Pentti Vartia Managing director Pasi Sorjonen Head of forecasting group 1.1 Summary The world economy started to recover rapidly at the start of the year. Despite this rebound in activity, near-term growth will remain relatively slow as a result of heightened economic uncertainty. Our forecast for the U.S. shows the economy expanding by only 2.4 percent this year, before accelerating slightly in 23. The risk that the U.S. slowdown will be prolonged is nevertheless high. EU GDP growth is forecast at only 1.2 percent this year and 2.6 percent next year. The euro is expected to appreciate somewhat further against the U.S. dollar. ETLA s forecasts for Finnish GDP growth have been revised downwards, and we now expect total output to grow by 1.9 percent this year and by 3.7 percent in 23. Exports will increase by around 3 percent this year, supported by noticeable growth in exports manufactured by the electronic equipment and forest industries. Export growth will pick up to around 7 percent next year, reflecting strengthening export demand as the world economy recovers. Private consumption growth will accelerate during the forecast period. Private investment will not increase until next year. The unemployment rate will rise to 9.2 percent this year, before easing next year to 9 percent. Inflation will remain subdued during the forecast period. World Economy Recovering The volume of global merchandise trade increased at slower pace than world GDP last year. This is extremely rare and highlights well the moribund state of global demand, particularly for information technology products. In the beginning of this year economic activity rebounded sharply. The near-term prospects for growth are not as bright, though, particularly in light of the heightened level of uncertainty and recent declines in equity prices. World trade growth is expected to pick up to 2.5 percent this year, owing primarily to the strong performance in the first half of the year, before accelerating next year to 7.5 percent in response to improved cyclical conditions. U.S. GDP growth slowed sharply in the second quarter of this year. Growth will continue to be sluggish in the second half of the year, since falling equity prices have raised uncertainty about the strength of the recovery. Investment growth will remain lackluster and, at worst, the investment recovery could stall if demand slows appreciably. Our forecast for GDP growth shows the U.S. economy expanding by 2.4 percent this year and by around 3 percent next year. Growth will be supported by accommodative monetary and fiscal policy. 5
The Finnish Economy and Society 3/22 Despite the export-led upturn in the beginning of this year, the Japanese economic situation is still very fragile. Deflation is discouraging spending, there is very little room for countercyclical economic policy, and difficult structural problems are dampening growth. Japanese GDP is forecast to contract somewhat this year. Next year, total output should increase slightly from this year s average level. The Euro Area economy is recovering, albeit at a slower pace than we projected in June. Euro Area GDP growth will slow this year compared to last year, to an average annual rate of 1.2 percent. Exports are expected to increase, while imports stagnate. Investment will continue to contract and private consumption growth will moderate. Nevertheless, economic growth is expected to pick up at the end of the year. The European Commission and Euroframe leading indicators point to an acceleration in GDP growth already in the second quarter of this year. GDP growth is forecast at just over 2.5 percent for 23, supported primarily by private consumption and investment. Flood repairs could provide a temporary boost to Germany s sluggish pace of growth. Finnish GDP Has Turned Up Finland s GDP contracted by 2 percent in January-March from its level one year earlier and by more than.5 percent from the previous quarter. This left seasonally adjusted GDP at the low level recorded in the second quarter of 21. Although national accounts figures for the second quarter are still not available at the time of writing, economic indicators already released suggest that GDP increased by 2.5-3 percent both in year-on-year as well as quarter-onquarter terms. As such, Finnish total output increased during the first half of this year, at a pace probably just under.4 percent. Business survey results published by the Confederation of Finnish Industry and Employers and the Em- Balance of Resources and Expenditure Value Volume Price Bill. EUR Change, Change, 21 21 22 F 23 F 21 22 F 23 F Gross domestic product 135.1.7 1.9 3.7 3. 1.4 2.5 Imports 42.6.1 1.1 6.8-2.2-1.6 1.3 - goods 33.6.5 1.2 7.9-3.1-2.2.6 - services 9. -1.7.9 1.8 1.7.8 5. Total resources 177.7.5 1.7 4.5 1.7.7 2.2 Exports 54.5-2.2 3.1 6.6-1.2-1.3 2.5 - goods 47.8-1.8 3.2 6.6-1.6-1.5 2.3 - services 6.7-5.3 2.3 6.3 2.2.5 4. Investment 26.5 4. -2.3 4.6 2.8 2.6 2.6 - private 22.9 4.6-2.6 4.8 2.7 2.5 2.5 - public 3.6.8. 3. 3.7 3. 3. Consumption 96.2 1.4 2.2 2.6 3.1 1.9 2. - private 67.6 1.1 2.4 3.4 2.9 1.7 1.6 - public 28.6 2.1 1.5.5 3.7 2.5 3. Stockbuilding 1).3.1 2) -.2.2...... Total demand 177.7.5 1.7 4.5 1.7.7 2.2 1) Including statistical discrepancy. 2) Contribution of stockbuilding to total demand growth, percentage points. Source: Statistics Finland. 6
