Transcript of a video Conference of Mr. Fischer with the University of California San Diego Economic Roundtable

February 10, 1999

February 10, 1999
11:00 a.m.
IMF Headquarters
Washington, D.C.

(Moderator) MR. STARR: It's a pleasure now to introduce today's speaker. Stan Fischer is a leading American economic analyst and a leading economic policymaker. He's straddled successfully the worlds of academia and policy. He's Professor of Economics at Massachusetts Institute of Technology, past chair of the Economics Department at Massachusetts Institute of Technology. Many years past he was Chief Economist for the World Bank and now he's moved across the street to the International Monetary Fund where he is First Deputy Managing Director of the International Monetary Fund, and he's been in that capacity for about five years during which he has presided over the restructuring of several financially troubled countries and of course he has his plate full at the moment. Please join me in welcoming Dr. Stanley Fischer.

MR. FISCHER: Thanks a lot, Ross. Thanks for the opportunity to speak to your group. We're talking at a time when the global economy is going through a tremendously difficult period and what I'd like to do is just present a global overview without going very much into reflections on what it means about the global system except for a few comments towards the end of my remarks and then I hope we'll have some time to have a serious discussion of where we are and where we should be going.

As far as the global economic situation is concerned, we are very fortunate indeed that at a time when so many emerging market countries are in trouble and when one of the three largest economies in the world, Japan, is in trouble that the U.S. economy continues to do spectacularly well. If it was not for that, we could be in a global recession, but we are not there now and the reason is that it is quite likely that growth in the world as a whole will be around two percent or a bit more in 1999. That's not a superb performance, but it's way better than what would happen in a world recession.

So that it's the United States that is the island of growth and the hope in the world economy now. Now, U.S. growth in every year since 1996 has exceeded expectations and not least so in 1998, particularly after the very frightening financial crisis that occurred in U.S. capital markets following the Russian devaluation and debt restructuring. And there was a period which you probably remember in late September, early October, when people as experienced as Alan Greenspan and Robert Rubin said that they had never seen anything like this in the capital markets, in one case 25 years, in the other case 40 years. It was for a short time in the U.S. capital markets a series of phenomena, drying up of liquidity, drying up of trading, that had not been seen for a long time, and of course it was far worse for the emerging markets.

Thanks to the very rapid, very calm actions of the Federal Reserve and a bit later actions taken by the European Central Banks in cutting interest rates, and then thanks to the international package of support for Brazil, which was put together and which calmed markets for a few months, that period of extreme tension and concern has gone. We are still in a difficult situation, but we are very far from being in the alarming state we were in September and that's not an accident. That's testimony to the actions taken by the Fed, in particular by the U.S. government, in helping orchestrate the support package, the international support package for Brazil, and by the Europeans a bit later in cutting their interest rates and trying to prevent a slowdown there.

U.S. economy we all say every year cannot continue to grow at the rates it's growing. Private sector cannot continue reducing its savings rate. So that we look to always some return of U.S. growth to closer to what is regarded as the potential growth rate which is around two percent, 2-1/4 percent, with employment very full by any standards. We should not and will not in the longer run be growing more rapidly than that. When that slowdown comes is not clear. If it's just a slowdown, that will be fine. And so far the Fed and I would say fiscal policy has managed the situation very well, and this economy has been run exceptionally well for quite some years now.

In Europe, we see a slowdown in the fourth quarter of 1998, possibly related to some statistical difficulties, but growth continues there. The Europeans have by now much lower interest rates than we have. They have less inflation than we have. And I'm sure that if it becomes necessary, the European Central Bank will cut interest rates a bit more if necessary. They don't see the need right now, but they're certainly watching that situation closely and stand ready to take action if needed.

We should as we do our tour of the world economy not fail to notice the remarkably smooth way in which the euro has been introduced in Europe. This is a development with very profound implications for the long run. It is the first time possibly in history that a large group of countries has decided to give up on the use of a national currency and use an international currency. No doubt it has a deep political motivation, but I'm quite convinced that if it is successful, we will see more and more countries questioning why they should operate with a national currency at all, and movements like that we've heard of out of Argentina now possibly to begin to use the dollar, literally use the dollar, rather than the fix to the dollar and have their own currency.

