Stability, Growth, and Prosperity: The Global Economy and the IMFSpeech by Anne O. Krueger
First Deputy Managing Director, IMF
Conference De Montreal
June 7, 2006
Good morning and thank you for that kind introduction. I'm pleased to be in Montreal and to have the chance to discuss some of the important issues facing the global economy.
We meet at a moment of great opportunity for the world economy. Over the past few years we have all benefited from a period of global economic expansion remarkable for its pace, its length and its breadth. On current projections, 2006 is likely to be the fourth consecutive year that real world GDP has grown by more than 4 percent: indeed, we now expect growth this year to be close to 5 percent.
And every region of the world has shared in this expansion. The United States, of course, has continued to be a major engine of growth, but emerging Asia has grown even more rapidly; growth has been strong in the Middle East, Latin America and Africa; there are promising signs of accelerating growth in Western Europe and in Japan the recovery appears to be firmly entrenched.
Canadians have first hand experience of the benefits of growth: this country has experienced average annual real GDP growth of 3.4 percent over the past decade—making it one of the most rapidly growing industrial economies. Per capita income has also outpaced the other big economies, growing by an average of 2.4 percent a year. Unemployment is at a 30 year low. And inflation has been contained. Canada has demonstrated that sound monetary policy and fiscal prudence—including a reduction in government debt—provide a solid foundation for rapid growth over a prolonged period.
The impressive performance of the global economy in recent years is, truly, a cause for celebration. Accelerated growth is vital prerequisite for poverty reduction in developing countries. Without sustained and rapid growth, lasting poverty reduction will prove elusive.
We can celebrate what has been achieved thus far: but we must do so without being distracted from the need to preserve and build on the progress we have made. That entails, first, being aware of, and responding to, the downside risks that could undermine our currently buoyant growth projections. Persistent and rising global imbalances; lack of progress in the Doha trade negotiations; high and rising oil prices; continuing geopolitical uncertainty; the threat of an avian flu outbreak: any one or a combination of these could result in growth slower than we currently expect.
Thus far, none of these risks has weakened growth performance. Indeed, in April, the Fund revised upwards its central growth forecast for this year. Rather than shrugging off the risks, however, wise policymakers regard the current conjuncture as a rare but welcome opportunity to press ahead with economic policy reforms that will reduce those risks and mitigate their impact.
Periods of strong growth—at the national and the global level—provide an important opportunity for policymakers to strengthen their economies by raising growth potential, reducing vulnerability to shocks and increasing resilience in the face of future economic downturns.
Make no mistake: downturns are inevitable. All the evidence suggests that the business cycle is alive and well and at some point there will be another downturn. But effective action at the national level will help ensure that at the global level, downturns, when they occur, will be more modest and short-lived than they would otherwise be. And the more countries that are well-prepared to cope with such shocks, the milder, and shorter, the global downturn is likely to be.
So I want this morning to say something about what we have learned about the policies needed to foster long term growth and about how we might strengthen our economies still further and mitigate the risks to growth.
In addressing these issues, I will, of course, say something about the IMF's role. The Fund's principal mandate has been, and remains, the maintenance of international financial stability—without which sustained global growth would not be possible. But as the global economy evolves, so must the way we carry out our mandate. The most important risks to the currently buoyant outlook can most effectively be addressed at the multilateral level. In consequence, as I shall explain, the Fund is moving swiftly to strengthen its multilateral surveillance work and to play a central role in seeking multilateral solutions to multilateral problems. Our first priority in this work is the issue of global imbalances.
Success on inflation
Let me start, though, with a vivid illustration of the benefits that have already accrued from economic reforms—the successful global effort to reduce inflation. A generation ago, chronic inflation was a global problem—and there were those who believed it would remain one. How wrong the pessimists were!
Twenty five years ago, 111 of the IMF's member countries—close to two thirds of our membership at the time—had double digit inflation rates. Last year, only 35 countries had double-digit inflation: that's less than a fifth of our members. In 1980, 39 members had inflation rates above 20 percent. Last year only five did.