ployers Confederation of Service Industries point to an improvement in cyclical conditions and a strengthening of economic growth in the second half of the year. Even if the level of GDP remained at April s level for the remainder of the year, the annual average rate of growth for this year would stand at approximately one percent. Finnish Exports Rebounded in April-June According to figures released by the National Board of Customs, merchandise exports rebounded in April-June following four consecutive quarters of decline. Export growth in April- June came in at 4 percent in year-on-year terms. Due to weaker growth at the beginning of the year, however, total merchandise exports in January-June declined by almost one percent from a year earlier. We expect growth to accelerate noticeably in the second half of the year, however, led by exports of electronic equipment and paper. Total merchandise exports are forecast to increase by around 3 percent this year. The forecast has been raised slightly due to the stronger-than-expected export performance in the first half of the year. The upturn in exports is visible across many industries. The most positive developments have been enjoyed by the electronic equipment industry, which will continue to act as the engine of export growth thanks to the introduction of new Nokia mobile phone models, the forest industry and the chemical industry. Exports of machinery and metal products will contract. Merchandise exports excluding electronics will grow by approximately 1.5 percent. Export prices are expected to decline by just over one percent on average. In 23, the volume of exports of goods and services is forecast to increase by around 6.5 percent. Exports excluding electronic equipment will grow by a couple of percent, supported by improved export developments across many industries. Fewer ship deliveries will translate into negative export growth for the overall machinery and metal products industry, even though exports of machinery and equipment as well as metal products are expected to increase. Despite falling prices of electronic equipment exports, average export prices are expected to rise by a couple of percent. Private Consumption Growth Picking Up Private consumption is forecast to grow by almost 2.5 percent this year. Growth will accelerate next year to 3.4 percent, owing to a faster Key Forecasts 2 21 22 F 23 F Consumer price index, change 3.3 2.6 1.7 1.7 Average earnings, change 3.8 4.5 3.4 3.7 Unemployment rate, 9.8 9.1 9.2 9. Current account surplus / GDP, 7.2 6.9 7.6 8.4 Industrial production, change 11.2 -.5 1.8 5.7 Three-month EURIBOR, 4.4 4.3 3.4 3.7 EU real GDP, change 3.4 1.6 1.2 2.6 Euro Area 3.5 1.4 1.2 2.6 EU consumer price inflation, 2.5 2.5 2. 1.8 Euro Area 1) 2.4 2.5 2.1 1.7 Finland s general govt. surplus, of GDP 7. 4.9 3.2 3.3 Finland s general govt. debt, of GDP 44. 43.3 41.7 39.6 1) Harmonized index. Source: Statistics Finland. 7
The Finnish Economy and Society 3/22 rate of increase in the wage bill in response to the improved employment outlook. Growth in demand will center on durable consumer goods, particularly automobiles. Real household disposable income will increase by just over 2 percent this year, supported by rising earnings, tax cuts and low inflation. Real household purchasing power is expected to accelerate to a pace of 3.5 percent, reflecting stronger growth in the wage bill, subdued inflation and a further easing in income taxation. We expect that a moderate outcome, one that supports competitiveness and employment 4-4 -8 1985 9 95 15 1 5 Economic Developments Changes in GDP 1985 9 95 8 4-4 Unemployment rate 1) Current account, of GDP -8 1985 9 95 2 2 2 1) Since 1988 according to EU harmonized statistics. Source: Statistics Finland. ETLA S2.3/y1 growth, will be reached in the next round of wage bargaining to begin this fall. Average earnings are forecast to rise by 3.4 percent this year and by just over 3.5 percent next year. The household saving rate will remain well below its long-run average level. Investment To Increase Only Next Year Private investment fell during the course of 21. Nevertheless, the revised national accounts figures show that investment rose on average in 21 compared to the level recorded in 2, and did so by much more than that indicated by the preliminary figures. This year, private investment is forecast to contract, reflecting the effect of heightened economic uncertainty on the investment decisions of businesses. Investment should recover noticeably in 23. Public investment will also recover only next year. The cyclical upturn will not have an immediate impact on investment activity because many industries are still plagued by excess capacity. As such, higher output levels can be achieved by raising rates of capacity utilization. Capacity utilization rates in the export sector will nevertheless rise towards the end of the year, paving the way for investment in new production capacity in industry next year. Hence, the fastest phase of investment in machinery and equipment will take place next year. Residential building investment began to recover slowly at the end of last year, following a downturn that began in 2. The recent downturn was so pronounced, however, that despite the current upturn residential building investment will remain unchanged this year from last year s average annual level. In 23, residential building investment is forecast to rise 3.5 percent above this year s average level, supported by low interest rates, among other things. Due to the slowdown in commercial and office building construction, resources can be shifted easily towards the construction of residential buildings. Output Growth Accelerating Finnish GDP growth slowed to.7 percent last year, according to revised national accounts figures. Growth is forecast to accelerate to 1.9 8