There are similar thoughts in Mexico which get no support from the government right now. That movement would gain strength if the European experiment succeeds and I really do believe the European experiment will succeed. I believe it will help create a larger market, more competitive capital markets, more competitive goods markets, and a more vibrant economy after a period of some years in which enterprises and labor unions have to learn to operate in the system in which their national authorities do not have the ability to change interest rates but the interest rates come from somewhere else.

We're used to that in the United States. California no more thinks of changing Californian monetary policy than eventually the Germans will think of changing German monetary policy because they just don't have that ability. But it will take awhile for the markets to begin to understand the new realities. When they do, I expect that the European economy will be a better and be more of a challenge for the United States as the largest economy in the world than it has recently.

But as we know in economics, competition is not a zero sum game. Improved European performance will benefit everyone who trades with Europe and it will be good for us if Europe is stronger, if Europe grows more rapidly, if Europe is a larger and more integrated market so that American firms that want to export to Europe can think of that as one unit rather than 11 or 15, as we've had to until recently.

Well, those are the bright spots in the international economy, the United States primarily, Europe to a considerable extent, growing a bit more slowly with a bit more doubt about how it was doing at the end of 1998, and then we go to a series of countries which are in more difficulty, particularly Japan.

I keep saying that one day we'll be wrong in being too pessimistic on Japan. I don't know when that date will come. It seems likely that the Japanese recession is bottoming out now. That's partly because they have a very expansionary fiscal policy at the moment and it seems to be having an impact on growth in Japan. But how rapidly the recovery will come about, whether it will be a very noticeable recovery, those are still questions for the future. And they're important questions. They are questions because Japan's fiscal expansion is coming in an economy where the government budget deficit is so large that financing it even at these low interest rates is becoming problematic. And you've seen long-term interest rates in Japan beginning to creep up.

They were below one percent. They're above two percent. We know that the banking system needs to be strengthened. The government has made lots of money available for that purpose. The banks are beginning to accept the aid of the central government, but there is still more work to be done there. There's more work to be done in the insurance sector. This is a complicated situation which has been made more complicated by the difficulties of the Japanese government in dealing with a situation decisively early on.

And in many ways it's interesting fact of political economy that a crisis like the one Japan is in, which is a creeping crisis, is much harder to deal with than a good clean sharp crisis. It's just that Japan has been growing slowly. It only got into a recession in 1997. But for most of the '90s it was doing badly but not terribly. Those are difficult conditions under which to take decisive action, and it is noticeable that it is since the downturn negative growth started that action has become more decisive in Japan.

I don't know when that situation will turn around, but this is a great economy. It's a very productive economy. It has enormously skilled technologies and technology. It is an enormously hardworking labor force, and it will one day return to growth. We have to hope it is sooner rather than later, but as long as Japanese growth is slow, that exerts a considerable drag on the world economy to some extent and on the Asian economy to a much greater extent, and we have to worry about and seek to help Japan overcome the difficulties in which it has found itself in recent years.

I think we should be hopeful now because they have decided to deal with the banks, they have made a lot of money available, and they have decided on a very expansionary fiscal policy, at the same time as we recognize the crosscurrents in this situation, an expansionary fiscal policy means lots of government borrowing. That's bad for the bond markets. It's bad for interest rates. Reorganizing the banks always means for awhile slower lending. Those things are going to happen, but they have to be dealt with sooner rather than later.

Just as a footnote, we in the IMF are often told it was a mistake to try to deal with the banking problems in Asia right at the beginning of their crisis. We should have waited till they stabilized before seeking to deal with banking sector and corporate debt problems. It's a good argument, but I think it flies in the face of the reality of the political economy reality which is the time to deal with a problem is in a crisis, and if you wait until you stabilize the situation, then there are underlying politically difficult, economically difficult problems to deal with like fixing a banking system. If you wait, it doesn't get done. And that I think is one of the things we've seen in Japan, one of the reasons I have absolutely no doubt that the IMF prescriptions in Asia to move fast on the banking systems and to move fast on restructuring corporate debt were the right prescriptions at the beginnings of the crisis, and it is noticeable now that everybody sees that need. There has been movement but not as much as we would have liked.

