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A gradual recovery in high-income countries

Activity in high-income countries has been under considerable pressure from fiscal and banking sector consolidation and associated uncertainties. These pressures are expected to remain over the forecast period, although the drag they are exerting on growth is projected to diminish, in part because much of the necessary adjustment has already been accomplished.

In the United States, the private sector recovery appears to be relatively robust. By some measures, growth in the first quarter of 2013 was stronger than expected with industrial production expanding at a 4.4 percent annualized pace, and retail sales at a 2.9 percent pace. First quarter GDP growth was relatively weak at 2.4 percent, in part because of a decline in government spending. The gathering momentum in the U.S. economy is both reflected in and prompted by an improving labor market (unemployment has fallen to 7.6 percent) and recovery in the housing market.

Progress toward agreeing on a credible plan to bring the deficit down to sustainable levels has been slow. However, policy makers have extended both the debt ceiling and spending authorizations well into the future, thereby reducing the likelihood of a debt-ceiling confrontation and the threat of default. On the downside, both the tax increases agreed at the beginning of the year and the spending sequester will be a drag on growth in coming quarters, continuing to offset some of the strength from the private sector recovery. Overall, GDP growth for the year is projected to slow somewhat, compared with 2012, to about 2.0 percent in 2013, before strengthening to 2.8 percent in 2014 and 3.0 in 2015.

The economy of the Euro Area remains very weak despite improved financial conditions and some signs of strengthening. On the positive side, funding costs in core Euro Area countries have declined, and lending has started to grow again. Imports, exports, and industrial production have all returned to positive (albeit modest) growth.

However, borrowing costs in high-spread economies remain very high; unemployment continues to rise (including in so-called core economies); and weak growth is compromising progress on the fiscal front. Moreover, although important structural and fiscal consolidation reforms have been undertaken (see box 1), the pace of progress has eased, leading to concerns of reform fatigue, while several elections have highlighted popular discontent with austerity. Finally, unemployment is crushingly high in periphery economies (27 percent in Spain and Greece, 18 percent in Portugal, 14 percent in Ireland, and 12 percent in Italy).

Growth in the Euro Area is expected to pick up slowly during the course of 2013, in part because the drag from fiscal consolidation and banking sector restructuring in the core countries is expected to become less intense.FN4 As a result, quarterly growth for the Euro Area as a whole is expected to return to positive territory in the middle of 2013 and then gradually gain strength. Nevertheless, whole year GDP is projected to contract by 0.6 percent in 2013, with annual growth slowly strengthening to 0.9 percent in 2014 and to about 1.5 percent by 2015. Despite the return to positive growth, little progress is expected to be made in reducing unemployment. Weakness in high-spread economies where the deepest adjustments are occurring will continue, with growth not turning positive until 2014 and then only to a soft 0.3 percent.

Growth in Japan rebounded in the fourth quarter of 2012 and into the first quarter of 2013, expanding at a 4.1 percent annualized pace, with consumer demand rather than investment a major driver—although industrial production expanded rapidly (8.9 percent in 2013Q1). Trade denominated in U.S. dollars has dropped off precipitously (as of April 2013, it was 8.0 percent lower than in June 2012), in part because of the 18 percent depreciation of the Yen vis-à-vis the dollar since March 2012. The decline also reflects bilateral weakness in Japan’s exports and imports to and from China, apparently linked to tensions over disputed territories.

The strength in the Japanese economy partly reflects the effects of announcements of a shift toward looser monetary policy made in November and confirmed with announcements of a large quantitative easing, fiscal stimulus and structural reform policy in January. Growth is projected to come in at 1.4 percent this year and in 2014 and at 1.3 percent in 2015. For growth to remain strong through 2015, however, Japan will have to implement a robust set of productivity enhancing policy changes. Measures announced to date, include deregulation of the agriculture and electricity sectors, a relaxation of rules in health care, investment tax incentives, (including FDI); some corporate governance reforms; and a partial relaxation of restrictions on the investment behavior of pension funds.

4. The IMF (2013a) estimates an overall fiscal contraction for the Euro Area of 0.7 percent of GDP, compared with 0.5 percent in 2012 and 2.1 percentage points in 2011.

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