Early Action to Ward Off Deflationary Pressures Is Key -- A Commentary by Shigemitsu Sugisaki, Deputy Managing Director, IMF

May 26, 2003

Early Action to Ward Off Deflationary Pressures Is Key
A Commentary
By Shigemitsu Sugisaki
Deputy Managing Director
International Monetary Fund
Nihon Keizai Shimbun
May 26, 2003

The G-8 summit in Evian, France comes at a propitious time. The welcome end to war in Iraq and the sharp fall in world oil prices are positive developments for the world economy. But significant uncertainties remain and sustained global recovery is not yet assured. In times of uncertainty, leadership and cooperation are of paramount importance. The G8 leaders will have an opportunity to provide these when they meet in Evian, building upon the agenda set out at the recent G-8 Finance Ministers meeting in Deauville.

Let me highlight five areas of particular importance for the coming months.

First, policy-makers in the major industrial countries must tackle the impediments to robust growth in their own economies. A sustained global recovery requires a revival of demand in the largest economies and a return to more balanced growth, with less reliance on the United States.

The recent weakening in the US dollar is part of the process of adjustment in global current account imbalances, but could set back recovery prospects in Japan and Europe. Policy-makers in Europe should be mindful of the experience of Japan in the first half of the 1990s, when a sharp yen appreciation contributed to the prolonged domestic recession. Early, more aggressive monetary easing in Japan might with hindsight have helped to contain these effects.

Low global inflation and the high anti-inflation credibility achieved by major central banks provide ample room for monetary policy to support demand. Fund staff do not view global deflation as a significant risk at this stage, but deflationary pressures have risen in some cases, and history points to the importance of early, aggressive action to ward off such pressures. More aggressive steps are needed in Japan, where deflation has become entrenched. This should include stepped up purchases of JGBs and other assets, and clear communication of the commitment to end deflation. Under the new leadership of Governor Toshihiko Fukui, the Bank of Japan has recently taken some additional measures. I welcome his determination and and look forward to further efforts to combat deflation.

Scope for fiscal expansion in the major industrial countries is constrained by concerns about high public debt and medium-term sustainability. Indeed, a modest start on fiscal consolidation may be appropriate in Japan and some euro area economies. Beyond this, the automatic budget stabilizers, whereby deficits widen during a slowdown because of weaker revenues and higher benefit payments, should be allowed to operate. Fiscal stimulus in the United States that includes tax reductions should not be allowed to weaken the credibility of commitments to medium-term fiscal balance.

More progress on structural reforms is essential for stronger growth. This includes more aggressive corporate and financial sector reform in Japan, and accelerating labor and product market reforms in Europe. Forceful implementation of corporate governance reforms is also important to boost investor confidence in the United States and elsewhere. In Japan, I am encouraged by the broad recognition of the linkages between non-performing bank loans and corporate debt restructuring, and look forward to the Industrial Revitalization Corporation of Japan playing a useful role in overcoming this protracted problem. The injection of public funds into Resona Bank will help to strengthen the banking system, but needs to be accompanied by steps to accelerate the disposal of the bank's non-performing loans and to improve its profitability.

The second area worth highlighting is the importance of disciplined macroeconomic policies and continued progress on structural reforms in emerging market economies. Most such economies are now benefiting from lower oil prices and improved financial market conditions, with bond spreads falling to levels well below historical averages in many cases. For countries such as the Philippines, however, where bond spreads remain relatively wide, markets are signaling that policies need to be further strengthened. More generally, experience has demonstrated that financing conditions facing emerging market borrowers can change quickly, and policy-makers should not become complacent.

Third, international trade is a vital ingredient for reducing poverty and building confidence in a strong and lasting global recovery. The expansion of global trade and prosperity since World War II provides vivid testimony to the benefits of reduced trade barriers within a multilateral framework. The G8 leaders could provide no clearer signal of their commitment to international cooperation for the benefit of all, including the world's poorest nations, than by giving renewed impetus to the successful completion of the Doha Round. The round is now entering a critical phase in the runup to the September WTO Ministerial meeting in Cancun, and such leadership at this time would pay major dividends.

Agriculture is particularly important for poverty reduction, as most of the world's poor depend on agriculture for their livelihoods. Unless advanced economies open their markets to greater access for the poorest countries, I fear that meeting the Millenium Development Goals for poverty reduction may remain elusive. Countries such as Japan, which continue to heavily protect their agricultural sectors, can demonstrate global leadership in this area. However, this will require a coordinated strategy for international negotiation under the direction of Prime Minister Koizumi, and perhaps could be facilitated by the appointment of a special envoy.

Fourth, helping those countries that are emerging from conflicts should be a top priority for the international community, to demonstrate the benefits of peace and bring hope to their populations. Iraq will clearly be a prime focus in the months ahead, and it is hoped that the G-8 leaders will demonstrate a clear agreement among themselves to work for the welfare of the people in Iraq. The IMF stands ready to play its role in helping the Iraqi people.

Foreign Minister Kawaguchi's peace-building diplomacy is already bearing fruit in Asia, including in Sri Lanka--where Japan will host an important donors meeting next month. Japan, along with the other major industrial countries, has a critical role to play in ensuring the success of these efforts, not just in Asia but also in post-conflict countries in Africa, such as Angola and Sudan.

Fifth, efforts must continue to focus the prevention of financial crises, and on a strengthened framework for crisis resolution. Much has already been achieved, building upon the lessons of the financial crises in the 1990s. The recent resilience of the global economy in the face of several severe shocks is a testimony in this regard. The IMF will continue to work to strengthen the effectiveness of its surveillance over economic developments, including through improved assessments of vulnerabilities, continued efforts to enhance transparency, and support for countries' efforts to strengthen their institutions, policy frameworks and financial sectors. Effective private sector engagement in crisis resolution must be part of this process.

In sum, the global economy continues to face significant uncertainties, but with the right policies these uncertainties can be overcome. The G-8 leaders will have an important opportunity in Evian to demonstrate their resolve, in the spirit of international cooperation, to tackle the impediments to stronger growth, and ensure that the benefits are shared by all. A positive outcome could do much to achieve a turnaround in global consumer and business confidence, and lay the basis for a robust and lasting global recovery.


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