Transcript of a Press Conference by Michael Mussa on the World Economic Outlook
April 20, 1999
April 20, 1999
Meeting Hall A
International Monetary Fund
MR. MUSSA: Let me start with three main points. First, for this year, 1999, the world growth forecast of 2.3 percent in the present WEO is little changed from that of either the interim WEO of last December, or last autumn's main WEO exercise. The lack of change reflects upgrades of the growth forecast for the U.S., Canada, Australia, Korea, Thailand, Malaysia, and a couple of other countries, which offset weaker forecasts for 1999 for Japan, Latin America, and for a number of European economies.
Second, I would rate the balance of risks in the current forecast for 1999 as essentially even. There are uncertainties that could materialize both on the upside and on the downside. And this is a considerable change from last December and particularly from last October, when we saw the balance of risks as decidedly on the downside. It is important to emphasize that policy actions, both in the industrial countries where monetary policies have been eased significantly and in emerging market countries where reform efforts have been either continued or strengthened, have contributed to the removal of what was a decided downward bias. Sentiment in financial markets has clearly improved for both industrial and emerging market economies. Brazil, in particular, has enjoyed a remarkable restoration of confidence following the announcement of the new IMF program and determined policy actions taken by the Brazilian authorities. And capital flows to emerging market countries more generally appear likely now to recover from their lows following Russia's default and devaluation late last summer.
Third, for next year, the year 2000, the WEO foresees a recovery of world output growth to 3.4 percent, about 1 percentage point stronger than this year. Certainly, there are good reasons to expect recovery, but the forces that will sustain that recovery cannot be said to be completely secure. In the U.S. economy, growth has been at about 4 percent in terms of GDP for the past three years, and domestic demand growth has been almost 5 percent. The U.S. economy will need to slow down at some point over the next year or two.
In Europe, economic growth has slowed recently, and the recovery to growth of about 3 percent is embodied in the WEO forecast. But we have yet to see the basis for that recovery of growth. The recent easing of monetary policy by the European Central Bank and the depreciation of the euro will contribute a positive factor, but we will need to see how the situation develops over time.
In Japan, the economy appears to be bottoming out, and growth next year well above the 0.3 percent in the WEO forecast is certainly possible. But, recovery of consumer confidence is now essential to drive the recovery of private demand. And policy support will need to continue to be provided until the private sector of the economy is clearly in recovery mode.
The crisis economies of Asia, most of them are clearly turning around. But that turnaround needs to be sustained, both by policy action and by recovery in the private sector.
In China, strong stimulative policies have helped to sustain growth in 1998 and in the first part of 1999, but that level of support cannot continue indefinitely.
Much of Latin America, particularly South America, is now in recession. Recovery should begin a little bit later this year. And a strong rebound is again surely feasible. The same may be said for a number of developing countries and transition economies as well, though most of them are not experiencing recessions at present.
All of these economies, however, will need to rely on at least a moderately favorable growth environment among the major industrial countries if they are to achieve the growth forecasts that are in the present WEO.
Let me stop there and ask Mr. Larsen to say a few words about the special topics in this edition of the WEO.
MR. LARSEN: There is quite a lot of material in the report before you. So, I thought it would be useful to provide some indication of how the various pieces connect. There are three main themes that are running through the various chapters. The first theme is the ongoing process of adjustment in the wake of the emerging market crisis: in the crisis countries themselves, in countries that have been adversely affected by negative spillovers and by financial contagion, and in global financial markets and in the pattern of trade internationally.
The issue of financial contagion which has been such a prominent feature of the recent crisis, is analyzed in depth in chapter 3. The research reported here attempts to identify whether such financial contagion hits the innocent bystander completely at random, or whether there seems to be a pattern and therefore perhaps a degree of predictability. The conclusion, although many qualifications are in order, is that countries do seem to have scope for reducing their vulnerability to financial contagion in the case of crisis elsewhere in the system.
The second theme concerns the medium-term implications of the lopsided pattern of growth experienced recently among the industrial countries and the widening of external payments imbalances that have been the result of this lopsided growth pattern. In this context, we look at the sustainability of the large private sector saving-investment imbalance in the United States, and we discuss the chances of a soft landing as opposed to the risks of a less favorable scenario. We also discussed the global ramifications of alternative U.S. scenarios and the need for other regions to help sustain global growth if or when the U.S. begins to slow.
