19.12.2016 |
Austria:
• IMF: Low potential growth amid lack of reform and negative demographics
Last week, staff of the International Monetary Fund (IMF) concluded the official visit to member country Austria. The comprehensive Article IV report about the economic developments in Austria will be released upon IMF executive board approval. The concluding statement of the mission honours that Austria’s economy is stable and prosperous; nevertheless, it can still improve its economic performance. A comprehensive package of structural and fiscal reforms can raise low GDP growth, according to the IMF.
Austria’s recovery has recently strengthened. The IMF projects 1.4 % GDP growth for this year amid broad-based growth in private consumption supported by income tax reductions (Steuerreform), a pick-up in investment and higher public expenditure on refugees. The near-term outlook remains similar to developments in 2016. For 2017 the GDP growth forecast is 1.3 % what is equivalent to the current median growth projection among analysts reporting forecasts to Bloomberg, while the Institute of Advanced Studies (HIS) released forecasts last week at 1.4 % in 2017 and 1.5 % in 2018. The IMF estimates that the potential growth rate of the Austrian economy is 1 %. According to the theoretical concept, actual GDP growth can be expected to revert to that growth rate in the medium term when sources of production and labor are fully employed and inflation is assumed to be neither accelerating nor decelerating. In other words, Austria’s economy can be expected to grow on average by 1 % in the longer run in the absence of structural changes or reforms. Other challenges that the IMF addresses are long-term fiscal sustainability and further strengthening of the financial system. The IMF states that a comprehensive, consistent and coordinated policy package would address these challenges and a reform package combining structural reforms with deficit-neutral fiscal measures could permanently boost GDP by 3 % over the medium-term (The level of GDP would increase permanently by 3 % but not the GDP growth rate). The structural reforms that are proposed include lowering barriers to entrepreneurship (regulations that hinder firm’s market entry and competition and regulations that impose high administrative burden on companies, including start-ups) and barriers to investment in the network sectors. With respect to the public sector, the IMF stresses the need of investment in Austria’s infrastructure and a shift in the tax mix away from labor towards taxation of property, pollution and consumption. Furthermore, the IMF stresses the need of raising labor force participation (LFP) by the elderly and women and asks for further tightening early retirement options and indexing the pension age to life expectancy in order to increase LFP of the elderly population. Reducing the public debt toward 60 % of GDP would require additional policy measures to counteract the impact of population ageing on public spending. Significant savings in the health sector should be feasible. Figure 1 illustrates the demographic shock that is going to evolve over the coming decades once large baby-boomer cohorts will reach the retirement age.
In the peak period (2025-30), the rise in the population of age 65 or older will be 50,000 persons per anno, while at the same time working-age population (~20-64 years) is going to shrink by 25,000 persons per year according to demographic forecasts from Statistics Austria. Hence, the working age population will shrink by 0.4 % per year between 2025 and 2030 and by 0.3 % in 2025-30. If we assume that productivity growth (0.5 % p. a.) and growth in the stock of physical capital (1.8 % p. a.) will equal the average growth rate since 2000, we can isolate the negative drag of labor supply (Figure 1) on potential GDP growth during the next 20 years within a small growth model (Figure 2).
The simple observation allows drawing a number of first-priority conclusions: First, the positive effect of a rise in labor force participation becomes eminently clear. Second, decreasing the elevated unemployment rate becomes a main policy priority. Thirds, increased migration theoretically increases labor supply and, hence, labor market integration of migrants becomes a major policy priority in order to enhance potential GDP growth.
USA
• Fed raised key policy rate, as broadly expected
• FOMC was not convincingly “hawkish”
As widely expected, the U.S. central bank Fed raised the target range of the federal funds rate by 25 basis points to 0.5 % to 0.75 % in the December meeting of the federal open market committee (FOMC).
The FOMC made minor changes in its statement compared to the previous statement in November. It says that the economy has been expanding at a moderate pace since mid-year, while previously it stated that economic activity has picked up from the modest pace in the first half of the year. Job gains have been solid in recent months and the unemployment rate has declined (4.6 % in November). With regards to inflation, the statement mentions that market-based measures of inflation compensation have moved up “considerably” (inserted versus previous statement) but still are low; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months. Figure 3 shows the upward trend in a market-based measure of inflation expectations (5 years forward inflation swaps).
Unchanged to the November (pre-presidential election) statement, the FOMC “expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will strengthen somewhat further.” Near-term risks to the outlook appear roughly balanced.
In its updated, quarterly summary of economic projections (SEP), the Fed forecasts that real GDP will expand by 2.1 % in 2017 (previously: 2.0 %) and 2.0 % in 2018 (unchanged). The forecast for the unemployment rate was lowered from 4.6 % to 4.5 % for 2017 but remained unchanged for later periods. The inflation projections were unchanged compared to the September SEP (2017: 1.9 %, 2018: 2.0 %). The median of FOMC member’s projection for the fed funds rate increased from 1.1 % to 1.4 % implying three policy rate hikes (each 25 basis points) next year and 2.1 % for 2018 (after 1.9 % previously) implying two to three rate hikes in 2018 (Figure 4).
In addition, some of Chair Yellen’s comments during the press conference were interpreted as pointing towards a more restrictive monetary policy stance. In particular, she noted that she never advocated running a “high pressure” or over-heating economy. On the other side, Yellen said that it is “far too early” to judge the effects of loosening fiscal policy (tax cuts, rising public expenditure and deregulation by the incoming administration). In summary, minor changes in the statement and negligible changes to the growth outlook combined with a gradually steeper fed funds rate path projection do not appear convincingly and consistently “hawkish”, to us.