A Medium-Term Outlook for the World Economy: 2006-2012 [ NIME 2006 - JAN - 13/03/2006]

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The January 2006 issue of the NIME Economic Outlook (NEO) for the World Economy presents a 2006-2012 macroeconomic outlook for the major areas of the world. The outlook was produced using NIME, the Federal Planning Bureau’s macroeconometric world model. The January 2006 issue also features an assessment of the response of the euro area economy to a shift away from the direct taxation of labour towards the indirect taxation of final demand.

After a year of weak economic growth in 2005, euro area GDP growth should rebound in 2006 while the rise in the consumer price deflator is expected to remain well below the 2% mark. The pick-up in growth is largely based on a further strengthening of employment growth and continued favourable monetary conditions. Over the 2007-2012 period, the area’s GDP will rise on average by 2% per annum, notwithstanding the declining growth rate of the working-age population. At the same time consumer price inflation will average 1.8%, edging up towards the end of the period. The short-term interest rate will rise from 2.2% in 2005 to 4.4% in 2012, bringing to bear inflationary pressures. Assuming no policy changes, the area’s fiscal deficit will recede gradually, falling from 2.6% of GDP in 2006 to 1.6% of GDP in 2012.

Over the 2006-2012 period, GDP growth will average 2.8% per annum for the group of countries comprising the United Kingdom, Sweden and Denmark, and 3.6% for the group comprising the EU’S recently acceded Member States. Real GDP in the United States is expected to rise on average by 2.6% over the 2006-2012 period. However, growth will be uneven as, under current US laws and policies, the sunset of important tax cut provisions will significantly weaken domestic demand throughout the projection period. At the same time, significant fiscal and external imbalances should persist. Japanese real GDP is expected to rise on average by 1.7% per annum over the 2006-2012 period, although growth should weaken notably by the end of the projection period as the labour supply falls due to the ageing of the population.

The Focus in this issue of the NEO analyses the potential gains in output and employment from a tax shift away from social security contributions towards indirect taxes on final demand. Simulations with the NIME model indicate that the potential gains could be very limited for the euro area. Indeed, a shift from direct to indirect taxes equivalent to 1% of GDP throughout the 2006-2012 period would initially raise euro area real GDP by 0.11% above its baseline level, followed by further gains of up to 0.3% above baseline in 2007, but these positive effects would then level off at just 0.19% by 2012. The employment gain would be 0.06% in 2005 and 0.13% in 2012. The potential effects on output and employment are small as the gains from a general (non-targeted) reduction in the social contribution rate would be mitigated by the rise in the indirect tax rate, which would squeeze corporate profit margins and temper labour demand.