Well, those are the main industrialized countries. Two-thirds of the world's industrialized economies doing well; one-third or a little less than one-third, because Japan is bit a smaller than the European and U.S. economies, doing poorly at the moment. And we have to hope that policymakers in the United States, in Europe, continue to take the responsibility for keeping the world economy going as they have done in the past couple of years. Without their growth, this would be a very, very serious recession, but it is not now. It is a very difficult situation for many countries, but not for the world economy as a whole.

Let me turn now to the emerging market countries, the countries in particular that the IMF has been dealing with, and, of course, at the moment Brazil tops the list. The Brazilians until 1994 were an economy that had only known inflation for some 40 or more years, and in the end towards 1993 and 1994, they were in a hyperinflation with inflation rates in excess of 1000 percent per annum.

They had the most sophisticated indexation mechanisms for dealing with inflation of any country in the world. And the Brazilians knew how to live with inflation. When the discussion on indexation began in the 1970s, many of us thought, well, inflation isn't such a problem if you can learn to live with it. Look how well the Brazilians are doing because they were doing well then. Or look at how well the Israelis are doing because they also had sophisticated mechanisms, or the Argentines. But what we saw in the next decade was that all the countries which had thought they could live happily with inflation found themselves running into bigger and bigger problems.

You don't have inflation unless there's an underlying problem and the more you move to mitigate the effects of the inflation, the more you push up the inflation rate. And the crisis just comes at a higher inflation rate. Anyway, in 1994, the Brazilians very successfully stabilized inflation and got inflation down through the so-called Plan Real to single digit range within a couple of years, probably the best designed and most successful stabilization program ever. It was brilliant.

At that time, they had a very good budget situation and low national debt. Unfortunately, in the next few years, the pressures of the constitutional constraints plus the political pressures in a very democratic system came to the fore and the Brazilian government deficit rose over time. The debt began to increase and the pressures on the Brazilian economy began to rise. They came under attack--remember they had an almost fixed exchange rate--in October 1997 as the Asian crisis gained strength. They fought that off by raising interest rates and by promising fiscal action, but much of that was not delivered in 1998 as a presidential election took place.

And then in the wake of the Russian crisis, they were attacked again by investors who thought they could not sustain the fixed exchange rate that they had. Let me just mention that they did not have a strictly fixed exchange rate. They had what is called a crawling peg. They were devaluing at a steady rate of about 7-1/2 percent a year, possibly up to nine percent a year, but they were not allowing the exchange rate to adjust in response to market pressures.

We believed and our shareholders, and our shareholders are the 182 countries who own the IMF, believed that we ought to help them try to avoid a recession, a devaluation. And we put a program together. It had help from 20 other countries. It amounted to $41 billion in support of Brazil's attempt to maintain its exchange rate and stabilize the economy. That program was signed on December 2. Underlying it was a strong fiscal policy that was supposed to reduce the government budget deficit and reduce the need to borrow and the thing hung together well.

There were two very unfortunate developments soon after. First, a perfectly routine measure that had been agreed with the IMF was defeated in the Congress. Nobody had expected that. Possibly the government did not use all the pressure, political pressure, it might have to make that measure go through. They were as surprised as we are, as we were. The markets took that very badly. They put in place very rapidly alternative measures to achieve the same reduction in the deficit, but the markets began to wonder about their ability to get their program through nonetheless.

And then the second thing that happened was that the now governor of one of the largest states, the third largest state, said he would not meet his obligations to the federal government.

That certainly reduced confidence in the Brazilian program and they came under enormous market pressure. They lost a lot of reserves and they had to devalue from the crawling peg they had had first into a wider band and secondly they let the exchange rate float.

Our program with them was based on an assumption about exchange rates that is no longer valid. So we are discussing with them now how to change this program. The discussion started ten days ago. It will continue possibly for another week, possibly for another ten days. We have put in place a good framework that should bring stability to the Brazilian economy, stability in the sense of preventing a resurgence of inflation.

