Chapter

Chapter 1 Developments in the World Economy

Author(s):
International Monetary Fund
Published Date:
September 1975
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By traditional standards, the performance of the world economy during 1974 and the first half of 1975 was poor. But by reference to the serious and complex range of problems that had to be confronted, this performance can be characterized as mixed. The slowdown of economic growth in the industrial world that was in process around the beginning of 1974 developed into an unexpectedly severe and widespread recession, featuring exceptionally high rates of unemployment. On the other hand, expansionary policies have been adopted in a number of industrial countries to foster resumption of economic growth; essentially because of the international recession, progress on the inflation front has been better than anticipated; and the problems of financing the external current account deficits associated with the oil price increase have proved—partly because of the recession—less intractable than initially feared.

During the first half of 1975, unemployment and slack in utilization of productive capacity in the large industrial countries reached levels not witnessed for several decades. The effects of the downturn in the industrial world had spread progressively to other areas after mid-1974, making it difficult for many developing countries to maintain satisfactory rates of growth in their real incomes.

However, the downward momentum of late 1974 and early 1975 seems to have diminished or disappeared in very recent months. By the second quarter, the authorities of most major industrial countries had instituted fiscal and monetary policies designed to spur recovery, and the stage appeared to be set for renewed acceleration of economic activity. Although such an upturn was not yet clearly in evidence at mid-1975, it was generally expected to begin during the second half of the year.

Because of the virulence of the inflation that had developed during the 1972-73 boom, the expansionary fiscal and monetary measures adopted to combat the subsequent recession have remained generally cautious.

While rates of inflation have generally been subsiding during the recession, prices are still rising in most countries at a pace that is extremely high by historical standards, and cost-push pressures remain a widespread problem. The danger that unduly stimulative policies might reactivate an inflationary psychology cannot be ignored by national authorities.

These circumstances, given the difficulties and uncertainties of economic forecasting, call for watchfulness with respect to evolving trends and for flexibility in the adaptation of national policies. The risks of an excess of caution that could prolong the wasteful underutilization of manpower and capital facilities must be continually weighed against those of an overly rapid expansion of demand that could generate renewed instability of prices.

The massive disequilibrium in international payments that arose from the overlay of higher oil prices on a situation already characterized by sizable imbalances among the industrial countries remains a serious problem, but has assumed an altered form. To date, investment of the surpluses of oil exporting countries in national and international financial markets—together with the expansion of official financing (through both bilateral arrangements and multilateral facilities) — has resulted in a satisfactory channeling of funds into the financing of the current account deficits of the oil importing countries. The process of international reserve creation that takes place when reserves transferred to the oil exporting countries are replenished through borrowing in the United States or the Eurocurrency market has meant that a substantial accrual of reserves by the oil countries could proceed without serious reduction of the reserves held by the majority of oil importing countries.

However, a crucial problem looms for the period ahead inasmuch as the cyclical downturn in the industrial countries has resulted in a marked shift of current account deficits from those countries toward the primary producing countries. For the latter, considerable erosion of earlier gains in the terms of trade was already evident in 1974; and severe further declines in their terms of trade, coupled with loss of buoyancy in their export markets and the urgent need to maintain essential imports, are tending to raise their current account deficits even higher in 1975 than in 1974. Their need for external financing thus remains high; and many of the non-oil developing countries have already strained their debt-servicing capacity to finance the greatly enlarged current account deficits confronted in 1974.

At best, the non-oil developing countries may have to contemplate some considerable reduction of their net reserve positions to finance the even larger current account deficits in prospect for 1975. For countries with the most severely strained borrowing capabilities, the need for larger flows of concessional aid is urgent; and maintenance of the net inflow of private capital at its high 1974 level will require both care on the part of the borrowing countries to follow policies that defend their creditworthiness and cooperative efforts by capital exporting countries to encourage the needed flows of financial assistance.

To obtain a satisfactory share of the expanded export markets that should materialize when the expected upturn of economic activity in the industrial world takes place, developing countries will require ready access to such markets. In this context, it is heartening to note that the spirit of the Rome communiqué of January 1974 has been observed by most Fund members; with some exceptions, they have avoided the imposition or intensification of restrictions notwithstanding enlarged current account deficits and the impact of recession. It is important that vigilance be maintained in this field because of the damage to the world economy that would result from any widespread resort to restrictions.

Domestic Economic Activity

Trends in Output and Inflation

After the 1970–71 economic slowdown, growth of real gross national product (GNP) in the industrial countries accelerated and reached an unsustainably high rate of 8 per cent in the first half of 1973; the rate of increase then fell off sharply in the second half of that year and became negative in both halves of 1974 (Chart 1). These wide fluctuations were in contrast to the growth rate of 4½-5 per cent registered by the industrial countries over the decade of the 1960s (Table 1).

Chart 1.Semiannual Changes in Output and Prices in Industrial Countries, First Half 1973-First Half 1975

(Percentage changes in real GNP and GNP deflators from preceding half year, seasonally adjusted, at annual rates)

1 Include, in addition to the countries shown separately in the chart, Austria, Belgium, Denmark, Luxembourg, the Netherlands, Norway, Sweden, and Switzerland.

Despite the developing weakness in real activity, price increases grew larger in 1973 and 1974 (Table 2).

Table 1.Growth of World Output, 196–74(Percentage changes in real GNP)
Annual Average 1Change from Preceding Year
1960-701960-651965-7019701971197219731974
Industrial countries4.85.14.52.63.75.76.2-0.2
Canada5.25.64.82.55.86.06.92.8
United States4.04.93.2-0.43.36.25.9-2.1
Japan11.210.212.110.36.88.710.2-1.8
France5.75.75.65.85.35.76.03.9
Germany, Fed. Rep. of4.95.04.85.83.03.45.30.4
Italy5.65.35.94.91.63.16.33.4
United Kingdom2.73.22.22.12.23.45.40.3
Other industrial countries24.95.04.75.63.24.74.22.7
Primary producing countries5.65.35.86.65.45.77.15.6
More developed35.85.95.86.05.75.66.13.5
Less developed45.55.15.86.95.25.77.66.4
World55.05.14.83.44.05.76.41.0
Sources: National economic reports, secretariat of the Organization for Economic Cooperation and Development, secretariat of the United Nations, U. S. Agency for International Development, International Bank for Reconstruction and Development, and Fund staff estimates.

Compound annual rates of change.

Austria, Belgium, Denmark, Luxembourg, the Netherlands, Norway, Sweden, and Switzerland.

Comprise Australia, Finland, Greece, Iceland, Ireland, Malta, New Zealand, Portugal, South Africa, Spain, Turkey, and Yugoslavia.

Comprise Fund member countries not listed above as “Industrial countries,” or as being “More developed” (footnote 3, above). In some of the other tables in this chapter, the less developed countries are subdivided to distinguish the “major oil exporters” (Algeria, Bahrain, Indonesia, Iran, Iraq, Kuwait, the Libyan Arab Republic, Nigeria, Oman, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela) and “other developing countries” (or “non-oil developing countries”).

Fund member countries (listed in Appendix I, Table I.1) plus Switzerland.

Sources: National economic reports, secretariat of the Organization for Economic Cooperation and Development, secretariat of the United Nations, U. S. Agency for International Development, International Bank for Reconstruction and Development, and Fund staff estimates.

Compound annual rates of change.

Austria, Belgium, Denmark, Luxembourg, the Netherlands, Norway, Sweden, and Switzerland.

Comprise Australia, Finland, Greece, Iceland, Ireland, Malta, New Zealand, Portugal, South Africa, Spain, Turkey, and Yugoslavia.

Comprise Fund member countries not listed above as “Industrial countries,” or as being “More developed” (footnote 3, above). In some of the other tables in this chapter, the less developed countries are subdivided to distinguish the “major oil exporters” (Algeria, Bahrain, Indonesia, Iran, Iraq, Kuwait, the Libyan Arab Republic, Nigeria, Oman, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela) and “other developing countries” (or “non-oil developing countries”).

Fund member countries (listed in Appendix I, Table I.1) plus Switzerland.

Table 2.Price Increases in Developed Countries, 1960-74(Percentage changes in GNP deflators)
Annual Average 1Change from Preceding Year
1960-71960-651965-7019701971197219731974
Industrial countries23.42.64.25.95.44.87.011.7
Canada3.01.94.24.73.24.98.413.8
United States2.71.44.15.54.53.45.610.3
Japan4.84.94.76.74.65.011.120.9
France4.34.14.45.55.66.07.29.6
Germany, Fed. Rep. of3.53.63.47.17.95.95.96.6
Italy4.45.53.56.66.65.910.316.3
United Kingdom4.33.65.07.38.97.77.412.6
Other industrial countries 2, 34.54.44.55.97.27.37.99.8
More developed primary producing countries24.84.74.96.29.09.414.016.5
Australia2.92.23.64.66.57.611.816.2
Spain5.86.65.04.97.48.913.812.9
Other countries 2,45.25.05.47.410.610.216.819.5
Sources: National economic reports, secretariat of the Organization for Economic Cooperation and Development, and Fund staff estimates.

Compound annual rates of change.

Average of percentage changes for individual countries weighted by the U. S. dollar value of their GNPs at current prices in the preceding year.

Austria, Belgium, Denmark, Luxembourg, the Netherlands, Norway, Sweden, and Switzerland.

Finland, Greece, Iceland, Ireland, Malta, New Zealand, Portugal, South Africa, Turkey, and Yugoslavia.

Sources: National economic reports, secretariat of the Organization for Economic Cooperation and Development, and Fund staff estimates.

Compound annual rates of change.

Average of percentage changes for individual countries weighted by the U. S. dollar value of their GNPs at current prices in the preceding year.

Austria, Belgium, Denmark, Luxembourg, the Netherlands, Norway, Sweden, and Switzerland.

Finland, Greece, Iceland, Ireland, Malta, New Zealand, Portugal, South Africa, Turkey, and Yugoslavia.

The overall rate of price inflation in the industrial countries—as measured by the comprehensive GNP deflators—accelerated to an annual rate of more than 13 per cent in the second half of 1974 (Chart 1). In that period, exceptionally rapid rates of price inflation, together with low or negative rates of growth in output, were widely prevalent among these countries—a situation unprecedented in postwar history.

