Chapter II. The World Economy

Uncertainties over the prospects for the oil price mean that the short-term forecast is subject to a wider margin of error than usual. The Iraqi invasion of Kuwait could lead to a reduction of world oil production by at least eight per cent immediately and has already produced a significant rise in oil prices. Our central forecast assumes that in the short term oil prices will stay firmer, but that in the longer run there will be no major change in oil market conditions. We have assumed that oil prices (or more precisely the arithmetic average of Brent and Dubai spot prices) will be around $25 per barrel in the second half of 1990, but that they will fall thereafter. This should leave crude oil prices in the range $20–22 per barrel by the end of 1991. Annex I to the chapter investigates the effects of an oil price rise on the world economy, and looks in particular at the distribution of the effects across the major economies. The conclusion of the Annex is that a 25 per cent rise in oil prices is likely to raise inflation in the major seven economies by only a quarter to a half a per cent in the short run, and to lower output by up to a half per cent.