"Global Prospects and Policy Challenges" by Deputy Managing Director Shinohara's Speech at the Japan Society, New York

April 25, 2013

Deputy Managing Director Shinohara’s Speech at the Japan Society, New York
Thursday, April 25, 2013

As prepared for delivery

Good afternoon to you all! Thank you, Jeffrey, for your kind words. I am honored to speak today at the Japan Society. For more than a century, this organization has been at the center of exchanges between the U.S. and Japan. It has sought to foster mutual understanding and cooperation. It has also given Japanese art an important place in one of the world’s cultural capitals, and it has carried out an important educational mission. So I express my gratitude to the Society for this invitation.

The topic of my remarks is “Global Prospects and Policy Challenges”, a topic that encompasses some of the most important economic issues of our time. It has been nearly five years since an unprecedented financial crisis erupted in this city with the collapse of Lehman Brothers. In many respects, we have come a long way since the 2009 recession. As this audience certainly knows, the global economy continues to feel the aftershocks from that crisis. And policymakers continue to grapple with the policy response—in Europe, in Washington, in the emerging market economies, and certainly in Tokyo. Indeed, Japan is one of the countries whose performance is crucial to restoring the world economy to health. I will return to that topic during this speech.

Global Economic Prospects

Let us begin with the economic outlook. The global economy entered 2013 with receding tail risks, thanks to policy actions that averted the U.S. fiscal cliff and an escalation of the euro area crisis. While financial market conditions have markedly across the board for the last half year or so, the real economy continues to lag—we still are not seeing the levels of growth needed to drive a real global rebound, and many risks remain. That means there is not enough growth to generate jobs for the millions who have fallen into unemployment over the past five years.

The latest IMF forecasts show that the world economy is strengthening but only gradually. World growth is expected to reach 3.3 percent in 2013, and a more optimistic 4 percent in 2014. But this improvement masks some significant divergence in prospects across countries, and hence the new label “three-speed” global recovery.

There are countries that are doing well, particularly emerging and developing economies. There are countries that are on the mend, such as the U.S. Finally, there are countries that still have some distance to travel—including the Euro Area and Japan.

Activity is strong in emerging markets and developing economies. For the past half decade, the emerging markets and developing economies have led the world’s recovery—accounting for a remarkable three-quarters of global growth. After a slight slowdown last year, they are bouncing back again. Today, developing Asia and Sub-Saharan Africa are the two fastest-growing regions of the world—we are projecting them to grow at 7.1 and 5.6 percent, respectively, this year. The one exception is the Middle East and North Africa, where there are several challenges. The most notable of these are the political transitions that several countries are facing after the Arab Spring.

At the same time, many emerging markets are looking at the advanced countries with some serious concern. Many are worrying about the potential fallout from exceptionally loose monetary policy, especially from unconventional easing. Policymakers worry that exceptionally loose monetary policy will affect exchange rates and capital flows, and threaten financial stability through high asset prices and rapid credit growth.

Right now, these risks appear under control. But we must be alert to any warning signs. Corporations in emerging markets, for example, are taking on more debt and foreign exchange exposure. Another example is that, over the past year, bank credit has increased by 13 percent in Latin America and 11 percent in Asia.

It is worth noting that the low-income countries especially in Asia and Africa, frontier economies have been experiencing higher growth since 2008 than in the years leading up to the crisis. Their economies have benefited from high commodities prices, investment flows from emerging market countries, good harvests, and rising demand from their own businesses and consumers like China.

In addition, there have been significant improvements in governance. In the past, high commodities prices, low interest rates, and strong capital flows might have caused credit booms and overheating. But policy makers in the low-income countries have been doing a good job of managing these pressures, helped by the absence of global inflation.

Some advanced economies are on the mend, most notably the U.S., but also others such as Sweden and Switzerland. In the U.S., balance sheets and house prices are improving, credit growth has picked up, and bank lending conditions have been easing. A modest growth recovery is envisaged, to about 2 percent in 2013 and 3 percent in 2014, as private demand firms up, although growth this year is still not strong enough to have a significant impact on unemployment. But it will be achieved despite the strong fiscal consolidation equivalent to about 1.8 percent of GDP. The budget sequester will result in too much short-term fiscal consolidation while a credible medium-term roadmap remains lacking. The balance needs to be right, as this would help the U.S. to break free from the weak growth in recent years.