During 1974, the extent of weakness in real activity and of strength in price pressures was, in general, not foreseen by national officials, or by private and international forecasters. At mid-1974, as noted in last year’s Annual Report, inflation was widely regarded as the dominant problem of economic policy; the underlying demand situation still appeared to be expansionary; and most of the major countries were expecting an upturn of real GNP during the second half of the year, although the possibility of international recession was not ruled out. As matters developed, judgments about the trend of real activity were wide of the mark for many of the industrial countries, including the three largest: the United States, the Federal Republic of Germany, and Japan.

This unsatisfactory experience of the industrial countries with respect to output became even worse in early 1975. For these countries as a group, real GNP is estimated to have fallen at an annual rate of 4 per cent from the second half of 1974 to the first half of 1975; the declines were widespread, the largest being that for the United States, estimated at 8 per cent. However, the spreading of recession during 1974 and the early months of 1975 has had the effect of bringing about some noticeable success on the inflation front, and the weighted-average increase of GNP deflators for the industrial countries is estimated to have declined from the peak annual rate of more than 13 per cent in the second half of 1974 to a rate of about 10 per cent in the first half of 1975—still far above the average price increase of about 2½ per cent experienced by the industrial countries in the early 1960s. Although price inflation has accelerated almost steadily over the past ten years, the main change occurred after 1972; in that year, when inflation was already considered a worrisome problem, GNP deflators rose on the average by “only” about 5 per cent.

Compared with the semiannual GNP figures, a somewhat sharper perspective on recent and current developments is afforded by monthly data on industrial production and on consumer prices. The production data, as summarized in Chart 2, indicate that there have been substantial declines of activity in the industrial sectors of most industrial countries. These declines have been in the neighborhood of 19 per cent for Japan, 13 per cent for the United States, 11 per cent for France and Italy, and 9 per cent for the Federal Republic of Germany, while the downward tendency of industrial production in Canada and the United Kingdom has been less marked.1 Meanwhile, there has been a widespread easing of consumer price increases except in the United Kingdom. From December 1974 to May 1975 (the latest month for which consumer price data are presently available), increases averaged about 9 per cent at an annual rate, down from the rate of 14 per cent recorded for the third and fourth quarters of 1974.

Chart 2.Industrial Production in Industrial Countries, 1970-May 1975

(Indices adjusted for seasonal variation; 1970 = 100)

1 Austria, Belgium, the Netherlands, Norway, and Sweden.

The economic slowdown or recession that has developed in all the industrial countries since 1973 has produced an extraordinary degree of economic slack. This is directly evident from officially reported unemployment figures, but is measured most comprehensively in terms of the gap between actual GNP and “potential” GNP.2 This broad measure of underutilization of resources is subject to a number of conceptual and statistical difficulties that prevent its serving as a precise guide to policy. For recent periods, it is especially difficult to make adequate allowances for the impact of changes in costs of energy, for the existence of obsolete plant capacity, and for the inhibiting influence of bottlenecks in particular sectors. Nevertheless, with due caution regarding such deficiencies, the “gap” measure can be of some use as a general indication of comparative economic conditions in the present circumstances. According to “gap” estimates of the Fund staff drawing on national sources to the extent possible, the degree of slack prevailing in the seven major industrial countries during the first half of 1975 was generally substantial both in absolute terms and in relation to prior periods; the indicated underutilization of resources was much larger in the United States and Japan (some 12-14 per cent) than in Canada, the Federal Republic of Germany, and Italy (7-8 per cent) or in France and the United Kingdom (around 5 percent).

The statistical picture of the current economic situation is much less adequate for the primary producing countries than for the industrial countries. However, the available figures for the more developed primary producing countries indicate that the average rate of growth in real GNP slowed down from about 6 per cent in 1973 to some 3½ per cent in 1974 (Table 1). While a majority of the more developed primary producing countries experienced slower real growth in 1974 than in 1973, economic activity in some of them (e.g., South Africa and Turkey) expanded at substantially higher rates. The overall price increase reached the high rate of 17 per cent in 1974 in the more developed primary producing countries (Table 2), with almost all the countries comprising this group experiencing double-digit inflation. In 1973, the rate of inflation in these countries, averaging 14 per cent, had been about twice as high as that recorded in the industrial countries.

Total real output in the less developed primary producing countries seems to have risen in 1974 by about 6½ per cent—not far from the average for the past ten years. Growth rates for the oil exporting countries were relatively high (about 9 per cent, on average), reflecting the effects of stepped-up domestic expenditures made possible by increased oil revenues. In the other (non-oil) developing countries, the volume of both domestic demand and imports maintained a high rate of increase from 1973 to 1974, broadly similar to that from 1972 to 1973; however, a sharply reduced rate of growth in foreign demand apparently resulted in some slowing of overall output growth from 1973 to 1974. Moreover, trade indicators suggest that the pace of economic activity slowed considerably in the course of 1974.

The available data on consumer prices for the less developed countries show that domestic price inflation, after accelerating sharply in 1973, leveled off at a very high rate during 1974 (Table 3). In line with the experience of recent years, inflation in the oil exporting countries in 1974 tended to be lower (about 20 per cent, on average) than in the non-oil countries (more than 30 per cent). In each of four broad regions, the rate of inflation of consumer prices increased markedly from 1973 to 1974, to rates of some 17 per cent in Africa and the Middle East, and to rates of over 30 per cent in Asia and the Western Hemisphere. By the fourth quarter of 1974 and the early months of 1975, however, rates of inflation had generally stabilized in developing countries and were beginning to come down in some of them.

Table 3.Price Increases in Less Developed Countries, 1965–Fourth Quarter 1974

(Percentage changes in consumer prices)1

Annual

Average

1965-702
Change from Preceding YearFourth Quarter 1973

to

Fourth Quarter 1974
1971197219731974
Less developed countries131012212929
In Africa66591717
In Asia16368183128
In the Middle East456101717
In the Western Hemisphere15152029 336 336 3
Sources: IMF Data Fund and Fund staff estimates.

Calculated from weighted geometric means of country indices expressed in terms of local currency. Weights are proportional to GDP (in U. S. dollars) in 1970.

Compound annual rates of change.

Excluding one high-inflation country, the Asian figure in the first column would be 7 per cent; with a similar exclusion, the Western Hemisphere figures in the last three columns would be 20 per cent, 25 per cent, and 27 per cent, respectively.

Sources: IMF Data Fund and Fund staff estimates.

Calculated from weighted geometric means of country indices expressed in terms of local currency. Weights are proportional to GDP (in U. S. dollars) in 1970.

Compound annual rates of change.

Excluding one high-inflation country, the Asian figure in the first column would be 7 per cent; with a similar exclusion, the Western Hemisphere figures in the last three columns would be 20 per cent, 25 per cent, and 27 per cent, respectively.

GNP estimates for the first half of 1975, or projections for the year, are not available for the primary producing countries, but it is nonetheless clear that growth-depressing influences are at work. Because of the slowdown or recession in industrial countries and other factors, the volume of exports of both the more developed primary producers and the non-oil developing countries is unlikely to show any increase at all in 1975 (over 1974) even if, as is generally expected, demand and output in the industrial countries show an upturn in the second half of the year. In 1974, both groups of primary producing countries experienced a partial reversal of the gains in terms of trade realized in the 1972-73 boom, and the non-oil developing group is also being hit by a sharp deterioration of the terms of trade in 1975. Although the growth of import volume of this latter group was maintained surprisingly well in 1974, the associated impairment of external financial positions—through heavy foreign borrowing and a decline in the real purchasing power of reserves—is expected to lead to a considerable decline of import volume in 1975; this would inevitably affect domestic growth rates and development plans. For the more developed primary producers also, a decline of import volume from 1974 to 1975 is likely, and a further slowing of real GNP growth is in prospect, as many of these countries undertake to reduce their still high rates of inflation and to deal with increasingly severe balance of payments problems.

The major oil exporting countries are in a very different position by reason of the large improvement that has occurred in their terms of trade since late in 1973. Without exception, the governments pf those countries are endeavoring to bring about a faster rate of economic growth and development. In a number of cases the rapid increases in domestic liquidity, together with rising import costs, are exerting strong pressures on domestic prices and wages, as domestic demand surges upward while local productive resources are insufficient to meet the added demands associated with the overall boom in spending.

Factors in the Current Inflation and Recession

Any review of factors responsible for the steep acceleration of inflation in the period 1973-74, and for the onset of the severe 1974-75 recession, must start with the unusually high degree of coincidence in the phasing of business expansion in many countries during 1972 and 1973. In practically all the developed countries, economic activity advanced sharply and aggregate demand rose to new high levels during this period.

The 1972-73 upsurge of global demand was to some extent attributable to miscalculations in the conduct of monetary and fiscal policies. In relation to the buoyancy of private demand that materialized, these policies proved excessively expansionary from the standpoint of controlling inflation. They fueled a widespread investment boom that was further driven, during its later stages, by emerging limitations on productive capacity.

As was pointed out in last year’s Annual Report, several distinctive features of the boom help to explain why a sharply higher rate of price inflation developed in 1973 and 1974. Among these were the high rates of price increase sustained through the 1970-71 economic slowdown and the upward momentum thus already prevailing at the beginning of the 1972-73 upswing—a momentum doubtless reflecting the evolution of public attitudes and institutional practices that, particularly since the mid-1960s, have become geared to an assured expectation of continuing advances in costs, prices, and rates of remuneration.

A second distinctive feature of the recent boom was the magnitude of the increase in many primary commodity prices, even apart from oil (Chart 3). The upsurge of commodity prices from the beginning of 1972 through the early months of 1974 had no parallel with earlier peacetime experience—a fact suggesting that this upsurge may have stemmed in part from factors essentially independent of the general process of inflation in the world economy. Such factors included shortages attributable to crop failures resulting from drought or flood, as well as changes in stock positions emanating from earlier shifts of agricultural policy in key countries. In important respects, however, the escalation of commodity prices must be seen as responsive to the boom itself; a special aspect of this response—especially during the latter part of 1973 and the early months of 1974—was anticipatory buying in a climate of inflationary expectations, real or threatened shortages of various materials, and uncertainties regarding the future values of currencies.

