-to-GDP ratios are projected to stabilise by 2016 in the OECD area as a whole, a decline in the ratio in the euro area offsetting an increase in Japan and the United States (in 2015 only). However, government debt is still very high relative to GDP in most OECD countries.

Fiscal positions will continue to improve

Statlink http://dx.doi.org/10.1787/888933221734

The evolution of government debt essentially depends on economic growth and interest rates going forward, rising budgetary pressures associated with population ageing, and the design of fiscal policies, which itself can have a significant impact on economic activity.

• In most OECD countries, exceptionally low interest rates help to contain debt servicing costs at present (). Interest rates for 10-year government bonds and implicit interest rates for servicing overall government debt are below GDP growth rates in 75% and 40%, respectively, of the OECD countries, with the euro area economies that were hardest hit by the crisis being the main exceptions. Interest rates are likely to rise in the medium term as the economy strengthens and policy rates normalise. Moreover, better risk differentiation by capital markets since the crisis might imply that lenders will demand higher risk premia than those seen in earlier years to finance high government debt levels. Hence, there is a premium on boosting sustainable growth rates now.

• On unchanged policies, population ageing and rising healthcare costs are set to lead to rapidly rising spending pressure on public budgets. Public spending on healthcare, long-term care and pensions is estimated to increase by 2½ per cent of GDP between 2015 and 2030 on average in the OECD, with the fiscal burden differing considerably between countries (). The increase in spending pressure would be even greater if the increase in healthcare costs is not contained. Hence, both policy reforms and sustainable growth are needed.

Government debt dynamics

The interest rate is a weighted sum (0.25*IRS + 0.75*IRL). IRS is the 3-month market interest rate and IRL is the 10-year government bond rate.

In the scenario the following assumptions are made: Output gaps close until 2020, with the speed of the closing depending on the size of the gap at the end of the short-term projection period (2016) according to the relationship diff(GAP(t)) = 0.2*diff(GAP(t-1)) – 0.4*GAP(t-1), where diff() denotes year-on-year difference and GAP denotes the output gap. Primary balances improve in line with the closing output gaps using fiscal elasticities as estimated in Mourre et al. (2014) for the EU countries and Girouard and André (2005) for all the other countries. In addition, primary balances incorporate the estimated (linearised) increase in spending on health care, long-term care and pensions as reported in Table 4.5 in OECD Economic Outlook 96. Greece and Norway are not shown.

OECD Economic Outlook 97 database; and OECD calculations.

Statlink http://dx.doi.org/10.1787/888933220782

Assuming, in a stylised scenario, that automatic stabilisers improve government finances as output gaps close, and estimated spending pressure stemming from healthcare, long-term care and pensions materialises without further fiscal consolidation, debt ratios would continue to rise in about two-thirds of OECD countries, if interest rates equal GDP growth rates from 2020 onwards (). Adverse debt dynamics would be more negative if interest rates were to exceed growth rates. It is clear that increases in potential growth rates as well as moves to address social spending pressures are crucial. Otherwise, several countries, at least, face unsustainable fiscal developments.

Effective fiscal adjustment over the medium term requires credible multi-annual fiscal plans to chart a path towards sustainable public finances, supported by growth, as well as to minimise the risk of uncertainty weighing on private spending. Simple plans are likely to be more credible, because they focus on key medium-term challenges facing public finances ().

Challenges to anchoring the public finances in the medium term with the euro area fiscal rules

Anchoring the public finances in the medium term to achieve a prudent and sustainable level of debt and net worth can be supported by well-designed fiscal rules (Fall et al., 2015). These can help to guide fiscal policy decisions and to commit governments to sound policies in the face of short-term pressures. Fiscal rules are especially important in a monetary union to ensure that budgetary policy plays the required counter-cyclical stabilisation role in the absence of other levers at national level, and because market creditworthiness may be fragile.

The Stability and Growth Pact (SGP) of the EU Treaty provides the cornerstone of EU fiscal governance. A major overhaul of the euro area fiscal rules was undertaken in 2011-13 with the Six and Two Packs of regulations and laws and the new Fiscal Compact Treaty. These rules aim to avoid excessive fiscal imbalances and to provide a set of rules for the medium-term budget balance and the debt-to-GDP ratio.

While the application of the new rules is still in its infancy (European Commission, 2014), experience of applying the new framework in recent years points to a number of questions about whether the rules could be made more effective in anchoring policy in the medium term. There are three main areas where the EU rules currently raise concerns.

First, many countries are still to meet the 3% of GDP deficit ceiling of the corrective arm of the SGP. Deadlines have been extended on 12 occasions since 2009. This partly reflects the fact that a headline GDP ceiling during a cyclical downturn can lead to undesirable pro-cyclical policies. It has therefore been appropriate to allow some slippage. However, the uncertainty around whether such leeway would be granted and requirements imposed around it could create uncertainty about policy and risk undermining some of the beneficial effects on demand that can be achieved by allowing fiscal policy to offset negative economic shocks.

Second, the medium-term objectives (MTOs) for the structural budget balance in the preventive arm of the SGP point to some problems because of measurement issues that are inherent with cyclical adjustment in general and with the EU’s agreed methodology for estimating potential output and output gaps in particular. While the focus on structural budget balances should in principle provide a more stable medium-term anchor for fiscal policy, there are cases where the measurement problems may be leading to pro-cyclical and unstable policy requirements.

For example, European Commission estimates of potential output growth in Italy and Spain have been revised substantially over the past year (Figure). These effects are large enough to have policy-relevant implications for how much fiscal consolidation is required each year to meet the MTOs. A number of methodological changes, including options that countries can apply, have been introduced in the past year, but these issues merit a more comprehensive approach to address longstanding measurement problems (OECD, 2010).

Third, the design of the numerical debt rule and the expenditure benchmark can create anomalies that run counter to a medium-term policy orientation. For example, the debt rule potentially requires very large swings in the budget balance when it begins to bind, if a country’s budget balance and GDP growth start from a position far from what is needed to meet the frontloaded adjustments imposed on high-debt countries (Barnes et al., 2012). While the expenditure benchmark is intended to achieve the MTO, it uses a long average of potential output and this may lead to inconsistent signals to the MTO. Updating the benchmark on an annual basis and the translation from the real-terms measures in the expenditure benchmark to nominal quantities required for budgeting may make multi-annual budgeting more difficult.

Potential growth output estimates

European Commission, Winter forecast 2014 and Winter forecast 2015.

Statlink http://dx.doi.org/10.1787/888933220824

Recent experience suggests that the medium-term orientation of EU fiscal rules may be undermined by weaknesses in their design (complexity) and operation (extensions, poor choice of fiscal consolidation strategies, minimal compliance, and/or gaming the system). Widespread deviations are likely to undermine the effectiveness of the overall framework and political support for it. Hence, fiscal oversight should put greater emphasis on the medium-term outlook for observable variables, including the budget balance and debt-to-GDP ratio, supported by sound macroeconomic forecasts and realistic budgetary projections. Less emphasis should be put on the numerical debt and expenditure rules, while focussing surveillance more on the drivers of the medium-term debt-to-GDP ratio and public spending.

Moreover, the composition of fiscal policy matters. Fiscal consolidation in the aftermath of the crisis relied to a considerable extent on cutting public investment (about one-quarter of the consolidation effort since 2010). This has been costly in terms of demand stabilisation as fiscal multipliers associated with government investment spending are higher than for other fiscal instruments (). Empirical analysis also suggests that cuts in public spending on infrastructure can lower potential growth (e.g. Barbiero and Cournède, 2013). A budget-neutral reallocation of public spending towards investment would thus support the economy’s growth potential, provided projects are carefully chosen, and make debt dynamics more favourable.

Government investment would be particularly powerful if it helps pave the way for private investment. In the European Union, the Investment Plan for Europe (Juncker Plan) provides an opportunity to adjust public spending along these lines ( in ). Complementary budgetary measures to bring forward private investment could include the introduction of temporary tax credits or accelerated depreciation of capital equipment for tax purposes.

In addition, fiscal-structural policies should be adjusted to lessen pressures on public budgets and strengthen output growth. Raising the effective retirement age can help to tackle the spending pressure that ageing will create and would also support the productive potential of the economy. Also, OECD analysis suggests that there is much scope for efficiency improvement in healthcare and education that would leave the quality of services intact (Joumard et al., 2008; Sutherland et al., 2009).

Complete policy packages should integrate fiscal, monetary and demand-friendly structural policies

Monetary and fiscal policy action should be supported by structural policy changes in an integrated, rather than a piecemeal, approach. First, within structural policy, attention to labour and business settings is important. For example, product market reforms undertaken in a strict labour environment tend to limit the ability of new firms to hire the labour they need. Alternatively, labour market reforms undertaken within a rigid business environment with large incumbent firms tend to force all adjustment onto labour. Overall, structural policies can contribute substantially to fiscal sustainability and soften trade-offs between fiscal consolidation, growth and equity objectives. But while such policy actions are often undertaken with a view to boosting long-run growth from the supply side, their short-term effects on demand are less certain and these must also be considered.

When pro-growth structural policies are introduced in normal times and with the support of other macro policies, the empirical evidence generally points to greater short-term gains than losses. In bad times, however, and especially when fiscal and monetary policies are not deployed to offset short-run negative effects, the negative transitional dynamics associated with structural changes are not as easily smoothed. In such a situation, structural policies that boost short-run demand should be prioritised. They include policies that reduce entry barriers in sectors with pent-up demand, policies to reduce administrative burdens on firms, and policies that boost aggregate demand directly such as public infrastructure investment. Policies that improve confidence or reduce uncertainty over future economic conditions may offer the biggest short-term impact as they can rapidly boost consumption and investment through wealth effects and improved expectations. Examples include credible reforms to pension and health systems that improve the sustainability of public finances, reducing the need for precautionary saving and creating fiscal space for stimulus. A forthcoming OECD study on the short-term effects of structural reforms discusses these issues in greater depth (Caldera Sanchez et al., 2015).

Rebalancing continues

Weak global commodity markets, notably those for iron ore and coal, and the consequent decline in resource-sector investment have generated job and output losses, although commodity production itself has not been cut back substantially. Positive adjustments in the non-resource sector are underway, with the exchange-rate depreciation lifting exports and employment; for instance, tourism has picked up. Meanwhile, house prices and credit growth continue to rise, especially in the largest cities, and are increasingly driven by investors. Building-approval data indicate a significant supply response is underway. Consumer-price inflation remains benign with recent figures pushed up by exchange-rate depreciation but damped by the drop in oil prices.

Australia

Mining sector investment refers to financial years. For commodity prices, index 2007Jan=100. Real effective exchange rate is based on constant trade weights.

OECD Economic Outlook 97 database; OECD, Housing Prices Database; Australian Bureau of Statistics, Cat. No. 5204.0 and 5206.0; and Reserve Bank of Australia.

Statlink http://dx.doi.org/10.1787/888933220831

Macroeconomic policies are accommodating the commodity-market downturn

Concern for real-side developments and the absence of inflationary pressure prompted a policy-rate cut of 25 basis points to 2.25% in February and to 2% in May, the first moves since August 2013. However, the net gains from further monetary expansion in the near term are finely balanced. The momentum in the housing market and possible need for expansionary firepower given uncertainties in the macroeconomic outlook suggest caution. The Reserve Bank of Australia is assumed to commence policy-rate increases in early 2016 in response to improved economic conditions.

Australia: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222086

Budget proposals published in May do not endeavour to make up for the larger-than-expected deficit results; indeed, the pace of consolidation is slightly lower than in the previous budget. This approach is appropriate given weakening revenues and macroeconomic outcomes in the wake of the commodity price falls. The general-government deficit is projected fall to 1.9% of GDP in 2015 and to 1.5% of GDP in 2016.

Structural reforms should assist economic adjustment and inclusive growth

Structural reforms are underway to assist the economic adjustment of activity away from the resource sector. In particular, initiatives to strengthen infrastructure and some initial steps in tax reform have already been taken. The budget for 2015-16 focuses on a smaller set of structural reforms with less emphasis on cost-cutting measures compared with the previous year’s budget. It notably proposes a package of measures supporting small and medium enterprise, including a preferential rate of corporate taxation and increased tax allowances. Also of note are measures increasing support for child-care and proposals to tackle base erosion and profit shifting. The latter include new anti-avoidance legislation and the extension of the Goods and Services Tax to cross-border supplies of digital services and products. Future structural reforms should prioritise further tax changes, shifting away from direct taxation and towards indirect taxation, including reduced reliance on personal and corporate income taxes and measures such as increased use of the Goods and Services Tax and land tax. Ensuring increased well-being will also be helped by the proposals to increase child-care subsidies by boosting inclusion through positive effects on female labour participation. In environmental policy it remains important that the Emission Reduction Fund is efficient through robust measurement and verification methods and implementation of a safeguard mechanism that prevents offsetting emissions elsewhere in the economy.

Output growth will pick up in 2016, and external uncertainties dominate the risk profile

Strengthening private consumption will contribute significantly to output increases with housing construction and exports also playing a role. The unemployment rate is projected to decline as employment adjusts to sectoral shifts in demand due to economic rebalancing. Inflation will remain moderate throughout the projection period due to continuing slack.

External risks remain prominent. Commodity prices may well rise from current levels, recharging company and government balances. Alternatively, if current commodity prices persist, or head down further, then revenue impacts will deepen and cutbacks in production could become substantial. Domestically, the continuing property market momentum adds to the risk of a sharp correction and there are sizeable upside and downside uncertainties in the strength of household spending growth.

Economy activity has fallen behind

Economic activity has been very weak since the beginning of 2012. Despite the increasing output gap and rising unemployment, inflation has been higher than in other euro area countries. Poor real disposable income growth has been partly offset by declining saving rates, helping to maintain consumption. Falling labour productivity has weakened international competitiveness and, despite real wages being still below pre-crisis levels, triggered substantial losses in export market shares. Structural changes in the composition of global value chains, in particular with respect to Germany, may have amplified these losses. Business and consumer confidence remained subdued despite the uptick of activity in the euro area in early 2015.

Austria

Real compensation per employee is defined as compensation per employee (wages plus employers' contributions) divided by the private consumption deflator.

4-quarter moving average of nominal share of total investment to GDP.

OECD Economic Outlook 97 database.

Statlink http://dx.doi.org/10.1787/888933220841

Fundamentals are improving, but structural reforms in services are crucial

A tax reform, to be legislated in mid-2015, will enter in force on 1 January 2016 and reduce income taxation significantly. This should buttress private consumption despite some projected increase in the saving rate. External conditions have improved owing to stronger growth prospects in the euro area and price competitiveness gains vis-à-vis partners outside the euro area following the depreciation of the euro. Notably, the strong appreciation of the Swiss franc improves prospects for the Austrian tourism sector. In addition, the low real interest rate environment and the plunge in oil prices should strengthen domestic demand.