Recovery remains elusive in some economies, including the euro area and Japan. The crisis affecting the euro area’s periphery—particularly southern Europe—continues to depress EU growth. We are forecasting a mild contraction of one-quarter of a percent this year in the euro area, and this weakness has now extended to some core countries. Germany’s growth is strengthening, but it is still forecasted to be only 0.6 percent this year. France’s growth will be slightly negative this year, reflecting a combination of fiscal consolidation, poor exports, and low confidence. Spain and Italy will experience substantial contractions. While we expect continued fiscal consolidation in the euro area, monetary policy will likely remain highly accommodative in light of the weak outlook and substantial remaining slack.

European policymakers have accomplished a lot over the past year or so. At the same time there is still a lot to do. If you look at the banking system, especially in the periphery, many banks are still in an early stage of repair. Across the European periphery, credit has contracted by 5 percent since the onset of the crisis, hitting small and medium-sized enterprises particularly hard. Even outside the periphery, there is a need to shrink balance sheets, reduce reliance on wholesale funding, and improve business models.

This is part of a very difficult adjustment in Europe’s periphery countries that is being called “internal devaluation.” This refers to the efforts to regain competitiveness when governments cannot adjust interest rates controlled by the European Central Bank, and when they lack a currency to devalue. These countries are adjusting, including through structural reforms. The process of internal devaluation is slowly taking place, and most of these countries are slowly becoming competitive. But these measures so far do not fully compensate for weak internal demand, the weaknesses in the banking sector, nor the lack of credit to drive investment, and unemployment that in some countries exceeds 20 percent.

But the huge overhang of European debt will take time to address, and the pain of adjustment has the potential to give rise to adjustment fatigue, or even backtracking on reforms.

Then there is Japan, which, by contrast, is in a very different place and it may be more accurate to talk about a “three and a half” rather than a “three-speed” recovery. Its economic sluggishness has lasted for decades—so long that Japanese college graduates this year will have grown up knowing nothing but almost-zero growth.

So it is good to see Japan forging a new strategy. As many of you know, Japan’s new government announced a radically different three-pronged approach to revive the economy. These are—a higher inflation target and more aggressive quantitative easing, flexible fiscal policy, and structural reforms to raise long-term growth. Immediate action has included setting a 2 percent inflation target with massive easing and fiscal stimulus of about 1½ percent of GDP over two years. This is reflected in our forecast of 1.6 percent growth this year.

Japan’s new approach has our support. However, it is also the job of the IMF to point to risks. Given Japan’s very high level of public debt, fiscal stimulus without a medium-term plan for fiscal consolidation gives cause for concern. It increases the possibility that investors will require a risk premium, and it raises the specter of unsustainable debt further down the road. I will return to what else Japan needs to do as we address the policy challenges facing policymakers.

Global Policy Challenges

I would like to turn briefly to the remaining global policy challenges to the recovery. The continued problems in the euro area and with the U.S. fiscal policies certainly create near-term risks. There is also the challenge of rebalancing global demand. Here I refer to the imbalances between countries with large current-account surpluses and those with big deficits—more investment in Germany and more consumption in China. Imbalances were not an immediate cause of the 2008 crisis, but they are a problem that must be remedied if we are to return to stability.

A second challenge is building a system that safely supports the real economy while limiting dangerous risk taking. Policymakers need to complete the reform agenda for the financial sector. Put simply, we cannot build defenses against a future crisis without addressing the last crisis. There has been progress in terms of more stringent capital and liquidity requirements, capital surcharges for global banks, and clearer standards of supervision and resolution. But the progress is uneven across countries and across issues. There are concerns that commitment of any cooperation between country authorities may be waning. Also there still remain several issues, including oversight of banks considered “too big to fail,” and inadequate supervision of derivatives markets and shadow banking.

The third overarching issue involves jobs and equity. This is an urgent priority as it goes to the human cost of the crisis—a cost that is falling disproportionately on young people. The best way to create jobs is through growth, and some countries can spur this growth with labor market policies that can assist job creation.

National Challenges

Now let us examine the policy challenges faced by the three groups of economies that I discussed earlier.

For the emerging market and low-income economies, the primary challenge relates to economic forces they have limited control over—weak demand from their traditional markets and the rapid increase in global liquidity fueled by monetary policy in the advanced economies, which are likely to lead to continuing capital inflows and exchange rate pressure in many emerging market countries. This is basically a desirable process, but at the same time capital inflows can be volatile, making macroeconomic management more difficult.