Chart 3.Indices of Prices of Commodities Exported by Primary Producing Countries, 1971-June 1975

(Expressed in U. S. dollars; 1968-70 = 100)

The cost-raising influences of the oil price rise and temporary embargo of late 1973 and early 1974 comprised another special feature of the recent boom that contributed to inflation. Because of the relatively low elasticity of demand for oil and its pervasive use in productive processes (given also the short-run limitations of supply), an increase in the price of petroleum of the magnitude witnessed inevitably became an additional element in the ongoing inflationary process.

Still another distinctive feature of the recent inflationary upsurge was the way in which increases in the prices of oil, primary commodities, and capital goods became a form of imported cost inflation in many countries that was very difficult to influence or control. These elements of import cost tended to enter into the domestic cost structure through the process of linking wages to prices, both in formal contractual arrangements and in de facto patterns of labor market adjustment. Moreover, producers usually continued raising their prices to cover at least the additional costs, and were able to raise them by larger amounts in the many situations permitting imperfectly competitive pricing practices. In a more general sense, it became increasingly apparent during 1973 and 1974 that the problem of retarding the momentum of price advances was greatly complicated by the ease with which impulses originating in one area were transmitted to other parts of the world through their influence on the cost of living, wage demands, and business costs. Following a long period of near stability, foreign trade prices 3 went up by 12 per cent from 1972 to 1973 and by more than 50 per cent (at an annual rate) in the first half of 1974.

During the first two or three quarters of 1974, policies pursued in the industrial countries generally reflected the continuance of very high rates of price inflation and the indications that aggregate demand remained strong. While expansionary fiscal measures were adopted in some countries (e.g., the Federal Republic of Germany, the Netherlands, and Sweden) in late 1973 or early 1974, the fiscal posture in most industrial countries through at least the first half of 1974 either remained moderately restrictive (as, e.g., in the United States) or was further tightened (as, e.g., in Denmark, France, and Japan). Concurrently, the thrust of monetary policy became more generally restrictive because of apprehensiveness over inflation and in some cases also because of the need to induce capital inflows to finance the large current account deficits that emerged because of the oil price rise. In the Federal Republic of Germany, Switzerland, and several other countries, rates of monetary expansion had already been sharply reduced during 1973, and the tendency toward a tightening of monetary conditions became more general in 1974; this was reflected not only in reduced rates of increase in monetary aggregates during much of the year, but also in a heightening of interest rates in a number of countries (Chart 4).

Chart 4.Major Industrial Countries: Selected Short-Term Interest Rates, 1973-May 1975

(In per cent)

Note: All series are monthly averages except for Italy where the final month in each quarter is used.

Apart from the effects of steeply higher petroleum costs, a factor that clouded perception of the demand situation in the first half of 1974 was a sharp increase in the volume of exports from the industrial countries to the rest of the world. Not only did the imports of the oil exporting countries expand rapidly, as was to be expected in view of their enlarged export earnings, but the volume of imports into other primary producing countries also continued to increase at an exceptional rate. Moreover, anticipatory buying and speculative inventory accumulation associated with inflationary expectations appear to have been a significant influence helping to sustain the rise of domestic demand in early 1974. Capital spending plans and orders for durable goods showed continued strength in some countries, and certain elements of demand—for example, for steel and raw materials—remained quite buoyant. International prices of metals—which normally are sensitive to changes in business cycle conditions in the industrial countries—rose to a peak in the first half of 1974 (Chart 3).

In general, however, major components of private demand in key countries were considerably weaker in the first two or three quarters of 1974 than they were judged to be at the time. In the unexpectedly sharp decline of economic activity that occurred in several of the major industrial countries during the closing months of 1974 and the early part of 1975 (Chart 2), one important element was a weakening of consumer outlays in real terms, and especially of those for consumer durable goods. This development touched off a process of unplanned inventory accumulation and of subsequent liquidation, with sharply adverse impact on industrial output. The slower pace of real consumer spending seems to have reflected a fairly general loss of confidence in the prospects for maintenance of employment levels and real purchasing power. Also, the persistence through the second half of 1974 of extremely high rates of increase in consumer prices, following a period of rather active buying stimulated by expectations of such price increases, was probably a factor underlying the subsequent slowing of real spending in a number of countries. The further deceleration or decline in the volume of private investment during the latter part of 1974 and early 1975 was the most direct and obvious manifestation of monetary restraint, which bore especially heavily in a number of countries on residential construction (reflecting the familiar chain of association running from tight credit and high interest rates to scarcity of funds for home building, and hence to a drop in such activity).

Mention might be made of three other contributing elements in the 1974-75 weakening of economic activity in the industrial countries: the reaction to oil deficits, the squeeze on profits, and the downturn in exports.

The increase of petroleum prices not only would add to inflation through its cost-raising effects but also could be expected, in the absence of offsetting changes, to have a deflationary effect stemming from the much greater increase of imports than of exports that would occur in the trade of oil importing countries with the oil exporting countries.4 A deflationary effect would be felt to the extent that larger payments for oil were financed through diversion from other expenditures; this effect would be averted to the extent that such payments were financed out of consumer or business saving, or to the extent that government measures of expansion provided an offset. In the event, it would appear that, by and large, the deflationary effect of the oil price increase was not averted by autonomous and government-induced forces of expansion in 1974; monetary and fiscal policies were generally restrictive because of the severity of the inflation problem.5

In many industrial countries the profit picture seems to have worsened during 1974 and early 1975, casting a depressing influence on investment plans. Intensification of the process of wage-push inflation was a principal factor underlying this development. The rise in food prices, which peaked only near the end of 1974, combined with rapidly adjusting internal prices of energy and with other factors to keep consumer prices in most countries on a steep upward path through the end of 1974. Reactions of labor groups to this inflation of consumer prices tended to counteract, at least in the short run, any tendencies for wages to slacken in response to the weakening demand for labor. In the second half of 1974, escalation of nominal wages, combined with the downturn in productivity, was reflected in sharp increases of unit labor costs in the industrial countries, at a time when the onset of recession was cutting into sales volumes.

Also important in the evolution of recession in the industrial world was the weakening of foreign demand. Growth in import volume of the non-oil primary producing countries, although strong in the first half of 1974, was virtually halted in the second half. The total volume of imports of the industrial countries fell off in the latter period, and the decline intensified in the first half of 1975. Imports of the oil exporting countries, however, accelerated dramatically during 1974. Overall, the volume of world trade ceased growing in the second half of 1974 and declined considerably—by perhaps 5 per cent—in the first half of 1975; the impact of this unusual development on the exports of individual countries was quite uneven, depending (inter alia) on a country’s trade position in the expansive market of the major oil exporters and on the capacity to supply goods for export, as well as on the general composition of the country’s exports.

Among the many influences that contributed to the 1974-75 international recession, one deserving particular attention—indeed, it would appear in retrospect to have been the proximate cause of this recession—is the unexpected strength of price pressures that developed in the course of 1974. Demand management policies had not allowed for the full strength of such pressures inasmuch as they were geared to lower price expectations.6 In the circumstances, output growth might have continued with a higher degree of monetary expansion, but such a course of policy probably would have exacerbated the already severe problem of inflation and made the inevitable—postponed—adjustment still more costly.

The period 1973-74, as discussed earlier, was one of general monetary tightening in the industrial world in reaction to the excessive monetary expansion of 1971-72—an expansion that evidently was a powerful force propelling prices upward during 1973 and 1974.7 During 1974 monetary policy was restrained because of concern over inflation, notwithstanding the potentially deflationary effect of the higher oil prices.

These observations regarding inflation as a causal factor in the current recession are intended to flag the importance of bringing the current inflation down to acceptable levels and of avoiding overly expansionary policies that might lead to its continuance or resurgence. Unfortunately, this clear lesson of recent experience cannot readily be translated into precise guidelines for current policy, inasmuch as the present situation is so different from that in previous postwar periods—more economic slack and more inflation—as to make it very difficult to judge the degrees of monetary or fiscal expansion that might prove sufficient to restore adequate levels of resource utilization at a satisfactory pace without touching off new difficulties regarding inflation; the issues involved are controversial, among both economists and the general public. Moreover, the scope for generalizations on this matter is limited because of the fact that the major industrial countries differ markedly as to the degree of economic slack and price inflation that currently prevail, as well as to balance of payments positions. In a number of countries, one inhibiting influence in the formulation of demand management policies to reverse recessionary trends and to foster sustained recovery is the inflexibility of the budget instrument— the lack of any assurance that, in the upward phase of the cycle, taxes could be raised or expenditures cut.

It is now widely expected that, on the basis of expansionary shifts in fiscal and monetary policies during recent months, together with the working of corrective forces in the cyclical process, an economic upturn will occur in the industrial countries during the second half of 1975 and extend into 1976. This prospect—and some of the policy issues involved—is discussed later.

World Trade and Payments

During the year that has elapsed since the preparation of the 1974 Annual Report, world trade developments have been dominated by the onset and deepening of the current international recession. First in the industrial countries and later in the primary producing countries (other than the oil exporters), the previous upward momentum of import volume gave way to a pervasive weakness of import demand. The total volume of world trade appears to have stopped growing in the second half of 1974 and to have turned downward in the first half of 1975. The slowing of growth in trade was accompanied by deceleration of the earlier increases in foreign trade prices. Because the changes in price movements varied sharply in timing and degree among different types of products, they resulted in marked shifts in the terms of trade for various groups of countries. The uneven character of both the volume changes and the terms of trade shifts was reflected, of course, in altered patterns of current account balances and external financing problems.