This is the thing most on the minds of the Brazilians. They do not want to go back to their 40 year history of ongoing inflation. What they want to make sure is that this devaluation raises the price level for the next few months and then stops and does not turn into an ongoing inflation. That means they'll have to have a tight monetary policy for some time to make sure they do not let inflation return to Brazil, that will bring back all the old demons of this economy, and that is what the program we're negotiating with them is designed to do.

As I say, we have a framework, but as you all know, the devil is in the details and we are now negotiating with them how they will meet these targets. How will they meet that budget deficit target? How will they carry out the monetary policy? What financing will be available from the international community, from the IMF, from the World Bank, from the bilateral creditors? Those are all the things we're working on now and which we will get settled soon. As soon as it's settled, they will publish, I hope, the details of their program, try to convince the markets that they have a coherent program that will enable them to finance themselves, and that will encourage the markets to understand that this is a viable proposition, one in which it is safe to invest. That's a couple, ten days, possibly a bit longer, away, but we know what the outlines are. We need to fill in the details.

Second important emerging market country is Russia. After the Russian devaluation and debt restructuring in August, a new government was appointed. It is not a reformist government. It seems not very willing to undertake the measures that would stabilize this situation. But they have not done what many thought they would do: say to the West, say to the IMF, we want a new course, this idea of joining the world has turned out to be a disaster; we want to go back to where we were in the 1980s, closed, self-sufficient, without an involvement with the world economy, without an involvement with world capital markets.

I don't think that alternative course is actually a realistic one. I don't think even Russia with all its vast wealth and all its skilled people is capable of turning in on itself and operating in that way. But the temptation must be there. It is important that this government has not succumbed to that temptation and is seeking to remain engaged with us with the West and to join other countries in running a market economy.

The present government does not have the same view of what that means as you or I do. But they do understand that they have to let market forces work. We continue to negotiate with them. We had a team there which left a couple of days ago to come back to Washington. We've asked them to do a number of things. We'll see whether they do them. We're ready at any time to resume the negotiations and go back.

On Asia, let me turn quickly to the countries which got into difficulties in 1997 and which had IMF programs and discuss what is happening there. There were four countries in Asia that have programs with the IMF: Philippines, Indonesia, Korea, Thailand.

Philippines was in a program with the IMF from the beginning, before the crisis broke out, and we have been lending to them. We have an agreed framework. They have basically followed that program pretty well and partly as a result they have avoided getting into a deep crisis. Philippines may have negative growth or about zero growth in 1998, but of the Asian countries it has done best and that is partly because they are already and have been and continue to be in a program with the IMF in which they follow an agreed set of policies.

The Korean economy is undoubtedly turning around. We believe they will grow in 1999. Our growth numbers--we're trying to be cautious because we've been accused of being too optimistic in the past--are in the area of two percent for '99. The Koreans are already putting their numbers at four percent. It is interesting that the pattern they are following is not very different from the Mexican pattern. A crisis late in the year, a year of very negative growth, followed by a recovery in the next year.

It's harder for them because whereas Mexico in 1995 had an export market next door that was strong, the Koreans are operating in a region where growth is very weak, where the Japanese economy has been in recession, and one of the most telling sets of data about Asia is that if you look at the crisis countries and ask what has happened to their exports since they got into trouble, you'll see double digit rates of increase of exports to Europe and to the United States, negative 20 percent increase in exports to each other, but also negative double digit exports increase to Japan. Big declines in exports to Japan and there is no question that the weakness of the Japanese economy has made it harder for the Asians in crisis to recover.

Korea is turning, it is rebuilding its reserves. It started this crisis with reserves of 35 billion. They're up to well in excess of 50 billion. They're repaying us the $15 billion we lent them. They're in a very strong position. They made it clear they're going to get themselves enough reserves so they're not going to get into another crisis like this and that's fine with us. We don't particularly value having had this crisis to deal with and we would be very happy if we don't have another one like that.

Thailand is also doing well and is likely to grow in '99. Both countries have made important progress on restructuring their financial systems, a little less progress on restructuring corporate debt, but they are moving ahead, and the pressure from the IMF, from our colleagues in the World Bank, now will be to focus on getting the financial system healthy and on getting rid of those extraordinary leverage ratios in the corporate sector. Those ratios that have made that sector and therefore the banks so vulnerable to a change in the underlying economic situation because of leverage ratios in excess of 400 percent, 500 percent, debt to equity ratios of 400/500 percent, any change in the underlying economy translates immediately into negative profits, difficulties in servicing the debt. The debt is owed to the banks. The banks are in trouble. That's what happened. That ought to change and we're pushing for that. They're moving possibly not as fast as we would all like them to.

