The global economic slowdown is accentuated by the terrorists attacks in the United States on September 11, the delayed economic recovery in the United States from a recession that "officially" began in March, weakening demand and confidence in Europe, another recession in Japan, a decline in information technology (IT) spending around the world, further deterioration of financial conditions for emerging markets (especially Latin America), and declining equity markets.

The outlook for 2002 is (as usual) uncertain.  Most of the prominent economic forecasts for 2002 have recently been revised downward.  However, none are predicting a global recession or depression. The actual economic performance next year will depend upon the reaction of consumers to the events of 2001, their confidence in the future, the effects of lower interest rates worldwide, and the success of the various economic stimulus packages in some of the world's biggest economies.

The Global Economy

The global economy is comprised of 177 countries.  However, the largest 17 (about 10%) of those countries produce 75% of the world's gross domestic product (GDP).  The United States alone accounts for 22% of world output.  Thus, only a few countries primarily determine the course of the global economy.  Last year, those 17 economies grew at a weighted average annual rate of 4.7 per cent.  This year they will have grown by a mere 2.5 per cent.  Next year, most of them are projected to grow slower than 2.0 per cent.

The table below shows the real GDP, inflation rate, and unemployment rate for the world's 17 largest economies.  The United States is expected to grow by only 1.3 per cent this year compared to 4.1 per cent last year.  China, the world's 2nd largest economy, will have increased production by 7.5 per cent in 2001.  It is the fastest growing economy in the group.  Japan, now in its fourth recession in a decade, will have decreased production by -0.5 per cent in 2001.  India, the world's 4th largest economy, is growing at 4.5 per cent this year.  The European trilogy of Germany, France, and Italy will have increased production this year by 0.8, 2.0, and 1.8 per cent, respectively.  Rounding out the top 7, the United Kingdom expects to see 2.0 per cent growth for the year 2001.
 

Real GDP, Inflation, and Unemployment -- 2000 and 2001
The Largest 17 Countries in the World

Flag	Country	% of World GDP*	growth 2000	growth 2001	inflation 2001	unemployment (latest month)
	United States	22.0	4.1 %	1.3 %	3.2 %	5.4 % (Oct)
	China	11.5	8.0 %	7.5 %	1.0 %	N.A.
	Japan	7.3	1.5 %	-0.5 %	-0.7 %	5.3 % (Sept)
	India	4.6	6.0 %	4.5 %	3.6 %	N.A.
	Germany	4.5	3.0 %	0.8 %	2.5 %	9.5 % (Oct)
	France	3.2	3.4 %	2.0 %	1.8 %	9.1 % (Sept)
	United Kingdom	3.1	3.1 %	2.0 %	2.2 %	5.1 % (Aug)
	Italy	3.1	2.9 %	1.8 %	2.6 %	9.4 % (July)
	Brazil	2.7	4.5 %	2.2 %	6.2 %	N.A.
	Russia	2.5	8.3 %	4.0 %	22.1 %	N.A.
	Canada	1.9	4.4 %	2.0 %	3.1 %	7.3 % (Oct)
	Mexico	1.9	6.0 %	0.8 %	6.3 %	N.A.
	Spain	1.7	4.1 %	2.7 %	3.6 %	13.0 % (Sept)
	South Korea	1.7	8.8 %	2.5 %	4.4 %	N.A.
	Indonesia	1.5	4.8 %	3.0 %	10.8 %	N.A.
	Australia	1.1	3.8 %	2.3 %	4.2 %	7.1 % (Oct)
	Taiwan	1.0	6.0 %	-1.0 %	0.1 %	N.A.
	All 17	75.3	4.7 %	2.5 %	N.A.	N.A.

The visual image below depicts the playing field of The Global Economics Game and the relative economic performance of the world's largest 17 countries in 2001.  The further to the right a country/flag is, the faster the rate of growth.  The very center is approximately 4 per cent real growth.  When a country moves to the left of the playing field,  the economy's rate of growth slows down and it can slip into recession (as in the case of Japan).  Declining GDP causes cyclical unemployment. The higher up in the playing field a country goes, the higher the rate of inflation.  For example, Russia's inflation rate is 22.1%.  The middle of the playing field is assumed to be approximately 2.5% annual inflation.  Differences in the natural rate of unemployment for different countries can cause incongruities regarding inflation and unemployment trade-offs.  [Editor's note: The numbers in the playing field indicate a country's score as it attempts to balance growth, pollution, inflation, and unemployment.  Black numbers are positive; red numbers are negative.  The objective is to land in or near the center square. Placement of countries on the playing field based on IMF statistics is only an approximation.]
 