Volume of Trade

The impact of the recession on world trade volume is clearly evident even in the annual data summarized in Table 4. Total world trade rose in real terms by 5 per cent in 1974, after having expanded by 13 per cent in 1973 and by an annual average of 8½ per cent over the decade of the 1960s. The only segment still expanding vigorously in 1974 and early 1975 was the flow of imports into the oil exporting countries. These imports increased by nearly 40 per cent in 1974, and continued to expand rapidly in the first half of 1975. The industrial countries as a group, despite their role as principal suppliers to the oil exporters, experienced a sharp drop in the rate of increase in export volume during 1974, and the incomplete data available indicate an outright decline in the first half of 1975. Even weaker trends were evident during 1974 and early 1975 in the imports of the industrial countries and, correspondingly, in the volumes of exports of all groups of primary producing countries (including the oil exporters).

Table 4.World Trade Summary, 1960-741(Percentage changes in volume, in U.S. dollar value, and in unit value of foreign trade)
Annual

Average

1960–702
Change from Preceding Year
19701971197219731974
World Trade 3Volume69135
U. S. dollar value1014½121838½47
Unit value 41822½40
Imports
VolumeIndustrial countries109611½121/2
Primary producing countries
More developed countries91316
Major oil exporters10½121837
Non-oil developing countries611312
Unit value4Industrial countries122½41
Primary producing countries
More developed countries56921½42
Major oil exporters145818½25½
Non-oil developing countries146819½38½
Exports
VolumeIndustrial countries13½
Primary producing countries
More developed countries8132
Major oil exporters9118712-1
Non-oil developing countries6810½14½2
Unit value 4Industrial countries6582025
Primary producing countries
More developed countries24412½3627
Major oil exporters-1222½1338½186
Non-oil developing countries5-3½2733
Sources: National economic reports, IMF Data Fund, and Fund staff estimates.

For classification of countries in groupings shown here, see Table 1 (and especially footnotes 2–4).

Compound annual rates of change.

Fund member countries (listed in Appendix I, Table I.1) plus Switzerland. Based on approximate averages of growth rates for world exports and world imports.

Based on indices in U. S. dollar terms.

Sources: National economic reports, IMF Data Fund, and Fund staff estimates.

For classification of countries in groupings shown here, see Table 1 (and especially footnotes 2–4).

Compound annual rates of change.

Fund member countries (listed in Appendix I, Table I.1) plus Switzerland. Based on approximate averages of growth rates for world exports and world imports.

Based on indices in U. S. dollar terms.

The last major segment of world trade to be affected by the recession in the industrial world was the flow of imports into the non-oil primary producing countries; this flow was strongly sustained—to the detriment of the external financial positions of many of the countries concerned—through about the middle of 1974. By early 1975, however, maintenance of these imports in real terms would appear to have been no longer feasible.

Chart 5 depicts the recent changes in volume of world trade in a broad historical perspective. Also indicated in the chart are the wide fluctuations in value of world trade in recent years—attributable to the sharp variations in foreign trade prices that have accompanied the volume changes.

Chart 5.Growth of World Trade, 1953-First Half 1975

(Percentage changes from preceding year) 1

1 Based on approximate averages of growth rates for world exports and world imports.

2 Compound annual rates of change.

3 Estimated change from first half of 1974 to first half of 1975.

Foreign Trade Prices

Movements of foreign trade prices, after having been dominated in the first half of 1974 by the oil price increase and the upsurge of many primary commodity prices to peak levels, were much smaller and less uneven in the second half of 1974. Further upward movements in the latter period and in the early months of 1975 were primarily reflections of the continuing momentum of inflation, especially in the industrial countries, and of the lags between changes in market prices of primary commodities and the ensuing changes in unit values of goods moving in international trade. Although the average of such market prices had turned downward before the middle of 1974, the corresponding export unit values continued to rise in the second half of that year. Nevertheless, average rates of increase in export unit values of all the primary producing areas were greatly diminished after mid-1974; this was particularly true of the oil exporting countries, whose oil export prices were raised only slightly further during the subsequent months. To a lesser extent, rates of increase in export unit values for industrial goods were also subsiding in the course of 1974.

Despite the slowing of foreign trade price increases during 1974, the average of such prices for the year as a whole exceeded the corresponding average for the previous year by an extraordinarily wide margin, reflecting the high rates of inflation in the industrial countries during the second half of 1973 and early 1974, the steep rise in primary commodity prices over the same period, and the tripling of oil export prices at the beginning of 1974. In terms of U. S. dollars, world trade prices (i.e., unit values) rose by an average of some 40 per cent from 1973 to 1974.

By the second half of 1974, however, the average annual rate of increase in world trade prices (in U. S. dollars) had receded to about 20 per cent (by comparison with the immediately preceding half year), and a further drop, to about 12 per cent, is suggested by the available data for the first half of 1975. The estimated average for the latter period comprises an actual decline in export unit values for primary commodities (non-oil), as well as a considerably reduced rate of inflation in prices of industrial goods.

The movements of foreign trade prices in recent years have resulted in sizable changes in the terms of trade for major groups of countries. With respect to the industrial group, whose composite terms of trade had declined slightly in 1973 and then fell sharply in 1974 (chiefly because of the oil price increase), there was some rise in the terms of trade during the first half of 1975. For the two groups of non-oil primary producing countries shown in Table 5, deterioration of the terms of trade from 1973 to 1974 reversed most of the upward movement of their terms of trade that had occurred from 1972 to 1973; the deterioration accelerated in the latter part of 1974 and the first half of 1975 for the non-oil developing group. Factors in this accelerated decline include not only the downward movements of raw material and food prices but also continuing price increases for many imported industrial products. The other major group of countries—the oil exporters— experienced negative terms of trade changes in the latter part of 1974 and the first half of 1975; these declines represented a fraction of the rise in the oil exporters’ terms of trade that resulted from the increases in oil prices late in 1973 and at the beginning of 1974.

Table 5.Terms of Trade Developments, 1960-741(Percentage changes)
Annual

Average

1960-702
Change from Preceding Year
19701971197219731974
Industrial countries½½½-2-11½
Primary producing countries
More developed countries½-1-1½12-10½
Major oil exporters-2-217516½128
Non-oil developing countries½-1-9½-4
Sources: National economic reports, IMF Data Fund, and Fund staff estimates.

For classification of countries in groupings shown here, see Table 1 (and especially footnotes 2-4).

Compound annual rates of change.

Sources: National economic reports, IMF Data Fund, and Fund staff estimates.

For classification of countries in groupings shown here, see Table 1 (and especially footnotes 2-4).

Compound annual rates of change.

Balance of Payments Developments in 1974

Changes in payments balances and in the structure of the underlying transactions from 1973 to 1974 were strongly conditioned by three major influences. These were the prevalence, since the first quarter of 1973, of generalized floating of major currencies; the cresting of the boom in economic activity in the industrial countries; and the sudden increase in the price of oil at the beginning of 1974.

The oil price rise in 1974 produced a radical transformation of the global pattern of balance of payments relationships. The major oil exporters, whose combined balance of payments was already in surplus in 1973, were able to raise their collective surplus on current account to an estimated $70 billion in 1974, compared with $6 billion in 1973. A significant part of this unprecedented total (as recorded on the accrual basis customary for balance of payments statistics) represented export credits (in the nature of accounts receivable) for oil shipped out of the producing countries during 1974 and valued in their balance of payments statistics at the new prices that went into effect at the beginning of that year, but not yet received or paid for by the importers within the same period. However, the oil exporters also added an amount estimated at more than $50 billion to their net international financial positions, including $37 billion of net additions to their official reserve assets.

The counterpart of the increase in current account surpluses of the oil countries from 1973 to 1974 was spread widely among the oil importing countries, all major groups of which were left in substantial deficit (Table 6). Their combined deficit, based upon their own balance of payments statistics (in which the higher-priced oil imports were reported appreciably later than in the statistics of the exporting countries), amounted to about $51 billion in 1974, compared with a small surplus in 1973. Considerably more than half of the adverse shift in this aggregate balance was absorbed by the primary producing countries, and especially by the non-oil developing countries, many of which had to pay substantially higher prices for food, fertilizers, and other essential imports, as well as for oil. These developing countries, being characteristically importers of capital, already had a combined current account deficit of $9 billion in 1973; in 1974, it soared to about $28 billion—the financing of which required very heavy borrowing. In contrast to the buildup of reserves in 1973, there was virtually no reserve accumulation in 1974.

Table 6.Global Balance of Payments Summary, 1972-74(In billions of U. S. dollars)
Balance on
TradeServices

and

private

transfers
Current

account
Capital

Account

Balance1
Overall

Balance2
Industrial countries3197211.2-0.910.3-11.0 4-0.7
197311.0-0.810.2-10.6 4-0.3
1974-10.0-1.6-11.5-4.5 4-16.1
Major oil exporters 3197213.0-10.42.61.33.9
197321.6-16.05.6-1.34.3
197483.4-13.470.0-33.636.8
Other primary producing countries 31972-9.62.2-7.421.714.3
1973-11.33.7-7.718.410.7
1974-40.81.0-39.836.3-3.5
More developed areas1972-2.94.61.76.27.9
1973-5.06.31.31.12.4
1974-18.56.6-12.07.3-4.7
Less developed areas1972-6.7-2.4-9.115.56.4
1973-6.3-2.6-8.917.38.4
1974-22.3-5.5-27.829.01.2
In Africa19720.1-1.6-1.51.70.2
19730.9-1.9-1.11.50.4
19740.5-2.4-1.92.10.1
In Asia1972-3.30.8-2.54.82.3
1973-2.50.9-1.64.12.5
1974-9.60.9-8.710.01.3
In the Middle East1972-2.31.7-0.61.40.7
1973-4.12.1-2.03.11.1
1974-5.91.5-4.44.60.3
In the Western Hemisphere1972-1.2-3.2-4.47.63.1
1973-0.5-3.8-4.38.74.4
1974-7.3-5.5-12.812.3-0.5
Total, all countries5197214.6-9.15.512.017.5
197321.3-13.28.26.514.7
197432.6-13.918.7-1.417.2
Sources: Data reported to the International Monetary Fund and Fund staff estimates.

This balance is computed residually as the difference between the overall balance and the current account balance; it includes net errors and omissions, as well as reported capital movements, government transfers, and, for 1972, allocations of SDRs.

