Policy Steps Toward a Full-Speed Global EconomyBy Christine Lagarde
Managing Director, International Monetary Fund
Washington DC, June 4, 2013
As prepared for delivery
Good afternoon. It is always a pleasure to come to Brookings, one of the most influential research institutions in this country. Let me thank the members of the Board and the Council for inviting me today. Let me offer a special word of thanks to my friend Kemal Dervis, a man who has devoted his entire life to public service, both on the national and international stage, and who remains a leading figure in the international economic debate.
Today, I would like to give you a snapshot of global economic trends. Just over a month ago at the IMF’s Spring Meetings, I spoke of the fragile and uneven recovery that is taking place—and of an emerging “three speed” global economy. We projected overall global growth of 3.3 percent.
How has the picture changed since then? Broadly, we are still seeing the three speeds, with countries splitting off into: (i) those that are doing well; (ii) those that are on the mend, and; (iii) those that still have some distance to travel. We are still seeing upbeat financial markets sitting uncomfortably beside a more downbeat real economy. We are still seeing a global jobs crisis and a recovery that is not doing enough to lift the prospects of all people.
We are, however, also seeing some glimpses of more somber trends. Recent data, for example, suggest some slowdown in growth. At the same time, the downside risks to growth remain as prominent as ever.
So we could be entering a softer patch. This only reinforces my core message—making policies stronger to stop the global economy getting weaker.
We can do better than the current three-speed solution. We need a full speed global recovery. How do we do that? It requires careful, customized policy responses in each of the three groups. Let me flesh this out.
1. The first-speed group
I will begin with the first speed group, which comprises, essentially, the emerging markets and developing countries. These countries entered the crisis from positions of strength, and are still in positions of strength.
In a world of too much bad news, we do not hear enough about this good news. In fact, over the past half decade, the emerging markets and developing economies have led the world’s recovery, accounting for three-quarters of global growth. Today, developing Asia and Sub-Saharan Africa are the two fastest-growing regions of the world. Moreover, a recent IMF study suggested that today’s growth in the low-income countries is more robust that in the past, and less vulnerable to pitfalls and setbacks.
Of course, we must not get too carried away on a wave of optimism. In the past few months, we see signs of slowing momentum in some emerging markets. In China, recent activity has been weak and growth remains too reliant on credit, property investment, and infrastructure. Investment prospects also look less bright in key markets like Brazil, India, Russia and South Africa.
These countries need to implement policies to protect what they have accomplished—and stay strong. In part, this means looking inwards and getting to grips with domestic vulnerabilities and structural obstacles to sustained growth—including infrastructure and regulatory bottlenecks, as well as governance. It also means looking outwards, keeping a watchful eye on spillovers from the advanced economies, especially from an extended period of unconventional monetary policy.
The IMF has done some research on this issue, as part of our ongoing work on examining the role and effects of monetary policy during and after the crisis.
What did we find? First, unconventional monetary policy has achieved a great deal on the domestic front. It helped make financial markets work again, and it took the most severe risks off the table. It also helped growth, although the effects here are hard to quantify.
Turning to the rest of the world, we believe these policies have also had a positive effect on balance—especially through better global financial stability, higher growth in advanced economies, lower interest rates and lower spreads.
For sure, the persistence of easy monetary policy increased the flow of capital to emerging markets, especially in Asia and Latin America. Such flows can be beneficial to an economy, but they can also lead to financial stability risks. Even worse than the tide coming in is the tide going out—a possible sudden reversal of large capital flows that can overwhelm an economy.
Right now, these risks appear under control, and can be managed with sound macroeconomic policies complemented by macroprudential policies geared toward taming financial excess. In some cases, measures to directly control capital flows can also help.
Let me be clear: we believe that accommodative monetary policy in advanced economies, including unconventional measures, should continue. We must also acknowledge, however, that longer duration and growing scale leads to growing risks.
At the same time, monetary policy must not be asked to do too much—and should not be used as an excuse to avoid bringing more balance to fiscal policy or defer much-needed structural and financial reforms. On the contrary, countries must use the breathing space offered by unconventional monetary policy to come to grips with underlying economic fragilities.
With the right set of policies on both sides of the equation—advanced economies and emerging markets—I believe these risks can be managed, so the global economy can continue its forward momentum.
2. The second-speed group
Let me now turn to the second speed group—countries that suffered through crisis, but are now on the mend. This includes the United States, plus also countries like Australia, Canada, New Zealand, Sweden and Switzerland.
The US has certainly come a long way in a short time. Just five years ago, it was the triggering point of the crisis, geared by financial excess. Thanks to good progress in fixing its financial system, we are seeing a steady increase in private demand, driven by a recovery in the housing sector and in the automobile industry, and easing financial conditions. Because of this, we believe growth will be almost 2 percent this year, and higher still next year.
Despite this progress, the US is not doing as well as it should, largely because of self-inflicted fiscal wounds. This year alone, fiscal adjustment will constitute an enormous 2½ percent of GDP.
Sequestration alone—if not reversed—could cut a half percent of GDP from growth. It is also an extremely blunt instrument, imposing deep cuts in many vital programs—including those that help the most vulnerable—while leaving untouched the key drivers of long-term spending. If the sequester were to be replaced by more back-loaded measures, however, growth should strengthen in the second half of the year.
The US also needs a durable solution to raise the debt ceiling. This would help avoid financial market instability and the possibility of undermining the recovery with another self-inflicted wound.
Turning to the longer-term fiscal horizon: the US has made steady progress, reducing its fiscal deficit by some 7 percentage points of GDP since 2009. We believe that the deficit will continue to shrink over the next few years, as revenues recover with faster economic growth. The public debt ratio should also start declining in 2015, as growth picks up and provided interest rates stay low.