The third major theme running through the report concerns the different and yet highly complementary roles of macroeconomic and structural policies in helping to achieve stronger sustained growth over the medium term. In emerging Asia, for example, where there are now signs of recovery, there is still a continuing need to persevere with the structural reforms that have been initiated in the wake of the crisis. In Japan--where reforms are needed not only in the financial sector, where they are now under way, but also more broadly in the economy to promote restructuring, to increase efficiency and enhance employment prospects, particularly in services. In Europe--where EMU has added to the urgency of reforming European labor markets.
On this last important topic, chapter 4 of the report makes some important points. I would just mention four of them. One, if we look back over the past quarter century, the differences in labor market performance between the United States, in particular, and the euro area are truly astounding, and cry out for an economic explanation. Two, the causes of this differential performance can be found largely in differences in the institutional characteristics of the economies in the two areas that have produced different responses to a succession of negative shocks that have hit the industrial countries during the past two or three decades.
The third point is that given the institutional roots of the increase in unemployment in the euro area and the persistency of this unemployment, reducing unemployment will require structural reforms and cannot be achieved by demand management alone, even though demand management policies also have an important role to play in ensuring that structural reforms do indeed translate into rising employment.
The fourth point is perhaps a bit more encouraging, because we now have ample experience from a small number of European countries that shows that structural reforms is both possible and capable of significantly reducing unemployment, and there have been important improvements in labor market performance already in the Netherlands and the United Kingdom and more recently in Iceland and Denmark. Reforms are clearly possible, and clearly can have an effect.
The less encouraging message is, of course, still that the progress with labor market reforms remains too timid in many European countries, so that the prospects for reducing unemployment substantially remain very bleak, beyond the impact of the recovery that has now been underway for some time on cyclical unemployment. The structural unemployment is likely to remain very high in Europe until these structural reforms are being implemented more forcefully than we have seen so far.
QUESTION: What you say about the weakness of European growth and the need to provide a supportive environment for structural reform, is it right to rule out further cuts in euro's own interest rates in this cycle?
MR. MUSSA: Never say never on these issues. There has recently been some concern about the weakness of the euro in the foreign exchange market. I think it was appropriate having taken a 50 basis-point move, which somewhat surprised marks market, not to suggest that further easing was immediately in the offing. However, as we look beyond the next couple of months, it will, I think, be appropriate to assess how the economic situation is developing and then to consider at that time whether further adjustments in the monetary policy stance are appropriate. It would be premature at this time to make a judgment they should ease further and I would not suggest that, but I wouldn't rule it out, depending upon how conditions evolve through time.
QUESTION: My question is on Latin America. First of all, your new statistics are kind of impressive in terms of the recovery in one year, but when do you expect to see a recovery on the unemployment in Latin America, taking the fact that the situation in Brazil still is weak. Your comments on Brazil sound very impressive in terms of seeing Brazil on the way to recovery in less than a year. But still the problem of unemployment. In Mexico, when are you going to announce the finalization of the negotiation with the Mexican government about the new program?
MR. MUSSA: First, on the economic situation in Brazil, it is clear that there has been a really remarkable recovery of confidence in financial markets. The real, which moved to 2.20 to the dollar at the low point has recovered to 1.65-1.67. And that is a very important factor going forward. Inflation, as you know, has been very low despite the depreciation; and the fact that the currency has now appreciated and recovered half of the ground that it lost earlier is one of the reasons to expect that the central bank and the Government will be successful in keeping the inflationary reaction really very well contained. That has enabled the central bank already to cut interest rates from the 45 percent that they raised them to when Mr. Fraga took over, down to 35 percent and even a little bit lower. The indications in financial markets are clearly of an expectation of further significant interest rate reductions as we go forward.
So I think that by the time we get to the second half of this year, we will see nominal interest rates in Brazil well down, not only from their peak, but also from where they are today, and that will help provide a much better basis for recovery of the economy.
I do not however want to suggest that the recession ended yesterday or is going to end today or is about to end tomorrow. The first quarter was undoubtedly difficult in Brazil, and I think probably the second quarter is again going to be a difficult quarter for the economy.
I do believe, however, that in the second half of the year we will begin to see fairly clear evidence that the Brazilian economy has stopped contracting and indeed is beginning to expand. It is important to recall that the recession in Brazil really began now almost a year ago, and Brazil has been in fairly steep recession since the summer of last year. Now, as the factors that have contributed to that recession are beginning to be reversed I think it is reasonable to expect that after about a year of recession the economy will begin to turn around, and as often happens, as happened in Mexico, Argentina after the tequila crisis, the rebound can be fairly vigorous.
