Programme Paper

Project: International Economics Department

Vanessa Rossi and Rodrigo Delgado Aguilera
  • One year on from the onset of the global crisis, as policymakers turn from firefighting to considering the next steps for recovery, a key question is whether there has been a severe but temporary setback to economic growth or a permanent adjustment in long-run projections. Could this crisis and the cost in terms of public finances haunt the world economy for many years to come?
  • Many analysts would agree that, compared with pre-crisis assessments for the GDP outlook, this recession will cast a long shadow over prospects for the economies most involved, chiefly the US and Europe. But should this shadow extend over the 10-20-year view and beyond? The short-term shock is unlikely to change demographics, but arguably it will encourage more cautious reappraisals of the other determinant of long run growth, future productivity trends.
  • Long-term GDP projections are indeed under review but proposed changes should not go unchallenged as they are highly debatable, politically sensitive and critical to the short- to medium-term outlook. Firstly, given the intrinsic difficulties in forecasting productivity (GDP/head), all projections are tenuous and reflect factors other than economic opinion, such as forecast credibility, business confidence and political leanings. Secondly, GDP projections will be critical in policy-setting, including planning the timing and scale of exit strategies such as the normalization of monetary and fiscal policy.
  • Estimates for future GDP, public-sector deficits and debt are particularly important for the Euro area given that currently high government deficits are pushing up average debt to 70-80% of GDP, well above the debt target of 60%. Adjustments required to bring debt down will be even tougher if GDP growth is low.
  • Given the important influence that long-run GDP assumptions have on policy and thus on the short-run economic outlook, they need to be scrutinized carefully. And policy decisions should take into account the highly uncertain nature of such estimates, adopting a flexible approach to target setting to allow for the possibility of further adjustments based on new information.