Overall balances are measured by net changes in official gross reserve assets (gold, SDRs, reserve positions in the Fund, and foreign exchange assets) and in certain reserve-related liabilities (such as Fund credit and various liabilities to foreign official institutions). In Table 7, the conventionally measured overall balances of the industrial countries are disaggregated into their asset and liability components. Some deficiencies of the overall balance concept under present circumstances are noted in the accompanying text.

For classification of countries shown here, see Table 1 (and especially footnotes 2-4).

See footnote 5.

Global balance of payments aggregations inevitably contain many asymmetries arising from discrepancies of coverage or classification, timing, and valuation in the recording of individual transactions by the countries involved. A major area of asymmetrical classification during recent years concerns the recording of official claims placed in Euro-currency markets. These transactions, although treated as changes in reserve assets by the investing countries, are recorded as capital inflows by the recipient industrial countries. Had such transactions been recorded symmetrically, the global summations would show both a larger net capital outflow and a lower aggregate of overall surpluses. If identified Euro-currency reserve placements (shown in terms of SDRs in Table 14 of this Report) are excluded from the recorded net capital account balances of the industrial countries, their adjusted net capital outflows amount to $21.3 billion, $18.3 billion, and $19.8 billion over the years 1972, 1973, and 1974, respectively. This adjustment alone would reduce the net asymmetry in global overall balances to $7.1 billion, $7.0 billion, and $2.0 billion for the same years.

Sources: Data reported to the International Monetary Fund and Fund staff estimates.

This balance is computed residually as the difference between the overall balance and the current account balance; it includes net errors and omissions, as well as reported capital movements, government transfers, and, for 1972, allocations of SDRs.

Overall balances are measured by net changes in official gross reserve assets (gold, SDRs, reserve positions in the Fund, and foreign exchange assets) and in certain reserve-related liabilities (such as Fund credit and various liabilities to foreign official institutions). In Table 7, the conventionally measured overall balances of the industrial countries are disaggregated into their asset and liability components. Some deficiencies of the overall balance concept under present circumstances are noted in the accompanying text.

For classification of countries shown here, see Table 1 (and especially footnotes 2-4).

See footnote 5.

Global balance of payments aggregations inevitably contain many asymmetries arising from discrepancies of coverage or classification, timing, and valuation in the recording of individual transactions by the countries involved. A major area of asymmetrical classification during recent years concerns the recording of official claims placed in Euro-currency markets. These transactions, although treated as changes in reserve assets by the investing countries, are recorded as capital inflows by the recipient industrial countries. Had such transactions been recorded symmetrically, the global summations would show both a larger net capital outflow and a lower aggregate of overall surpluses. If identified Euro-currency reserve placements (shown in terms of SDRs in Table 14 of this Report) are excluded from the recorded net capital account balances of the industrial countries, their adjusted net capital outflows amount to $21.3 billion, $18.3 billion, and $19.8 billion over the years 1972, 1973, and 1974, respectively. This adjustment alone would reduce the net asymmetry in global overall balances to $7.1 billion, $7.0 billion, and $2.0 billion for the same years.

The availability of such large amounts of credit for developing countries, at a time when both the industrial countries and the more developed primary producing countries were also in need of net capital inflows to finance their respective current account deficits, was in large measure an outgrowth of the investment of surplus funds (including official reserve deposits) by the oil exporting countries. Direct loans and grants from the latter to non-oil developing countries, although making a substantial contribution to the needed financing, did not comprise a very large proportion of the total. The remainder was supplied to the developing countries, in a direct sense, by investors, financial institutions, or governments in the industrial countries.

The industrial countries, however, were direct recipients of large placements of surplus funds by the oil exporting countries. Although the industrial countries themselves were substantial net international borrowers, because of their sizable collective deficit on external current account, the amounts placed in their capital and credit markets by the oil exporting countries in 1974 greatly exceeded the current account deficit of the industrial countries. Indirectly, therefore, the oil exporting countries must be viewed as the ultimate source of a considerable part of the movement of capital and credit from the industrial countries to the non-oil developing countries, as well as to the more developed primary producing countries, in 1974.

The buildup of foreign currency claims in the hands of the oil exporting countries during 1974 took the form, in the main, of enlarged holdings of official reserves by the national monetary authorities. On balance, however, the rise in reserve holdings of the oil exporting countries did not occur through net transfers of existing reserves of oil importing countries. As explained in Chapter 2, new reserves were created on a large scale—chiefly through processes involving official placements of reserve deposits in the Euro-currency markets or the United States by some countries and borrowing from those markets by other countries. In the circumstances of 1974, it was thus possible for reserves paid out by deficit countries to be fully replenished through borrowing, so that the entire growth of reserves of the oil surplus countries could come from creation of new reserves, rather than transfer of reserve assets held by other countries.

The absence of sizable shifts in reserve asset holdings among oil importing countries was due in large part to the prevalence of general floating of exchange rates for major currencies. With exchange rate fluctuations being permitted to absorb high proportions of the exchange market pressures that arose during 1974, shifts of outstanding reserve assets were generally small. However, reserve asset holdings of some countries were maintained only through heavy borrowing by or on behalf of the monetary authorities. Among industrial countries, the outstanding cases in point were the United Kingdom and Italy. (See Table 7, where the amounts thus obtained from foreign official agencies are indicated in the sixth column.)8

Table 7.Industrial Countries: Balance of Payments Summaries, 1972-74(In billions of U.S. dollars)
Balance onCapital

Account

Balance 1
Overall

Balance 2
Change in

Liabilities to

Foreign

Official

Agencies
Balance

Financed

by Transactions in

Reserve

Assets
TradeServices

and

private

transfers
Current

account
United States1972-6.4-0.6-7.0-3.3-10.410.3
19731.02.03.0-8.3-5.35.1-0.2
1974-5.58.12.5-10.9-8.49.81.4
United Kingdom1972-1.62.40.8-3.7-2.9-0.1-3.1
1973-5.73.6-2.12.80.7-0.10.5
1974-12.34.1-8.23.9-4.44.70.2
Canada19721.9-2.3-0.50.80.30.3
19732.7-2.7-0.5-0.5-0.5
19741.6-3.3-1.71.7
France19721.3-0.31.00.81.81.8
19730.8-0.8-0.1-1.7-1.70.1-1.7
1974-3.9-0.9-4.84.7-0.1-0.1
Germany, Federal Republic of19728.2-5.52.82.25.05.0
197314.4-7.86.62.59.2-0.48.7
197422.7-10.512.2-12.7-0.50.1-0.4
Italy19720.12.93.0-3.7-0.7-0.7
1973-3.92.8-1.10.9-0.20.30.1
1974-8.21.0-7.22.6-4.65.00.4
Japan19729.0-2.07.0-3.83.13.1
19733.7-3.60.1-6.2-6.1-6.1
19741.4-5.9-4.55.81.31.3
Other industrial countries 31972-1.24.43.2-0.23.03.0
1973.-1.95.73.8-0.13.60.54.2
1974-5.75.90.20.40.5-0.70.2
Total, industrial countries197211.2-0.910.3-11.04-0.710.29.4
197311.0-0.810.2-10.6 4-0.35.55.1
1974-10.0-1.6-11.5-4.5 4-16.119.03.0
Sources: Data reported to the International Monetary Fund and Fund staff estimates.

See Table 6, footnote 1.

See Table 6, footnote 2.

Austria, Belgium-Luxembourg, Denmark, the Netherlands, Norway, Sweden, and Switzerland.

See Table 6, footnote 5.

Sources: Data reported to the International Monetary Fund and Fund staff estimates.

See Table 6, footnote 1.

See Table 6, footnote 2.

Austria, Belgium-Luxembourg, Denmark, the Netherlands, Norway, Sweden, and Switzerland.

See Table 6, footnote 5.

A rise in obligations traditionally treated in the balance of payments statistics as official liabilities also was the principal means by which an $8½ billion “overall deficit” of the United States was financed in 1974. The $10 billion rise in U. S. liabilities to foreign official agencies, however, was due to placements of funds in the United States by the major oil exporting countries. In present circumstances, the greatly increased holdings of those countries might be viewed as having the character, at least in considerable part, of investments rather than of reserves in the usual sense, even though many of the financial claims held are liquid. These considerations, among others, create ambiguities of interpretation with respect to the conventional concept of the overall balance of payments deficit. If the 1974 flows of oil surplus funds to the United States were treated as inflows on capital account in the U. S. balance of payments, rather than as a means of financing, the payments balance of the United States would show a small surplus (as indicated in the last column of Table 7), instead of an $8½ billion deficit. Such a result would be more consistent with the behavior of the effective exchange rate for the U. S. dollar (as described in Chapter 2).

The main influences of cyclical developments upon changes in the global pattern of current account balances have been outlined earlier, in the discussion of world trade volume and price movements. In addition, cyclical developments exerted strong influences upon capital flows, chiefly through their impact on monetary and credit conditions and comparative yields on financial claims held in different countries. For example, the relative stringency of monetary policy in the Federal Republic of Germany during much of 1973 and early 1974, of U. S. monetary conditions in the middle quarters of 1974, and of Italian policy in the second half of that year all exerted important influences on short-term capital movements and exchange rate developments, as did the rapid easing of U. S. monetary conditions in late 1974 and early 1975 and the earlier easing of monetary policy in the Federal Republic of Germany. Without such a shift in the Federal Republic of Germany, the short-term capital outflows essential to balance that country’s large 1974 current account surplus at the prevailing average exchange rate for the deutsche mark would not have been forthcoming.

Unlike the Federal Republic of Germany and the United States, but like the United Kingdom and Italy, the other three major industrial countries all had sizable current account deficits in 1974. France financed its deficit chiefly through maintenance of monetary conditions that induced exceptionally large inflows of private short-term capital, and Canada’s enlarged current account deficit in 1974 was also financed mainly through an inward shift of private short-term capital. For Japan, short-term inflows during 1974 were large enough to cover both the current account deficit and a sizable net outflow of long-term capital and aid. (See Table 7.)

The course of the international business cycle also played a part, along with the direct and indirect investment of oil surplus funds, in the financing of the extraordinary current account deficits incurred by non-oil primary producing countries in 1974. In most of the industrial countries, relaxation of monetary and credit conditions accompanied or quickly followed the downturns in aggregate demand and production. This relaxation, resulting in appreciable declines of both short-term and long-term interest rates, facilitated the international borrowing by primary producing countries that was necessary to finance their enlarged current account deficits during the latter part of 1974 and early 1975.