The global inflation rate has declined from an annual average of close to 15 per cent in 1980-84 to 3.8 per cent in 2005. The average inflation rate in the industrial economies fell from almost 9.5 per cent between 1975 and 1979, and nearly 9 per cent in the early 1980s, to 2.3 per cent in 2005 and is projected to decline further, according to our latest World Economic Outlook, or WEO.
In developing countries, the decline has been even steeper and more rapid. In the early 1990s, the average inflation rate in developing countries was around 80 per cent; that had declined to 5.4 per cent by 2005. The IMF forecasts currently project a further drop, to below 5 percent by 2007.
This dramatic fall owes a great deal to significantly improved macroeconomic management. Monetary policy has become much more effective, helped by the spread of central bank independence and, in many cases, by inflation targeting. And as inflation has declined, and more countries have adopted fiscally prudent policies, growth has become more rapid and, equally important, more durable. The global low-inflation environment helped ensure that the downturn in 2001-2002 was both modest and short-lived. And countries whose fiscal accounts were in order were able to employ counter-cyclical policy during the downturn.
The pessimists were wrong to assume that persistently high inflation could not be lowered. The battle against inflation was worth fighting and global economic performance has improved as a result.
The changing global environment
The history of economic policy-making is one of learning from experience in a changing world. As we learn more about how economies work, interact and evolve, we gain a greater understanding of how best to shape policies that foster growth and continuing prosperity. Experience taught us much about how best to combat the threat of inflation just as it taught policymakers in Canada, Britain, Australia and elsewhere which policies were most likely to deliver stability and sustained growth. Better growth performance now is undoubtedly attributable in part to lower inflation.
And experience shaped the thinking of those who designed the postwar multilateral economic framework that has served the world economy so well for so long. The architects of the postwar economic framework were determined to avoid a repeat of the beggar-thy-neighbor policies of the 1930s that wreaked so much destruction and brought the global economy to the brink of collapse. High tariff and non-tariff barriers and competitive exchange rate devaluations had not protected national economies from hardship and decline, but had instead undermined the functioning of the entire global economic system.
So the creators of the postwar system realized that a multilateral approach was crucial. They understood the close link between rapid economic growth and the rapid expansion of world trade. They also understood that the maintenance of international financial stability was essential for the expansion of global trade: that, of course, is why the IMF was created at the Bretton Woods conference in 1944.
And the postwar architects also recognized that trade liberalization was an equally vital ingredient in this equation. Trade liberalization has fuelled an extraordinary expansion of world trade.
And this, in turn, has acted as a key driver of global growth. At the time, we thought the growth rates of the industrial countries in the early postwar period were remarkable; and they were, indeed, unprecedented: GDP per capita in the United States grew by 2.4 percent a year for more than 20 years; in Germany it grew by 5 percent a year over the same period. Yet the growth rates achieved by countries like Korea and other Asian tigers from the 1960s onwards, as a result of their integration into the world economy, made the achievements of the industrial countries seem modest. In the four decades from 1960, Korean per capita GDP grew roughly tenfold. More recently, we have seen rapid growth in China, India and elsewhere. The rapid growth of world trade and the rise in GDP that this made possible has enabled hundreds of millions of people to escape poverty.
Yet the framework itself remains largely intact, resting as it does on the maintenance of international financial stability and the multilateral liberalization of trade. What we have learned about economic policies over the years has enabled a growing number of countries to take full advantage of this framework and so achieve rapid and sustainable growth.
The opportunity for further progress
In recent years, we have learned a great deal about the importance of macroeconomic stability and how to achieve it. We have come to recognize the importance of flexible exchange rate regimes; the need to pay close attention to debt sustainability; the crucial role that flexibility plays in strengthening economies and raising potential growth rates. We have also acquired a greater understanding of the central importance of a healthy financial system for economic stability and growth. And we have learned much about the importance of transparency in policymaking.