Austria: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222092

Progress in deregulating product markets has been impressive. Its success should inspire similar structural reforms in the service sector, where regulations, in particular entry regulations, are still among the most stringent in the OECD. These regulations hamper labour productivity and partly explain the downward rigidity of prices, since nearly three quarters of the inflation differential with respect to the euro area and Germany can be ascribed to services. Besides the close monitoring and supervision of banks, the authorities should push forward the defragmentation of the overbanked domestic financial market to reduce operating costs. In this regard, the merger of the Volksbanken, which would bring down the number of their branches from 63 to 8, is a welcome first step.

Further growth potential resides in the promotion of a more gender-balanced society by shifting to a tax-and-benefit system that encourages a better distribution of work, the provision of more full-day schools and care centres, and sensitising the private sector for more family-friendly workplaces and working time models.

Economic activity is set to recover gradually

GDP growth is projected to increase gradually over the projection period driven by a pick-up in export and investment with an additional boost provided by private consumption. Risks for the projections are balanced. If cost pressures increase further, Austria’s exporters may benefit less than projected from the weakness of the euro. Uncertainty about bank balance sheet impairments remains. If this channel explains more of the current sluggishness of investment and consumer confidence than assumed, growth may prove more subdued than projected. On the upside, the tax reform could boost private consumption more if saving rates pick up less than expected. Second-round effects on employment and investment may also be stronger than anticipated. Finally, export performance may be stronger than projected if lost market shares are regained more swiftly.

Activity is picking up slowly

The economy has continued to recover as household consumption and business investment have strengthened somewhat, but growth has been weak. Business confidence has increased and consumer confidence has returned to its long term average. Supportive lending conditions and increasing profit margins have supported business investment. Capacity utilisation has also returned to its long term average, creating a positive environment for further investment spending. Nevertheless, the unemployment rate is still high at around 8.5%. While core inflation has fallen largely in line with that in the euro area, it still remains relatively high.

Belgium

Capacity utilisation rate in the manufacturing sector, seasonally adjusted. Investment is nominal private non-residential gross fixed capital formation.

Harmonised consumer price index excluding food and energy.

European Commission; National Bank of Belgium; and OECD Economic Outlook 97 database.

Statlink http://dx.doi.org/10.1787/888933220854

Fiscal consolidation and wage moderation will weigh on domestic demand

After pausing in 2014, fiscal consolidation is planned to resume, with an annual structural balance adjustment of 0.7% of GDP in 2015 and 2016, and it is to be expenditure-based. Further consolidation is a welcome step towards securing fiscal sustainability as public debt remains large, and the emphasis on containing spending is welcome. Success, however, will require co-ordinated efforts at all levels of government. The drag on domestic demand will be partly offset by accommodative monetary policy in the euro area and better financial conditions, as lending standards for non-financial corporations have eased further.

Belgium: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222101

The authorities continue to pursue wage moderation policies, by keeping low the maximum real wage increase in the collective bargaining process. This implies zero real growth for negotiated wages in 2015 and a modest 0.5% growth in 2016. In addition, parliament has recently approved a temporary suspension of the nominal indexation of wages and replacement income (known as index jump). While a protracted period of low wage growth will help regain external competiveness, the situation highlights the need to reform wage setting more broadly in order to link wage growth more closely to domestic productivity developments. As part of this reform, social partners should be encouraged to phase out the automatic wage indexation mechanism and to consider reintroducing a lower youth minimum wage. The growth potential could be increased and become more inclusive by investing in skills and by improving integration policies, as the labour force is ageing and the large foreign-born population suffers from poor labour market prospects. This requires notably developing more equitable education and training system.

The recovery will gradually continue

Growth is projected to broaden and gradually increase in line with the recovery in the euro area. Improving external demand and the exchange rate depreciation will support exports and the current account surplus will continue to rise. Accommodative monetary policy and improving confidence should further bolster investment growth. However, the strength of the recovery in domestic demand will likely be limited by fiscal consolidation and wage moderation. Unemployment is projected to edge down and, as the substantial downward pressure from low energy prices fades away, headline inflation will gradually increase.

House prices are rising again and remain at historically high levels. A correction would cut household wealth and consumption. The Belgium economy is highly dependent on the strength of the recovery in the euro area, and therefore developments in geopolitical tensions and negotiations with Greece. Improved corporate profits and continued supporting financial conditions could trigger a faster-than-projected recovery of business investment.

Growth has stalled and confidence has declined

The economy came to a standstill in 2014 against the background of deteriorating terms of trade, domestic bottlenecks and policy uncertainty. While monetary policy tightened, fiscal policy delivered a sizeable stimulus. In practice, several of the fiscal measures failed to support growth effectively and further added to existing distortions. Fiscal accounts deteriorated and the primary balance, which had been in surplus since 1999 to keep public debt on a declining path, turned into a deficit. As a result, gross debt increased by almost 7 percentage points of GDP. Headline and core inflation have been significantly above the 4.5% inflation target, and have risen above the ceiling of the tolerance band in early 2015 due to adjustments in administrative prices. Short-term indicators including business conditions and retail sales are consistent with a contraction of activity in early 2015.

Brazil

The inflation target is met whenever the accumulated inflation during the period January-December of each year falls within the tolerance band.

Central Bank of Brazil; and IBGE.

Statlink http://dx.doi.org/10.1787/888933220867

Business and consumer confidence has deteriorated sharply owing to a combination of low growth and high inflation, the corruption investigations and discussions about possible sovereign rating downgrades. Deteriorating international competitiveness and substantial policy uncertainties resulting from a series of ad-hoc policy changes that affected the conditions of doing business added to the decline of confidence among investors, and thus to a contraction of investment.

Brazil: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222357

Macroeconomic policy space is limited but structural reforms can boost growth

Macroeconomic policy space is severely limited by the need to restore confidence and preserve Brazil’s investment grade rating. In January 2015, the new government announced a significant fiscal adjustment, with primary surplus targets of 1.2% and 2% of GDP for 2015 and 2016. The new targets are backed by concrete measures to reduce expenditures and – to a lesser extent – raise revenues. This has lent credibility to the consolidation plans. At the same time, the central bank adopted a more ambitious strategy of bringing inflation back to the 4.5% target by end-2016 and, accordingly, has raised the policy rate further. Despite hikes in administrative prices and a depreciated currency, which have pushed year-on-year headline inflation significantly above the target range in early 2015, inflation expectations have declined, probably as a result of these stronger fiscal and monetary policies. Also, price realignments, as in the energy sector, are aimed at ensuring the right signals are in place for markets to work well.

Brazil

Central Bank of Brazil; and IBGE.

Statlink http://dx.doi.org/10.1787/888933220871

Structural reforms have a significant potential to boost growth. Reducing the compliance costs and distortions imposed by Brazil’s fragmented system of indirect taxes could provide an almost immediate cost reduction for firms, and could be achieved by consolidating indirect taxes into a single, broad-based value-added tax with full deductibility for inputs and an exemption for exports. This would improve competitiveness, adding to the effects of the depreciated exchange rate. In addition, reducing barriers to international trade would reduce the costs of imported inputs and strengthen incentives to enhance productivity by exposing Brazilian firms to more international competition. Lowering domestic entry barriers could reinforce the limited exposure of Brazilian firms to competitive pressures, eventually raising productivity. Improvements in infrastructure could also reduce transport costs, particularly for exporters. Although concessions already play an important role in infrastructure in Brazil, improvements in the regulatory environment could enhance predictability and boost new and sizeable investments by the private sector. PPPs are to play a much larger role in the upcoming concessions, in line with less participation by public banks, in particular BNDES.

Brazil has achieved substantial reductions of poverty and inequality and has seen the emergence of a new middle class. Policy efforts, including in education and social transfers, have played a crucial role in this process and this momentum should be maintained to make growth more inclusive.

The economy will contract in 2015, followed by a gradual recovery in 2016

The economy will be negatively affected in 2015 by low levels of confidence, lower investment in the oil sector and the headwinds from macroeconomic policy tightening. Over the course of the year, however, improved macroeconomic policies and a few announced structural policy reforms are assumed to raise confidence. Private consumption, and with some delay also investment, are projected to rebound and lead the recovery of growth. Exports will be supported by a more competitive exchange rate, which will reduce the current account deficit.

Unemployment, which has so far been isolated from low activity levels due to declining labour participation among young cohorts, is expected to rise during 2015, before beginning to fall again slowly as of 2016. As the effects of administrative price hikes and currency depreciation taper off, inflation is projected to decline over the projection period and converge to the inflation target by the end of 2016.

Risks to the outlook include a failure to achieve the announced fiscal adjustment, which will be seen as a litmus test for improved macroeconomic policies. Besides reducing investment, this could trigger a loss of Brazil’s investment grade rating. Fallout from the events unfolding at Petrobras could be stronger than expected, particularly if the investigations lead to more bankruptcies in upstream activities. Although water reservoir levels have recently risen following a prolonged drought, the possibility of energy or water rationing remains. Such rationing significantly dented growth in the early 2000s. A principal upside risk is related to the structural reform agenda. Given the significant scope to improve the business climate, a few key reforms could make a significant difference for productivity and boost growth.

The fall in oil prices has weakened the expansion

GDP rose 2.4% in 2014, driven by private consumption, reflecting some improvement in the labour market and low interest rates. A weaker currency and stronger growth in export markets (particularly the United States) have boosted export growth. However, a slowing in activity has begun, with GDP declining in the first quarter of 2015. The decline in oil prices in late 2014 and early 2015 have reduced incomes and oil investment. Weaker consumer confidence and, in early 2015, poor weather have also undermined consumption growth.

Canada

OECD Economic Outlook 97 database.

Statlink http://dx.doi.org/10.1787/888933220887

The labour market has improved over the past year, but the downturn in the oil sector is depressing short-term employment prospects. Wage growth has remained fairly modest, albeit with some pick-up. Headline inflation has moderated to the lower end of the Bank of Canada’s target range, given large declines in gasoline prices. Despite some remaining slack, core inflation remains slightly above the 2% target midpoint, in part reflecting the currency depreciation. However, pass-through from lower oil prices should weaken core inflation slightly in 2015 before it returns to the midpoint of the target range in mid-2016.

Canada: Employment, income and inflation

Statlink http://dx.doi.org/10.1787/888933222007

Monetary conditions are accommodative, and the pace of fiscal consolidation is easing

Monetary policy will remain accommodative throughout the forecast period. The Bank of Canada lowered its policy rate by 25 basis points, to 0.75%, in January 2015 to counter the expected weakness from the fall in oil prices. This stance is appropriate for now, but monetary stimulus will need to be gradually withdrawn as economic slack diminishes. While the timing will depend on economic developments, it is assumed that the first policy rate increase will occur in the first quarter of 2016, with further increases thereafter. Given the supportive monetary stance, further macro-prudential measures on mortgage lending to ensure financial stability should be considered if housing-related risks increase.

Canada

Based on A. Binette et al. (2014), Canadian Non-Energy Exports: Past Performance and Future Prospects, Bank of Canada Discussion Paper 2014-1, April. Lagging export sectors include those facing longer-term structural challenges.

OECD Economic Outlook 97 database; Statistics Canada; and OECD calculations.

Statlink http://dx.doi.org/10.1787/888933220894

In recent quarters the pace of fiscal consolidation has proceeded broadly as planned. On the basis of budget plans, an additional cumulative structural consolidation of only 0.4% of GDP is projected to occur over 2014-16. The latest federal budget showed that the government is on track to eliminate its deficit in the current fiscal year, largely through maintaining spending restraint. However, given lower revenues, particularly following the decline in oil prices that result in smaller projected surpluses at the federal level and deficits in some oil-producing provinces, less consolidation is anticipated through 2016 than in previous official projections. As a result, provincial governments plan to reduce their combined deficits by a weaker 0.3% of GDP over 2014-16. The general government debt-to-GDP ratio is expected to be fairly flat. Rising health-care costs will remain a longer-run challenge, and continued structural reforms to limit such expenditure growth are needed. Raising tax efficiency by relying more on environmentally related taxes would help achieve greener growth. In addition, reducing regressive and distortive income-tax expenditures could help support inclusive growth.

Canada: Financial indicators

Statlink http://dx.doi.org/10.1787/888933222018

Growth in non-energy exports and investment should lead the expansion

GDP growth is projected to recover from recent low rates to 2¼ per cent in 2016, as the drag from weaker oil-related investment diminishes. Private consumption is also expected to recover from the weak start to 2015 as the effects of the harsh winter and adjustment to the decline in oil prices fade. Interest rate increases in 2016 will dampen household spending and residential investment later in the year. Exports, particularly non-energy, will benefit from the lower Canadian dollar and stronger export market growth. However, the sensitivity of non-energy exports to exchange rate movements depends on the sector, with some likely to continue to face broader competitiveness or structural challenges. As capacity is limited in non-energy export industries, investment should rise with a lag, although there is considerable uncertainty regarding its timing.

Canada: Demand and output

Statlink http://dx.doi.org/10.1787/888933222025

The main upside risk to the projections is that oil demand and prices rebound, driven for example by geopolitical risks. Stronger growth in key export markets, particularly the United States, could lead to a faster rotation towards non-energy exports than projected and call forth a quicker increase in investment. The main downside risk remains a disorderly housing market correction, particularly given high household debt, which would depress private consumption and residential investment and could, in the extreme, threaten financial stability. In addition, further declines in oil prices, a sudden slowdown in China or slower-than-projected growth in the United States could lead to a greater and more protracted than expected deceleration in activity, including weaker investment, exports and private consumption.

Canada: External indicators

Statlink http://dx.doi.org/10.1787/888933222033

The economy is in transition

The long phase of strong economic growth driven by the booming mining sector has come to an end. Declining copper prices and lower demand from China have reduced the terms of trade, business confidence and investment. The mining sector over-invested during the commodity super-cycle – when mining investment grew from approximately 2% to almost 7% of GDP – creating a lot of spare capacity. As a result, mining investment has declined by a third since 2012, and is expected to remain weak in the medium term. Lower terms of trade have also cut household incomes and private consumption.

Chile

OECD Economic Outlook 97 database; Datastream; and Central Bank of Chile.

Statlink http://dx.doi.org/10.1787/888933220903

Monetary and fiscal policies are supporting the recovery

To support domestic demand, the central bank decreased policy interest rates by 200 basis points and has kept them close to historical lows since October 2014. This monetary support resulted in an exchange rate depreciation of around 15% in real terms since early 2013, cushioning the economy from the falling terms of trade by boosting exports and investment in non-mining sectors. The current account deficit has already fallen from 3½ per cent of GDP in 2013 to projected ¾ per cent in 2015.

Chile: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222118

Fiscal policy is also supporting activity. Taking advantage of a robust fiscal situation – with a near absence of net debt – the government has responded to the slowdown in activity with a strong fiscal impulse to the economy in 2015. Government expenditures will grow by around 10% in 2015, part of which will however be offset by tax increases. Because most of the increase in spending is in public investment and infrastructure investment, the fiscal stimulus can remain temporary, leaving the government in a position to achieve its goal of zero structural balance by 2018.