 

Output Gaps

It is clear from the image above that the major industrialized economies in the world have experienced a dramatic slowdown in their rates of growth in 2001.  [They have moved to left side of the playing area].  Virtually all of them have what economists call a recessionary output gap.  An output gap is the difference between a country's actual GDP and its potential GDP.  If the actual GDP is greater than an economy's potential GDP (assuming a natural rate of unemployment), then the economy is experiencing an inflationary output gap.  If the actual GDP is lower than the economy's potential GDP, then the economy has a recessionary output gap.  The table below shows the IMF's estimated output gaps for selected countries in the year 2001.  The table shows, for example, that Japan's actual GDP in 2001 is 4.8% below its potential GDP.
 
 

Output Gaps: Selected Countries 2001

	Australia	-0.6
	Canada	-0.6
	China	-4.7
	France	-0.8
	Germany	-1.5
	Italy	-2.0
	Japan	-4.8
	South Korea	-2.5
	Spain	+0.0
	Taiwan	-4.9
	United Kingdom	-0.3
	United States	-0.5

Recessionary output gaps cause cyclical unemployment.  More workers begin to lose their jobs as employers cut back production.  On the other hand, recessionary output gaps dampen the threat of inflation.  It is clear from the economic data for 2001 that the world is more concerned about declining output and rising unemployment than it is concerned about inflation.  Also, recessionary output gaps correlate with declining revenues and profits for business enterprises.

Equity Markets

The year 2001 has not been kind to equity markets.  Stock market investors around the world have suffered losses this year.  Three notable exceptions are Mexico, South Korea, and Russia.  The table below shows the percentage declines (-) or advances (+) in selected stock market indices from December 31, 2000 to November 7, 2001.
 
 

The Wealth Effect and Consumer Confidence

Falling output, eroding profits, rising unemployment, and declining stock prices undermine consumer confidence.  The wealth effect refers to how people behave when they suffer losses in wealth.  When stock prices fall, for example, stock holders have experienced a decline in their net worth.  When people feel poorer, they have less confidence and tend to spend less as consumers.  Declining consumption expenditures can cause a recession or aggravate an economic slowdown.  However, confidence levels can sometimes be restored with deliberate simulative economic policies.

Economic Policies -- Monetary and Fiscal

When market oriented economies experience an economic slowdown, government policy makers have essentially two choices.  One is to do nothing and wait for natural market incentives to bring about an economic recovery.  This is called laissez faire policy -- leave the economy alone.  A surprisingly large percentage of economists adhere to this school of thought.  To be fair, however, they advocate this policy consistently and are quick to point out that many recessions have been caused by restrictive economic policies (such as an overly tight monetary policy).  If a recession has been caused by ill-timed or overly restrictive policies, then it would be necessary for government policy makers to correct their mistake.

The other choice for policy makers is to continually monitor and actively participate in the economy's overall performance.  That is, for example, to undertake simulative policies when the economy slows down or falls into a recession. Most governments around the world seem to have adopted this thinking in response to the 2001 economic slowdown.

The two major economic policy tools available to governments are monetary and fiscal policy.  Monetary policy refers to the control of money, credit, and interest rates.  Fiscal policy refers to government spending and tax policy.  Monetary policy has the advantage of rapid implementation.  Independent central banks can act quickly.  Monetary policy has the disadvantage of a long effect lag.  That is, it can take a long time before the economy responds to a given monetary policy.  Fiscal policy has the disadvantage of political gridlock.  It can take a long time before budget bills and stimulus packages can work their way through a democratic congress.  Also, governments that are already handcuffed by a relatively large debt find it difficult to deficit spend.  Fiscal policy has the advantage of a fairly rapid multiplier effect once government spending is actually increased and/or taxes are cut.

Monetary authorities around the world have been quick to respond to the economic slowdown of 2001.  They have added liquidity to their economies, and interest rates have fallen dramatically for the past year.  The table below shows per annum interest rates for 3-month money market instruments on November 7, 2001 compared to the same rates one year earlier.  The Federal Reserve Bank in the United States has been particularly aggressive, increasing the broad measure of the money supply by nearly 12% over the past twelve months.  The 3-month money market rate has fallen in the United States from 6.50% to 2.02%.
 

Fiscal stimulus packages are also being implemented in Europe, the United States, Asia, and Latin America.  The United States plans to spend more on its war on terrorism, and an economic stimulus package authorizing  more government spending and tax cuts is currently finding its way through the US congress.  The United States has seen its budget surpluses evaporate and is apparently willing to deficit spend to turn its economy around.

Outlook for the Year 2002

According to the IMF, "Substantial uncertainties and risks persist [for the year 2002], as the downturn makes the world more vulnerable to further unexpected developments, and a significant danger of a deeper and more prolonged slowdown remains."  However, if the combination of lower interest rates, fiscal stimulus packages, and restored confidence were to prevail, then the global economy could experience a mild economic recovery next year.

Sources and Recommended Links

http://www.imf.org/

http://www.economist.com/