Where policymakers have implemented reforms that reflect these lessons, they are bearing fruit. The dramatic progress in lowering inflation rates around the world is just one result of improved macroeconomic management. But while progress on many fronts has been impressive, challenges, inevitably, remain. After all, if anything has become clear over the past sixty years, it is that economic reform is a continuous process. Policies have to adapt to reflect both our increased understanding and the fact that the world economy is constantly evolving.
The favorable short-term outlook is a window of opportunity that policymakers can not and should not ignore. It is always easier to introduce reforms during periods of expansion: they can be planned carefully, for maximum effectiveness. And building a consensus for reform, while always challenging, is easier during good times.
There are challenges for all countries. Among the industrial economies, there is scope for further fiscal adjustment, to aim for balance over the business cycle. Economies with high budget deficits in good times have little room for maneuver in more difficult times. Global growth performance may have been strong, but, as I said, there is no evidence that we have abolished occasional downturns.
Most industrial countries are also facing the prospect of significant demographic change. As populations age—very rapidly in some countries—public pension systems are coming under strain. As the elderly dependency ratio rises, and fewer workers support an increasing number of older retired citizens, measures will be needed to ensure that fiscal policy remains on a sustainable path. Action is needed sooner rather than later in order to avoid a fiscal crunch.
In emerging market countries, governments need to press ahead with further fiscal reforms and with debt reduction. Measures have already been taken in many emerging market economies to bring down debt to GDP ratios, to reduce foreign currency exposure and to lengthen debt maturities. But debt levels remain uncomfortably high in many emerging market countries, making them more vulnerable than is desirable to changes in the global interest rates or liquidity environment, or to currency fluctuations. Without further fiscal consolidation and debt reduction, governments in some emerging market economies will not be able to use counter-cyclical fiscal policies when appropriate; and that would intensify the effects of a downturn.
Fiscal reform is also important because many of these countries will also confront demographic change: it may be further off for most of these countries but the challenges are greater: public pension schemes, while usually more limited in coverage, are already expensive and unsustainably generous to those who are covered.
The currently favorable outlook also provides an important opportunity for governments, particularly in developing countries, to press on with the structural reforms that will further enhance the flexibility of their economies and increase their growth potential. Many economies have labor market rigidities that hamper growth prospects; many have burdensome business regulations and weak enforcement of contracts and property rights that discourage enterprise and so undermine growth and, in turn, poverty reduction.
The role of the Fund
The IMF has an important role to play is helping our 184 member countries meet the policy challenges they face. I noted earlier that the maintenance of international financial stability is our principal mandate: our main focus is on macroeconomic policy. Better policies delivering more flexibility and thus stability at the national level greatly reduce the risk of instability at the global level. More rapidly growing national economies make for more rapid global growth—which was, after all, the ultimate objective of the postwar economic framework.
Our surveillance work at the national level enables us to highlight the need for and the benefits of reform. In our annual Article IV consultations with our member countries, we can draw attention to potential policy weaknesses—and also note policy successes in individual countries. The Fund has a unique cross-country perspective, enabling us to understand better what works and what doesn't and to provide appropriate advice to our members.
The Fund also provides technical assistance to member countries wanting specific help with reforms. This now accounts for a significant element of our work and ranges from assistance in improving customs procedures and tax and public expenditure administration to the management of monetary policy as more and more countries recognize both the importance of macroeconomic stability and the role within that of an efficient public sector.
Of course, we continue to have an important role in crisis prevention and resolution. The past fifteen years or so have given us plenty of experience with the latter. But the fact that we currently have a very small number of borrowers might suggest that we are now doing better at prevention. I would hesitate to be so glib: but our aim is certainly to push for further reforms and further strengthen economic performance in the hope that the world economy will be more resilient when the next slowdown comes.
The Fund's multilateral role
Perhaps the most urgent short-term challenge is securing a satisfactory outcome to the Doha round of trade negotiations. The prospect of a significant lowering of barriers to agricultural and services trade, and further liberalization of trade in manufactures, could provide a boost to world trade and, in turn, global growth.
