How the IMF Can Help Promote a Collaborative Solution to Global ImbalancesRemarks by Rodrigo de Rato
Managing Director, International Monetary Fund
At the Center for European Studies, Harvard Business School
April 4, 2006
As Prepared for Delivery
1. Thank you very much.
2. Many people, looking out over the global economy, see an untroubled landscape and a sky with few clouds in it. A comforting prospect, if true. However, experience should warn us of the dangers of complacency. Global economic imbalances are large and in my view unsustainable. If these imbalances are unwound in a disorderly way, the result could be financial crises and a global recession. To tackle global economic imbalances we need global economic cooperation. The IMF is the only institution with a global membership and a mandate to engage with our members in policy discussion, so we have a special responsibility to address this problem. Today, I would like to propose some ways in which I think the Fund can help. Specifically, I would like to share with you some ideas that I will be discussing with our membership for changes in the way the Fund monitors individual countries' economies and the global economy. Over the coming months I will seek the support of the major players in the global economy for an intensified multilateral approach based on these ideas.
3. The backdrop to this discussion is that global economic conditions are unusually favorable in many respects. The world is set for its fourth consecutive year of 4 percent plus GDP growth, inflation is subdued, interest rates are low and financial markets are more resilient to shocks than in the past. There are risks to global growth: notably, the risk that high oil prices are here to stay and the risks of an avian flu pandemic. There are also long term problems that need to be tackled: for example, global warming and aging populations. But for many countries, the economic environment is as good as it has been for many years. So what is the problem?
4. The problem is that good economic performance rests on a shaky foundation, because of large and continuing global imbalances. By definition, imbalances have two sides to them. The most visible aspect of the global imbalances problem is a large deficit in the current account of the balance of payments of the United States—almost 6½ percent of GDP in 2005, and expected to be as high again this year. The other side if the coin is large surpluses in the external accounts of other countries, including oil exporters such as Russia and Saudi Arabia, Japan and the emerging market countries of Asia, especially China. In some of these countries, current account surpluses have contributed to a very large build up of international reserves by central banks. And in the United States, repeated current account deficits have resulted in growing external indebtedness.
5. Current account imbalances are only part of the story. What underlies them is different patterns of global saving and investment. In the United States, saving is too low. The U.S. household saving rate has been on a downward trend for the past two decades and has accelerated in recent years, partly owing to the effects of the housing boom. Meanwhile, the federal budget deficit, after improving in 2005, is expected to widen to about 3 percent of GDP this year as revenue growth slows and the costs of rebuilding in the Gulf Coast area, military operations in Iraq and Afghanistan, and the introduction of the new prescription drug benefit scheme all increase expenditure. In emerging Asia on the other hand, saving is relatively high, but in recent years most countries in emerging Asia have suffered an investment drought. In the past five years, investment in emerging Asia excluding China has averaged about 25 percent of GDP, about 7 percentage points of GDP below its average in the five pre-crisis years. Although investment in China is high, national savings is even higher, including precautionary saving by households, which has led to relatively low consumption. As a result, China has recently built up very large surpluses in the current account of the balance of payments. In oil exporting countries, surpluses are being spent only slowly. Meanwhile, the euro area's external accounts are close to balance, but both output and expenditure are lower than they could be because of structural rigidities, such as uncompetitive product and labor markets. Structural reforms are also needed to strengthen domestic demand in Japan, which would support a reduction of its current account surplus.
6. In a world of globalization and large private capital flows, imbalances like this can last for a long time. Indeed, they have. But eventually they must unwind. Eventually, U.S. households will wake up to the fact that their saving rate is insufficient. Eventually, the governments and citizens of surplus countries will decide to save less and consume and invest more. The risk is that global imbalances will be unwound in an abrupt and disorderly way. I do not believe that the risk of a disorderly adjustment in the near future is high, but it is increasing as imbalances continue. If a disorderly adjustment does take place, it will be very costly and disruptive to the world economy. There are two obvious ways in which a disorderly adjustment of global imbalances could happen. One would be an abrupt fall in the rate of consumption growth in the United States, which has supported global economic growth. U.S. consumption growth has to slow because the negative household saving rate is unsustainable. But if it slows abruptly, as it could, especially if there is a bust in the housing market, it will take away a major support from world demand. This would hit growth in other economies, for example in Europe and China, because demand for their exports would fall. In this scenario, there would be a contraction of global demand, and possibly a global recession.
7. Another possibility is that adjustment could be forced by financial markets. In this scenario, investors might become unwilling to hold increasing amounts of U.S. financial assets at current exchange rates and interest rates. This would lead to a depreciation of the U.S. dollar and increases in U.S. interest rates, which in turn would cause U.S. domestic demand to contract. Again, if this happened abruptly, it could cause a severe downturn, as well as global financial market disruptions. In either scenario, there is a risk that economic damage would be worsened by an upsurge in protectionism. Indeed, there are indications that protectionist pressures are already building.