11 1 9 8 7 6 5 4 3 2 1 Money Supply Growth and Inflation in the Euro Area 12-month growth rate of the broad monetary aggregate M3 Year-on-year change in consumer prices 4.5 reference value for the growth of M3 2 reference value for inflation 1998 99 2 1 2 3 2 1-1 -2-3 -4 Euro Area Public Sector Budget Balance and Gross Debt as a Percentage of GDP Budget balance (left-hand scale) -3 reference value for the budget balance (left-hand scale) 6 reference value for gross debt (right-hand scale) Gross debt (right-hand scale) -5-6 199 92 94 96 98 2 2 16 14 12 1 8 6 4 2 Sources: Bank of Finland, Statistics Finland. ETLA S2.3/r18 Source: OECD. ETLA S2.3/k17 percent this year and to 3.7 percent in 23, thanks to an upturn in exports and industrial production beginning in the second half of this year. Industrial production is forecast to increase by just under 2 percent this year. The industrial upturn will be led by the electronic equipment industry (7 percent growth this year) and the forest industry (almost 5 percent). Excluding electronic equipment, manufacturing will remain unchanged at last year s average level. Strengthening export demand will foster an acceleration in industrial production growth to around 5.5 percent next year. Many industries, including the traditional metal industry, will record swift output growth. Manufacturing excluding electronic equipment will increase by slightly more than 5 percent. Output in the private service sector will grow by around 4 percent, as will construction. Our forecast thus shows growth in Finnish economic activity picking up this year and even more so in 23, before slowing in the years that follow. During the 22-26 period, Finland s total output is projected to expand at an average annual pace of 3 percent. Slight Increase in Unemployment Employment will remain roughly unchanged during the forecast period. Employment levels will rise, however, particularly in the private service sector and in construction. The number of industrial jobs will decline. Weakening municipal budgetary positions will also depress growth in the number of public sector jobs. The unemployment rate will rise to an average of 9.2 percent this year, before falling slightly next year to 9 percent. Inflation Subdued Consumer price inflation will moderate to 1.7 percent this year. The moderation stems primarily from lower energy prices and interest rates. Inflation is expected to remain at 1.7 percent next year, with commodity tax harmonization, among other things, helping to contain price rises. 9
The Finnish Economy and Society 3/22 1.2 Economic Policy ECB To Raise Interest Rates Only in 23 Economic growth in the Euro Area will remain slow this year. There are no significant inflationary pressures, nor will such pressures emerge when growth accelerates owing to excess capacity. Therefore, the European Central Bank will be in no hurry to raise interest rates this year, and market rates of interest will remain low. The ECB could even move to lower rates. As inflation moderates, real interest rates will rise. Unless the ECB s policy-determined rate is lowered accordingly, this would generate a de facto tightening of monetary policy at a stage likely to be seen by many Euro Area economies as too early. The monetary policy assumption embedded in our forecast is that the ECB will raise interest rates by.25 of a percentage point late next spring and by the same amount again late next fall. The three-month EURIBOR is expected to average 3.4 percent this year and 3.7 percent next year. Further Easing of Earned Income Taxation Called For Fiscal policy has provided support to economic activity over the last couple of years, mainly through tax cuts. These tax reductions have come at a right time, since they were implemented during the economic downturn. Policymakers should not move to tighten their fiscal policy stance now, given current cyclical conditions. Finland still has the resources to continue cutting taxes, nor is it too late to offer further tax reductions as a reward for reaching a moderate outcome in the wage negotiations this autumn. Our forecast for public finances takes into account the reductions in income taxes and social security contributions that have already been implemented this year. Next year, we make the assumption that earned income taxation will be eased by lowering marginal tax rates by one percentage point across all income brackets and with a two-percent inflationary adjustment to the income tax schedule. Taxes on alcoholic beverages are expected to decline gradually starting in 23, in accordance with the government s earlier decision. If our forecast for economic growth materializes, the general government will record a budget surplus amounting to slightly more than three percent of GDP both this year and next. Central government debt will decline from 46.2 percent of GDP last year to around 4 percent in 23. 1