A Doha agreement would greatly strengthen the global trading system. But a failure would weaken it and give encouragements to protectionists who mistakenly believe that economies gain from erecting trade barriers against other countries—which was the fallacy of the 1930s. Without a Doha agreement global growth would be slower; and the world economy could be less resilient in the face of shocks.
The Doha negotiations are, of course, principally the responsibility of the World Trade Organization, under whose auspices they are conducted. But the Fund has always enjoyed a good working relationship with the WTO and we have worked hard to support the WTO's efforts to bring the Doha round to a successful conclusion.
There are however many multilateral issues on which the IMF is best-placed to play a central role. Many of the most pressing challenges facing the international economy can be most effectively addressed multilaterally. These issues often cut across existing groups of countries and policy fora. The IMF is ideally placed to address these issues: we are, after all, a global institution, with a macroeconomic policy mandate.
For some time, we have been moving to strengthen our surveillance work at the multilateral and regional levels. At our Spring Meetings in Washington in April it was agreed that we should take this work even further and establish a new process of multilateral consultations to address issues of global concern. It was also agreed that the first issue we should address in this new process would be the problem of global imbalances, to which I referred earlier.
The cumulatively very large imbalances we now see in the world economy are the result of a combination of factors: low consumption and rising surpluses in Asia; the large and rising US current account deficit; sluggish growth in Europe; and, more recently, rising surpluses in the main oil-exporting countries. A failure to unwind these imbalances smoothly over time could undermine global growth prospects. There will always be current account surpluses and deficits. But if they reach unsustainable levels there is a risk of abrupt action to correct them and this in turn could lead to a disorderly unwinding of the imbalances. Hence the case for addressing imbalances before they reach that point.
A disorderly unwinding of these imbalances is low risk but cannot be ruled out. Much more likely is that individual countries might act on their own and in so doing make adjustment more costly for all. At the very least, any one country or region taking action alone will benefit less than if all countries acted together. It is easy to envisage a situation where unilateral actions could have significant negative effects on other countries, and on the world economy as a whole.
Coordinated action to reduce global imbalances will significantly reduce the risks of negative spillovers while greatly increasing the gains to be had by all the countries involved and reducing the likelihood of a disorderly adjustment. A multilateral solution to the problem is therefore vital.
It became clear at our Spring Meetings that there is now broad agreement on the steps needed to resolve these imbalances. These include raising national saving in the United States—with measures to reduce the fiscal deficit and spur private saving; implementing structural reforms to increase flexibility and growth in the Euro area and several other countries; further structural reforms, including fiscal consolidation, in Japan; increasing consumption and increased exchange rate flexibility in a number of surplus countries in emerging Asia; and promoting the efficient absorption of higher oil revenues in oil-exporting countries with strong macroeconomic policies.
The challenge for the Fund is to translate this agreement on the steps to be taken into a policy prescription for effective, coordinated action. We are moving ahead rapidly as we can on this, and we have just announced the first set of multilateral consultations involving China, the Euro Area, Japan, Saudi Arabia and the United States, all of whom have agreed to participate.
I've outlined some important challenges facing national economies and the IMF. Taken together they may seem daunting. Several of them are certainly pressing—we urgently need further progress in the Doha round of trade negotiations, and we need to make progress on a multilateral resolution of global imbalances.
National policymakers need to implement reforms to strengthen their economies and raise potential growth rates while ensuring that they safeguard the significant gains made in achieving macroeconomic stability and providing them for room for maneuver in the next downturn.
At the multilateral level, the IMF has an important challenge as we seek to facilitate a coordinated, effective response to the problem of global imbalances.
Successful reform at the national and multilateral levels will lay the foundations for sustainable and rapid growth in the future.
There can be no better environment than the present in which to press ahead with the reforms needed, at the national and global level. Global growth has been, and remains, strong. Inflation remains subdued in most parts of the world. Much progress has already been made in improving the quality of macroeconomic management and tackling the reform agenda. This is an opportunity not to be squandered.