8. There is a broad consensus among policy makers on the measures that are needed to reduce global imbalances. Most policy makers around the world agree that what is needed is fiscal adjustment and measures to stimulate private saving in the United States, exchange rate appreciation and measures to stimulate domestic demand in emerging Asia, and structural reforms to stimulate demand and improve productivity in the non-tradeables sector in Europe and Japan. But this consensus has not, except at the margins, yet been translated into action. Why is this?
9. Some people argue that global imbalances will either persist indefinitely or dissipate gradually of their own accord, with no need for action by governments. I find these views optimistic to the point of willful blindness. To rebut them, let me quote from a recent speech in India by Larry Summers. President Summers said:
"In general, my view about past experience with tech stocks in the United States or with the Japanese stock market or with a range of emerging market situations is that the moment of maximum risk comes precisely when those concerned about sustainability lose confidence in their views, as their warnings prove to have been premature, and when rationalizations come to the forefront."
10. There is also some tendency for policy makers and commentators to emphasize the need for action by countries other than their own. Often the arguments are cast in academic terms. Spokespersons for U.S. policy institutions tend to stress the limited contribution that reductions in the fiscal deficit can make to global imbalances and urge more exchange rate action by Asian countries. Spokespersons for the Asian countries suggest that most plausible exchange rate adjustments would have only a modest impact. Economic policy makers in Europe suggest that Europe is not really part of the problem at all.
11. To those who argue that it is up to others to act or to act first, I would say, "Be careful what you wish for." A disorderly adjustment of global imbalances could be produced not only by inaction, but by unbalanced actions. For example, substantial fiscal adjustment in the United States, in the absence of measures to increase demand in other countries, could reduce global demand in the same way as a fall in private consumption in the U.S. would. Similarly, a fall in demand for U.S. financial assets by foreign central banks could itself cause a disorderly depreciation of the dollar and cause interest rates to rise, especially if it precipitated a reassessment of the dollar by private investors.
12. What is needed is coordinated action by the major players in the global economy. Global imbalances should be seen as a shared responsibility by governments in systemically important countries. This would make the necessary actions both politically easier and economically more effective. Politically easier, because instead of finger-pointing and recriminations there would be mutual support and burden sharing. Economically more effective, because as demand is withdrawn in the United States it would be added in Europe, Asia, and the oil-exporting countries, and as financial flows from Asia and oil exporters become less available, so they would become less necessary in the United States. The question is how to achieve such coordinated action.
13. The IMF can and should play an important role. When the IMF was created in the 1940s, the founders did not envisage a world of large and rapid capital movements. But for the Fund to play a role in coordinating multilateral action to address such issues is perfectly in line with the purposes for which it was created. The Fund has already helped to frame the debate, and has taken the lead in organizing discussion not only in our Executive Board but also at ministerial level. It is also organizing a conference on global imbalances involving senior officials and noted academics that will take place just before our Spring meetings at the end of this month. But I think we also need a more systematic approach, including a re-evaluation of the way in which we conduct surveillance of the global economy. One reason that countries have been reluctant to take action on global imbalances is because notwithstanding the many economic benefits to their own countries, there are also political costs to action. But perhaps another reason is that the Fund has been insufficiently persuasive in its advice and has lacked mechanisms to promote multilateral action. So I have some suggestions that I hope will improve the way the IMF formulates and communicates its advice, and make it easier for our members to agree on collaborative solutions to problems based on that advice.
14. These suggestions arise out of a discussion that I initiated last year on the medium-term strategy for the IMF. The central theme of this discussion is that globalization has fundamentally transformed the way the nations of the world conduct macroeconomic policy. Globalization has been around for a long time, but the extraordinary flowering of international trade and financial flows over the past decade has resulted in its effects being felt more deeply and more quickly by people all over the world. Global imbalances themselves are an aspect of globalization: imbalances of the current magnitude would not have been possible without more integrated global financial markets in which more diversified capital flows are able to finance larger current account deficits. And the Fund must adapt its surveillance to reflect the changes produced by globalization, including large global imbalances. How should we do so? Some of my suggestions relate specifically to the issue of global imbalances, others are broader in scope.