The economy is projected to rebound, but structural reforms are essential for sustained growth

Economic activity posted a moderate recovery during the first months of the year, and the exchange rate depreciation and stronger growth of trading partners in the second half of 2015 and in 2016 are expected to boost industrial exports. Similarly, private consumption will increasingly add to growth as lower prices of oil contribute to improve the income of families.

The economic consequences of the large drop in copper prices have shown how much Chile is affected by external shocks. Growth, however, will depend on implementing the government’s ambitious reform agenda. Uncertainties on this point, or about the effects of reform, could depress confidence and therefore the speed of the investment recovery. By contrast, tangible progress in reform — particularly policies to foster competition, reduce skill mismatches, increase economic diversification and raise female labour force participation — could boost economic potential more than assumed and will help to reduce inequalities.

Orderly adjustment towards a new normal rate of growth is underway

China’s output growth continued to slip in early 2015, with excess capacity weighing on business investment, in particular for state-owned firms, whose leverage is high and whose profits are slowing. Real estate investment also remained weak in the context of the ongoing property market correction. However, lower interest rates and the recent relaxation of down-payment ratios for second-home buyers will support housing demand in the short run. Meanwhile, investment in infrastructure and social housing has been stepped up.

China

Fixed asset investment and residential investment refer to nominal values and do not include investment by rural households.

CEIC.

Statlink http://dx.doi.org/10.1787/888933220919

Buoyant household incomes are supporting robust consumption growth. Despite exchange rate appreciation, exports have continued to expand and, with the slowdown in growth and especially investment, imports have weakened. These factors, and falling prices for commodity imports, have widened the trade surplus.

China: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222361

Macroeconomic policy easing is accompanied by structural reforms

Against the backdrop of a cooling economy, interest rates and the reserve requirement ratio have been cut in steps over the past few months, somewhat reducing financing costs. The People’s Bank of China has also made use of short-term instruments to drive down interbank interest rates. At the same time, it has reined in shadow banking, thereby improving the credit structure. Bank lending has been geared towards more productive uses as entities enjoying implicit guarantees now have more restricted access to credit. Indeed, the recent default by a private company on its bond principal repayment signals that implicit state guarantees can no longer be taken for granted, which will foster better pricing of risk. Accordingly, smaller and private firms will face less crowding out in the credit market, although their financing costs remain high even for viable projects. Better disclosure and reporting requirements would also help them obtain financing.

China

In Panel A, the informal lending rate refers to lending by private informal institutions in Wenzhou. In Panel B, total refers to industrial enterprises. By the same token, state-owned enterprises also only include industrial enterprises.

CEIC.

Statlink http://dx.doi.org/10.1787/888933220927

The effective exchange rate has appreciated sharply, in tandem with the strengthening of the dollar (to which the renminbi is closely linked), and with reduced foreign exchange intervention by the People’s Bank of China. The narrowing interest rate differential with the United States will alleviate appreciation pressure to some extent. Greater exchange rate flexibility is a prerequisite for full interest liberalisation and gradually increasing capital account convertibility, and will help the economy absorb shocks. In the transition to a market-based exchange rate regime, a peg to a trade-weighted basket could help anchor expectations and damp output fluctuations.

Fiscal policy is set to loosen with a 2.3% of GDP headline deficit target (2.7% accounting for carry-over and debt-swaps) for 2015, up from 1.8% in 2014 (in terms of a broader definition of the budget, the deficit is set to increase from 0.3% in 2014 to 1.2% in 2015). Large infrastructure projects are being implemented, including in railways, water and environment protection, where ample needs remain. Urbanisation will be another driver of infrastructure investment spending. Tax cuts have been adopted for micro and small firms and the threshold below which such cuts apply has been raised. Tariffs have also been cut on several consumption goods. In contrast, spending pressure is high in areas that are vital for long-term growth such as education, innovation, health and social security. Debt swaps at the sub-national level should help reduce debt-servicing costs and mitigate fiscal risks, but unconditional rollover of sub-national debt by creditors may jeopardise the cleaning of sub-national balance sheets. Recent measures to reform the pension system for civil servants will strengthen longer-term fiscal sustainability.

Growth will continue to slow

More stimulative macroeconomic policies and lower commodity prices are projected to keep growth at the government target of around 7%. Consumption is set to remain robust on the back of rising real incomes. Infrastructure investment will partly offset the slowing of real estate and equipment investment in some manufacturing sectors. Inflation will remain very low in part due to economic slack. The current account surplus is set to increase to 2.4% of GDP this year owing to lower commodity prices.

Faster adjustment in industries affected by overcapacity would further slow investment in the short term, but is necessary to reduce imbalances. Propping up housing demand by easing home-purchase restrictions would support short-term growth at the cost of increasing imbalances. A strong appreciation of the effective exchange rate would hurt international competitiveness. An unexpectedly vigorous global recovery, an acceleration of infrastructure investment and the effective kick-off of the New Silk Road strategy could lead to higher growth through stronger investment and exports. Stepping up structural reforms to streamline business regulation and reduce the costs of doing business could also provide a boost to growth.

Growth is moderating due to lower commodity prices

Lower global commodity prices and declining resource-sector investment have resulted in reduced output and widened the current account deficit. Inflation has edged above the target zone, driven mainly by increased food prices, due to adverse weather conditions, a recent trucker strike, and the depreciation of the peso. Private consumption growth has slowed as employment growth moderated and consumer confidence weakened.

Colombia

OECD Economic Outlook 97 database; and OECD National Account Database.

Statlink http://dx.doi.org/10.1787/888933220932

Monetary policy is supportive but public spending growth is slowing

The monetary policy rate has remained at 4.5% since September 2014, despite the recent surge in inflation. This monetary support is appropriate given economic uncertainties, since the increase in inflation is mainly due to transitory factors and inflation expectations remain close to the 3% target. Reducing agricultural trade barriers would curb the impact of local weather conditions on food prices.

Colombia: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222410

As resource-related revenues fall, public spending will be reduced to achieve budget balance targets in 2015 and 2016. Colombia’s fiscal rule allows for automatic stabilisers, but as the decline in oil and coal prices might be permanent adjusting spending is appropriate. However, public investment in transport infrastructure needed to remove bottlenecks should not be cut. A structural tax reform is needed to raise more revenues, reduce the tax burden on investment to support growth outside the commodity sector, and decrease informality and inequalities.

Structural reforms would facilitate the adjustment process and would make growth more inclusive. Fostering competition in product markets such as telecommunications, food and the retail sectors will boost productivity. More competition in banking would reduce financing costs. Reforming the minimum wage, reducing non-wage labour costs and more skills investment are needed to curb labour informality and reduce inequality. A structural pension reform to increase pension coverage is needed to reduce still high old-age poverty.

Growth will weaken as structural constraints slow adjustment

Growth will be reduced by the gradual rebalancing of investment and employment towards non-commodity exports and tradables that compete with imports. This will reduce the dominance of oil and mining exports, now 70% of total exports, in a healthy adjustment. Investment is projected to gain some momentum towards the second half of 2016 and lower employment growth will contain private consumption growth. The current account deficit will widen in 2015 but then gradually narrow again as competitiveness improves and external demand from neighbouring oil-exporting countries picks up. Inflation is projected to move closer to the target due to increased economic slack and the fading effects of the weaker currency and food-price shocks related in part to the drought caused by the El Niño phenomenon. The drought will also affect output negatively by reducing agricultural production and energy supply.

The evolution of global oil and coal prices, and of external demand from the United States and China, could significantly alter short-term prospects. The large current account is a vulnerability, but this is mitigated by good capital market access, the flexible exchange rate regime, a prudent debt composition and contingent credit lines. Successful execution of the transport infrastructure programme is key to the economic rebalancing. Better climate conditions should the drought ease would raise growth and lower inflation.

Domestic demand is driving the expansion

Strong domestic demand growth in 2014 is set to continue in 2015. Public investment has risen as EU structural funds that will expire in 2015 are being spent. Business investment is also recovering. Household spending on durable goods has turned up, likely reflecting higher consumer confidence and pent-up demand. In addition, exports are benefitting from stronger trading partner growth and market share gains. Year-on-year headline inflation fell to 0.1% in the first quarter of 2015, due to falling energy and food prices. But core inflation has continued to rise and inflation expectations appear well anchored.

Czech Republic

Data refer to private non-residential and government fixed capital formation.

Manufacturing sector.

OECD Economic Outlook 97 database; and OECD, Main Economic Indicators Database.

Statlink http://dx.doi.org/10.1787/888933220946

Policy settings are supporting growth but could be augmented by further structural reforms

Monetary policy remains very accommodative. The policy rate has been close to zero since late 2012 and the exchange rate floor for the koruna (against the euro) has prevented an appreciation. The Czech National Bank has committed to maintaining the floor until at least mid-2016, but it should be removed when upward pressure on the currency no longer poses a severe deflationary threat. The policy rate is expected to remain unchanged throughout 2015 and 2016.

Czech Republic: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222128

Fiscal policy is also supporting growth. Public investment rose by almost one-fifth in 2014, and a further increase is expected in 2015 before some of the available EU structural funds expire. If funds are spent well, the investment in infrastructure and innovation should lift productivity. Fiscal policy is expected to tighten slightly in 2016. Government finances will continue to benefit from very low borrowing costs. Nonetheless, further steps should be taken to secure fiscal sustainability, including creating an independent fiscal council, as is currently proposed, and containing ageing-related spending.

Structural reforms that reduce barriers to competition and improve the business environment would support the upswing in investment. Reforms that reduce skills mismatches in the labour market and increase the participation of women, minorities and older workers, would help boost potential GDP and make growth more inclusive.

The expansion will be robust

Private sector demand growth is being driven by rising confidence and incomes, as well as easing credit conditions and the temporary boost from lower oil prices. As the unemployment rate falls further, stronger wage growth will support household incomes. Investment will contribute to growth in both years, boosted by higher public investment in 2015 and rising business capital spending in 2015 and 2016. However, the overall pace of investment growth will slow in 2016. Stronger external demand will drive ongoing growth in exports. Rising cost pressures and margin re-building will push up inflation in 2015 and 2016.

Stronger business sentiment than assumed could drive investment higher than expected. This could occur if the recent surge in European car sales were to be sustained. Government investment could also be stronger than projected. On the downside, if wage growth does not pick up further or households’ renewed optimism proved fleeting, consumption could be lower than projected. Exports could be lower if the euro area recovery was slower than expected or if gains in export market share were not realised.

Recovery has gained ground

The recovery of the Danish economy took hold last year. Foreign trade strengthened and export of sea freight services is picking up. Housing investment has increased markedly, linked to the recovery in the housing market, related tax incentives and historically low interest rates. With unemployment edging down and employment improving, private consumption has also firmed up. Consumer price inflation is about zero, but core inflation and wage growth are positive. Consumer confidence has reached record high and retail sales have been on an upward trend, signalling further upswing of household spending in the near future.

Denmark

OECD Economic Outlook 97 database; OECD Monthly Economic Indicators Database; and Statistics Denmark.

Statlink http://dx.doi.org/10.1787/888933220958

Supportive domestic policies combined with improved external environment provide a boost

Private consumption is supported by favourable financial conditions, wage growth and recovering house prices. A firming domestic and world-wide outlook, increasing capacity utilisation and high savings surplus in the corporate sector should lead to recovery of business investment, although there is some uncertainty on this score given the persistent weakness of investment in many advanced economies. Stronger competition in domestic services sectors that remain heavily regulated could help to boost investment opportunities as well as productivity growth. At the same time, high public investment will slowly decelerate, as the authorities move towards a broadly neutral fiscal policy. Recent developments in unit labour costs, that are growing more moderately than in the past, and improved trade prospects, should boost exports.

Denmark: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222134

Structural and fiscal policies should lean against the cycle

In defence of the euro-krone peg, the central bank decreased the main deposit rate further into negative territory earlier this year, further easing already very supportive financial conditions. Monetary policy is assumed to maintain this stance throughout the projection period. This feeds particularly into the housing market, where strong price increases are already apparent in the capital and some other urban areas. As these pressures are likely to continue, the authorities should bring forward a restoration of the link between property value and taxation (property values have not been updated since 2002), which is planned for 2020.

Significant one-off government revenues (related to the tax treatment of pensions) used in recent years have come to an end and, combined with lower revenues from North Sea production, this will result in worsening of the public finance deficit. The authorities have set a medium-term goal of ‘at minimum’ a structural balance by 2020. Fiscal policy should move to a neutral stance earlier to ensure this objective as the economy continues to recover. Prudent fiscal stance is important to cope with future spending pressures related to ageing while maintaining the current welfare system and low levels of inequality.

Stronger demand underpins the recovery

Output is projected to accelerate in 2015 to 1.9% and to 2.3% in 2016. The recovery reflects strengthening private consumption, private investment and foreign trade. Inflation is projected to rise slightly towards the end of the projection period. Public investment is set to decrease slowly while business investment, both non-residential and housing, is projected to pick up. As growth rises, and as recent benefit reforms take hold, both employment and the labour force are projected to rise, leaving the unemployment rate broadly unchanged.

There is some uncertainty about the projected pick-up in investment and private consumption. The investment ratio of the Danish corporations has been low for some years now. Allowing for more competition in domestic services sector, notably in retail trade, pharmacies, taxis and professional services would improve investment opportunities. Household consumption depends on the extent of debt reduction, house price and interest rate developments. Denmark is a trading nation, and its prospects therefore depend on the evolution of its export markets. A stronger pass through of supportive domestic financial conditions could raise domestic demand growth more than projected.

Economic activity is being subdued by weak investment and export growth

Economic growth was weak at the beginning of 2015 as export growth decelerated owing to weakness in some of Estonia’s main trading partners, including Finland and Russia (which account for 15% and 10% of Estonia’s exports). Business investment is being held back by subdued confidence, in part due to heightened geopolitical tensions, and low capacity utilisation. Public investment has also weakened: transfers from the EU are lower this year and next, as the selection of projects for the new EU multi-annual budget period is only starting; and investment projects financed via earlier sales of Kyoto permits are being phased out. However, private consumption continues to grow vigorously, underpinned by real wage gains, declining unemployment and low interest rates. Lending to the private non-financial sector has been moderate, although international financial market confidence in Estonia’s economy is strong, as reflected by low long-term interest rates.

Estonia

Real gross fixed capital formation. Four-quarter moving average.

Average nominal wage per employee, seasonally adjusted.

OECD Economic Outlook 97 database.

Statlink http://dx.doi.org/10.1787/888933220960

Competitiveness is broadly unchanged. The depreciation of the euro affects Estonia’s exports only moderately, as most of its trade is within the euro area and the currencies of Sweden and Russia, two important non-euro area trading partners, also depreciated. Wage growth remains high, offsetting the effects of depreciation on competitiveness. Wage growth has been fuelled by skill mismatches and demographic ageing. Emigration of young workers also contributed, though diminishing recently. The lower global oil price has reduced costs, but also the profitability of the domestic oil shale industry.