Indonesia is in a more difficult situation because political difficulties there have been very, very profound. There is also an election coming up in June. There is a lot of uncertainty about how the economy will move in the period up to there. There is uncertainty about policy. Things that may be economically wise like encouraging the Chinese minority to keep their money in Indonesia, provide reassurances to them, may be politically difficult at a time of elections. They should be done anyway and to the credit of the president he has been moving in that direction. But at this time, it's politically awkward.

Well, where do we go from here? What do we have to worry about? Obviously, the Brazilian crisis is new. It's only a month old, less than a month old. The question is how soon will Brazil stabilize? We hope that when we finalize an agreement with them, the exchange rate will stabilize and that the so far very limited contagion that has been seen in the rest of Latin America will be even reduced.

People often ask what was the point of this program? Don't you think it was a failure? Yes, in a sense that Brazil ended up devaluing, this program did not work. But in the sense that it provided as it was being negotiated and for another month a time in which investors regained confidence, in which countries strengthened their defenses, in which the entire feverish atmosphere in the international capital markets calmed down, in that sense, this was a very important and successful program.

We expect based on the discussions we've had with the Brazilians that they will get their program in order, that the exchange rate will begin to stabilize and strengthen, that interest rates will begin to come down, and that the contagion from Brazil will be far, far less than the awful contagion we had from Russia last August that is responsible for so much of the difficulties we now see.

So we are in a difficult situation. We are not in a hopeless situation by any means. It will take careful management by the Brazilians, by the other countries in Latin America, by the international institutions, by the countries that support us, the G-7, all other countries, and by the Asian economies coming out of crisis and not least by the policymakers in the United States, Europe, and especially Japan. So let me stop there. Thank you for listening. And let's have a few minutes of questions, Ross.

MR. STARR: Thank you very much, Stan. We'll open the questioning with a couple of UCSD faculty who are familiar with this area. Let's start with Professor David Reicher, and we have a mobile mike wielded by Edie Monk who will be going around Oprah-like to let us speak to Stan.

MR. REICHER: Hello, Dr. Fischer. Of course the business community of San Diego being very closely linked to Latin America, I think of contagion being something that's probably very interesting to this audience, the idea that financial and currency crises within countries spill over to other countries. So Thailand and Korea, possibly that Brazil would affect the rest of Latin America, this idea of thinking of contagion rather than isolated cases of countries. I was wondering if you could comment on how this works, what the channels would be, say trade and capital flows through which we might be concerned about contagion, and also how this consideration of contagion would affect IMF decisions or whether to implement a stabilization plan and perhaps how to structure it?

MR. FISCHER: Let me--thanks for the question which is obviously critical to lots of what we do. There is--and I'll take the second part of the question first--obviously when we help a country, one of the things that is most on our mind is what will happen to its neighbors? People often say, well, those guys misbehaved, they ran their policies badly, why don't you just let them fail? And it will be good for them to suffer the failure, they'll do better next time.

There are really two answers to that. The first is when you let them fail, who exactly are you letting fail? It's not the finance minister who you're worried about. It's about the people who live in that country, the people who do business in that country, and if you refuse to help a country in trouble, it may teach a good lesson to a lot of people, but frequently you're trying to teach three people a lesson by punishing in the Mexican case 80 or 90 million or in the Brazilian case it would be 150 million.

So I think we have an obligation in the international community to help the people who live in countries and therefore you would help them if the policymakers agree to straighten out their policies.

But the second issue, the contagion one, is really critical. We know that if Brazil goes down in a profound sense and there's massive instability there, that it will spread in Latin America. Why? There are two channels. There's first the current account. Other countries trade with Brazil. That's important. Obviously most important to Argentina and if Brazil is weak, the Argentine economy is weakened. And there's no good reason why Argentina should be weakened if we have the capacity to help Brazil.