Broad Picture of Current Accounts in 1975

The year 1974 was one of startling changes in current account balances, involving large swings in the balances of many individual countries. Further substantial changes in current account balances are in prospect for 1975; these are indicated, for four groups of countries, by the estimates provided in Table 8. Following are the main points to which attention should be drawn.

Table 8.Summary of Payments Balances on Current Account 1,2(In billions of U. S. dollars)
197319741975

(Projection)3
Major oil exporters67050
Industrial countries10-121
Non-oil primary producing countries More developed Less developed1-12-12
More developed Less developed-9-28-35
Total 48194
Sources: Data reported to the International Monetary Fund and Fund staff estimates.

Goods, services, and private transfers.

For classification of countries in groups shown here, see Table 1 (and especially footnotes 2-4).

The 1975 projections are subject to considerable uncertainty and should be viewed as rough orders of magnitude.

Reflects balances of countries covered here with non-reporting countries, plus (quantitatively more important) statistical errors and asymmetries.

Sources: Data reported to the International Monetary Fund and Fund staff estimates.

Goods, services, and private transfers.

For classification of countries in groups shown here, see Table 1 (and especially footnotes 2-4).

The 1975 projections are subject to considerable uncertainty and should be viewed as rough orders of magnitude.

Reflects balances of countries covered here with non-reporting countries, plus (quantitatively more important) statistical errors and asymmetries.

—The projected drop in the overall current account surplus of the major oil exporting countries—from $70 billion in 1974 to about $50 billion in 1975—is attributable chiefly to two assumptions: that the volume of imports by this group of countries will expand by some 30 per cent in 1975 (over 1974), following a rise of nearly 40 per cent in 1974; and that the volume of their exports will decline by about 10 per cent under the impact not only of the adverse cyclical position but also of demand responses to the 1974 oil price increase and of other factors.

—The main counterpart of the decline in the projected 1975 oil surplus is to be found in the accounts of the industrial countries. The estimated shift from substantial deficit to approximate balance in the overall current account position of those countries includes the prospect of considerably smaller—though still sizable— deficits for France, Italy, and the United Kingdom, and of a continued large surplus for the Federal Republic of Germany. Thus, the 1975 current account balance of the industrial countries shown in Table 8 still encompasses a very uneven distribution of deficits and surpluses among individual countries of the group.

—For the more developed primary producing countries, the estimated current account deficit of $12 billion for 1975 is the same as the 1974 deficit and thus remains in striking contrast to the surplus of about $1 billion realized by that group of countries in 1973. In the case of the (non-oil) less developed primary producing countries, the combined current account deficit is projected to rise from $28 billion in 1974 to $35 billion in 1975—about four times as large as the $9 billion deficit incurred in 1973. On the basis of studies made within the Fund on an individual country basis, a pattern of widespread increases in current account deficits among the non-oil developing countries is indicated for 1975.

—The projection of a $35 billion current account deficit for this group of countries is based on the implicit assumption that the necessary financing will be available. However, the sheer size of the aggregate deficit inevitably raises questions as to the actual ability and willingness of the countries concerned to finance it. A possible pattern of financing is suggested in the last section of this chapter, but it is clear—even on assumptions that could prove optimistic in several respects— that many of the non-oil developing countries are likely to find themselves in financial difficulty in 1975 and beyond, with severe problems obviously facing the group of developing countries classified by the United Nations as the “most seriously affected.”

—The estimates of current account balances for 1975 shown in Table 8 are strongly affected by cyclical influences emanating from the recession in the industrial world.9 Among the projected consequences are (1) an elimination of the deficit for the industrial countries, in part because of the easing of demand for oil; (2) a lowering of the surplus of the oil exporting countries for the same reason; and (3) a raising of the deficit for the non-oil developing countries, because of the impact of the recession on those countries’ export earnings. Thus, in an economic situation of fuller utilization of resources than that embodied in the estimates for 1975, strengthening of demand for oil and other primary products by the industrial countries would be expected to restore a deficit in the combined accounts of those countries, shore up the oil exporters’ surplus, and reduce the deficit of the (non-oil) primary producing countries.

Economic and Financial Issues

Domestic Policy

Any assessment of the current economic situation and outlook, with a primary focus on the industrial countries because of their heavy weight in the world economy, must address itself to two broad issues. The first relates to the general trend of economic activity— to the objective of ending the recession and launching a solid and sustained recovery, while reducing upward pressures on the levels of costs and prices. The second issue has to do with the use and limitations of policy instruments to meet such an objective over the course of the next year or two.

Officials of numerous industrial countries with which the Fund has recently held consultations are of the belief that, in all probability, the trough of the recession either has been passed or soon will be. Such judgment has had to rely on the analysis of current trends and of various forward-looking indicators; an upturn is not yet clearly in evidence, and thus remains in the nature of a forecast.

Although the actual timing of an upturn is uncertain, it is generally expected to occur during the second half of 1975. In the recent consultations, it was the general view that, after the upturn, demand could at some point expand rapidly and become difficult to moderate unless flexible adjustments of policy were effected. Guarded optimism was expressed on prices, but continuing concern over inflation clearly remains a dominant influence on policy formulation and planning in the industrial countries.

Those who expect an early revival of economic activity in the industrial world—including not only national officials but also forecasters generally—base this view on consideration both of the expansionary policy measures that have been taken in many countries and of the stimulus to an economic turnaround that may be expected from the more or less automatic functioning of cyclical forces. As a result of overt policy moves and of the slump in economic activity, monetary and credit conditions have shifted considerably away from the stringency prevailing through much of 1974; and the recent widespread adoption of expansionary fiscal measures supports the near-term prospect. Price inflation is being reduced markedly, helping to strengthen real incomes, and inventory-sales relationships are being brought into better alignment. Also, the groundwork has been laid for an evolution of somewhat longer-run relationships—among wages, productivity, profits, and interest rates—that should help to bring renewed expansion of fixed investment as demand prospects improve.

Important fiscal changes were initiated by numerous industrial countries in the latter part of 1974 and the first half of 1975. These budgetary moves include shifts in both tax and spending plans of the Federal Republic of Germany and the United States, as well as of Canada, Denmark, and the Netherlands, In addition, a number of other countries—including Austria, Japan, Belgium, and France—have recently adopted selective fiscal measures to counter economic slack. Among continental European countries, steps have been taken to bring about shifts in budgetary balances from 1974 to 1975 amounting to 2-5 per cent of GNP—4-5 per cent for the large economy of the Federal Republic of Germany. In the United States, the tax measures adopted in March 1975, together with the expenditure plans currently taking shape in the Congress, are estimated to bring about a budgetary shift equivalent to some 4-5 per cent of GNP.10 In Japan, fiscal measures to date consist mainly of an acceleration in government spending. In the United Kingdom, a sharp fiscal expansion in 1974 was followed in April 1975 by a budget that set out a fairly restrictive program of demand management for the next two years, aimed at creating enough spare capacity to allow the U. K. economy to take advantage, from early 1976 onward, of the expected upturn in world trade.

Easing of monetary conditions during recent months is one of the forces expected to encourage a recovery of demand in the United States. In Canada, too, monetary conditions are now considerably easier than during the early and middle quarters of 1974. In Japan, where the countering of inflation is still a paramount objective of economic policy, together with the ensuring of a steady recovery, a relatively moderate relaxation of monetary policy has taken place since about the beginning of 1975. In Europe, the monetary situation is mixed but most countries are now pursuing expansionary, or less restrictive, monetary policies, generally accommodative of the stimulative fiscal programs that have been introduced.

For most industrial countries, the generally expected turnaround of aggregate output in the second half of 1975 hinges mainly on an increase in real consumption (deriving from fiscal and monetary stimulus and from lower rates of price inflation) and on the adjustment of business inventory positions, involving progressively smaller liquidation of inventories, pending the resumption of accumulation. Fixed investment is subject to short-run weakness stemming from the current excess supply of productive capacity, and is not expected to rebound until aggregate demand becomes stronger. Moreover, since the pervasiveness of the current recession has severely curtailed the capacity to import in most parts of the world, foreign demand is unlikely to be a leading source of stimulus for many countries in the early stages of recovery.

Thus, it would seem that prospects for a sustained economic recovery in the industrial world depend to a great extent on consumer spending to lead the upturn and on business fixed investment to cease declining, or to pick up momentum, after some lag. This general pattern is not very different from that of earlier postwar recoveries, but the underlying economic situation from which the recovery must begin is one of considerably greater economic slack as a result of the most protracted and severe recession in the postwar period. The extent of idle capacity and manpower has led some observers to fear that private spending and investment may be more subdued than in earlier postwar recoveries—that they may not respond as quickly or as fully to government measures of stimulus, or to declines in rates of price increase from the current exceptional levels, as past relationships would suggest.

At any rate, there would be general agreement that economic forecasting and policy formulation at the present time are unusually difficult. Because of the prevailing uncertainties, and of the large scope for error, projections could prove to be significantly wrong at the present critical juncture when world trade and activity are in a slump and price inflation remains a problem.

The situation calls for national authorities, as a matter of prudence, to maintain a close watch over evolving trends and to be prepared to alter their policies as promptly as possible if these trends should point to a substantive change in the outlook. Such flexibility could be of crucial importance. Policies that permitted an overly rapid expansion of demand could obviously make for new and serious instabilities, given the fact that inflation in the industrial countries is still running at very high rates. However, policies that were overly cautious could prolong the underutilization of resources, lead to widespread pressures for a rapid shift to expansionary measures, and forgo the beneficial price effects of gains in productivity stemming from the resumption of solid economic growth and the absorption of slack.