Estonia: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222146

Fiscal and structural reforms are supporting growth, but more energy-saving investment is needed

Fiscal policy is expansionary. The government raised spending on child and family cash benefits and free school meals at the beginning of 2015, and cut the income tax and unemployment insurance contributions rates. These measures have been partly financed by some broadening of the VAT tax base, as well as by higher tobacco and alcohol taxes.

A number of recent structural reforms aim at raising growth prospects and macroeconomic stability, and may begin to show first results already during the projection horizon. The government has implemented reforms to make the R&D system more effective, including through a new innovation strategy and by strengthening co-ordination across ministries. The government has also taken substantial steps to improve vocational education, including by upgrading the technical equipment in vocational schools. The new macro-prudential policy framework, established in 2014, allows the Estonian central bank to take action, for example if low interest rates risk result in excessive lending. Steps to address gender imbalances in pay and improve women’s career prospects in business leadership would help reduce shortages of skilled labour and raise productivity.

More investment in energy efficiency can reduce environmental damage, and its economic costs, and bolster innovation. Greenhouse gas emissions per unit of GDP remain among the highest in the OECD, largely due to the use of domestic oil shale. High emission intensity makes activity vulnerable to rising CO₂ emissions prices in the European emissions trading system. Estonia can do more to improve energy efficiency in district heating and buildings and promote the processing of oil shale into lighter oil products. Also, taxation of the various energy sources should be harmonised according to their CO₂ emission content.

Domestic demand is projected to drive growth

Economic growth is projected to strengthen gradually. Household consumption will continue to grow strongly, fuelled by decreasing unemployment and solid wage growth. Weakness of some of Estonia’s main trading partners continues to weigh on export growth. Investment will strengthen slowly as capacity utilisation improves. Inflation is projected to increase slowly, damped by low global commodity prices and the negative output gap. The government’s budget balance is projected to remain in surplus.

Risks are broadly balanced. Heightened geopolitical tensions, notably regarding Russia and Ukraine, may further damp private sector confidence and trade. On the downside, private investment could recover faster than projected, for instance if plans to boost cross border infrastructure gain traction. The newly elected government has announced further reductions in labour taxation which may provide additional growth stimulus if implemented during the projection horizon.

A moderate upswing has set in

A moderate economic upswing continued in the first half of 2015 as domestic and external demand firmed. Still, business investment remains sluggish. Following significant recessions, some vulnerable economies now have quarterly growth rates above the area average. Unemployment is slowly declining from high levels, but still exceed pre-crisis levels by wide margins. Germany remains the main exception. In many countries, youth unemployment rates are at least twice the rate of the average. Still-high margins of economic slack and past declines in oil and food prices have kept inflation very low.

Euro area

Interest rates on new loans to non-financial corporations (all maturities) except for Greece (maturity up to one year).

European Central Bank; and OECD Economic Outlook 97 database.

Statlink http://dx.doi.org/10.1787/888933220978

Highly expansionary monetary policy needs to go hand in hand with further structural reform

Subdued confidence, reflecting uncertainty about the underlying strength of the euro area economy and world economic prospects, is still weighing on economic activity and, notably, business investment. High private debt and unemployment are also restraining household demand. However, the large oil price decline and euro depreciation from earlier highs are boosting growth. The oil price effect alone could add about 0.2 percentage point to GDP growth this year and next.

Euro area: Employment, income and inflation

Statlink http://dx.doi.org/10.1787/888933222040

Moreover, a number of fundamental factors have improved. Internal euro area rebalancing has progressed, supported by fiscal consolidation, adjustment in unit labour cost and improved export performance of vulnerable countries. All vulnerable countries now have current account surpluses, although it will require many years of strong current account positions to reduce their large foreign debt.

Euro area

OECD Economic Outlook 97 database.

Statlink http://dx.doi.org/10.1787/888933220983

Structural reforms in vulnerable countries in recent years have been significant. However, there remains ample scope for competition-friendly reform to help further restoring competitiveness and resource reallocation, thus raising economic potential and making growth more inclusive. The core euro area countries can contribute to strengthening economic activity by reducing entry barriers in their service sectors. The euro area is still subject to various significant barriers affecting key areas such as entrepreneurship, labour mobility and energy efficiency. Completing a genuine Single Market could contribute substantially to boosting medium-term growth.

Euro area: Financial indicators

Statlink http://dx.doi.org/10.1787/888933222055

Financial conditions have improved. Credit to the private sector is gradually recovering as banks have begun relaxing their tight lending standards for loans to enterprises and non-residential loans to private households. Bank capitalisation has also increased, although non-performing loans are still high in many countries. The ECB’s 2014 comprehensive assessment of banks’ balance sheets should also contribute to further improvement in lending conditions as it reduced uncertainty.

Euro area: Demand and output

Statlink http://dx.doi.org/10.1787/888933222069

The European Central Bank has embarked on a large open-ended asset purchase programme to move inflation back up towards its target. This policy has reduced interest rates and triggered a substantial depreciation of the euro, both of which are projected to increase euro area growth. However, such expansionary monetary policy poses risks for financial stability and macro-prudential measures will be important to help contain them.

Euro area: External indicators

Statlink http://dx.doi.org/10.1787/888933222074

Fiscal policy is set to be roughly neutral this year and next, which is appropriate as the recovery is still weak and significant consolidation gains have already been achieved in past years. However, strong fiscal positions will need to be maintained to reduce public debt ratios relative to GDP, and this will be made more difficult if spending pressures associated with population aging are not addressed. This requires credible and detailed multi-annual fiscal plans at the national level. The credibility of the EU fiscal governance framework should also be strengthened, with simplified fiscal rules.

Growth will firm gradually

GDP growth is projected to strengthen gradually to 2¼ per cent in 2016. Unemployment will decline only gradually, to a rate of 10¼ per cent end-2016, and inflation is projected to edge up to around 1½ per cent.

Risks are broadly symmetrical around the most likely scenario represented by these projections. Growth will depend on the evolution of the euro exchange rate and global energy prices, which could come in weaker or stronger than assumed. The effectiveness of, and risks associated with, the ECB quantitative easing programme are uncertain. More rapid progress in structural reform or stronger accelerator effects for investment would boost growth relative to the projection. Intensified geopolitical risks or insufficient progress on structural reforms could undermine confidence and weaken investment and activity overall. Uncertainty surrounding Greece poses a unique set of risks.

Output has contracted further

Real GDP declined in 2014 for the third consecutive year. Private consumption edged down and residential investment fell substantially, reflecting low consumer confidence as unemployment rose and real income growth remained weak despite lower energy prices. Total investment is now at its lowest level since 2000. Business investment plummeted, as ample spare capacity and uncertainties persisted, and public investment rose only modestly. Exports also shrank, but falling domestic demand meant that imports fell even more.

Finland

OECD Economic Outlook 97 database.

Statlink http://dx.doi.org/10.1787/888933220993

Policy makers face tough challenges and need to implement structural reforms

The government deficit exceeded 3% of GDP in 2014, and gross public debt (Maastricht definition) will move above 60% of GDP in 2015. Negative economic growth has undermined revenue, while expenditure has risen rapidly, not least owing to population ageing. As the economy remains weak, fiscal consolidation needs to proceed gradually. Structural reforms to contain age-related spending and enhance the efficiency of public services, notably in health care, will be critical to ensure fiscal sustainability over the long term.

Finland: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222156

In the face of demographic drag, mobilising labour resources is essential to boost growth. The employment rate is low compared with other Nordic countries, notably for youth and older people. Pension reform needs to push up the effective retirement age, by linking the minimum retirement age and pension benefits to life expectancy and continuing to limit opportunities for early retirement. Labour market reforms to enhance work incentives and stronger activation policies would raise employment. Beyond lifting potential output, pushing up employment would help to make growth more inclusive. Regulatory reforms to increase competition in retail trade and transport would boost the growth potential. Implementing this set of structural reforms would in turn contribute to fiscal sustainability.

Growth is projected to pick up

Exports will be the main source of growth in 2015, although domestic demand is also gathering momentum. The boost from a brighter global environment and the weaker euro is partly offset by the slump of the Russian economy. As wage moderation is necessary to improve competitiveness, household income growth is sluggish, leading to a slow recovery in private consumption and residential investment despite very low interest rates. Business investment, although damped by ample spare capacity, is projected to bottom out in 2015, with large-scale projects in the forest industry and the improving global economic outlook reviving capital spending thereafter. Public investment will be bolstered in 2015 by spending on transport, energy and water supply infrastructure. It is set to slow in 2016, partly because of tightening fiscal constraints.

Risks are mainly related to export developments. On the upside, improvements in cost competitiveness through wage moderation and the weak euro could boost exports more than expected. A stronger-than-expected recovery in global investment would benefit Finland’s exports, which are skewed towards capital goods. A pick-up in exports would also help revive domestic investment as spare capacity is worked off. On the downside, Finland’s loss of market share, largely related to non-cost factors, could continue. A further deterioration in the economic situation in Russia would also hurt Finnish exports.

External conditions have improved

France is benefitting from a modest expansion, sustained by improving external and financial conditions. Exports picked up at the end of 2014 on the back of stronger world trade, and consumption rose in the first quarter, driven by income effects stemming from lower oil prices and weather-induced demand for energy. The rise in unemployment has slowed, mainly due to subsidised jobs in the non-market sector targeted at youth and the low skilled. However, high unemployment and ample economic slack have pushed inflation down further, despite very accommodative euro area monetary conditions.

France

Harmonised.

OECD Economic Outlook 97 database.

Statlink http://dx.doi.org/10.1787/888933221001

Euro depreciation is boosting French exports directly and strengthening France’s euro-area export markets. The trade deficit is now around 1.6% of GDP, compared to a peak of 3% of GDP in 2011. Lower energy prices are also raising both domestic demand and demand from export markets. At the same time, household confidence and the business climate have improved considerably, although both indicators remain below their longer-term averages. Private consumption has started to recover gradually, even though high unemployment led to an increase in precautionary saving in 2014. Business investment should follow as credit supply conditions ease further and uncertainty about demand and the reform agenda dissipates. Temporary national fiscal measures in 2015-16, a raft of structural changes designed to boost profitability (see below) and the Juncker plan for leveraged EU-wide investment in 2016 should also help kick-start business investment.

France: Employment, income and inflation

Statlink http://dx.doi.org/10.1787/888933221907

The pace of fiscal consolidation has eased

Fiscal imbalances have diminished, but further efforts will be necessary to ease the tax burden and put public debt on a firmly declining trend. The amount of structural consolidation over 2015-16 is set to fall to 1% of GDP, which is broadly appropriate given the weak recovery. On the spending side, low interest payments on public debt and the 2010 pension reform will bring some savings, as will the continuing freeze in base wages of central government civil servants and efforts to moderate health-care expenditures. However, these savings will be partly offset by the gradual ramping up of the competitiveness tax credit (CICE), which reduces labour costs on low and medium wages. At the same time, reductions in personal income tax for low-income households, in employers’ social contributions on earnings and a moderate corporate tax cut are expected to depress government revenues.

France

Goods and services.

In volume.

OECD Economic Outlook 97 database.

Statlink http://dx.doi.org/10.1787/888933221019

The labour market should be the priority for structural reforms

Improving the labour market, simplifying administrative and regulatory procedures and further decreasing public spending as a share of GDP over the medium term are key to improving growth prospects, confidence and investment. The CICE and cuts in social contributions from the Responsibility and Solidarity Pact will lower labour costs by around 1.4% of GDP once fully effective in 2016. These measures will enhance international competitiveness though they may be partly offset by dynamic wage increases despite significant economic slack. Restoring competitiveness and improving productivity require more ambitious structural reforms, including further public spending restraint over the medium term to provide the fiscal space to cut taxes. Ongoing efforts to lighten the regulatory burden and increase competition are welcome and reinforce the effects of labour cost and business tax cuts. But they need to be taken significantly further. Skills have to be improved to foster long-term growth and to make growth more inclusive. In particular, the government should expand significantly apprenticeships in secondary education and develop an efficient quality-insurance system for adult training providers as planned.

France: Financial indicators

Statlink http://dx.doi.org/10.1787/888933221912

The recovery will be led by exports and consumption

Improved financial conditions, the euro depreciation, income effects from lower energy prices and the slowing pace of fiscal consolidation should strengthen exports and private consumption growth. As uncertainties dissipate somewhat, a gradual acceleration in business investment will place the expansion on a sounder footing. The unemployment rate will edge up a little more before starting to decline slowly in the latter part of 2015. The current account deficit should continue shrinking as the energy import bill drops and France’s export market share recovers moderately with euro depreciation and better cost competitiveness.

France: Demand and output

Statlink http://dx.doi.org/10.1787/888933221921

There are several risks around the central projection. The programme of structural reforms could raise confidence more than assumed, boosting consumption and business investment. The euro area quantitative easing could trigger further currency depreciation, increasing demand from key export markets. Additional declines in oil prices would also have significant positive income effects. And the household saving rate remains high, allowing for a potential boost to private consumption once the turnaround takes hold. On the other hand, if structural reforms are poorly communicated or weakly implemented, and prove insufficient to restore confidence, the recovery could flag. In addition, the impact of low business profitability, housing market contraction and policy uncertainty could be larger than expected, while a higher-than-assumed exchange rate and oil prices would weigh on activity.

Household demand has sustained economic growth

Industrial production was weak in the first quarter, held back by subdued demand in major trading partners, notably in the euro area as well as in China and Russia. Activity expanded vigorously in services, boosted by household demand, which is growing on the back of real wage growth and lower oil prices. Wage growth has strengthened recently, as the labour market is tightening. The minimum wage of EUR 8.50 per hour is expected to raise wages by about ½ percentage point, mostly in 2015. The number of minijobs (low pay employment contracts with limited social security coverage and lower taxes) has fallen since the introduction of the minimum wage, as more workers on minijobs have moved to standard employment contracts. Employment has continued to grow, absorbing the substantial inflow of immigrants. The already low unemployment rate has continued to fall somewhat.

Germany

Four-quarter moving average. Based on nominal series.

OECD Economic Outlook 97 database; and Deutsche Bundesbank.

Statlink http://dx.doi.org/10.1787/888933221025

Historically low interest rates have strengthened residential investment, which grew by 4% in 2014. Nonetheless, lending growth has remained modest. House prices are rising more slowly and, on average, remain broadly aligned with fundamentals. Business investment has picked up somewhat recently, supported by high profitability and strong business balance sheets. However, the fixed investment share in GDP remains close to historic lows and spending on knowledge-based capital remains well below levels in leading OECD economies. Both of these factors have weakened productivity growth.