These countries have done a good job adjusting, but for some there is a need to think in terms of additional steps—for example, rebuilding fiscal buffers that have been depleted by efforts to boost domestic demand. Fiscal buffers will be needed for a rainy day—to respond to future shocks. These countries also need to strengthen financial regulation and supervision, in part to manage volatile capital flows and limit risks to financial excesses. This is an area that has come to be called macroprudential policy.

Some of these countries face the additional challenge of reforming expensive subsidies that often benefit the wealthy more than the poor they are intended to help. This is particularly true of energy subsidies. It is essential that more of the limited resources of low-income countries go to infrastructure projects and targeted social programs in order to build on success, rather than energy subsidy.

For the U.S., the challenges are already clear. At this stage of the economic recovery, there must be no doubt about the willingness of the U.S. government to raise the federal debt ceiling. While the budget sequester will result in too much short-term fiscal consolidation, an agreement on a credible, medium-term fiscal roadmap is imperative. U.S. debt needs be reduced through entitlement and tax reform. The accommodative monetary stance remains appropriate. But there are rising concerns that it is being overburdened and is generating adverse spillovers to other economies. In addition, exit from the unconventional monetary policies will pose several risks—for instance, long-term bond rates could overshoot, derailing the recovery and inducing volatility, or capital could suddenly move out of emerging markets. The Fund will continue to engage on policy options, including on exiting from monetary support, and analyze spillovers.

In the euro area, monetary policy should remain accommodative, and fiscal consolidation should be calibrated to the situation in each country. Those that have room to increase spending to strengthen demand should do so. Those that have to rein in debt and deficits need to protect those left most vulnerable by the crisis. Governments must also continue with the urgent task of fixing their banking systems, by prompting banks to repair balance sheets. This is crucial because the problems of the banking system are preventing low interest rates from translating into the credit needed to lift growth. They also need to implement structural reforms to rebuild competitiveness.

The problems of the European financial system also require collective solutions. This should include bank recapitalization through the European Stability Mechanism, a real banking union that will add a single resolution authority to the recently established supervisory authority, and a deposit insurance fund. There is also a need for greater fiscal integration. Consideration should also be given to the development of new credit instruments for nonfinancial enterprises—for example, securitized lending for small and medium-sized businesses. All of this is essential if Europe is to climb out of a cycle of crisis and decline.

Now let us turn back to Japan. As I said earlier, we are witnessing important developments, including the Bank of Japan’s monetary easing framework aimed at achieving 2 percent inflation over the next two years. This policy is important for Japan and the global economy.

We believe it is possible to achieve that level of inflation, but leaving deflation behind will require a broader policy effort. Monetary policy measure alone is not sufficient. Growth needs to rise as well. Let me therefore emphasize the importance of complementary fiscal and structural reforms.

The new monetary policy framework is not without fiscal risks. As I suggested earlier, in the absence of credible fiscal and growth plans, aggressive monetary easing could focus market concerns eventually on deficit financing. That scenario could bring a sudden a rise in interest rates that would hurt Japan. Thus it is critical that the growth and fiscal strategies the government plans to announce this summer should be ambitious and credible. So, for example, it is important to confirm the consumption tax increases planned for 2014 and 2015, with the single rate structure intact. But the need for credible medium-term plan for fiscal consolidation should not lead to sharp contraction in the fiscal position—fiscal consolidation needs to be carried out steadily over the medium term.

Japan’s decision to enter negotiations to join the Trans Pacific Partnership has sent a strong signal of its willingness to enact reforms that can boost growth. We hope the government also will carry out labor market measures that spur employment—especially of women. Other needed reforms include deregulation of the product and service sectors to increase productivity, and financial sector reforms aimed at encouraging investment in new and innovative sectors.

I am aware that there are some concerns—especially in Asia—that the new BOJ policy will have a negative impact beyond Japan’s borders, both in terms of sudden capital flows and competitive devaluations. However, these concerns may be exaggerated. A comprehensive package of fiscal, monetary, and structural reforms is essential to a Japanese economic revival. Monetary easing could weaken the yen, but we see this as temporary detour. A stronger Japan is essential for a world economy that needs both growth and stability.


The bottom line, if we are to return the global economy to growth and stability, is the collective action of the governments. At the height of the crisis, we saw unprecedented collaboration among governments to ensure that the crisis was contained. Now, after five years of crisis and slow growth, it remains essential that the international community stays focused on building the framework of a new era of growth and stability.

Thank you for your attention.


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