Flexibility in the stance of policy—a willingness to adopt new measures in conformity with changing circumstances—will be hampered unless supported by the availability of effective instruments. With respect to fiscal policy, the main problem concerns the relative inflexibility of the budget instrument, as reflected in the frequent inability to introduce timely increases in taxation or cuts in expenditures. In some countries, notably the United States, there is concern that stimulus provided by the budget may not be rolled back fast enough in relation to the expected recovery of private demand during 1976 and 1977. The inadequacy of the budget instrument is a problem of long standing in industrial countries; in the past, fiscal policy has sometimes been so inadequate that it worked at cross-purposes from monetary policy, greatly complicating the task of economic stabilization.

On the subject of incomes policy, the prevalence of adverse wage-price trends in a number of member countries continues to pose questions about the need for new initiatives in this field. Without these, it may prove very difficult in some countries to limit the effects of cost pressures on prices and to achieve price moderation except at the expense of greater slack and unemployment. Of course, incomes policies are difficult to devise and implement, and must be geared in each country to its own institutions, traditions, and other aspects of the social and political setting.

Other significant problems facing governments in the forthcoming recovery period include a need for interrelated measures to improve supply conditions, to strengthen productive capacity and productivity, and to alleviate cost pressures. In large part, such measures must be directed specifically to the elimination of structural imbalances, such as mismatches between the skills and aptitudes of the unemployed and those required by employers. Because of the growth of structural rigidities and bottlenecks, business expansions in the postwar period have topped off at successively higher levels of unemployment.

External Policy

As discussed earlier, payments balances are now being affected markedly by cyclical influences. Coming on top of changes in current and capital account positions set into motion by the oil price rise, these influences make it difficult to ascertain whether recent developments and current prospects represent progress toward the reduction of disequilibria among the major industrial countries.

To arrive at judgments whether payments positions are sustainable, it is necessary not only to remove cyclical and special influences from actual positions but also to take a view of capital flows. At this juncture, the main questions on capital flows concern prospects for the oil exporters’ surpluses and the distribution among countries of the capital movements related to such surpluses; substantial uncertainty prevails as to how such factors should be taken into account. Research is going forward in this area within the Fund, in the endeavor to examine the principal elements involved in an assessment of the underlying payments positions of major countries.

For the present, judgments about the working of the adjustment process must be quite general and based mainly on the actual experience of countries in coping with their balance of payments situations. From the Fund’s recent consultations with members, it would appear that, with certain exceptions, industrial countries are less worried about their short-run balance of payments prospects than they were during much of 1974. Some of the largest current account deficits have been, or are in the process of being, reduced considerably. Even though in certain instances the reductions stem from a change in cyclical conditions, they have the immediate effect of lowering payments pressures. Furthermore, most of the industrial countries that have had a strained payments position in the recent past do not seem doubtful as regards their capacity to obtain capital sufficient to meet their prospective needs. A potential additional factor—still awaiting enabling actions by participating governments—is the OECD Support Fund (the “safety net”), which has been devised to provide assistance on external financing supplementary to that available from other sources, including the Fund. Also, the situation in the Euro-currency market has improved markedly since mid-1974, evolving from what might be termed a climate of concern to one of cautious optimism. Finally, the existence of floating rates has increased the flexibility of adjustment, notwithstanding the short-run drawbacks seen by some countries to adjustment through exchange rate changes.

For many of the nonindustrial oil importing countries, payments prospects have worsened over the past year, and the deteriorating external position may be expected to exercise considerable restraint on economic growth in 1975. Particularly with respect to the developing countries, as already indicated, it is questionable whether flows of capital and aid will be sufficient to permit sharply higher current account deficits, and thus obviate a need for new measures to effect adjustment. In some cases, such a need may also be indicated by the growth of external debt in the light of past borrowing and prospective foreign exchange earnings. To the extent that balance of payments problems of the non-oil developing countries may be resolved through limitation of their imports, rather than through provision of needed financing, a dampening influence on the export markets of the industrial countries—and hence on their cyclical recovery prospects—will be felt.

Adjustment for the major oil exporters involves bringing domestic expenditure more into line with their sharply higher level of income. Despite wide differences among them with respect to domestic absorptive capacity, the oil exporting countries—like other developing countries—are generally constrained as regards the speed at which domestic expenditure can be raised without causing undue pressures on domestic resources. Serious bottlenecks are already being encountered. Although the currencies of certain oil exporting countries have appreciated, most such countries have not used currency appreciation as a method of adjustment because, while it would help in dealing with inflation, it would tend to hamper the development of certain domestic sectors, as well as the flow of non-oil exports. However, measures adopted by the oil exporting countries to deal with inflation and its effects on the distribution of income have included reductions in import duties and other actions to reduce the landed costs, and facilitate the growth, of imports.

With respect to the means for promoting adjustment, certain differences in viewpoint continue among the major countries notwithstanding the change in the economic situation—prevalence of greater slack—that has taken place since the 1974 Annual Report. Countries in relatively weak balance of payments positions generally would like to see greater demand expansion by countries in relatively strong positions. However, the latter—still concerned about inflation—consider that the steps they have already taken to deal with the recession are adequate, and that further stimulative actions at the present time, given the probable lags in their impact, could endanger the stability of the recovery at a later stage. There is general agreement that countries with relatively weak external payments situations should position themselves, through maintenance of adequate restraint on domestic demand and of appropriate exchange rates, to take advantage of the cyclical upswing in global demand when it comes.

Insulation from external influences, particularly external cyclical weakness, is very difficult for countries that are highly dependent on foreign trade. In many of them, the capacity for compensatory domestic demand policies is quite limited, and they therefore have a vital interest in the kinds of countercyclical policies pursued by their main trading partners.

Attention generally focuses in this connection on the demand policies of the United States, the Federal Republic of Germany, and Japan. Because these countries have such a big weight in the world economy and their external payments positions are comparatively favorable, it is quite natural that other countries should expect them to take the lead in promoting recovery from the international recession. It seems reasonable to ask these countries to do everything possible, as discussed earlier, to assure the effectiveness of their policies in restoring solid economic growth; but it would not be reasonable to expect them to push expansionary measures to the point that would run the risk of evoking new inflationary pressures.

Differences also persist among industrial countries in respect of exchange rate policy, with some countries engaging in a substantial amount of intervention while others limit themselves to no more than the smoothing of very short-run fluctuations in market rates. Although it is difficult to generalize in this area, countries with the strongest payments positions have tended to intervene rather moderately, and appear to have been willing to allow their currencies to appreciate. Reserve holdings of countries in weaker payments positions have also been relatively steady. Some of the countries with large current account deficits have permitted their currencies to depreciate, but private or official capital inflows have averted or mitigated in varying degrees the downward pressures on exchange rates that might otherwise have emerged. As noted in Chapter 2, the exchange rate changes that have taken place during the period (since early 1973) of generalized floating of major currencies appear to have largely offset sizable differences in relative rates of inflation among the larger industrial countries.

A noteworthy feature of exchange rate experience in the last two years has been the powerful effect of changes in relative monetary conditions on rates. The influence of monetary policy on exchange rates has led some to argue for the coordination of such policies among the major countries to achieve some particular set of exchange rate aims. Any concerted effort of this type would require both agreement on a suitable pattern of exchange rates and understandings on how monetary policies would be aligned among countries to serve internationally agreed external aims, while not contradicting high-priority domestic objectives. The formidable difficulties encountered in meeting either requirement suggest that, even though countries may be expected to continue using monetary policy to influence their exchange rates, effective multinational coordination of monetary policy for balance of payments purposes cannot be an immediate goal.

Differences of view among countries in the area of exchange rates still constitute an important unsettled issue. These differences relate to the extent of influence that countries should exercise over exchange rates, through intervention or other policies, and have implications with respect to the appropriate nature of the exchange rate regime.

For many countries, particularly those that peg to a single currency or to some basket of currencies, issues in respect of adjustment are not significantly different from those posed in the past. The main question for them is whether the simultaneous achievement of a sustainable balance of payments position and a satisfactory level of domestic economic activity is feasible at the existing exchange rate. Countries in this group generally see floating rates as troublesome insofar as they affect price relationships and cause variations in the purchasing power of their foreign reserves. At the other extreme are countries that see floating rates as the principal external adjustment mechanism, and are generally reluctant to interfere directly in the operation of exchange markets, although exchange rates are influenced indirectly, of course, by policies in other fields. A number of countries allow their currencies to float but engage in substantial intervention to influence exchange rates.

In general, the larger, the more diversified, and the less dependent on foreign trade the country concerned, the more it inclines to free floating; and the smaller, less diversified, and more dependent on trade it is, the more it inclines to pegging. Countries with floating currencies and a record of substantial intervention tend to comprise a middle group.

Despite the issues that are outstanding in respect of demand adjustment and exchange rates, sight should not be lost of the accomplishments of the past year. Soon after the upsurge in oil prices, the concept of accepting and financing the aggregate oil deficit was developed as a basic principle of behavior for countries in the new situation. As discussed in the 1974 Annual Report, this principle was not intended to absolve individual countries from paying attention to adjustment, but was aimed at avoiding more adjustment than was collectively possible for the oil importing countries and at establishing standards for adjustment. Such standards, as enunciated by the Committee of Twenty at its Rome meeting in January 1974, included the avoidance of deflation, restrictions, and competitive depreciation as inappropriate responses to the balance of payments changes that stemmed from the rise in the price of oil; observance of these standards has been generally good to date, although it has become increasingly difficult for many Fund members, particularly among the developing countries.

During the period since the Rome meeting, the industrial countries have followed policies that contributed to a downturn in economic activity, but these policies were adopted primarily because of strong inflationary pressures, rather than balance of payments considerations (with which, however, the measures adopted were also consistent in a number of cases). With regard to exchange rates, initiatives to depreciate currencies proved to be much less evident than had been feared; even in countries that might appropriately have taken such initiatives, the existence of inflationary pressures was a deterrent. Restrictions have been introduced by some countries, but resort to such measures to date has been neither widespread nor, in most instances, of quantitative importance.

With respect to restrictions, perhaps the outcome up to now has been reasonably satisfactory because of an awareness by countries of the inappropriateness of policy actions not allowing sufficiently for the interests of others. Yet, many countries—some with burdensome debt positions—face the problem of financing greatly enlarged current account deficits, and there are growing pressures for restrictions. Because of the dangers that any trend toward restrictions would involve, policymakers have the difficult task of devising suitable alternative means for adjustment. Also, the situation points up the importance of providing concessional finance to those countries not in a position to borrow funds on commercial terms.

