WORLD OUTLOOK

Abstract

The rise in the oil price since the Iraqi invasion of Kuwait in early August does not radically alter prospects for the world economy; rather it exacerbates existing trends. The US economy was, in any case, heading towards recession and a sizeable overshoot of its budget deficit targets. Japan, especially, but also continental Europe had still not reached the peak of the economic cycle so that inflation and interest rates were still rising. While the higher oil price adds to costs and prices in all countries, the policy response is unlikely to be unborn. In the US the adverse effects on output are being emphasized while elsewhere the inflationary implications are to the fore. In Japan, where acute labour shortages are emerging, the monetary authorities have already raised interest rates and we expect a similar response from the Bunds bank In the US such a move is unlikely; indeed once an agreement on the budget deficit is obtained between President and Congress, we would effect the Federal Reserve to cut interest rates. Despite this view on policy, the forecast offers little prospect of the US avoiding a pronounced slowdown and takes a gloomy view on US growth in the medium term. In Japan and Germany on the other hand the short‐term inflation outlook appears containable and growth prospects over the medium term robust. The central forecast is based on a $25 oil price; we explore in a simulation what might happen if the price rose to $45 a barrel for a limited period.