The Multilateral Approach to Global ImbalancesRemarks by John Lipsky at the Brussels Economic Forum 2007
First Deputy Managing Director
International Monetary Fund
May 31, 2007
Good morning. It is a pleasure to have the opportunity to participate in the Brussels Economic Forum for the first time as the First Deputy Managing Director of the International Monetary Fund.
My assignment today, and those of my fellow panelists, is to address the issue of global imbalances. This is a topic that has generated substantial and enduring interest, and one that is highly germane to the concerns and responsibilities of the International Monetary Fund. After all, a basic task of the IMF is to watch after the stability and sustained smooth expansion of the global economy. The emergence in recent years of record international payments imbalances has been widely perceived as a threat to both growth and stability. I'm going to try to put the current situation in some perspective, and to provide an update on the results so far of the IMF-sponsored Multilateral Consultations on Global Imbalances. These consultations were convened in order to shape a policy agenda that would support the dual goals of sustaining global growth while reducing imbalances (Slide 1).
Of course, perceptions about whether global imbalances represent a concern or even a surprise have shifted over the past decade. In particular, it is worthwhile to recall that the reemergence of substantial imbalances in the late 1990s reflected in large part two unanticipated developments: First was the US economic growth surge that began in 1995. As you will recall, this growth speed-up was associated with acceleration in US productivity gains that raised US potential growth. The second key factor was the financial and economic convulsions that shook Emerging Asia during 1997 and 1998. The net effect was to push the world's fastest growing area into a brief but shocking recession. Of course, the subsequent impact of the 1998 Russian debt default and devaluation, the 1999 Brazilian devaluation and difficulties in places like Turkey also contributed to the growth divergence (Slide 2).
Thus, when the IMF's 2000 World Economic Outlook took note of the expansion of the US current account deficit, its source was easy to understand. Moreover, the consensus assumption at that time was that a renewed global expansion — including a probable moderation in the US growth surge — would reduce imbalances, or at least diminish the concerns that something was going wrong. In the event, however, new surprises, including the 2000 bursting of the dot.com/high tech bubble — followed by the shock of 9/11 and subsequent geopolitical events — heightened concerns about the global outlook. As you may recall, the post-9/11 consensus was that the global recovery was going to be weak, uncertain, uneven and potentially volatile.
Despite this newly-pessimistic consensus, the post-2002 recovery in global growth was both stronger and better balanced than anticipated. Nonetheless, rather than shrinking as anticipated, global payments imbalances reached a record high, leading to growing concerns about the threat of impending economic and financial instability (Slide 3).
In discussing a multilateral approach to addressing payments imbalances, my presentation revolves around two key considerations (Slide 4):
• First, that while the unexpected combination of strong growth and record imbalances created some real risks, a growing consensus has emerged that these risks are more likely to represent a medium-term challenge, rather than a short-term policy emergency. In fact, excessively precipitous policy actions undertaken with the sole aim of immediate and substantial reductions in imbalances could be unnecessarily disruptive to global growth and could even undermine financial market stability. In other words, a medium-term perspective on this issue is likely to be appropriate. Just to be clear, this is not to condone inaction. In fact, a failure of policymakers to take appropriate — albeit medium-term — policy measures could undermine investor confidence and create near-term market strains. Furthermore, the IMF's International Monetary and Financial Committee (or IMFC for short - which advises the Fund's Board of Governors) promulgated just such a policy strategy in late 2004.
• Second, the IMF's Multilateral Consultation on Global Imbalances — that was endorsed by the IMFC in early 2006, and recently reviewed by the IMFC at its meeting last month — represented the first use of a new multilateral consultation tool proposed by the IMF in 2005 as an innovative approach to addressing global policy challenges. As such, the Multilateral Consultation on Global Imbalances represents something of an experiment in international policy coordination. As I hope that you know already, the Fund's Multilateral Consultation on Global Imbalances brings together senior monetary and economic officials from five key global economies to discuss the design and implementation of a medium-term strategy to sustain robust global growth while reducing payments imbalances. The participants include the euro area, China, Saudi Arabia, Japan and the United States. These participants were selected either because they have large current account deficits or surpluses, or because they account for a large share of global output.
Globalization's Impact on Economies and Financial Markets
Before addressing the progress to date from this new multilateral effort, it is worth making a few key points about globalization's impact on economies and on financial markets (Slide 5).
The first is to underscore that the positive economic results of the past five years have been to a large degree unexpected. How many of you guessed in 2002 that global growth would average close to 5% per annum for the following five years — the fastest for a similar period in more than three decades? (Slide 6).
Of course, it is not just the overall speed of the expansion that surprised consensus views, but its ubiquity and cyclical simultaneity. This is evident if one looks at the standard deviation of the changes in growth rates across countries. It is striking that the recent period of rapid growth also has been marked by unprecedented cyclical simultaneity. This could have been a coincidence, but it seems more likely to have reflected the accelerating pace of globalization. Of course, this simultaneity makes the growth in payments imbalances more striking (Slide 7).
