Liquidity Offsets Adverse Shocks

1. Global Assessment and Outlook The world economy is forecast to expand by 3.1% in 2002 from the rate of 2.6% to which is estimated to have slipped this year. The major reason forthe expected strengthening of economic activity in the world economy in 2002 is the current acceleration in global liquidity, accompanied by a moderate fiscal easing. The adverse effects of the last two years' economic shocks will be offset by growthoriented economic policies. The foundation for the current global slowdown was set three to four years ago. The United States that led the last upswing of the global business cycle started to implement an expansionary monetary in the mid-nineties. Growth in the money supply peaked in 1998, which generated the 1999-2000 above trend economic growth. The same synchronous pattern was followed to a lesser degree by Japan thus leading to a fragile recovery. After advancing at an annual average growth rate of 4.8% during 1995-97 and 4.6 % in 1998, the growth of the money supply in the European Union reached its peak in 1999, a year later than the financial peaks of the United States, Japan and other industrial countries. In the developing countries, after an average annual growth rate of about 20% during 1995-97 due to several financial crises, money supply growth decelerated during 1998-99. Monetary growth stabilized in 2000 around 11% in Asia and Latin America, and reached nearly a 16% rate in Africa. With a one to two-year lag, central banks in all countries followed the Federal Reserve's interest rate increases and implemented tight monetary policies, resulting in a moderation in the growth of global liquidity during 1999-2000. The change in helped to alleviate inflationary pressures and slowed down global economic activity. In the current phase of the global cycle, the world economy is on a downswing led by a significant weakening in the United States, a stalling of the Japanese economy, a slowdown in Europe and a growth moderation in the emerging economies, which depends on the strength of their linkages to the industrial countries. Along with the 1999-2000 tightening in global liquidity whose effects engineered the global slow down, several shocks have helped to generate the current world wide economic weakening: Higher energy costs, the fall in stock market prices and its wealth effects on the consumer, the sharp deceleration in the growth ofthe technology sector inherent to its unique innovation-- investment-inventory cycle, and the changing outlook on corporate profits because of weak earnings reports. The monetary policies, which operate with a lag, have eased significantly in the last four quarters, especially in the United States. Looking ahead, there is a high probability to expect monetary conditions to continue to ease. The political environment in the industrial countries is a return-to-growth policy for maintaining the newly created jobs and increasing workers' wages to cope with higher energy costs. With the exception of the African countries, in every other part of the world a continuation of monetary easing is expected over the next two quarters. Executives from eighty countries anticipate their central banks to lower the short-term cost of money and provide the needed liquidity for reviving domestic investment demand, productivity, and employment and, consequently, the world economy. As the fiscal consolidation efforts of the last decade produced smaller public deficits and even surpluses in some countries like the United States, an oldfashioned mix that is conducive to growth has reemerged. It is the combination of monetary easing and fiscal easing driven by reduction in tax rates. Tax-cuts are seen to play a dual role in their effect on the economy. First, tax cuts increase demand through rising after-tax incomes. Second, they have a supply-side effect by increasing savings and also by decreasing the cost of capital. …