Germany: Employment, income and inflation

Statlink http://dx.doi.org/10.1787/888933221878

Exchange rate depreciation is boosting activity but uncertainty about structural policies to deal with long-term challenges and gaps in infrastructure hold back investment

Recent exchange rate depreciation has improved the competitiveness of German exports with respect to economies outside the euro area, to which 65% of German exports are directed. The effect on overall competitiveness is only partly offset by strong wage growth, which is raising unit labour costs in Germany more quickly than elsewhere in the euro area. Demand in euro area export markets is expected to recover gradually, although this is partly offset by weaker demand growth in emerging economies, notably China and Russia. The relatively muted recovery of foreign demand for investment goods, on which German industry is specialised, may also keep foreign demand growth lower than in previous global recovery periods.

Germany

Population aged 15-74 years. Based on the German labour force survey.

Percentage of unfilled job vacancies relative to total employment.

Average nominal wage per employee.

Harmonised consumer price index. Core HICP excludes energy, food, alcohol and tobacco.

OECD Economic Outlook 97 database; and Statistisches Bundesamt.

Statlink http://dx.doi.org/10.1787/888933221039

Planned fiscal policy measures, mainly transfers to households, are expected to reduce the government budget surplus by 0.6 percentage point of GDP, mostly in 2015. More generous pension entitlements for some groups, additional funding for long-term care benefits, childcare benefits and child tax allowances account for about 0.3% of GDP of spending. Government investment spending for transport infrastructure investment, childcare facilities, universities and other research institutions will increase by 0.1 percentage point of GDP. Further improvement in childcare provision, including in its quality, and further investment in transport infrastructure would have benefits in terms of higher long-term inclusive growth. The recent pension reforms have also created incentives for workers with long contribution records to retire before the legal retirement age, contributing to shortages in the supply of skills.

Germany: Financial indicators

Statlink http://dx.doi.org/10.1787/888933221884

Lower oil prices, rising capacity utilisation, stronger export prospects and pent-up investment demand provide favourable conditions for business investment. However, survey evidence suggests that the share of German businesses intending to invest abroad has risen, especially in regions with dynamic growth prospects, such as the United States and Asia. Still, policy uncertainty remains significant, damping investment. Uncertainty about macroeconomic and financial policies within the euro area is likely to play a significant role. Uncertainty about which policies will be adopted to deal with domestic long-term challenges may also hold back investment. These include achieving long-term CO₂ emission targets and dealing with the economic challenges of ageing. Bottlenecks in domestic infrastructure, notably in telecommunications and transport, damp business investment in physical and knowledge-based capital, for example on information and communication technology.

Germany: Demand and output

Statlink http://dx.doi.org/10.1787/888933221895

Growth is projected to strengthen further on the back of a robust labour market and strengthening exports

Growth is projected to strengthen in 2015 and 2016, initially mostly driven by private consumption. Exports and business investment will gain momentum gradually. Consumer price inflation is projected to remain close to zero in 2015, reflecting lower oil prices, but will rise in 2016. The unemployment rate, already the lowest in the European Union, is expected to fall somewhat further. Strong tax revenue growth will allow the government surplus to rise. Lower oil prices as well as stronger exports and net foreign capital income will raise the current account surplus.

Renewed financial market turmoil in the euro area would weaken exports and domestic investment. Germany is significantly exposed to geopolitical tensions, notably in eastern Europe. On the other hand, recent policy action by the European Central Bank could reduce uncertainty about macroeconomic prospects in the euro area substantially, boosting exports and the attractiveness of Germany as a location to invest.

Growth has very slowly turned around

Following a very deep recession, activity gained some momentum in 2014 due to a good performance in tourism, a rebound in private consumption and investment, and better business and consumer confidence. The unemployment rate started to decline but remains very high at 26%. Consumer inflation remains negative, reflecting large excess capacity, cuts to indirect taxes and rent-reducing product market reforms. Unit labour costs continue to decline but the gains in competitiveness have failed to boost exports much due to remaining barriers to competition and transport.

Greece

Unweighted average of data for manufacturing industry, construction, trade and business-related services.

OECD Economic Outlook 97 database; and OECD National Account Database.

Statlink http://dx.doi.org/10.1787/888933221048

Public debt is above 175% of GDP and remains extremely high. While debt service is relatively low, large debt principal payments pose a short-term risk to macroeconomic and financial stability. Fiscal consolidation brought the primary surplus to 0.4% of GDP in 2014 and the fiscal deficit down to 3.6%. This was, however, short of target, as tax collection remains a challenge. Non-performing loans in the banking system continue to restrain credit growth and uncertainty regarding the agreement with creditors has led to large deposit withdrawals in recent months.

Greece: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222169

More structural reforms are needed to foster inclusive growth

Fiscal consolidation will moderate, even as the government appropriately aims at a small primary surplus. Further reforms to enhance the efficiency of public administration and the composition of consolidation can mitigate the growth impact of fiscal restraint and also can make growth more inclusive. A tax reform is needed to tackle tax evasion and increase revenues. A broader well-designed social safety net would help the most vulnerable and sharing the costs and benefits of adjustment more fairly. Reforming the pension system by limiting the special regimes of some professional groups would enhance fiscal sustainability and reduce inequalities.

If Greece fails to address non-performing loans in the banking sector, credit conditions can deteriorate further, reducing investment and consumption growth. A significant amount of non-performing loans could probably be recovered from the private sector, whose leverage is relatively low. Streamlining bankruptcy procedures and enhancing outside-court settlements would help resolve the non-performing loans problem. Reducing regulation in network industries, especially in the energy and transport sectors, would boost competition, exports and job creation. The overall business climate also needs to be improved further.

Uncertainty weighs on growth prospects

Assuming an agreement with creditors is found, growth in 2015 will nonetheless remain weak. Investment and consumption growth will be undermined by deteriorating credit conditions and low confidence. Gains in competitiveness will not be enough to boost exports in the absence of structural reforms to lower barriers to trade and investment. In 2016, the recovery is expected to gain strength. Exports, especially tourism, and investment will benefit from structural reforms and from the recovery in the euro area. Inflation will still be negative in 2015 reflecting large excess capacity but is likely to edge up gradually in 2016 with the economy recovering.

Implementation of reforms remains a challenge and failure to do so will hurt growth. By contrast, strong and credible implementation of reforms would boost growth. Exports can be higher than expected as the impacts of competitiveness gains may be underestimated. A threat hovering over the projection is the possibility that Greece will not arrive at a satisfactory agreement with official creditors. In the short term, at least, such an outcome would cause a significant contraction in output as well as household incomes.

Growth has been strong and broad-based

The Hungarian economy has continued to enjoy strong and broad-based growth going into 2015. Exports are benefitting from expanded car-making capacity, gradually improving economic performance in Europe and euro depreciation, as major exporters are well inserted into the supply chains of German firms selling to the rest of the world. Investment growth has remained robust, if decelerating, as the surge in EU−funded public investment will soon run its course. Compensation to households paid by banks (for past unilateral interest rate hikes and differences between buying and selling exchange rates), mandated by law, is spurring private consumption. In addition, an import financial risk for households was removed with the forced conversion of foreign to domestic denominated mortgage debt. Lower energy prices have further supported real incomes, but also resulted in a temporary bout of deflation. The size of the public works programme has been kept broadly stable, but is set to expand again, and the decline in unemployment has slowed since mid-2014.

Hungary

Year-on-year percentage change series cover transactions only. Lending to households refer to seasonally unadjusted data with rolling exchange rate adjustment. FGS: Funding for Growth Scheme.

OECD Economic Outlook 97 database; and Magyar Nemzeti Bank.

Statlink http://dx.doi.org/10.1787/888933221050

Monetary and fiscal policies remain supportive but structural reforms are needed

In March, the central bank resumed cuts to the policy rate, which had been stable since last July. Furthermore, the authorities extended again the Funding for Growth Scheme, which provides banks with free central bank refinancing for lending to SMEs, by another 1.5% of GDP, and added a new feature of limited risk-sharing with the central bank for losses on loans. After strong expansion in 2014, the fiscal stance is projected to ease slightly further in 2015, and then remain broadly neutral in 2016.

Hungary: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222174

The authorities have committed to a gradual reduction of the levy on financial institutions’ balance sheets, starting in 2016, and more broadly to providing a better operating environment for the sector. A central bank-owned agency is also to start buying bad commercial real estate loans and properties from banks later this year (up to 1% of GDP), thus speeding up the process of strengthening banks’ portfolios. Implementation of these steps should help unclog lending. However, investment in mainly non-tradable sectors, such as energy and retail, remains hampered by restrictive and frequently changing regulation. Structural reforms aimed at further lowering the internationally high tax wedge on low salaries would bolster job creation and would make growth more inclusive.

Growth will decelerate somewhat

As stimulus to consumption and investment fades, growth is projected to moderate, although to remain quite strong. Exports will remain the most dynamic demand component, and the large current account surplus will rise further. Unemployment is expected to decline slightly further over the projection horizon and, as the effects of cheaper energy wane, inflation will gradually converge to the 3% target.

Forint depreciation has become a smaller downside risk than in the past, due to a decline in foreign-currency indebtedness (in part due to large-scale conversion of foreign-denominated loans into forints) and to the weakness of the euro. The growing specialisation of manufacturing in the automobile sector is now strengthening growth, but could increase output volatility. A better operating environment for banks could result in faster credit growth than assumed, increasing domestic demand growth.

The economy is running out of spare capacity

The Icelandic economy has performed well and in 2014 real GDP returned to its pre-crisis level. The composition of growth has more recently switched towards domestic demand as investment and private consumption have recovered from depressed levels. Progress in household deleveraging has been considerable thanks to special resolution measures, but indebtedness remains high for some families. With the economic recovery, the unemployment rate has fallen and the labour market has tightened, encouraging high wage settlements in the current wage bargaining round after widespread strikes in the private and public sectors. Capital controls remain in place; they may be distorting investment decisions and uncertainty about how they will be eased is probably damaging to investment.

Iceland

OECD Economic Outlook 97 database; and Statistics Iceland.

Statlink http://dx.doi.org/10.1787/888933221062

Monetary policy needs to tighten, fiscal policy to remain neutral and structural policy to lift investment

Monetary policy faces challenges. Inflation expectations are not well anchored in Iceland. Accordingly, they declined in line with energy prices, but may be rising again. The central bank has consistently warned against granting excessive wage demands and indicated that it will raise interest rates if wage increases risk rekindling inflationary pressures. As large pay awards are being granted, the central bank will likely react firmly.

Iceland: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222188

Fiscal policy has made considerable progress in moving towards an overall budgetary surplus and bringing down debt. The government policy of reducing mortgage-related debt will support household consumption in 2015. However, with risks of the economy overheating, fiscal policy should not relax further but rather continue to bring down still-high public debt and contingent liabilities. Reducing the size of the government balance sheet as planned by selling shares in Landsbankinn, a state-owned bank, and using the proceeds to retire expensive government financial liabilities would be helpful in this regard.

Structural reforms can help lift investment by reforming product market regulation, such as by reducing the number of licences and permits required and relaxing legal barriers to entry in certain sectors.

Output growth is strong

With support from fiscal policy and recovering asset prices, private consumption is set to grow strongly in 2015. Investment is picking up, driven by a recovery of residential investment and the beginning of new investments in the energy-intensive industries. Inflation will pick up as domestic inflationary pressures mount, which is assumed to provoke a rise in interest rates to cool the economy. As a consequence, the unemployment rate will edge up. Fiscal policy should nonetheless remain on target to record central government surpluses in both 2015 and 2016.

Large increases in negotiated minimum wages could push up inflation before monetary policy begins to regain control. The needed lifting of capital controls could also involve financial turbulence with knock-on effects on growth. On the other hand, greater wage moderation, progress in lifting capital controls in an orderly way and a pick-up in investment would boost growth.

Growth is driven by public and private consumption

India has become one of the fastest growing countries in the world. Growth, which was substantially revised upwards by the adoption of the new national accounts methodology, has been driven by public and private consumption. But investment and exports have languished, especially during the last two quarters of 2014.

India

Year-on-year percentage changes; at market price in volume terms.

Central statistics Office; and Reserve Bank of India.

Statlink http://dx.doi.org/10.1787/888933221072

Inflation has continued to decline, reflecting lower oil and commodity prices, subdued Minimum Support Price increases, and low agricultural wage increases. Headline CPI inflation has fluctuated around 5% since the end of 2014, about half its average since 2008, and core inflation is falling, reflecting second-round effects from lower oil prices. Inflation expectations have also started to fall.

India: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222373

External vulnerability has declined. The current account deficit has shrunk, due to the drop in oil and commodity prices and lower gold imports, but also to weak investment. The rupee has appreciated in real effective terms and exports have been weak. The deficit was fully financed by net foreign direct investment flows late in 2014. Portfolio, in particular debt, inflows have also boomed but India’s overall foreign liabilities as a share of GDP remain low compared to other emerging economies. Foreign exchange reserves have been replenished.

India

FII stands for foreign institutional investor.

Central Statistics Office; Securities and Exchange Board of India; and Reserve Bank of India.

Statlink http://dx.doi.org/10.1787/888933221085

Policies are becoming more favourable to investment

The combined deficit for the central government and states remains high but its composition is improving. The government abolished diesel subsidies and hiked energy taxes in 2014, as international oil prices declined. In its FY 2015-16 Budget, the central government postponed fiscal consolidation and set out plans to increase infrastructure investment, notably in transport. The government also envisages cutting the corporate income tax rate from 30 to 25% over the next four years. Together with the planned implementation of the GST (a common sales tax for all India) from April 2016, these measures should help boost corporate investment.

More reforms are needed to improve the effectiveness of public spending. Subsidies – in particular fertiliser, food and non-diesel energy subsidies – continue to absorb a significant share of public resources. Moving to better targeted and cash-based transfers should be a priority. The policy of granting a unique personal identification number and providing bank accounts to the poor will reduce subsidy leakages and improve targeting. Public spending could be redirected to social infrastructure, including public health care spending which remains very low. To pursue fiscal consolidation, the government will need to broaden the tax base and improve tax compliance.

The flexible inflation targeting framework for monetary policy has been formally adopted, strengthening the credibility of the Reserve Bank of India. The Bank has cut the repo rate twice since the start of 2015 to 7.5%, and the Statutory Liquidity Ratio (SLR) requiring banks to hold public bonds to 21.5% of their portfolio. However, real interest rates have increased, lending rates have been slow to adjust to cuts in repo rates, and credit growth has been anaemic. Monetary policy transmission would be improved by reducing the SLR further and addressing the rising burden of non-performing loans.

Structural reforms would boost investment and help reallocate resources towards more productive sectors. The recent auctioning of coal mines in public ownership, partial privatisation of Coal India and deregulation of FDI in several sectors should boost investment. More is needed. Streamlining bankruptcy procedures, which are very long, would reduce the backlog of non-performing loans, freeing banks to finance new projects. Reforming the land acquisition process and speeding up environmental and social clearances would also reduce delays in investment.

New efforts are required to make growth more inclusive. Labour laws are stringent and complex. De facto, most workers are not covered by core labour laws and social protection. Reforming and simplifying labour law would reduce barriers to formal and better employment, and help to ensure equal work opportunities for women. Extending female quotas to state and national parliaments and enhancing the implementation of existing laws against gender discrimination would raise the very low female labour force participation, thereby including women in economic and social life. Expanding the number of health professionals and raising public spending on health care, with a focus on rural areas and urban slums, which are underserved, would improve health outcomes for all.