That affects also the countries around Brazil and those of you who know the map of Latin America know that almost every Latin American country touches on Brazil, I think, except Ecuador and Peru--all the South American countries. So the countries around Brazil are fundamentally South America and if you don't help Brazil, you are spreading through trade the crisis to the others.

But the other channel, the capital market channel, is at least as important. For whatever reason, the capital markets have not done a spectacular job at distinguishing among economies. Partly it has to do with how we invest. We think of emerging markets as a block. You put your money in an emerging markets fund and what happens is sometimes very, very interesting. How did the Russian crisis spread to Mexico? Why Mexico, one of the better run economies?

Because the companies which had invested in Russia which needed to liquidate positions liquidated them in the markets where they could liquidate best at least cost. Mexico is one of the most liquid of the international capital markets and were pretty strong at that point. That was the place to sell if you had to pay out to your shareholders who were trying to get out of emerging markets.

So the way these portfolios are managed in addition to the fact that the capital market people know the linkages among these economies on the trade side tends to spread contagion through the capital markets before it hits trade. And finally, the whole issue of excessive leverage which is on the minds of many of you. The Russian economy is very small. It's less, much less than the size of Brazil, half the size of Canada. The fact that a crisis in that country could wreck havoc on the rest of the world is a result of the fact that many companies were in, many investors were in Russia in an incredibly leveraged way. We saw that when Long Term Capital Management, which was not very exposed to Russia, got into trouble. There were data on how leveraged they were. But when they're very leveraged and they lose, they start having to sell.

And that chain of sales moves through emerging markets into other emerging markets and produces a general loss of confidence and then one final element, and then I'll get the next question. There is a very important Russian effect. There was a belief that the West, the G-7, would never let Russia down, that Russia was a safe investment not because the economy was good, but because it had 30,000 nuclear weapons and the G-7 when push came to shove would give them however much money it took to avoid a crisis.

That belief changed decisively on August 17, 1998. And when that belief changed, the view that too big to fail or too powerful to fail was a safe bet, then a lot of people reappraised a lot of bets all over the world, and that also spread the contagion.

MR. STARR: Thank you very much. Let's go on to Graham Elliott.

MR. ELLIOTT: Good morning, Professor Fischer. Just on the contagion and capital flows that you've mentioned a couple times that are important, play an important role in what's going on, I was wondering if you could speak a little bit about sort of the IMF's ideas in terms of what's going to go on with future regulation, perhaps the use of capital controls by countries, et cetera, to try and mitigate the chances of having these type of problems like in Asia? In particular, I'm thinking of the experience in Chile with capital controls and a very slow movement towards using the world capital markets versus some of the other countries that use much faster methods and indeed Malaysia has also just recently tried to use such capital controls.

MR. FISCHER: Thanks. There are two ways in which the international community is thinking about how to deal with the volatility of capital flows. First of all, there's a new phrase I see appearing. I only saw it two days ago, but it looks very good. Instead of talking about hedge funds, they now talk about high leveraged institutions. And the reason to do that is that a lot of hedge fund activities are actually carried out also by investment banks. And things that we identify as hedge fund, extreme leverage, taking positions in emerging markets, are done by many others. So the new phrase is HLIs, and you heard it first two days hot off the press. You'll be hearing it for some time to come.

There's a lot of discussion of whether the hedge funds ought to be required to make public their positions at all times, just as banks are. And whether they ought to be regulated. I'm a little skeptical. I think if you require George Soros to tell you every morning what he was doing, it might not reduce contagion. It might increase it. Because George Soros being so smart, everybody would see his position and take the same position the same day. So I'm not sure that would actually be a stabilizing force.

But what is emerging from the many studies being made of this is that we need to find ways of making those who lend to the hedge funds, which is in the first instance banks, primarily banks, get a whole lot more information and make that information available to the regulators. It is the financiers of the hedge funds to whom the international regulators are looking to regulate hedge funds and other highly leveraged institutions.

Will that be enough? I'm not certain. But it would certainly go a long way to controlling them. And you saw when Long Term Capital got into trouble who it was who put up the money for them. It was all the banks that had been financing them. Presumably they'll have a greater interest in avoiding having to do that sort of thing in future.