While overall GDP growth has become unusually simultaneous, the same can't be said for the components of growth. In fact, there has been no trend toward more simultaneous expansion in real domestic demand. This dichotomy defines the policy challenge of keeping the overall global growth strong while redressing the imbalances in domestic demand growth — basically strong demand in the US, but weak elsewhere — that have given rise to the record payments imbalances (Slide 8).
I'm sure that you can recall warnings made in the past few years to the effect that shifting investor sentiment could force a disorderly, disruptive, and possibly destructive re-balancing of the global economy. After all, the record imbalances were financed by unprecedented cross-border capital flows — including private sector flows — that could alter course at any time. Adding to the sense of impermanence, emerging market economies have remained net capital exporters since the late 1990s, despite their exceptionally strong growth performance.
The risks of an unfavorable outcome can't and shouldn't be ignored. Such a result could involve dramatic shifts in capital flows and wrenching economic strains. Nonetheless, a rapid, market-driven and disorderly unwinding of the current imbalances should be avoidable. Basically, the existing pattern of global saving, asset allocation and the force of financial globalization are likely to be sufficiently resilient. Nonetheless, there is no justification for complacency or inaction. To the contrary, there is a need for convincing policy actions that will support the twin goals of sustaining growth and reducing imbalances. But such actions appear to be attainable, as I will discuss later.
The counterpart to the post-2002 rise in imbalances has been a surge in cross-border capital flows. One reason for the favorable financial market conditions under which the growth of cross-border flows have taken place is that they have reflected complementary demand patterns: These has been an increase in demand for relatively risk-free financial assets by non-US investors, while US investors in particular have sought higher-return (and presumably higher-risk) investments (Slide 9).
Recent data have been striking: Cross-border financial flows — measured as a percentage of World GDP — are more than double what they were in 2000, and more than three times what they were at the beginning of the 1990s. But this process has not struck the protagonists as either defensive or unwarranted. For example, two thirds of the 175 global asset managers who participated in a recent survey (by Deloitte Touche Tohmatsu) considered that financial globalization had improved their asset allocation decisions (Slide 10).
In this context, evidence of the recent loss in investor "home bias" is striking: For example, the average share of international equities in developed economy pension fund portfolios grew anywhere from two to sixteen-fold between 1990 and 2005. And, of course, the loss of home-bias would be even more striking if we considered mutual funds, hedge funds, sovereign wealth funds, and other classes of asset managers (Slide 11).
It is instructive to examine the US current account deficit using several measures. For example, it is about 21% of world saving. We're more used to hearing it measured as a share of US GDP (about 6% plus). At the same time, however, the associated capital inflow amounts to only about 1% of US private assets and 2.6% of US marketable financial securities. The latter measure potentially is relevant to the issue of the near-term sustainability of the imbalances. It is also relevant to the issue of whether a medium-term perspective is reasonable in assessing the chances for success in reducing payments imbalances (Slide 12).
In judging the near-term sustainability of large inflows in to the US financial market, it is also worth noting that the aggregate value of US financial assets still roughly equals the combined value of equivalent assets in the Euro, Yen, and Sterling zones. The point is not that there are no near-term risks, but that the relative financial market stability over this recent period of growing imbalances reflects in part the US financial market's depth (Slide 13).
The IMF's Multilateral Consultations on Global Imbalances
As I stated earlier, the goal of the IMF's Multilateral Consultation on Global Imbalances has been to help position the global economy on an adjustment path toward a more durable and credible pattern of domestic demand growth while maintaining robust global GDP growth. The Consultations were launched in early 2006. The participants — together with Fund staff — presented a progress report to the April 2007 meeting of the IMFC. The formal presentations to that meeting were released to the public and they are available on the Fund's website. This includes a joint explanatory note plus the participants' individual policy plans (Slide 14).
I will very briefly discuss each participants' plan, and comment on how the Fund staff foresees potential progress on achieving the dual goals in light of these plans.
• The Euro area is not experiencing significant current account imbalances. Nonetheless, by strengthening and sustaining domestic demand growth and by improving potential growth, the euro area will make a contribution toward improving global performance. The integration and transformation of the euro area (and European) financial markets will provide an key impetus for improving the efficiency of the area's product and service markets. The renewed Lisbon Agenda reforms are critical to achieving this goal, including through labor market reforms. My fellow-panelist today, Jean-Philippe Cotis, will expound upon this subject in greater detail (Slide 15).
• China's policy commitments are structured around three cornerstones: First, rebalancing growth relatively more towards consumption while slowing investment growth and improving investment efficiency. Second, deepening financial sector reform. And, third, increasing the flexibility of the RMB. A more effective, market-driven financial system would help to strengthen domestic demand growth, while improving investment efficiency and increasing the usefulness of monetary policy instruments for maintaining macroeconomic balance. Experience has shown that such a sectoral and systemic transition is more easily managed with a flexible exchange rate policy. The recent announcements of new monetary policy measures, and the widening of the daily trading band for the RMB have been consistent with China's Multilateral Consultation policy plans. It is reasonable to anticipate further clear-cut progress on these and the other policy initiatives that are included China's policy plans. Deputy Governor Wu of the People's Bank of China, who is also on this panel, will provide more perspective on this subject in her remarks (Slide 16).