Growth depends on progress in structural reforms

Growth is projected to remain strong. Industrial production is firming up. Survey data suggest that stalled investment projects are gradually being cleared, in particular in the electricity and transport sectors as well as in the manufacturing sector. Business sentiment and household confidence are improving. Overall, growth is projected to become more balanced, with a shift from consumption to investment, in particular for the public sector. The recovery in investment will boost imports while exports will benefit from better prospects from trading partners. Still, the rupee appreciation in real effective terms will weigh on trade performance. Inflation will remain subdued, although it may be volatile.

The economy could grow by more than 8% if ambitious structural reforms, in particular the GST, land acquisition and labour laws, were to be approved by the parliament. Poor weather conditions would depress rural incomes and demand, exacerbate poverty and put pressure on both inflation and the budget. The decline in external vulnerability could raise confidence and improve growth, but because some corporations remain highly leveraged and have large unhedged foreign positions, large exchange rate movements could undermine growth.

Activity remains sluggish

Weak domestic and external demand have both contributed to a continuing trend of slowing economic growth. Household consumption is supporting activity but has slowed in recent quarters. Both investment and exports have been sluggish, in part due to weaker commodity prices. Government expenditure has yet to recover, despite plans to ramp up spending on education and investment using the space created by recent fuel subsidy cuts.

Indonesia

Statistics Indonesia (BPS); OECD Economic Outlook 97 database; and Bank Indonesia.

Statlink http://dx.doi.org/10.1787/888933221095

The exchange rate has continued its trend depreciation, declining by a further 8% against the US dollar over the past six months. However, the currency has recently stabilised with the growing expectations of a delay in US rate hikes and a better-than-expected trade surplus in March, the largest in 15 months. This is the result of imports falling more quickly than exports in dollar terms, in large part reflecting lower energy prices. Weaker external demand is also putting a damper on growth in export volumes.

Indonesia: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222384

Inflation is abating, but monetary policy remains cautious

The spike in inflation, which was due to the almost complete removal of government fuel subsidies at the end of 2014, is now dissipating, but the effect of the depreciating rupiah and higher administered prices are keeping inflation high for the time being. In February, Bank Indonesia cut official interest rates by 25 basis points, as concerns mounted over slowing economic growth. However, in March core inflation exceeded the central bank’s target range (4% ± 1%) for the first time of late, and strong pressure remains on the exchange rate. No further cuts in official interest rates are assumed until 2016, when rates will need to be lowered to prevent prices from undershooting. The 2015 budget deficit is assumed to be 2.1% of GDP, slightly larger than in 2014. This mild expansion is sustainable and appropriate, and leaves room for further supportive measures, if needed, particularly measures targeting poverty and enhancing access to services for poorer households.

The backlog of much-needed structural reform is growing

The government has appropriately identified a number of priority areas for reform, including improving the business climate, boosting infrastructure investment and refocusing education. Infrastructure especially needs urgent attention, particularly in the areas of logistics and transportation. Bottlenecks in roads, rail and ports are holding back business investment and engagement in international trade. The government has committed a large part of the saving from the almost complete abolition of fuel subsidies last year to spending on public infrastructure investment. However, implementation is slow, and priority needs to be given to overcoming significant political, administrative and implementation impediments.

Growth is projected to pick up gradually

Economic growth is expected to pick up in the course of 2015 and strengthen further in 2016. The government’s plans to lift spending should get traction and help confidence to recover, boosting private consumption and investment. Moreover, the lower rupiah will lift net exports. Inflation is likely to remain elevated for some time as the recent currency weakness offsets lower energy prices.

Political impediments to the implementation of the government’s economic agenda constitute a major downside risk both in the short and long-term. Developments in the external sector continue to be highly uncertain, including weakening demand in major trading partners. That said, FDI inflows have been strong, and, if commodity prices recover, a rebound in private investment is likely, and this would raise growth. Moreover, if the currency remains weak, the rebound in exports may be stronger than expected.

Growth is becoming steady and broad based

The Irish economy grew by 4.8% in 2014, the fastest in the OECD. This reflected in part some temporary factors, such as rebounding from the patent cliff (the expiry of a number of drug patents) which weighted on exports and growth in the previous year. Exports have sustained the recovery so far, owing to the outstanding performance of highly productive multi-national companies and to improved cost-competitiveness.

Ireland

OECD Economic Outlook 97 database; Central Bank of Ireland; Central statistics office, Ireland; and European Central Bank.

Statlink http://dx.doi.org/10.1787/888933221103

Domestic demand contributed to growth in 2014 for the first time since the crisis. Business investment has increased as firms rebuilt their capital stock. Both employment and wages, which had gone through significant downward adjustments, began to increase steadily, while the unemployment rate has fallen from its high level. The growth of household disposable real income turned positive, and household consumption is picking up.

Ireland: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222190

There will be less fiscal drag than in previous years and financial conditions have improved

Thanks to strong economic growth, the fiscal deficit is projected to decline to 2.5% of GDP in 2015, but then only slightly more in 2016. Under current plans, public debt should decline gradually relative to GDP. Nevertheless, it will still be well over 100% of GDP in 2016, and therefore fiscal gains from strong output growth and low interest costs should be used for more rapid debt reduction.

Financial conditions have improved on the back of monetary easing. The banking sector returned to profitability in 2014, improving its capacity to provide new lending. However, the private sector has to further reduce its still-high debt. Non-performing loans are also still a problem, especially in the SME sector.

The economy will grow robustly and structural policy should make growth more inclusive

Growth is expected to be robust and broadly based with inflation gradually rising. Exports will continue to be strong due to increasing demand in trading partners. The depreciation of the euro will help, in particular regarding exports of traditional goods to the UK market which are produced mainly by SMEs. Investment will grow solidly with an improvement in profitability and low financing costs. Household consumption will gather pace, with strong wage and employment growth. Low energy prices will also help to lift household consumption in the short run.

The benefits of this positive outlook should be widely distributed by getting more people back to work. Those remaining out of the labour market still account for a large share of the working-age population. The authorities should revamp the tax-benefit system to encourage more participation, notably by reducing high marginal effective tax rates arising from the family income supplement. They should also improve activation policy to upgrade the skills of the unemployed and strengthen their attachment to the labour market.

Pent-up demand after a long crisis may result in stronger household consumption than projected. Housing investment may accelerate faster than expected as property prices rise rapidly, although this would increase vulnerabilities if it were associated with further indebtedness. However, still-elevated joblessness and indebtedness may weigh on private spending more than expected. Investment by SMEs may also be very sluggish due to tight financing conditions.

Growth has picked up

After an upswing in late 2014, growth slowed somewhat in early 2015. The economy was supported by an increase in defence spending and exports, buoyed by revitalised external markets and a weakening shekel in late 2014. Private consumption was also very dynamic and remained strong in early 2015, but activity was restrained by a decline in business investment in the first quarter of 2015 due to temporary factors, which offset the gradual increase in housing investment. The unemployment rate fell below 5% at the beginning of 2015, and year-on-year underlying inflation stabilised at around 0.7%. The decline in overall prices gathered pace, however, to around -0.5% year on year, as a result of the drop in oil prices and temporary factors such as falls in the prices of water and electricity.

Israel

Bank of Israel; and OECD Economic Outlook 97 database.

Statlink http://dx.doi.org/10.1787/888933221117

Further fiscal consolidation should be complemented by structural reforms

In March 2015, the Bank of Israel again cut its rate, bringing it to a historic low of 0.10%, and continued to intervene in the currency market. After appreciating in early 2015, the shekel is now at its average 2014 level in nominal effective terms. This very flexible policy continues to foster lower long-term interest rates and higher prices for financial and real-estate assets. The result is to increase household wealth and support demand, but also to increase the risk of a speculative property bubble, whose effects should nevertheless be limited by the Bank's macro-prudential measures.

Israel: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222206

The state reached its target of reducing the deficit to 2.8% of GDP in 2014. Strict spending control in the interim budget (enacted in 2015 because of early elections) should bring the deficit down to the target of 2.5% of GDP. But this will further weaken civil expenditure, which is very low by international standards. For 2016, the next parliament is likely to struggle to contain fiscal spending growth below 2.6% in real terms and reduce the state's deficit to the 2% of GDP, as targeted. However, maintaining the strategy of debt reduction should continue to create more fiscal space. This would be helped by avoiding further tax cuts and preserving the integrity of the value added tax system, which has served the country well in the past. In addition, structural reforms are needed to improve competition in many sectors, in particular the food and electricity industries. Increasing state funding for education and making it conditional on whether schools teach a minimum core curriculum (including mathematics and foreign languages) would boost educational standards and earning capacities among the disadvantaged communities.

Activity should remain close to potential

An ongoing accommodative monetary policy, falling oil prices, a planned 16% increase in the minimum wage over three years and the recovery of external markets will all boost the economy in 2015 and 2016. Investment will also be supported by the launch of major new projects in the technology sector and the lifting of previous uncertainty surrounding property tax. Given these conditions, unemployment will remain low, as will inflation, although the latter should gradually edge back into the lower part of the official 1%-3% target range.

A further deterioration in the geopolitical situation would lower growth and fuel deflationary pressure, which might necessitate recourse to unconventional monetary measures. The new coalition government has agreed to some spending increases, which, if not offset by additional revenue, would stimulate the economy but weaken the budgetary position.

A recovery is incipient

In 2014, the decline in GDP growth slowed considerably as export performance improved and private consumption revived. This positive trend continued in the first quarter of 2015 as GDP increased by 0.3% with respect the previous quarter, the largest quarterly increase in the latest four years. Cost-competiveness gains are beginning to reverse external market share losses. Private consumption is being supported by employment and real wage gains, although it slowed down in the first quarter of 2015. The employment growth rate has turned positive after a long period of decline and the improved growth prospect is starting to encourage workers back to the labour market. However, the unemployment rate remains high. Investment growth is finally showing some signs of recovery, which however remains uncertain due to still large spare industrial capacity, restricted credit supply, and past public-investment cuts to achieve budget targets. Bank lending to non-financial companies has continued to fall in the first months of 2015, although at a somewhat slower pace than in the past. Residential investment is weak and property prices have been falling.

Italy

10-year benchmark government bond yields.

Annualised agreed rate (AAR).

OECD Economic Outlook 97 database; European Central Bank; and Datastream.

Statlink http://dx.doi.org/10.1787/888933221126

Macroeconomic and structural policies could reinforce growth prospects

The array of factors supporting Italy’s growth is the most propitious for some years. Consumer confidence is improving as the government makes progress on implementing its comprehensive reform plan and as rising employment and lower energy prices add to household purchasing power. The Jobs Act has the potential to drastically improve the labour market by reducing duality and providing universal unemployment benefits, thus increasing risk sharing and markedly improving the social safety net. The depreciation of the euro has further improved Italy’s international competitiveness and continues to support the external contribution to GDP growth.

Italy: Employment, income and inflation

Statlink http://dx.doi.org/10.1787/888933221934

However, the banking sector is still fragile and is not in a good position to fully support private investment. Surveys suggest that a large share of companies face unchanged conditions to access credit notwithstanding declining interest rates. Lending rates remain higher than in other euro area countries, probably owing to perceived risks relating to the rising amounts of non-performing loans on banks’ balance sheet. Investment would therefore be strengthened by enhancing the insolvency regime, expanding the use of specialised courts and out-of-court debt workouts, and by establishing a specialised asset management company to acquire bad loans. The government is concretely considering some of these measures so as to create a secondary market for non-performing loans in compliance with EU regulations on state aid.

Italy

National Accounts definition.

Data refer to private non-residential and government fixed capital formation.

OECD Economic Outlook 97 database.

Statlink http://dx.doi.org/10.1787/888933221131

To improve growth prospects over the medium term, the government should continue to press ahead with its ambitious and comprehensive plan of institutional and structural reforms. This includes the efficiency of the public administration and judicial system, reforming the school system, speeding up major public infrastructure projects and enhancing competitiveness through reducing barriers to entry in some service sectors. The recent approval of the new electoral law is a positive development as it is likely to result in more stable governments and reduce political uncertainty. More needs to be done to close gender gaps and to encourage female labour force participation, through strengthening the provision of good quality care for children and the elderly, so as to boost labour supply and reduce entrenched gender inequality.

Italy: Financial indicators

Statlink http://dx.doi.org/10.1787/888933221948

Over the projection period, the fiscal stance will only be mildly contractionary. The government’s budget deficit is projected at 2.6% in 2015 and 2% in 2016. The underlying consolidation path should be implemented, but the automatic stabilisers should be allowed to work. Pension reimbursements due to the recent constitutional court's ruling on the 2011 reform will not affect the projected budget deficit as reimbursements will be progressive and phased in. The ongoing ECB’s quantitative easing programme is helping to keep debt servicing costs low and the resulting savings are being partly used to forestall previously planned tax hikes and to boost public investment. However, continued efforts to enhance the transparency and effectiveness of public spending and procurement, and an unremittent fight on corruption will be paramount to ensure the planned increase in public infrastructure spending is not wasteful.

Italy: Demand and output

Statlink http://dx.doi.org/10.1787/888933221959

The recovery is still fragile

GDP growth is set to increase to 0.6% in 2015 and 1.5% in 2015, and price and wage inflation pressures are expected to remain moderate because of large, but declining, slack in output and labour markets. Unemployment is expected to remain broadly stable in 2015, as employment rises and improved prospects encourage workers back into the labour market. In 2016, as the recovery firms and labour market reforms take hold, the unemployment rate is projected to begin to decline. The current account surplus is poised to reach more than 3% of GDP. Gross fixed capital formation will turn positive in 2015, but will remain moderate.

The rebound in investment could be stronger than predicted, especially if residential property prices reverse course and the banking system is strengthened. The improving labour market could raise household confidence more than assumed, raising consumption growth. On the downside, Italy would be vulnerable to the effects of renewed financial turmoil in the euro area. A weaker-than-expected economic growth in Italy's main trading partners could result in lower exports.

Output growth has resumed following the tax hike

Output growth resumed in late 2014, led by exports, thanks in part to the weaker yen, which is nearly 30% below its level of late 2012 in trade-weighted terms. The recovery in private consumption following the large drop associated with the April 2014 tax hike has been modest, despite improving consumer confidence, rising bonus payments and the deceleration of inflation. After reaching 1½ per cent (year-on-year) in early 2014, consumer price inflation (excluding the impact of the tax hike) fell to close to zero in early 2015. Business investment has been sluggish since the second quarter of 2014 despite the weaker yen, record high earnings in the corporate sector and large cash holdings that exceed 60% of GDP. In addition, firms report capacity and labour shortages.

Japan

A seasonally-adjusted average of four indicators of overall livelihood, income growth, employment, and willingness to buy durable goods. If all respondents answered '' improving'' (''worsening'') for the four indicators, the index would be 100 (0).