Now, on the capital controls themselves, the biggest problem we face in the international system is the flows of very short-term capital, inter-bank lending, other short-term capital. You say hot money, but long-term bond finance could also be hot money, equity finance could be short-term. But fundamentally, it's the three month paper or the inter-bank lines that went into Korea, that went into Thailand that we're worried about. And the question is whether you can find ways of limiting those inflows?

What the Chileans do, for those in the audience who don't know, is they basically put on a tax which says if you keep your money in Chile for more than a year, the tax is quite small, but if you put it in for a month or two, it's high. They require you to make a deposit with the Central Bank and hold the deposit there for a year, and that discourages these short-term flows.

Brazil actually has similar regulations. They put a tax on short-term inflows. And the IMF which is not wild about capital controls in general has supported this and I believe we should support these and other measures, particularly publication of data, that would try to regulate short-term capital and keep those flows down. I don't think this is a long-term solution. You don't see within Europe, within the advance economies, these controls operating.

As economies get strong, as the financial system is strengthened, as monetary and fiscal policy is strengthened, you don't need them, but for weaker economies this could make sense. What we have not encouraged is controls in countries on capital outflows. The IMF's position and I think it's the position of our shareholders is don't put on controls if you don't have them. If you do have them, don't get rid of them prematurely. Get rid of them gradually.

But the notion that in the middle of a crisis, as money is flying out, you should put on controls to stop it going out is usually closing the barn door after the--the stable door after the horse has fled. And it's worse than that. Who will bring money back? That's what you're waiting for. You're waiting for the money to come back. If you've just put in a rule which says you bring money in here, you can't take it out, you're not going to encourage people to bring it back.

One of the most interesting things with capital controls is that it's always thought that as a country takes off its capital controls, money will go out of the country. What we've seen in many cases is that a country takes off capital controls, money comes in. Why? Because the domestic residents were not stopped by the controls from taking their money out. They took it out one way or the other. And when they have the freedom to move their money around, they'll bring it home. And you get more flows that way.

So the Malaysians, after trying to keep money going out, have been lifting their controls gradually. And those who predicted that the result of this crisis would be everybody would impose capital controls, you haven't seen it happen in Latin America. They are dead set against it. They've lived with that in the '80s and they don't want it. And you've seen very little of it in Asia.

But if we want to preserve this system, we have to do a better job of controlling the short-term flows.

MR. STARR: I'd like to recognize questions from the floor. Edie Monk will be walking around with the microphone. Cabrielle Zigley.

MR. ZIGLEY: Feel free to correct me if I'm wrong in my figures. But talking about Mexico, which we do a lot of work with here in San Diego, I believe there inflation was in the mid-20s or devaluation was in the low teens. Oil being at an all time low, the government has had quite a bit of trouble running its system. It has just put into place some of the highest taxes it has ever done in its country. And just seeing what you think of its future in relation to the U.S.?

MR. FISCHER: Mexico as an oil exporter as are oil exporters is going through a very difficult time now. I'm more impressed by how they have managed to keep control than anything else. First of all, they have floating exchange rates so they do not have to defend a particular level of the currency. That means they will not get into a 1994 style crisis or Brazilian style crisis or a Russian style crisis, whether either you hold the exchange rate or you get into a deep crisis. That's critical.

They're running monetary policy very well. When there's pressure on the exchange rate, they let the exchange rate depreciate. They use interest rates to try to prevent the exchange rate depreciating too fast. Now it is central to Mexico's stability that it does not get into another borrowing binge, either externally or domestically, and so they have committed themselves to keeping their budget deficit at 1-1/4 percent of GDP. That is very difficult as the price of oil goes down, but three times, twice in 1998, they cut government spending and they raised taxes somewhat to make sure that they could maintain that target.

This is a government which has learned a lot from its previous crisis. And I see no signs it's going to let things get out of control. It could perhaps have brought inflation down faster and possibly it should be in single digits by now. But it's in the low single digits and almost certainly coming down--sorry, it's in the low double digits--almost certainly coming down to single digits right now. So I have a lot of respect for the way the Mexicans have run their economy since the devaluation, since the crisis, keeping control as the world economy turned against them, keeping control as the spreads on all emerging market debt increased, managing to get fiscal policy through a congress which is no longer controlled by the PRI, by doing it in political horsetrading, and stitching together a compromise on how to fix the banking system.

