In the United States, household consumption began to fall during the second half of 2008, with a particularly sharp decline in spending on durables; fixed investment has been falling as well. Continued declines in real disposable income, and in housing prices are indicators of future weakness in demand that is likely to persist throughout at least the first half of 2009. Moreover, the sub-prime market crisis has turned into a fully-fledged financial crisis that severely affected the US financial sector. Large US financial institutions had to be rescued by the US authorities and credit to the US economy was drastically curtailed. Since late 2008, the effects of the financial crisis have impacted the real economy and have exacerbated the economic slowdown. The contribution to GDP growth of net exports increased in 2008, due largely to the contraction of US absorption and a fall in imports. Economic growth in the Eurozone declined in each of the final three quarters of 2008, and GDP contracted in the fourth quarter. Private consumption growth has been anemic and business investment fell, reflecting greater uncertainty and tighter lending conditions. At the end of 2008, the financial crisis that originated in the United States reached several European countries and pushed governments to bail out major financial institutions. Demand from emerging market economies weakened, reducing the contribution of net exports to growth. In Japan, economic activity contracted in the second quarter and again in the fourth quarter. As export growth slowed, reflecting the slowdown in global demand, knock-on effects reduced business investment. Unlike the situation in the United States and the Eurozone, however, residential investment has continued to pick up, as the sector recovered from the effects of regulatory changes introduced in 2007.
In the United States and the Eurozone, a significant output gap emerged in the course of 2008 thus reducing inflationary pressure which had been building in 2007. The stance of monetary policy has remained extremely accommodating in response to the turmoil in financial markets in 2007, but became especially expansive in the United States and then in Europe in the course of 2008 as the financial turmoil worsened and aggregate demand began to fall. Monetary policy is expected to revert towards neutral once growth momentum is restored in the second half of 2009. Despite the increase in fuel and food prices during the first half of 2008, core inflation had remained stable at about 2 percent. Inflation, as measured by the GDP deflator, registered a somewhat higher rate of 2.6 percent in 2008, up from 2.4 percent in 2007, and the OECD-wide private consumption deflator registered a somewhat higher 3.3 percent in 2008. Prospects in 2009 and 2010 are for the OECD-wide private consumption deflator to fall well below 2 percent in both years.
Outside the OECD area growth also slowed but remained strong, even in Asia, with China exhibiting GDP growth of 9.5 percent, down from 11.4 percent in 2007, and India around 7 percent. Brazil and Russia also registered strong GDP growth in 2008, 5.3 per cent and 6.5 per cent, respectively. In all four countries growth is expected to slow further in 2009 and then regain momentum in 2010, reflecting an expected moderate recovery in world demand for their exports.