The number of firms responding that they had a capacity shortage minus those reporting excess capacity. A positive number thus indicates an overall capacity shortage. Numbers for the second quarter in 2015 are companies' projections made in March 2015.

Cabinet Office; and OECD Economic Outlook 97 database.

Statlink http://dx.doi.org/10.1787/888933221142

Raising labour productivity and participation rates requires a number of structural reforms

Recent reforms to strengthen corporate governance are expected to prompt firms to use their large cash holdings more productively. In 2014, the government introduced a Stewardship Code to encourage institutional investors to constructively engage with the companies in which they invest. In addition, a corporate governance code that requires listed companies to have at least two independent directors (on a comply or explain basis) is being introduced. Its effectiveness will depend on the extent to which these directors are independent in practice. Another priority is to reduce product market regulation, which would boost investment, the diffusion of knowledge, managerial performance and the creation of new firms. Policies to revitalise venture capital investment, notably by ensuring second chances and developing entrepreneurial education, would also increase firm creation. The corporate income tax rate is to be cut from 34.6% in FY 2014 to 31.3% in FY 2016 to encourage investment. Higher business investment would offset the decline in public investment, which is expected to fall as reconstruction spending following the 2011 Great East Japan Earthquake fades.

Japan: Employment, income and inflation

Statlink http://dx.doi.org/10.1787/888933221831

The working-age population (15-64) is already falling by more than one million per year and is projected to decline by 17% by 2030. Raising women’s participation rate, which is 20 percentage points below that of men, is thus another priority to sustain growth. The large gender gap reflects the fact that only 38% of women remain in the labour force after having a baby. To narrow the gap, it is essential to expand childcare and improve work-life balance by changing the culture of long working hours. Aspects of the tax and social security systems that reduce work incentives for second earners should also be reformed. In addition, it is important to break down labour market dualism in order to reduce the large gender wage gap of 27% at the median earnings, which reflect women’s high share of relatively low paid non-regular employment.

Japan

The number of firms responding they had an excess number of workers minus those reporting a shortage. A negative number thus indicates an overall labour shortage. Numbers for the second quarter in 2015 are companies' projections made in March 2015.

In April 2014, the consumption tax was raised from 5% to 8%. The tax hike added 2 percentage points to inflation according to estimates by the Bank of Japan and the Cabinet Office.

OECD measure, which excludes food and energy.

OECD Economic Outlook 97 database; Bank of Japan; and OECD calculations.

Statlink http://dx.doi.org/10.1787/888933221150

Fiscal consolidation should continue, while monetary policy remains very supportive

The expected decline in government investment, from 4.7% of GDP in 2014 to around 3½ per cent in 2016, is the major factor driving fiscal consolidation during the projection period. The general government budget deficit is projected to narrow by 2 percentage points of GDP to 5¾ per cent in 2016. Nevertheless, Japan is not on track to achieve its target of a primary surplus (central and local governments) by FY 2020, even after the planned hike in the consumption tax to 10% in 2017. To maintain confidence in Japan’s fiscal sustainability, the fiscal plan to be announced by the summer of 2015 should set out a detailed and credible strategy to achieve a primary surplus by FY 2020, including additional measures to constrain government spending and raise revenues. Even at 10%, the consumption tax will remain about half the average value-added tax rate in OECD countries. Additional tax revenue should come from broadening the personal and corporate income tax bases and increasing environmental taxes. It is also essential to reform pension and health and long-term care to constrain the growth of social spending by measures such as raising the pension eligibility age, shortening hospital stays and increasing use of generic drugs.

Japan: Financial indicators

Statlink http://dx.doi.org/10.1787/888933221849

The recalibration of the Bank of Japan’s quantitative and qualitative monetary easing (QQE) in October 2014 raised the target increase in the monetary base to around 80 trillion yen per year, primarily through larger purchases of government bonds. Quantitative easing has already boosted the central bank’s balance sheet to 65% of GDP, and has helped boost inflation expectations. QQE should continue until the 2% inflation target is durably achieved.

Japan: Demand and output

Statlink http://dx.doi.org/10.1787/888933221853

The expansion is projected to strengthen through 2016

Despite continued fiscal consolidation, output growth is projected to pick up to around ¾ per cent in 2015 and 1½ per cent in 2016. The fall in the working-age population will further tighten labour markets. Recent wage settlements, combined with the slowdown in inflation, have pushed up real wages, supporting private consumption. Labour and capacity shortages, higher profits and improved corporate governance will support business investment. The sustained recovery is projected to increase inflation to 1½ per cent by the end of 2016. Given the weaker yen, Japan is well positioned to maintain export growth as world trade picks up, lifting the current account surplus to around 3% of GDP.

Japan: External indicators

Statlink http://dx.doi.org/10.1787/888933221860

Sustained output growth requires a virtuous circle of rising prices, wages and corporate earnings. Sluggish nominal wage growth is the key risk in this respect. Japan’s unprecedentedly high level of public debt implies that, in the absence of a credible plan to achieve its fiscal target, Japan could face a loss of confidence in its fiscal sustainability, which in turn could destabilise the financial sector and the real economy with large spillovers to the world economy. Japan’s export prospects depend on growth in emerging markets, especially China, Japan’s largest trading partner. On the positive side, private consumption may increase more rapidly if the shrinking labour force led to faster wage increases than projected. Likewise, firms might invest more strongly than projected.

Economic activity has been sluggish

Private consumption continues to be a drag on the economy, growing more slowly than output in 2014 for the ninth consecutive year. This reflects the lack of real wage growth in 2014, and rising household debt to over 160% of disposable income. Export growth has weakened sharply, reflecting the appreciation of the Korean won by 17% in trade-weighted terms since late 2012, and falling shipments to China in early 2015. Sluggish output growth and lower oil prices reduced consumer price inflation to 0.6% (year-on-year) in the first quarter of 2015.

Korea

Seasonally-adjusted for production and exports (on a national accounts basis).

Corresponds to the OECD measure of core inflation, which excludes food and energy.

Statistics Korea; OECD Economic Outlook 97 database; and Bank of Korea.

Statlink http://dx.doi.org/10.1787/888933221165

Monetary easing is supporting the economy

The Bank of Korea has responded by reducing its policy rate to 1¾ per cent through three cuts since mid-2014. In addition, the government has relaxed macro-prudential measures that have constrained mortgage lending in order to revitalise the housing market. Such measures, though, have led to a rise in real housing prices and risk further increasing household debt. Government spending is to rise by 5.7% in 2015 in an effort to boost demand. However, government consumption increased by less than 1% in the first quarter of 2015.

Korea: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222218

Structural reforms are needed to boost investment and labour force participation

The government’s Three-year Plan for Economic Innovation aims to increase business investment, which has fallen from more than 40% of GDP prior to the 1997 crisis to around 20%. To some extent, the decline reflects a welcome increase in firms’ focus on profitability and balance-sheet risks. Even with the decline, total fixed investment as a share of GDP in Korea is the highest in the OECD. The government aims to increase business investment primarily by capping the total burden of regulations by introducing a welcome one-in, one-out system: whenever a new regulation is introduced or existing regulations are strengthened, other regulations should be abolished or relaxed. Reducing product market regulation would also boost investment, the diffusion of knowledge, managerial performance and the creation of new firms.

With Korea’s working-age population (15-64) set to peak in 2016, it is increasingly important to reduce gender gaps and to boost the employment rate of women, which at 54% in 2013, was 21 percentage points below that of men. The low rate reflects the withdrawal of a majority of women at the time of marriage or childbirth, indicating the importance of improving work-life balance by reducing working hours, which are more than 20% higher than the OECD average. In addition, the 37% gender wage gap at median earnings is the highest in the OECD, discouraging female employment. The gap reflects the large share of women in non-regular jobs and the low share in management. It is necessary to create better job opportunities for women, notably by breaking down labour market dualism and expanding the role of performance, rather than seniority, in setting wages. In short, reforms are needed to offer women the hours, jobs, wages and careers that would encourage them to work.

Growth will pick up thanks in part to lower oil prices

Output growth is projected to pick up from 3% in 2015 to around 3½ per cent in 2016, as exports rise owing to the projected recovery in world trade and Korea’s free trade agreements with Australia, Canada, China and New Zealand in 2014. Faster export growth should promote fixed investment, although the operating profits of listed companies fell in 2014. Despite the high level of debt, private consumption is expected to gradually strengthen thanks to the impact of lower oil prices and real wage gains. Stronger growth, along with the assumed stability of oil prices and the won, is projected to push up inflation towards 2% in 2016.

Korea is particularly vulnerable to developments in the Chinese economy, as its exports to China account for 14% of Korean GDP. A rebound in private consumption could be stalled by continued stagnation in real wages and a further rise in household debt in response to lower interest rates and the measures to revitalise the housing market. On the upside, with the resolute implementation of structural reforms, Korea could once again regain its export dynamism.

Private consumption is the main growth driver

GDP growth has slowed but remains among the strongest in the euro area. The recession in Russia, Latvia’s third largest trading partner, has weighed on exports. Investment has remained subdued due to the deterioration of the regional business climate and uncertainty about economic developments in the euro area. Meanwhile, private consumption has sustained economic activity. The continuous fall in unemployment and strong increases in real disposable income, backed by the decline in oil prices and another significant hike in the minimum wage, have supported consumer confidence and spending.

Latvia

Real long-term interest rate based on lagged GDP deflator.

OECD Economic Outlook 97 database; European Commission; and Central Bank of Latvia.

Statlink http://dx.doi.org/10.1787/888933221177

Monetary and fiscal policies will be supportive but structural policies are needed to reduce inequality

Quantitative easing by the European Central Bank will keep interest rates low over the projection period. Financing conditions should improve over the next two years and sustain investment. Uncertainty created in the banking sector by recent changes in the insolvency law, notably the introduction of non-recourse loans which limit the liability of mortgage borrowers to collateral in March 2015, has faded gradually. Nevertheless, credit will recover only slowly as debt reduction is still on-going. Loan standards will remain relatively tight in the short run. Demand for credit is also expected to remain weak in 2015 because of uncertain prospects in real estate and export markets.

Latvia: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222429

Fiscal policy will support domestic demand in 2015, notably with another cut in the personal income tax rate. As a result, the structural deficit is set to widen and consolidation measures will be needed to comply with the national fiscal rule – a structural deficit of 0.5% of GDP – in 2016. Fiscal policy should remain prudent and build up a precautionary buffer. As for public investment, the priority should be to address infrastructure bottlenecks in transport and the energy sector. In the latter, lack of interconnected supply networks raises competition issues, and undermines both firms’ price competitiveness and energy security. Investment in infrastructure could be supported by an effective use of EU funds, which amount to around 2.8% of GDP per year in 2014-2020. Further streamlining procedures and reducing the administrative burden on funding recipients could help to make the most of these resources.

Latvia is one of the most unequal societies in the OECD and a relatively high share of the population is at risk of poverty or social exclusion. The estimated structural unemployment rate is 10% and long-term unemployment is very high. To better protect the most vulnerable against poverty and improve labour market performance, the tax and benefit system should be made more redistributive and barriers to employment eliminated. Social benefits - including family benefits - should be more targeted at those most in need and the tax burden on labour should be reduced. Government plans to increase the personal income tax basic allowance and phase it out for higher income would be a step in the right direction. Fighting informality is also crucial as it excludes part of the population from the social security system, lowers their contributions and their entitlement to contribution-based social benefits and diminishes tax revenues that are needed for growth-enhancing spending.

Growth will be closely linked to the recovery in Latvia’s trading partners

Exports are set to recover over the projection period, backed by a rebound in the euro area. The large steel producer JSC KVV Liepajas Metalurgs restarted production at the beginning of the year, which will also boost exports. Investment should progressively pick up, driven by exports growth, increases in capacity utilisation and the absorption of EU funds. Private consumption will contribute significantly to growth as wages further rise. As a result, GDP growth is set to reach 3.6% in 2016. Inflation will remain contained because firms are expected to continue to absorb some of the wage increases by lowering their margins. Rising unit labour costs will limit employment growth but unemployment will continue to decline steadily as the labour force shrinks.

The main risks relate to growth of Latvia’s biggest trading partners. A flare-up of regional tensions could further weigh on trade and investment. Conversely, a stronger recovery in the euro area could spur more activity. Domestically, the capacity of exporters to further diversify markets and the impact of wage developments on competitiveness is uncertain. Policies that improve the business environment by simplifying procedures, strengthening the enforcement of competition law or easing the use of EU funds would accelerate the recovery of investment.

Economic activity remains robust

Economic growth in 2014 remained significantly higher than the euro area average, supported by resilient domestic demand and robust activity in the financial sector. However, unemployment has continued to rise and the youth unemployment rate reached 22% at the end of 2014. Luxembourg’s external position is strong, characterised by persistent current account surpluses and a net international asset position of 219% of GDP. The general government budget is in surplus and general government gross debt, at 25% of GDP on the Maastricht definition, low.

Luxembourg

Undertakings for collective investment, net assets.

OECD Economic Outlook 97 database; Commission de Surveillance du Secteur Financier; and Banque Centrale du Luxembourg.

Statlink http://dx.doi.org/10.1787/888933221181

Financial risks should be monitored and structural reforms made to budgeting

The authorities should continue to monitor financial risks by using a comprehensive risk assessment framework that accounts for linkages between banks and non-bank financial intermediaries, notably investment funds. Continued co-operation with regulatory authorities in other jurisdictions outside the EU is also needed to develop resolution plans and to undertake resolvability assessments that facilitate effective cross-border resolution.

Luxembourg: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222223

The new EU VAT regime for e-commerce that started in January 2015 is expected to reduce government revenues by about 1.5% of GDP in 2015, as VAT is now collected in the buyer country instead of the seller country. In anticipation, the government has taken compensatory tax and spending measures. An increase in the VAT rates by 2 percentage points is expected to raise revenues by about 0.5% of GDP. In addition, the government has taken significant measures to reduce spending, estimated to generate net saving of 0.4% of GDP in 2015. These measures could be complemented by strengthening the fiscal framework by adding a spending ceiling to manage medium-term budgeting pressures. The newly established fiscal council could be charged with evaluating budgets from the perspective of the medium-term budget developments and, if it were adopted, the spending ceiling.

Growth is projected to recover

Growth is projected to slow just slightly in 2015 as the shift of the EU VAT regime for e-commerce weakens export growth and higher value-added tax rates bear on demand, and then to strengthen again in 2016. Throughout the projection, activity will be supported by very accommodative monetary conditions, domestic demand growth and improvements in trade of services. The unemployment rate will peak at 7.1% in 2015 and edge down in 2016. The VAT hike and a round of wage indexation expected to take place in 2016 will keep inflation above the euro area average.