Nevertheless, the longer-term debt profile remains a major concern. Spending on key health care programs and social security is expected to increase by 2 percentage points of GDP over the next decade. Interest outlays are also projected to increase by the same amount over this period as rates gradually return to neutral levels. These factors could widen the budget deficit and put the debt-GDP ratio back on a worryingly upward path—and all from a relatively high starting point.
The bottom line is clear: while fiscal adjustment might be too aggressive in the short term, it is certainly far too timid in the medium term. At this point in the recovery, it is more important than ever to put in place a credible, medium-term roadmap to bring down the debt—a balanced plan made up of savings in entitlement spending plus additional revenues.
This is the major policy challenge facing the US today—and it must be met. Otherwise, the substantial gains that have been made can be too easily lost.
3. The third-speed group
Let me now turn to the third speed group—the countries that still have some distance to travel to recovery. This group includes the Euro Area and Japan—although Japan is looking somewhat stronger today than even a few months ago.
Let me start with the Euro Area, first by acknowledging just how far it has come in a short space of time. Consider the list of achievements: the European Stability Mechanism, the ECB’s Outright Monetary Transactions, steps toward a single supervisory mechanism, and the agreement to help relieve the debt burden of Greece, not to mention the nascent European banking union.
Yet the Euro Area economy is still stuck in low gear. Activity has continued to shrink in the beginning of this year, and we expect negative growth—of -0.3 percent—for the year as a whole. Overall, the region is operating at “zero speed”.
Going forward, the indicators are not encouraging either. Lending to firms is rising only gradually in countries like Germany, and not at all in countries like Italy or Spain. The periphery is still mired in recession, with financial conditions that are unduly tight. Unemployment is still rising. This weakness—combined with lingering uncertainty over the Euro Area growth outlook and the evolution of Euro Area institutions—is draining momentum even from countries like Germany and France.
So the stakes are high on the policy front. What needs to be done?
First and foremost, the region needs a new growth agenda that combines both area-wide and national-level initiatives. This includes greater opportunities for people to take up a job anywhere in the Euro Area, support for credit provision, and for job creation through labor market reforms.
The following policies will help.
Because certain banks are burdened with bad assets, low interest rates are not translating into affordable credit for people and firms who need it. The plumbing is clogged up, and we are seeing more financial fragmentation. So financial repair is paramount. A priority must be to continue to clean up the banking system by recapitalizing, restructuring, or—where necessary—shutting down banks.
Likewise, monetary policy has a role to play in supporting growth. We strongly support the relatively accommodative stance and welcome the ECB’s recent actions—without which the Euro Area crisis would have developed without control. We see a need for further unconventional monetary policy to reduce fragmentation and help credit flows.
Beyond this, the Euro Area needs a real banking union to strengthen the foundations of monetary union. This means complementing the single supervisory mechanism with a single resolution authority, and deposit insurance backed by a common fiscal backstop.
Turning to fiscal policy: while fiscal consolidation is still necessary, it is essential to pace it well. Countries under market pressure have little choice but to stick to a consistent and steady path of adjustment. But elsewhere, the pace should be attuned to the speed of recovery, as the Europeans themselves are increasingly recognizing.
Some Euro Area countries also need structural reforms to unleash competitiveness.
With this package of policies, I believe that the Euro Area can get its growth engine up and running again.
This brings me to Japan, another country in the third-speed camp—and a country whose economy has indeed “sped up” over the past few months. In large part, this is due to recent monetary and fiscal stimulus combined with a depreciation of the yen by about 20 percent in real terms. In the first quarter alone, Japan grew by 3½ percent. We project growth of 1.6 percent for the year as a whole.
If this trajectory continues, we might be able to move Japan from the third to the second speed country group. Yet there is still some distance to go to make this higher gear permanent. Japan faces many challenges on the road ahead.
How can Japan solidify its gains? Monetary policy is certainly on the right track, especially with the new quantitative and qualitative easing framework aimed at achieving two percent inflation in two years.
Yet this new direction for monetary policy needs to be complemented by a more balanced fiscal policy. The recent fiscal stimulus will only be effective in the longer term if it is twinned with a credible strategy to bring down public debt, which now approaches 245 percent of GDP. This includes committing to the planned consumption tax increase from 5 to 10 percent in 2014-15, and addressing entitlement reforms.
Shifting to a higher gear also means pressing ahead with structural reforms to unlock productivity—including by opening up domestic services and agriculture.
Japan also needs to provide more employment opportunities for older workers and for women. Labor force participation is 24 percentage points lower for women than for men, lower than in comparator countries. This is simply throwing away so much economic potential at a time when it is most needed. So Japan should consider policies to attract more women into the workforce, including by stepping up efforts to reduce gender gaps in career positions and providing better support for working mothers.
Let me conclude. I have laid out the policies that I hope will transform the current three-speed economy into something stronger: the full-speed economy we all desire—solid, sustainable, balanced, and inclusive.
I have talked about the policy requirements in the three speed groups. Yet there are other overarching issues affecting all groups that we must not neglect. A reformed financial sector that supports rather than undermines stability and growth. A more balanced pattern of global demand between the regions of the world. More attention to growth, jobs, and equity in economic life—the issues that really matter to people.
So my message is that we must keep up the momentum on the policy agenda across all policies and all regions. With renewed threats of economic weakness on the horizon, it is more important than ever to push forward in a way that is concerted, consistent, and collaborative.
I will let the inimitable Ernest Hemingway have the last word: “Today is only one day in all the days that will ever be. But what will happen in all the other days that ever come can depend on what you do today.”
Thank you very much.