ECONOMICS

After nine years of rapid economic expansion, the United States’ (US) economy continued to show remarkably few signs of strain. In 1999, the US economy continued to register strong growth, low inflation and double-digit earnings gains. Gross domestic product (GDP) expanded by 4% in 1999 from 4.3% in 1998 on the back of strong productivity and earnings growth while inflationary pressures remained benign and increased by only 2.7 % in 1999.

Consumer expenditure and capital spending remained the core drivers of US economic growth in 1999. Spending on technology equipment, which is increasingly deemed as capital expenditure, remained buoyant throughout 1999. Despite buoyant aggregate demand, inflationary pressures continued to be subdued as core inflation remained below 2% during the year, wage pressures were weak, and average monthly job gains up to Nov 1999 recorded their lowest levels in four years. As a result, both real wage income and nominal wage income rose at the slowest pace in three years.

Real GDP expanded by 3.7% in the first quarter, 1.9% in the second quarter and 5.5% in the third quarter. This prompted the US Federal Reserve to raise short-term interest rates by 75 basis points on three separate occasions - effectively reversing the previous year’s interest rate cuts - during the period in review to check the economy’s robust expansion. Although these moves were aimed at pre-empting inflationary pressures - US monetary policy has a policy lag of about 12-18 months - the Fed adopted a moderate monetary stance towards the year end, heeding apparent concerns over potential illiquidity arising from the Y2K rollover period.

Strong domestic demand and a strong US dollar saw the US trade deficit balloon. The Jan-Sept cumulative deficit grew to US$239.5 billion following three straight record quarterly highs - eclipsing the annual record of US$220.5 billion registered in 1998 - and registered a current account deficit of US$323 billion in 1999. The potential adverse impact from the large current account deficit, however, was partially offset by the sizeable federal budget surplus, amounting to a forecast US$123 billion in 1999.

Japan’s real GDP expanded by a stronger-than-expected 1.9% in the first quarter of 1999, after five consecutive quarters of decline, raising hopes that the economy had finally emerged from its longest post-war slump. One-half of this increase came from public investment - reflecting the fiscal stimulus packages introduced in 1998 - but more noteworthy was the renewed growth in private demand. Although growth subsequently moderated in the second quarter, in part due to a decline in public investments, there were growing indications of an economic recovery: the widely followed tankan survey showed that business sentiment had improved, as suggested by a rise in the sentiment index from -47 points to -17 points in 1999. In addition, concerns about deflation and the health of the financial system appeared to have subsided following the government’s accommodative economic policies. Authorities continued with expansionary policies and restructuring efforts during the period in review to expedite economic recovery. The government recapitalised viable financial institutions and nationalised failed banks on the back of Bank of Japan’s loose monetary policy besides embarking on an expansionary fiscal policy, as evinced by a record ¥81.86 trillion budget allocation in 1999.

Expectations of an imminent economic recovery led to a massive turnaround in Japanese portfolio flows (from an outflow of ¥5.7 trillion in 1998 to an inflow of ¥1.8 trillion in 1999) as well as large bank loan inflows. These developments subsequently led to the appreciation of the Japanese yen, which experienced a significant rise from Jul 1999 onwards, despite the reported intervention by authorities to counter the rapid appreciation.

However, economic recovery in Japan remained slow despite some signs of improvement and renewed private sector growth. A continuing decline in household income and lingering worries of job losses appeared to contribute to private consumption weakness. Furthermore, many businesses, particularly those less exposed to international competition and pressures for restructuring, remained bogged down by large debt burdens and excess capacity. In addition, there were lingering worries that the economic recovery would lose its impetus as the effects of the earlier stimulus packages diminished. Despite these concerns, the Japanese economy was expected to expand by 1% in 1999.

There were signs of stronger domestic spending in the "core" economies of the European Union, especially Germany and Italy. A higher level of consumer confidence and a modest reduction in the unemployment rate supported growth in household expenditure across the region. Much of the increase in demand was absorbed by a slowing of the rate of stock accumulation which, in tandem with further declines in export volumes, had limited the pick-up in manufacturing output.

Nonetheless, business sentiment regarding future production had improved, due partly to a rise in foreign orders, the decline in the value of euro and the easing of monetary policy in April. The euro experienced a prolonged downtrend since introduction and reached new lows against the US dollar, the Japanese yen and the pound sterling towards the end of November, amid large capital outflows from the euro area.

Price pressures across the so-called euro-zone remained subdued, with the rate of inflation remaining close to 1% in recent months, despite the effect of the rise in oil prices. The rate of unemployment declined throughout 1999, although at a somewhat slower pace in later months, and stood at 10% in Sept 1999.

Estimates of fiscal positions in euro area countries show that the average government deficit-to-GDP ratio in 1999, at around 1.5%, was lower than expectations earlier in the year. In particular, government revenue was higher in many of these countries, partly as a result of improved economic conditions.

Appendix

Chart 22 Diffusion Index of Leading Indicators