Given Luxembourg’s trade and financial linkages, much depends on the strength of the ongoing recovery in the euro area. The negative effect of the new EU VAT regime on Luxembourg’s position in e-commerce could be larger than expected. High cross-border financial linkages between domestic banks, their groups’ foreign banks and investment funds could transmit external shocks, including enhanced financial volatility in the euro area, into the domestic economy. On the other hand, the solid reputation of the Luxembourg’s financial sector could also result in larger safe haven capital inflows. A sustained drop in the oil price and the euro depreciation might also support stronger growth via higher net exports.

The rebound in activity is gaining momentum

The Mexican economy has faced repeated delayed recoveries over the past few years due to a combination of weak global demand, domestic financial problems in the construction sector and, until last year, insufficient structural reforms. The ongoing strengthening of the US economy, an easing of the construction sector’s problems, and a recent comprehensive package of structural reforms are all improving the investment climate. Investment has picked up substantially, and manufacturing activity has been growing still faster, supporting a robust formal job market and boosting household incomes and consumption growth.

Mexico

Based on a 3-month moving average of the Markit Purchasing Managers' Index (PMI) for Mexico. Readings above 50.0 signal an improvement in business conditions on the previous month, while readings below 50.0 signal a deterioration.

Markit and OECD Economic Outlook 97 database.

Statlink http://dx.doi.org/10.1787/888933221196

Monetary policy remains supportive

The central bank’s target interest rate remains at an all-time low of 3%. Inflation has fallen closer to the centre of the Bank’s target band, easing concerns that interest rates will need to be raised soon. Moreover, inflation expectations are well anchored. At the same time, the Mexican peso has depreciated by almost 20% in nominal effective terms in recent months, helping to boost external competitiveness.

Mexico: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222233

Fiscal policy was accommodative until earlier this year, with the public sector borrowing requirement (PSBR) expanding by almost one percentage point of GDP from 2013 to 2014. However, following the collapse in oil prices, given the budget’s heavy dependence on oil, the government announced measures to reduce 2015 expenditures by 0.7% of GDP, which will decrease the fiscal cliff associated with a return to traditional budget balance by 2017, defined as approximately 3% of GDP in terms of the PSBR.

Demand is strengthening

As US imports and domestic demand continue to grow, activity will gain further momentum and start absorbing excess capacity. The early implementation of structural reforms by the administration – most notably in the energy, financial and telecommunications sectors – is already helping business confidence and the climate for private sector investment, while public sector reforms are helping as well. These reforms should boost potential growth through increases in the capital stock and gains in productivity. Residential investment is picking up as the housing sector recovers. Capital investment should surge this year and next, boosting manufacturing activity.

The main downside risk to growth comes from possible volatility associated with the withdrawal of US monetary policy accommodation. Mexico has fared well so far, but a bout of emerging market gloom could trigger capital outflows that would drive up longer-term interest rates. Record-high foreign exchange reserves and the Flexible Credit Line offer important backstops against possible shocks. On the positive side, the major structural reforms that have passed could have effects on productivity and investment that occur earlier and are larger than assumed, helping to support gains in well-being.

The pick-up in growth has been broad-based

The economic recovery has gained traction due to a continuing expansion of private consumption and robust growth of business investment. Exports have also performed strongly, benefitting from improving economic conditions in the European Union and the depreciation of the euro. The government deficit in 2014 was 2.3% of GDP, the same as the year before, as outlays fell slightly and lower gas revenues, mainly resulting from the government’s decision to reduce production, were broadly offset by higher tax revenues.

Netherlands

In nominal terms.

Population aged between 15 and 75.

OECD Economic Outlook 97 database; and Statistics Netherlands (CBS).

Statlink http://dx.doi.org/10.1787/888933221209

Consumer confidence has improved to levels last seen in 2007, which reflects falling unemployment, low inflation, increasing real wages and the ongoing recovery of the housing market. Producer confidence is above the historical average as well. Nevertheless, both indicators have been quite volatile in recent months, indicating that substantial uncertainty remains about the economic outlook.

Netherlands: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222243

Slower fiscal consolidation should be accompanied by further structural reforms

The budget plan for 2015 foresees a further reduction of the deficit, mostly as result of the improving economic situation. The implied limited fiscal consolidation strikes an appropriate balance between curbing negative effects on the economic recovery and reducing public debt.

Historically high unemployment indicates that the effects of the crisis are still widely felt. The inclusiveness of the recovery could be deepened by further easing the protection of regular contracts and reducing work disincentives through tax and benefit reforms, notably by making childcare support more dependent on second earners’ income rather than family income. Introducing tighter income conditions for social housing eligibility and accelerating the reduction in mortgage interest tax relief would improve the functioning of the housing market.

Growth will continue to strengthen

Economic activity is expected to accelerate further, supported by increasing domestic demand and strong exports. Inflation will edge up during 2015, but remain below wage growth. Households will use part of the substantial rise in real disposable income to step up consumption and the remainder to increase savings. Job creation will raise employment, but remains weak relative to the expanding labour force, making the decrease in unemployment very gradual. Public finances will improve due to the better economic climate and the foreseen spending restraint.

A halt in the housing market revival, either in the form of disappointing price developments or low sales volumes, could negatively affect consumer spending, mainly through lower confidence. In addition, if the government decides to further reduce gas production, growth could be lower and the budget deficit larger. The low interest rates could pose a risk for the financial position of pension funds and insurance companies. On the other hand, economic activity could expand faster if a tax reform is approved in the coming months. Growth would also benefit from higher than anticipated economic growth in the euro area or lower commodity prices.

Economic growth remains strong

Economic growth appears to have eased somewhat in 2015, but the robust expansion continues to be driven by construction activity in Canterbury and Auckland, high and rising levels of net immigration, low interest rates, and still relatively high terms of trade. Intensifying capacity constraints are boosting business investment. Employment growth has been very strong, yet, wage pressures remain subdued, reflecting very high net immigration, and firms’ reported difficulty in finding labour is close to its long-term average. Falling oil prices have driven headline CPI inflation down to 0.1%, but excluding vehicle fuels and cigarettes (on which excise tax again increased sharply), inflation is still only 0.7%. World prices for dairy products, New Zealand’s largest export, have fallen by half since the early-2014 peak, reversing most of the rise in recent years. But the resulting terms-of-trade decline has been attenuated by the oil price drop.

New Zealand

Permanent and long-term, working-age population, quarterly data seasonally adjusted.

Reserve Bank of New Zealand (2015), Monetary Policy Statement, March; and OECD Economic Outlook 97 database.

Statlink http://dx.doi.org/10.1787/888933221217

Fiscal policy is mildly contractionary, but monetary policy remains accommodative

The underlying primary surplus is projected to rise cumulatively by 0.5% of potential GDP over 2015-16, a similar annual rate of increase as in 2014. The government is right to continue to strengthen its fiscal position, as New Zealand faces potentially large macroeconomic shocks and long-term pensions and health-care spending pressures. Fiscal consolidation will also help to mitigate upward pressure on interest and exchange rates. Appropriately, planned consolidation is not to come at the expense of efforts to improve the well-being of the most vulnerable members of society. Certain groups, notably Maori and Pasifika, face long-term barriers to employment and income growth, and suffer from poor health outcomes, a situation that calls for policies to increase the inclusiveness of growth.

New Zealand: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222258

The central bank is maintaining an accommodating monetary policy stance to drive CPI inflation up towards the midpoint of the 1-3% target range. It has announced that it would be appropriate to lower the Official Cash Rate, which at 3.5% is already below the estimated neutral rate, if demand weakens and wage and price-setting outcomes settle at levels lower than is consistent with the inflation target. To counter house price inflation in Auckland, the bank favours removal of unwarranted barriers to supply, which would have most impact in the medium term, supported by restraints on short-term demand. It has announced new macro-prudential measures to rein in investor purchases that take effect from 1 October 2015. These are to be complemented by a government decision to extend the tax on trading gains on property.

Growth should moderate

Growth is projected to moderate to 3% in 2016 as the boost from construction eases and increases in private consumption slow. The maturing of the Canterbury rebuild and the assumed slowdown in net immigration (as the strength in the labour market relative to Australia’s diminishes) are set to curb the pace of the expansion. The unemployment rate should fall to near 5%. Wage increases are projected to rise only modestly, but headline inflation to pick up to 1.8% by late 2016. The current account deficit may reach 5¾ per cent of GDP, which is too high to stabilise net external liabilities as a share of GDP.

Prospects depend significantly on the evolution of global dairy prices. Further declines would reduce incomes and could put pressure on highly leveraged producers; but prices could also recover, in particular as China rebalances towards urban consumers, who tend to purchase milk products. Global interest rates could rise faster than assumed, perhaps as US monetary policy begins to normalise. For New Zealand, this could raise the cost of funds needed to finance the large negative international investment position. Continued house price appreciation would boost household wealth and consumption but also pose a growing risk of correction if prices deviate from fundamentals.

Activity is slowing in both oil and non-oil sectors

The mainland economy is weakening with the oil-price fall curbing activity in the offshore sector, with spillovers on domestic demand and employment in non-oil sectors. However, exchange rate depreciation and slower wage growth are helping the competitiveness of non-oil exporters, while lower interest rates support private consumption. House prices remain high, despite a weaker economy, and household debt levels rose to over 200% of disposable income.

Norway

Loan debt as a percentage of disposable income.

OECD Economic Outlook 97 database; Statistics Norway; and Norges Bank.

Statlink http://dx.doi.org/10.1787/888933221228

Monetary and fiscal policies support growth

The central bank cut its policy rates by 0.25 percentage point to 1.25% in December 2014 on concerns about the weakening domestic outlook. Monetary policy should remain accommodative for some time to support recovery, given that inflation is below target. Rising house prices and mortgage lending will require continued close monitoring in view of high household debt levels and risks of housing market overheating. Further macro-prudential measures should be considered to reduce risks to financial stability. The financial supervisory authority’s proposals for further tightening banks' mortgage lending practices go in the right direction.

Norway: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222265

The interim budget for 2015 entails a fiscal stimulus equivalent to half a percentage point of mainland GDP. An expansionary fiscal policy is appropriate given current circumstances. Prudence with respect to the 4% rule governing the use of oil revenues needs to continue, as this will provide a buffer if growth falters.

Structural policies should promote transition to broader-based growth

The government has already taken some steps to this end, including targeted tax reductions, new infrastructure investment and efforts to reduce government bureaucracy. The interim 2015 budget proposes measures to make tax collection simpler. Going forward, product market reforms and improvements to the education system are key to boosting competitiveness and productivity. In addition, further lightening of taxation and greater public-spending efficiency, through for example more extensive use of cost-benefit analysis for the selection of public-investment projects, would also help.

Continuing structural reforms to sustain inclusive growth is essential. Norway benefits from high labour-force participation, thanks largely to strong female participation, and low unemployment rates. However, the generous sickness and disability system has led to a significant number of people withdrawing from the labour market. The government has a quantitative goal to reduce sickness absence and has announced specific reforms towards this end, including a new medical assessment. Providing clear guidelines on disability assessment and monitoring compliance are important to lower the take-up of disability benefits.

Growth will pick up gradually

Growth is projected to rise in 2016, as business investment and exports increase and new oil investment projects partially offset the decline in ongoing projects. Housing construction will also contribute to the recovery on the back of low interest rates and relatively high house prices. The unemployment rate will edge up further but then start declining towards the end of the projection period. Inflation will remain low given economic slack, slowing wage growth and fading impact of imported inflation. The current account will continue to be in surplus.

Norway remains vulnerable to terms of trade shocks. Oil prices may rise from their current levels, boosting producers’ and government’s revenues. By contrast, a further decline could see cuts in oil production, further reduction in exploration activity and damp the mainland recovery through second-round effects on incomes and business demand. Domestically, the high level of household debt remains a risk, leaving households, and potentially the banking sector, vulnerable to interest-rate or house-price shocks. However, the slowdown in wage growth and progress in structural reforms may boost competitiveness and growth more than expected.

Output growth has been robust

Real GDP has been growing at a firm pace. Household consumption is being supported by an improving labour market and rising real incomes related to falling food and energy prices. Exports have been resilient, notwithstanding the Russia-Ukraine crisis. Still, despite favourable financial conditions and a better euro area outlook, business investment intentions remain below their historical average, curbed by uncertainty about future demand.

Poland

Only total investment data are available for the OECD aggregate.

OECD Economic Outlook 97 database; Eurostat; and National Bank of Poland.

Statlink http://dx.doi.org/10.1787/888933221231

Macroeconomic policies are appropriate, but structural reforms are needed to promote investment

Owing to subdued inflationary pressures coupled with steep declines in food and energy costs, headline consumer prices have been falling in annual terms since July 2014. Underlying inflation and inflation expectations are very low. In response, the central bank cut official interest rates further in March 2015 to 1.5%. As food and energy prices have started to turn around and the labour market is tightening, headline consumer prices are projected to start rising again. Once the central bank starts to normalise monetary policy it will have to proceed with caution, as this could lead to potentially destabilising capital inflows and upward pressure on the zloty as long as monetary policy in the euro area remains extremely supportive.

Poland: Demand, output and prices

Statlink http://dx.doi.org/10.1787/888933222273

The general government deficit is projected to fall from 3.2% of GDP in 2014 to 2.4% of GDP in 2016. This is in part due to continued economic growth and increased social contributions (many members of private pension funds switched to the state social security system following the recent pension reform). Growth in social transfers will be subdued by indexation to currently low inflation and wage growth and the government is expected to continue restraint on public-sector wages. This is only partially offset by increases in a few social expenditure items.

To support business investment in modern production capacity and innovation, barriers to firm entry and exit need to be reduced, contract enforcement facilitated and taxes simplified. This also requires building on ongoing efforts to improve university and vocational education, reinforcing links to business and practical experience. Energy generation capacity is ageing and very reliant on coal. Lowering barriers to entry into energy markets and raising energy prices to account for environmental damage and pollution would promote a more efficient and greener energy sector. Now that roads have been substantially upgraded, the focus should shift to investment in railways and urban public transport, also promoting green growth. Along with policies addressing local housing shortages, this would help workers move and commute, thereby improving the people’s welfare and productivity. By enabling workers to find higher-quality jobs, it would enhance inclusiveness.

Growth will pick up

A further pick-up in employment and real wage growth will support a gradual increase in private consumption. Exports are projected to rise as world trade strengthens. Investment will remain solid but somewhat limited by the slowdown in disbursement of EU structural funds that typically occurs at the switchover of budget periods. The faster projected GDP growth should gradually eliminate remaining spare capacity.

Growth depends on the pace of the recovery in the euro area, and intensification of tensions in Russia and Ukraine could depress exports and increase energy prices. By contrast, private consumption and investment could respond more substantially to swifter confidence improvements and income gains.

The recovery is continuing

Growth turned positive in 2014, reflecting a pick-up in private consumption and investment. The recovery is now getting firmer and gaining strength. Exports continue to support growth as market shares rise, and the current account remains in surplus. Employment is increasing at a modest pace, reversing the downward trend observed since 2009. However, the unemployment rate is still high, even though it is lower than at the peak of the crisis. Inflation will remain subdued and below the euro area average. Private debt continues to restrain domestic demand.