15. We need better mechanisms for consultations with more than one member at a time. Global imbalances are the problem not of just one country but of many, and we need a multilateral format for consultations to address them, and to address other issues of systemic importance, as they arise. One possibility, which I have raised with our Executive Board, is that the Fund complement its existing arrangements for consultations with individual countries with a multilateral consultation procedure, allowing the Fund to take up issues collectively with systemically important members and, where relevant, with entities formed by groups of members, such as the European Union, the Gulf Cooperation Council, and ASEAN +3. I would hope that such discussions would be conducive to agreements on actions by all of the participants to address issues, especially if such consultations were discussed not only by the IMF's Executive Board, which is composed of Directors appointed or elected by members, but by the International Monetary and Financial Committee—the IMFC—which is composed of finance ministers and central bank governors from those same members. In the same speech that I referred to earlier, President Summers emphasized the limitations of forums such as the G7, which does not include in its membership some of the largest surplus countries, and the need for a forum that, and I quote, "structurally has political clout over the international institutions and at least some ability to influence domestic policy decisions of individual countries." I can think of no better description of the IMFC.
16. I also see some merit in a more systematic assessment of the consistency of exchange rate policies with national and international stability. Exchange rates have always been at the heart of the IMF's analysis of members' policies: they are a price that affects every aspect of the economy. But they are also difficult to talk about: while many of our members favor exchange rate flexibility to various degrees, nobody likes exchange rate crises, which can occur when rates are pegged, and misconstrued comments can lead to crises. Notwithstanding this, as well as the well-known difficulties of such work, I think it would be useful for the thinking of policy makers to be informed by an analysis of exchange rates based on a consistent multilateral framework. The IMF has such a framework, which currently covers industrial countries, but it could usefully be extended to cover the major emerging market currencies. I think it would also be useful for the Fund to review the way we conduct surveillance of exchange rates more generally. Our current guidance dates back to the very different world of 1977, and while practice has evolved, first principles have not been modified over time. I think another look at them is in order.
17. As I have noted above, a disorderly resolution of global imbalances could have significant repercussion in financial markets. It is important that we understand the potential impact of this. More generally, understanding financial and capital markets is as fundamental to the Fund today as understanding fiscal and monetary economics, and we must make sure that its importance is systematically reflected in the work of the institution, and especially in our surveillance work. A number of far-reaching organizational changes and analytical efforts are already underway to strengthen the IMF's work on financial markets. We also need to ensure that our country consultations give a central role to financial sector issues, in the same way that they do to fiscal policy at present.
18. I also think that we need to give more prominence in both global surveillance and surveillance of individual members to issues of globalization. There are many ways that we could do this. We could include, in staff reports on countries where economic developments have significant regional or global impact, an assessment of international spillovers: that is, of the implications of a country's policies or vulnerabilities for its neighbors and the international community more generally. We could focus more in our global surveillance, on the effects of long-term trends in globalization on our members—for example, the global effects of demographic changes and of cross-border movements of people, capital and knowledge. We could also strengthen the Fund's regional surveillance work, to inform our advice to individual members and, in particular, draw lessons from the experiences of members in dealing with similar macroeconomic challenges.
19. I also think that the IMF can improve the way it communicates its advice. Let me specify two ways in which we could go about this.
• First, we can have more focused reports on individual countries. I am concerned that attempts to make our surveillance more comprehensive have sometimes made it less productive. A report that tries to say something about everything is unlikely to be read with much enthusiasm or interest. So I think it is important that the staff identify for each country the core issues on which we want to engage the authorities—the issues that are most fundamental for them and for the global community—and at each consultation develop an agenda covering the next few years based on these issues.
• We also need more active outreach. There is a story in the IMF of a past Managing Director who when asked what the staff should tell the press said, "You will tell them nothing." We are long past those days. In fact, we have made great strides in increased transparency and communications in the past decade, partly because we recognize that in democracies, bringing about policy change involves engaging people and civil society as well as governments. Much is said about the importance of ownership by member countries when the IMF is lending to them. But ownership is equally important in the surveillance relationship. To develop it, I would like to see press conferences at the end of missions become more routine, more regional outreach, and more communication by the senior staff and Management of the Fund.
20. A recommendation for more communication by IMF Management may be a little unwelcome at the end of a long speech. Let me qualify it. Communication is a two-way street, and we must listen as well as talk. I am very pleased that my proposals on the medium-term strategy for the IMF have stimulated debate, including contributions from U.S. Treasury Undersecretary Adams on exchange rate issues, from Governor King of the Bank of England on the independence of the Fund, and most recently from Governor Dodge of the Bank of Canada. The debate is also taking place within the IMF. We are now moving from planning to implementation of the medium-term strategy because the need for action is urgent, not only in dealing with global imbalances but in reform of the IMF more broadly. And just yesterday, our Executive Board discussed and broadly endorsed the plans for the next stage in implementing the medium-term strategy. But I will always remain open to ideas. And in that spirit, I invite your questions and comments.
21. Thank you very much.