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Global Economy Projected To Slow in 2006

Global Economy Projected To Slow in 2006, Research Group Says

Economists view high energy prices, not hurricane's impact as major factor

By Andrzej Zwaniecki
Washington File Staff Writer

Washington – The world economy will slow “considerably” in 2005 and 2006 as high energy prices and rising interest rates dampen growth, a group of private economists projects.

The Institute for International Economics (IIE) forecasts that the rate of global expansion will drop to 4 percent in 2005 and a “bit” over 3 percent in 2006 from 5 percent in 2004.

IIE’s Michael Mussa, who presented projections September 14, said that the global outlook for 2006 is “meaningfully darker” not because of Hurricane Katrina’s effects on the world economy, but mostly due to a surge in oil prices that preceded the disaster in the U.S. Gulf Coast region. Those prices are projected to remain high in the near future, he said.

Coupled with gradual tightening of U.S. monetary policy, declining residential investment and housing price gains in several developed markets and continued slowdown in investment growth in China, high energy costs are likely to push global growth “below potential” in 2006, said Mussa, a former International Monetary Fund chief economist.

Mussa said that although U.S. growth in the last quarter of 2005 will suffer somewhat from disruptions caused by the hurricane, growth of gross domestic product (GDP) for the entire year will be affected only “marginally.”

Another IIE economist, Martin Bailey, projected that the impact of Katrina will slow growth in the second half of 2005 to around 3.25 percent but added that the disaster’s effects will “dissipate or reverse” by 2006.

According to a September 6 Congressional Budget Office (CBO) report, the disaster could dampen by 0.5 percent to 1 percent the real, or inflation-adjusted, growth that most economists expected to be in the 3 percent to 4 percent range in the second half of 2005. CBO also said that the hurricane is likely to reduce employment by 400,000.

CBO and many private economists expect that reconstruction in the region hit by the hurricane will boost the U.S. economy in the first months of 2006.

Bailey said that the expected continued rise in interest rates, a declining stimulus from the housing market and high energy costs will offset any such boost and slow overall growth in 2006. Bailey and Mussa projected that real GDP growth for 2006 will fall to no more than 2.5 percent from 3.5 percent expected for 2005 and 4.25 percent achieved in 2004.

But Mussa cautioned that economic projections for 2006 are more uncertain than those made earlier for 2005 and the preceding three years. He said that risks for global growth in 2006 arise mostly from uncertainty about energy prices and their economic impact as well as timing and consequences of the possible shift in global current account imbalances.

Another private group in Washington said that the hurricane, which can magnify risks to the U.S. economy, should also be a wake-up call for world leaders.

“Katrina reminds us of broader uncertainties and the vulnerability of the world economy to shocks, whether from a natural disaster, a political event, or terrorism,” said Charles Dallara, managing director of the Institute of International Finance (IIF), which represents more than 340 of the largest banks in the world.

For more information on the storm and its aftermath, see Hurricane Katrina.

In a letter to finance ministers and central bank governors scheduled to attend the September 24-25 session of the World Bank and the International Monetary Fund, Dallara called for a new coordinated approach to global economic challenges that would involve more major economies.

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