• Turning to Saudi Arabia and other oil producers, the scale of recent revenue increases relative to the size of their economies implies that their adjustment process will have to be gradual. After all, adjustment must be undertaken in line with absorption capacities. So far, oil producing economies have on average spent 30-40% of their extra oil revenues on increased imports, but the variation across countries is significant. Saudi Arabia is taking the lead in increasing social outlays where returns are high, including on education, health, and social safety nets. In addition, Saudi Arabia is implementing ambitious investment plans, and not just in the hydrocarbon sector. The net effect of these efforts already is impressive: import growth in Saudi Arabia was more than 40% in 2006, after averaging some 23% in the preceding three years. Muhammad Al-Jasser, in his remarks, will elaborate on the scope for Saudi Arabia and other oil producers to help in sustaining growth while reducing global imbalances (Slide 17).
• In Japan, deeper structural reforms are needed to improve growth potential and safeguard living standards. The reform priorities are to increase labor market flexibility, promote competition through greater market opening, and deepen trade integration. Recent progress in these areas has been promising, but the agenda is far from finished. New structural measures will catalyze and sustain the on-going economic recovery. As consumption spending and investment strengthen, the current account surplus should narrow as a percent of GDP. Over the longer term, this trend toward a narrowing surplus also will be supported by demographic factors (Slide 18).
• The lynchpin of the US policy statement to the Multilateral Consultation appropriately focuses on raising national saving — both through policy incentives to raise private sector saving, and through plans to eliminate the fiscal deficit (ex-social security) by 2012. Between 2004 and 2006, the United State's general government deficit fell by 2 percent of GDP. Looking forward, the fiscal adjustment is planned to occur through tight controls on discretionary spending (Slide 19).
Some observers have expressed doubts whether the US savings rate can and will rise as intended. While there is general agreement that a rise in the US savings rate would be desirable, I also believe this to be the most likely outcome in the next few years. After all, several special factors contributed to an unexpected rise in US household's net worth over the past decade, encouraging a decline in savings out of current income. These factors include the unexpected decline in inflation that began in the 1990s, the increases in productivity and potential growth in the mid-1990s, and the more recent reduction in financial market volatility. A slowdown in the pace of asset price gains is to be expected in the coming years as these surprises are not repeated. As a result, the saving rate out of current income will tend to move back toward historic norms (Slide 20).
So what has the Multilateral Consultation on Global Imbalances accomplished so far? First, it has affirmed that pursuing the dual goal of sustaining global growth while reducing imbalances is a shared responsibility. It also has produced a coordinated set of policy actions that each of the participants considers being in their own respective interests. The participants agree that when implemented, these policies will make a significant contribution to achieving the dual goals. Finally, the agreed framework includes a sustained focus on the implementation of the policy plans through regular Fund surveillance. Moreover, the plans are reasonably explicit, and they have been published. Thus, the public and the press can judge the pace of progress for themselves (Slide 21).
To examine the potential impact of the five participants' Multilateral Consultation policy plans, Fund staff conducted some simulations (subject to the usual caveats) using our Global Macroeconomic Model (or GEM). We compared the effects of the five policy plans against two alternative scenarios: One alternative was a benign "no policy adjustment scenario", where all the adjustment in the saving-investment balance is driven by gradual private sector action. For benchmarking purposes, we called this the baseline scenario. We also used a "disruptive adjustment scenario", involving a loss of appetite for US assets and a sharp correction in exchange rates, leading to an output contraction. The "Multilateral Consultation policy adjustment scenario" including the participants' policy plans provided the most stable and enduring adjustment to the US current account deficit (Slide 22).
Using the GEM model, we simulated all the spill-over effects of the policy adjustment scenario, and calculated the relative effects of this scenario on global growth over the next six years. Relative to the baseline, global growth would be virtually unchanged in the first three years. However, the following three years generate an increase in global growth rates of 0.6% per year.
Moreover, global growth would be better balanced over the medium-term. From 2009 onwards, Japan, the Euro area, and emerging Asia would all grow 1.5- 2% more relative to the baseline, while US growth would be virtually unchanged from the baseline. The result would be a significant reduction in global payments imbalances (Slide 23).
So, what can we conclude? (Slide 24).
• Imbalances are a medium-term challenge, at least for now. Effective and appropriate policy actions will boost confidence, and help to insure that the challenges remain medium-term ones.
• For now, there are good reasons for optimism regarding achieving the dual goals: The Fund's World Economic Outlook baseline economic forecast is favorable, while the proposed policy plans are extensive and concrete.
• Thus, it appears that the Multilateral Consultations have created a potentially useful tool for addressing the dual challenges, but it will not be possible to draw solid conclusions until the policy plans are implemented.
• The publication of the Multilateral Consultation policy plans will allow interested (non-official) observers to review whether the participants are meeting their commitments.