The Situation of the Non-Oil Developing Countries

In view of the difficult situation of the non-oil developing countries, this section examines their position on external current account and then discusses some of the main economic and financial problems confronting them.

Current Account Developments and Prospects

The overall picture of developments and prospects on current account for the non-oil developing countries is one of sharp deterioration. After rising from $9 billion in 1973 to an estimated $28 billion in 1974, as noted earlier, the combined current account deficit of these countries is projected to reach about $35 billion in 1975. Because of the recession in the industrial countries, the volume of exports rose by only 2 per cent in 1974 (over 1973), compared with an average of 12 per cent per annum in the two preceding years, and is projected to decline slightly in 1975. Expansion of import volume by the non-oil developing countries was sustained at the high rate of 12 per cent in 1974 through heavy foreign borrowing and cessation of reserve accumulation, but a drop of 7 per cent is expected for 1975 in view of their weak prospects for export earnings, the continuing rise in their import prices, and the reduced purchasing power of their reserves in real terms.

Estimates for individual countries and regional groups indicate widely diffused increases in current account deficits for 1975. Proportionately the largest regional increase projected is that for Africa, where a doubling of the 1974 deficit seems to be in prospect and the level of indebtedness could become critical in the absence of concessionary capital flows. Relatively sizable increases are also indicated for Middle Eastern countries (non-oil) and for the Asian group. Non-oil developing countries of the Western Hemisphere are not as a group expected to move further into deficit on current account; but their 1975 deficit will probably remain the highest for any of the regions indicated, notwithstanding an estimated substantial drop in Brazil’s large deficit.

Some Major Problems

Important issues currently facing the non-oil developing countries include the impact of the international recession, containment of inflation, efforts to deal with higher costs of oil and other essential imports, and the financing of greatly increased current account deficits. These problems are to a large extent of external origin, although some of them have been compounded by domestic action or inaction on the part of the developing countries themselves, or have been affected by the constraints under which these countries operate.

The impact of the recession in the industrial world on the economies of non-oil developing countries appears to be falling mainly on the volume of goods and services available to them through importation and on their domestic growth rates and development targets. Although external balances are also being adversely affected, an enlargement of current account deficits sufficient to maintain import expansion commensurate with previous growth rates is clearly not possible. The many countries whose export earnings have leveled off or declined at a time of rising costs of essential imports have little choice but to forgo some imports; during this period of difficulty, the impact on the pace of development has tended to be especially severe where urgent requirements for imported food, fuel, or fertilizers have forced disproportionate cutbacks in other categories of imports. The principal means of limiting imports have been measures of fiscal or monetary restraint intended also to deal with domestic inflationary pressures; relatively few countries have considered it necessary to invoke import restrictions in order to provide immediate defense of the balance of payments.

The apparent effects of comparatively slack export earnings in the face of major cost increases are quite serious in many developing areas.

—The non-oil countries of Latin America and the Caribbean, for example, are expected to undergo in 1975 a drop of several percentage points in their average growth rate, which amounted to about 7 per cent in 1974. Only the Caribbean sugar/bauxite exporting countries seem likely to be able to maintain or increase the pace of their economic expansion.

—In Africa, where adverse movements in the terms of trade are taking place, growth prospects for 1975 seem to be impaired in a substantial majority of the non-oil developing countries of the area. The principal exceptions are likely to be found among the exporters of iron ore, uranium, bauxite, and phosphorus.

—Among non-oil developing countries of Asia, policy emphasis has shifted from the countering of inflation, which until at least mid-1974 was the foremost problem almost throughout the area, toward avoidance or mitigation of the impact of the recession. For most of the Asian countries, the recession, rising import prices, and effective depreciation of exchange rates will tend to hold down the growth of imports.

—Only with respect to non-oil countries of the Middle East can it be said that the recession in the industrial world does not seem to be playing a very important role in current economic developments. In most of this area, proximity to the fast-rising demands of the major oil exporting countries, together with financial assistance from them, appears to provide an adequate cushion for any local impact of the international recession.

During the 1972-73 boom in the industrial world, containment of inflation was difficult for the non-oil developing countries. As a group, they experienced an extraordinary bulge in export earnings, with volume rising by 14 per cent and average export unit values (in U. S. dollars) by 27 per cent in 1973. The result was a rapid buildup in international monetary reserves despite a substantial rise in the volume of imports. For many countries, the unaccustomed external surpluses created unusual problems of domestic financial management, but they also permitted acceleration of investment outlays and development projects long inhibited by balance of payments constraints. In some countries, however, a considerable proportion of the unprecedented rise in foreign exchange receipts was directed toward increased outlays for consumption. In the course of 1974, and especially in the second half, an increasing number of countries adopted stabilization measures that contributed to the easing of price pressures; these stabilization measures included, in addition to monetary and fiscal restraint, upward floating or revaluation of exchange rates by several Asian and African countries, liberalization of import restrictions and tariff reductions to temper the rise in costs, and application of export quotas to avert shortages of essential goods. The outlook for many non-oil developing countries in 1975, in line with world-wide trends, is for some decline in the rates of price inflation from the exceptionally high levels reached in 1974.

The widespread tightening of financial policies during 1974 was facilitated in many developing countries by the cessation of international reserve gains. This development, although unwelcome in certain other contexts, removed one of the previous sources of excess liquidity in the banking systems of the countries concerned. Avoidance of excessive monetary expansion thus became technically much less difficult than it had been at the crest of the commodity export boom.

In those developing countries where imported oil provides a large and vital proportion of total energy requirements, efforts to deal with higher costs of oil and other essential imports have included compensatory adjustments of non-oil transactions, emergency financing (including use of the Fund’s oil facility), and borrowing on international credit markets—an option available to a limited group of countries in 1974, and to even fewer in 1975 because of less favorable export positions and strained external debt-carrying capacities. Countries with relatively low dependence on oil were generally confronted with less pressing problems of adjustment during 1974, but even in that year some of them faced similar problems because of sharp increases in costs of other essential imports, such as foods; and in 1975 an excess of increases in import costs over gains in export earnings seems likely to be pervasive.

An initial reaction of some developing countries to the upsurge of import prices was to attempt to insulate domestic consumers and wage trends from these developments through subsidies or reductions of tariffs on essential consumer goods. Insulating measures of these types, however, tended to place heavy burdens on government budgets and to generate new domestic inflationary pressures. In some cases, the efforts to cushion the impact of import-cost increases were soon abandoned in favor of greater reliance on price mechanisms to regulate demands for imported goods.

With respect to oil, the great majority of developing countries sooner or later allowed a full or partial pass-through of import prices to domestic prices of petroleum products, sometimes with exceptions for products (such as kerosene) of particular importance to low-income residents. Conservation measures were widely introduced (with indifferent success in some areas), and countries in position to do so turned toward coal or hydroelectric power for greater portions of their energy requirements. Programs of oil exploration were also stepped up by a number of countries and met with some success in a few, particularly in Latin America.

External financing looms as a critical problem for many non-oil developing countries. According to Fund staff estimates, it seems improbable that—in the ordinary course of events—any substantial further increase in the aggregate flow of capital and aid to this group will be forthcoming in 1975. Countries whose needs for real resources from abroad exceed the financial flows available to them, and whose reserves are too low for significant use in external financing, will be compelled to cut back imports. For the entire group of non-oil developing countries, some considerable reduction of net reserve positions—probably involving both use of gross reserves and related borrowing on a sizable scale— appears necessary for the financing of a combined current account deficit of about $35 billion.

Within this group, problems of external financing are likely to be particularly acute among countries classified by the United Nations as the “most seriously affected.” For these and numerous other non-oil developing countries, the incurrence of additional indebtedness in 1975 could severely strain their debt-servicing capabilities, and there is urgent need for sizable flows of capital on concessionary terms or of outright grant assistance. Even to maintain the net inflow of private capital near its 1974 level—as assumed in the staff estimates—will require domestic financial policies that do not encourage residents to hold financial claims abroad or discourage nonresidents from extending credit, and that contribute generally to confidence of both residents and nonresidents in a country’s creditworthiness. By the same token, policies and attitudes in capital exporting countries will need to be such as to encourage the required flows of financial resources.

1

The figures are based on comparison of the latest three months for which data are available with the three months embracing the previous peak (which in each instance occurred in 1974 or in late 1973).

2

Potential GNP purports to measure what an economy would produce in a given period if all its resources were “fully” utilized, in a sense more or less consistent with reasonable price stability, given the technology and institutional arrangements existing at the time. The measurement of GNP gaps, therefore, is an attempt to quantify a concept that, by its nature, cannot be closely defined.

3

As measured by world export unit values in terms of SDRs.

4

The maximum potential effect was appreciable, ranging as a percentage of GNP from 5½ in Italy and 4 in Japan, to 2½—3½ in several other industrial countries, and to 1½ in the United States. (These figures relate to the change in the balance of trade in oil from 1973 to 1974 as a percentage of nominal GNP in 1973.)

5

In most industrial countries, it may be noted, there was a substantial increase in personal direct taxes from 1973 to 1974. This reflected mainly the effect of steep inflation rates, which pushed taxpayers into higher brackets and thus, perversely, brought about effective tax increases at a time of economic slowdown.

6

In general, authorities in the industrial countries were optimistic at the beginning of 1974, expecting both a fairly satisfactory rate of economic growth and a decline in price inflation. Their projections of nominal GNP expansion—like those of forecasters generally—often proved rather accurate, but the projected growth and price elements were badly in error.

7

The time lags involved in the effects of monetary policy are believed to be considerably longer with respect to prices than with respect to output.

8

For some countries, additional amounts borrowed by government agencies from private foreign lenders under special inducements from the monetary authorities are included in the fourth column of Table 7.

9

These influences are dominated by the severe recession in the first half of the year, even though an upturn of economic activity is assumed for the second half of 1975.

10

Measured as the change in the high-employment fiscal balance, in order to exclude cyclical effects, the shift toward stimulus would be equivalent to about 2½ per cent of GNP.

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