The European economy in the medium term; report presented to the AIECE spring meeting, Athens, 8-10 May 2002

Most of the difference in output growth can be explained by demographic factors. Contrary to popular belief, hourly productivity trends do not differ much.

These are some highlights of the study "The European economy in the medium term", published today by CPB Netherlands Bureau for Economic Policy Analysis. The report has been prepared on behalf of the ‘Working Group on Longer-Term Prospects and Structural Change' of the Association of European Conjuncture Institutes (AIECE). It discusses the medium-term outlook for the European economy taking account of the latest views of its member institutes.
The report contains the most recent medium-term forecasts of 18 AIECE member institutes from 16 European countries, of which 4 transition countries, and by aggregation also the consensus view for the European Union as a whole and - separately - for the transition economies. The first section of the report deals with the theoretical concept of potential output as a basis for medium-term forecasting and policy analysis. The second section deals with structural developments in the global economy over the period 1970-2010. The third section discusses the responses of the AIECE institutes to a questionnaire on their most recent medium-term forecasts.
Potential output in Western Europe is forecast to rise by almost 2.5% per year up to 2010. Hourly productivity growth contributes 2%, which is not much different from the average of the past twenty years. The remainder is explained by the growth of potential employment in total hours worked, which is projected to accelerate slightly to almost 0.5% a year. Rising participation rates explain almost all of the potential employment growth, as the working age population will hardly increase.

Potential output growth in the United States is projected at 3.25% per year up to 2010. Hourly productivity in the American economy increases by slightly more than 2% and potential employment by a bit over 1% per year. The latter increase is almost completely explained by the growing working age population, and this is where the supply sides of the European and the American economy differ most.

The growth forecasts for actual output growth are slightly higher than for potential output growth. Most countries are in excess supply now, and because the negative output gap is assumed to close gradually, the envisaged actual growth exceeds potential growth in the projection. On average, unemployment in Europe is currently above equilibrium level, which should help to contain inflation over the medium term, as labour market weakness is reflected in reduced wage pressure.
It is assumed that the European Central Bank will succeed in keeping the average inflation around its target value of 1.5 to 2%. Moreover, it is generally anticipated that the euro will regain some strength, which helps to keep import costs in check. Public sector financial balances are expected to move towards equilibrium pretty soon. Public debt for the European Union as a whole could decline from 63% of GDP in 2001 to some 56% in 2007.
Medium-term growth of the transition economies (average of Czech Republic, Hungary, Poland and Slovenia) is estimated at 4.5% per year. Here the period after the political transition is too short to allow a potential growth analysis. The unemployment rate could decline by some 2.5 percentage points up to 2007. Consumer price inflation is forecast to decelerate to 3.5% on average. However, public sector debt as a percentage of GDP tends to rise in these countries, albeit from relatively low levels.

Participating institutes in the enquiry are: