Transcript of a Conference Call on Euro Area Policies by Michael Deppler, Director, European Department, IMF

June 7, 2005

By Michael Deppler, Director, European Department
International Monetary Fund
Tuesday, June 7, 2005

MR. HAYDEN: Good morning. I'm Jeff Hayden, senior press officer with the IMF, and I would like to welcome all of you to this conference call by Michael Deppler, Director of the IMF's European Department.

Mr. Deppler is here to discuss an IMF concluding mission statement on euro area policies, which was released on Monday and can be found at our website, A link to the document is also available at the ECB's website.

Before we begin, let me go over the ground rules briefly. This is an on-the-record conference call, and its contents are embargoed until 15 minutes after the conclusion of the call. Mr. Deppler has about 20 minutes to take questions.

With that, Michael, would you like to say a few words of introduction?

MR. DEPPLER: Yes. Thank you, everybody, for joining. You have the concluding statement. I hope it's fairly self-explanatory. I'll be glad to answer questions. But let me, however, open with a few words about the current mood and conjuncture in Europe. And there I'd like to say that our view is that the glass is half-empty, but certainly not that it's empty. And I say that because the view seems to be--in some quarters seems to be a bit despairing.

Why do we say that the glass is not empty? And here this is basically things coming from both a longer-term and a shorter-term view of the situation. Europe has been for many years now following a strategy of stabilization and reform, embedded in the first instance in EMU. And in our view, this has been delivering results.

Just to think about some of these things, one of the features of the present situation is the absence of second-round effects in response to the oil price increases. This is quite new in Europe, and in the past, these second-round effects would have triggered increases in interest rates, which are absent from the current situation.

Similarly, I think people underestimate the improvement that's been done in labor markets over the past 10 years in Europe. It's not often noticed that employment growth in Europe over the past ten years has matched that of the U.S., whereas it was much short of that of the U.S. in the previous decade. Also, even participation rates have been rising, including in some of the latest statistics, participation rates of the elderly, the older members of the workforce, which has been one of the most intractable participation rates. And if you look at what's happened to employment over the cycle, over the past cycle, I mean, we're worlds apart from the experience of the early '90s in terms of the performance of employment, and the rise is unemployment is quite modest by historical standards.

The other feature of the situation is the situation in Germany. Let me start off--can we expect these improvements in performance that we've seen over the past ten years continue in the future? And, again, I would say that the answer to that is yes. I mean, many reforms have been done in Germany, pension reforms in France and Italy. All of these things are the sorts of things which give us confidence that employment will be quite sustained in the period ahead, you know, in the next five years say. You know, just as those reforms paid off in the past, there's no reason not to expect them to continue to pay off in the future.

Then, you know, coming back to Germany, no question but that the past decade has been a very difficult one for Germany, but it's one where it has registered strong improvements in competitiveness, and that you can see it clearly in the behavior of its exports. And just as, you know, strong improvements in competitiveness in France during--from the mid-eighties to the mid-nineties led to quite strong performance from the mid-nineties to now in France, well, basically we would expect the same thing to happen in Germany over the next five to ten years.

So in our view, the longer-term developments are, you know, not buoyant, but they're certainly not things to be as negative about as seems to be the prevailing mood in Europe today. It's true that the immediate situation is weak, and, frankly, it's somewhat unexpectedly weak. If you looked at developments last year, GDP was picking up. It grew by 2 percent. And not only GDP, but also domestic demand started accelerating last year. For the area as a whole, it averaged about 2 percent during the second half of 2004. And, you know, basically we were beginning to see the signs of a sustained recovery.

This came to a halt in the first half of this year. Domestic demand was quite weak in the first quarter, and all the indicators are that even though GDP was relatively strong in the first quarter--about 2 percent at annual rates--it will be about half that in the second quarter to judge from the indicators and in any case.

Now, the reasons for this really are not clear. I mean, there's a whole mess of factors. There's oil, there's exchange rates, there's adjustments to the reforms of the past few years. Global industrial production seems to be in the midst of a pause. There's some various erratic elements, and we really don't quite see clearly how to attribute any particular factor.

But if you think about the world as a whole, we're still projecting quite sustained growth in the IMF's World Economic Outlook, and we don't see why this hiatus that we're observing in Europe should be more than temporary. The fundamentals for the recovery remain in place, and we expect it to resume. So, basically, in our view, you know, the situation is not one of the glass being empty.

That being said, you know, the fact is it's not full either. Indeed, we would characterize it as half-empty. And it's not because the strategy isn't working, but basically because the strategy is being pursued half-heartedly. There's a need for more vigor in this strategy and all the usual elements as described in the note, you know, fiscal consolidation, labor market reforms, particularly on the entitlements and the regulatory side, and [inaudible] reforms essentially to strengthen competition and get productivity moving. Now, in our view, these things need to be reinforced going forward.

Overall, therefore, you know, I mean, clearly the situation is at somewhat awkward paths. A number of negative elements have come together at a very narrow point in time and have sort of interrupted the situation and created a hiatus. However, if one takes at all sort of a more longer-term view of this situation, we see the situation as transitory, the strategy has been and will continue to pay off, and the recovery is going to resume. When exactly is not too clear, but, in our view, it's on the horizon. So basically policies should stick the course and indeed strengthen the basic lines of the strategy.

Okay. That's our basic message that's fleshed out with particulars in the concluding statement, and I'll be glad to answer any questions.

QUESTION: Mr. Deppler, I wonder what do you expect from the European Central Bank as far as monetary policy is concerned. Should they cut rates to foster growth in Europe, or should they do as they have been doing the past week?

MR. DEPPLER: Well, I mean, our view on that is, as I was explaining, that in our view the situation is a bit hard to understand whether we're seeing demand shocks or supply shocks and, you know, the monetary response would depend on -- the appropriate monetary response would depend on what's at issue. And, more fundamentally, the issue is how temporary is this shock. And here our view for the time being is that it's temporary, and until that situation gets clarified, it's, in our view still appropriate for interest rates to remain on hold. However, if the situation were to persist--and, you know, here I'm talking about developments in the third quarter not pointing to some reversal--then we would see the need for a rate cut. As we say in the report, the need for a rate cut would materialize under those circumstances.

QUESTION: Hello, Mr. Deppler. A couple of questions.

One, regarding the euro, the euro has--the euro's strength against the dollar and other currencies has abated recently since the beginning of the year, which is basically presumably growth positive and positive for European exports. Do you share the view that the current level of the euro in approximate terms, not at the moment, is useful for your current juncture?

And, secondly, you mentioned in the paper released last night that--you make a rather cryptic reference to trade. Are you suggesting that the EU should not impose restrictions on Chinese textiles as they seem to be planning to do?

Thank you.

MR. DEPPLER: On trade, I'm sorry to hear that you think the reference is cryptic because, frankly, it wasn't intended to be cryptic. We definitely would--you know, are not in favor of imposing safeguards. And there clearly are issues to be discussed in between the various parties involved, but in our view, sort of imposing restrictions on trade is not the way to go.

On your first question on the euro, it's long been our view that the euro--and here I'm really talking in effective terms, that it's taking all currencies together. But given the present constellation of exchange rates and, hence, thinking in terms of the U.S. dollar, we've long thought that an exchange rate in between 1.20 and 1.30 for the euro was about right in a long-term equilibrium sense. And so we have been--you know, we think that the system has--needs to adjust to a rate of about that magnitude, and basically has adjusted to a rate of about that magnitude. I mean, some of the developments we see in Q1 may reflect the sort of coming together of exchange rate adjustments. It's been unclear what exactly's going on there.

So basically we would expect some fluctuations in rates around that level and that not to create any difficulties. Needless to say, for it to sort of go from the low 1.30s to the low 1.20s in the immediate juncture is helpful. But we would not see it as sort of a change that sort of fundamentally changes the situation. The euro area basically needs to adjust to rates of--average rates of about that magnitude. Indeed, in the longer-term context, we would see the risks to be on the upside of that because of the global imbalances. And it's in that context that the Europeans really need to think in terms of preparing for those eventualities, including by participating in a global strategy to avoid sharp exchange rate movements, where, in our view, [inaudible] sort of pick up speed on structural reforms.

QUESTION: Just to follow up on the rate cut question earlier, I just wanted to ask about the following perspective. A lot of people in Europe say, well, you know, a rate cut [inaudible] the reason people aren't spending isn't because they perceive rates to be so low but because they're insecure about all of the reforms that, you know, they're going through right now. Could I ask for your views on that?

MR. DEPPLER: I'm not sure I got--I heard all of your question, that I heard your message in--your question in its entirety.

On the question about--I mean, there clearly is an uncertainty in the point of consumers and investors about what the prospects are, and you see this in savings behavior. And there is an increase in savings behavior in the current quarter.

Now, in order to--in some regards, this is, we would think, a temporary phenomenon and will be reversed as prospects sort of strengthen.

The other dimension is that in a sense, you know, there is a basic unsustainability in pensions, and it's natural for people to increase their savings rates. But on neither of those counts would we see a reason for raising rates right now. But if the situation persists, that is, if we're viewing something which is more permanent, then as I answered in the previous question on the interest rates, then there would be a need for a cut. But, frankly, at this point it seems more of a sort of immediate rather than a fundamental reaction, and we would think that the underlying fundamentals would point to a strengthening during the third quarter.

QUESTION: I'll ask one on the current debate in the European Union following the French and Dutch rejection of the draft EU Constitution. Some minority ministers in Italy have suggested that Italy return to the lira and dump the euro, and--but perhaps a more representative government view is Mr. Clement in Germany, the Economic Minister, saying that Germany's paid a high price for the euro in terms of high real interest rates as far as Germany's economy is concerned. Even if companies have been reforming and the euro has helped them to--driven them to do this.

What is your view on Mr. Clement's point that Germany has actually paid a high price for the euro? And, secondly, do you think that an end to the euro is feasible, either by accident or by design?

MR. DEPPLER: On the question of Italy exiting, I mean, I think people really aren't, you know, I mean, thinking very straight. If you think about the kinds of travails Argentina went through when it exited its peg, even though it had its own currency but it was a very firmly fixed one, you know, the notion of exiting a currency being a viable option in a situation where all of your assets and liabilities are denominated in their currency I think really needs to be thought through a bit more carefully than it has been.

On the question of the cost to Germany of joining the euro, I think one has to bear in mind that all countries joined the euro with certain baggage. In some cases, it was favorable baggage. In some cases, it was unfavorable baggage. I think in the case of Germany, you know, Germany was, to an extent that no one really appreciated, paying for the baggage of the unification of Germany. Unification of Germany had led Germany to misread the strength of its underlying position during the first half of the '90s and in the run-up to EMU and needed to adjust to it. That adjustment was needed quite regardless of whether it joined the euro or not.

My view is Germany has adjusted, and basically, as I was saying earlier, there are good reasons to think that those adjustments are going to pay off. You know, there are--in a monetary union, there are very long cycles in performance among various elements of a union. I mean, if you think of the United States, for instance, I mean, there certainly were big swings in the performance of the Northeast and the South and the West and then the Northwest--you know, ebbs and flows in performance across these regions. That's relatively easier in the U.S. because of the flexibility of markets. But you observe the same thing within Europe, and I think it's a feature of the situation which governments need to become more focused on than they have been up to now.

But as regards Germany, I would say that, you know, it's turning the corner, and I would think that the next decade will be better than the last decade.

MR. HAYDEN: Okay. I think we will wrap it up, Michael, if you're prepared to do so.

MR. DEPPLER: Yes, that's fine.


MR. DEPPLER: Okay. Well, thank you very much, everybody.

MR. HAYDEN: Thank you for joining us.


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