The world economy is being affected by very divergent forces: the sustained strong demand expansion in the U.S. and the acceleration in economic growth in Europe tend to stimulate economic activity while the financial crisis in South-East Asia is spreading to other countries of this region and is bringing to a halt the upturn in Japan. Various economic policy measures have helped to prolong the economic upswing in the U.S. which started in 1991; real economic growth in 1997 is likely to reach almost 4 percent. The upturn has stimulated employment – the unemployment rate dropped below 5 percent – and reduced the public sector deficits (in 1997, the shortfall will be no more than ¼ percent of GDP). The economic growth potential has increased markedly, mainly as a result of high investment and the increase in labor supply. The rise in interest rates, the surge in the real effective exchange rate of the dollar (+22 percent since April 1995) and the repercussions from the crisis in Asia are expected to dampen economic growth to 2½ percent in 1998 and to 2 percent in 1999. In Europe, demand and output are forecast to expand by 2½ percent in real terms. In most Scandinavian countries, in the U.K. and Ireland, in Spain, Portugal and the Netherlands, the increase in exports has been accompanied by a strengthening of domestic demand. Along with discretionary labor market policies, the acceleration in economic growth has brought about a decline in unemployment, albeit from a high level. In Germany, France, and some smaller countries, however, the expansion in demand has so far been restricted almost entirely to exports. Private consumption has been dampened by a restrictive fiscal policy and high unemployment; investment expenditures have suffered from the weakness in aggregate demand and uncertainties regarding the future course of economic policy. In 1998, the increase in economic activity will spread to domestic demand also in these countries, and growth is likely to accelerate to about 3 percent in the EU. The upswing is expected to continue into 1999 and gradually reduce unemployment as well as alleviate the public sector's deficits. Thus, the transition to the Monetary Union should proceed smoothly. In view of the financial crisis which started in Thailand, Indonesia, Malaysia, and the Philippines and then spread to South Korea, Hong Kong, Singapore, and Taiwan, the forecasts for Asia will have to be revised downwards drastically. Important causes of the crisis were the decline in competitiveness of many countries in South-East Asia and speculative bubbles which had formed in the asset markets. The effects of the financial turmoil on the economy cannot yet be fully ascertained. Wealth losses and restrictive economic policies will strongly dampen consumer and investment expenditures and place a heavy burden on the banking system. The Japanese economy will suffer substantially from the financial crisis, as a result of the intensive trade and financial links to the countries most affected (which purchase about one fifth of Japanese exports). The economic recovery, for which there were clear signs at the beginning of 1997, will grind to a halt. The fragile situation of many financial institutions has become apparent. The stagnation of the Japanese economy, which set in at the beginning of the 1990s, is expected to last to the end of the decade: economic policy has very little leeway to turn the economy around. The repercussions of the crisis in South-East Asia on the economies of the U.S. and of Europe, however, are likely to be small.