Those are substantial achievements in very difficult circumstances. It means Mexico will grow very slowly if at all in 1999. But it also means Mexico will not lose the stability that it has been regaining since its devaluation in 1994.

MR. STARR: Jack White, please.

MR. WHITE: Capital outflows and collapses put a country into crisis. To retain and build capital, it seems to me would be contingent on demand. Could you address the demand side of the equation? What I'm thinking is if the whole world is in crisis, economic crisis, it's targeting the United States for [audio interference] not be in crisis ourselves as a result of that.

MR. FISCHER: Two things, Ross. I'm going to have to leave now so I'd like this to be the last question, and secondly just as you got to the point, there was a tremendous interference on the line so I got as far as you were saying something about demand. Then you turned to the United States and I didn't quite hear the question. I could guess that you said shouldn't we worry about demand? The U.S. is doing well on the demand front, but the rest of the world isn't. How do we deal with that? Was that the question or?

MR. WHITE: Well, the bottom line in my question was if the whole world is depending on--the whole world that's in crisis is depending on the U.S. for double digit imports, how would that possibly survive and not put the U.S. in crisis?

MR. STARR: Did you get that, Stan?

MR. FISCHER: Yeah, I heard that. It's clear that the U.S. cannot continue being the only large economy that has a robust level of demand, and that's one of the reasons why the European economy is so important. From where we start, it doesn't matter so much what the starting point is. It is that countries that are doing well ought to be running larger current account deficits. The U.S. current account deficit is large. It's not unsustainable. It's smaller as a share of GDP than it used to be early in the mid-'80s. So we've been, we've had larger current account deficits in the past.

We can as long as the rest of the world is willing to buy U.S. assets and it looks very willing to buy U.S. assets run these current account deficits. But I don't think they're sustainable over the longer period. We need Europe and we particularly need Japan to grow faster so that they can buy some of the exports from the emerging market countries that don't have finance, that are finding it difficult to get finance, and that need to export their way out of crises.

We in the IMF, governments of the industrialized countries, the government of Japan, can help those countries by providing financing for them so that they don't have to finance all their imports only through greater exports, but the amounts we have relative to the potential money they could get by exporting more are small. And these packages sound gigantic, but, you know, the IMF couldn't put up more than $100 billion into total to finance current account deficits and export growth could do a whole lot more than that in the coming years. So I fully agree with you.

We also need to help countries that are coming out of crises that have regained stability grow faster and that's why you'll see in Korea, in Thailand, in Indonesia, the IMF is supporting larger budget deficits, and in Japan we've been urging greater fiscal stimulus. We find ourselves vis-a-vis the Asian countries in our programs in a very strange situation.

Normally we fight with countries all the time because their budget deficits are too large. The Asians actually have an aversion to budget deficits and we have to fight with them because they haven't been meeting their deficit targets in recent months and we have to say please spend more. This doesn't come easily to us, you understand, because it's not the usual problem. But that is the problem in those countries and we're encouraging it, and just as soon as confidence returns in Latin America, fiscal policies there could also turn a bit more stimulative but we're not there yet in those countries. They have to regain stability or their currencies and then they can turn to this next stage.

Well, I thank you very much for the discussion. Unfortunately, I have to go back to meetings we're having with the executive directors of the IMF. Those are the representatives of the member countries. We have an executive board of 24 members who represent the 182 member countries, the large countries, U.S., UK, France, Germany, et cetera, Japan, represent themselves. Others represent groups of countries. And whatever we do, they have to approve of.

We're meeting with them now to discuss an issue I would have liked to get onto, time permitting, which is how to change the system so we'll operate more effectively in the future, the so-called architecture of the international system, and we're having an informal session with them for the whole day to see how to move ahead on that. But we'll have to leave that for next time. Thanks very much.

MR. STARR: Thank you very much, Dr. Stanley Fischer, speaking from IMF Headquarters in Washington, D.C.

[Edited transcript]


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