Now, more specifically, on unemployment. Unemployment typically tends to lag a bit the behavior of the business cycle, so it doesn't rise in the recession quite as rapidly as the economy deteriorates and unemployment doesn't decline quite as rapidly as the economy begins to recover. That has certainly been visible in Argentina subsequent to the Tequila Crisis and to an extent in Mexico as well. So, the turnaround in terms of unemployment is likely to be somewhat later than the turnaround in the economy. That is the normal pattern that has applied in Latin America as I think elsewhere around the world.
You had a question about Mexico?
QUESTION: The negotiations.
MR. MUSSA: The negotiations. Well, discussions continue with the Mexican authorities. There is probably at present less of a sense of urgency than there was a few weeks or months ago, as conditions in financial markets for emerging market countries appear to have improved. There is also a new facility that is under discussion by the Fund's Executive Board, the contingent credit line, and it is possible that they would want to have discussions about the use of that facility, which does not yet exist, so we will need to see how those discussions proceed and I have no specific news to give out on that.
QUESTION: Mr. Mussa, you said that the risks for growth are now more evenly balanced and that there is upside risks as much as downside risks. This is a little surprising to somebody who has read that advance copy where you state the assumptions underlying your recovery forecast but when you give a lot of weight to the downside risks and there isn't really any mention of significant upside risks. The ever surprising thing, that is the second question, is you devote an entire quarter of your two reports to the suggestions for euro, which is also a little surprising given what has been going in the rest of the world, whereas you have very little to say about general conclusions from the turmoil that was going on in Asia. You mention almost in passing that it is okay for countries to roll back on capital account liberalization, and impose some restrictions on short-term capital movements, but that is very short and there is not much more generalized discussion of what you have learned for the financial architecture as you have so much to say on euro. How is that to be explained?
MR. MUSSA: First, on the balance of risks in the forecast, what I said in my opening statement was that for 1999, for 1999, this year, I believe the risks are evenly balanced around a forecast of 2.3 percent real output growth for the world economy. For the year 2000, the forecast is for growth to recover to 3.4 percent. There, I feel the balance of risks is on the downside of a forecast of 3.4 percent. As I indicated in the latter part of my opening remarks, what the nature of those sort of balance of downside risks are, the U.S. economy that needs to slow down, a recovery in Europe that is forecast, but where the basis for it is not entirely clear, the expectation that Japan will turn around, but some doubt yet as to when private sector confidence will come back, and some worries about emerging markets. So, again, for this year, 1999, I think we have got both upside and downside risks. To reach 3.4 per cent growth in 2000, I would still like to see a little more evidence before I would conclude that the risks are evenly balanced.
In the WEO, each WEO, we have a number of special topics which we take up and we have treated the Asian crisis in considerable depth in the past WEOs. This time we wanted to look more closely at the issue of contagion, because I think that is an important question. And, we wanted to look at the problem of unemployment in Western Europe, because that has been a major factor that has constrained growth of output in an economy that is as large as that of the United States now for a number of years. If the world economy is going to have a sustained period of higher growth into the future, then this problem of high unemployment in Europe is one that certainly requires attention.
We will, obviously, return in later WEOs to look once again at the Asian crisis experience.
On the issue of the architecture of the international monetary system, the WEO is not the only Fund document on this issue. Actually, the fact of the matter is, I'm getting a little bit tired of the question and I find the WEO much more interesting than most of the discussions on architecture, so there.
QUESTION: I want to ask you how long you thought that the fiscal stimulus going on in China can continue without any kind of resurgence from consumer demand and when the coffers will actually run out in Asia? And secondly, how dangerous is it that the slow pace of structural reform in China may actually cause the spillover effects that you warn are still there and still possible for the rest of the region, and then destabilize the region once again?
MR. MUSSA: First, on the subject of fiscal stimulus, I think it is important to understand the fiscal stimulus supplied by the Chinese Government both last year and this year has been very substantial, on the order of 4 percent of GDP. Because of that strong policy stimulus and also a significant easing of monetary policy, it has been possible to sustain nearly 8 percent growth in the Chinese economy at a time when the rest of Asia was encountering very severe difficulties. That was a very important positive contribution of Chinese economic policy, not only to China, but also to avoid a broader and deeper downturn in the rest of Asia.
I would think that beyond this year, that is looking to 2000 and beyond, that the level of support from fiscal policy in China would need to be gradually reduced from the level that will be prevailing this year. Not a sudden stop or reversal of that policy, but a gradual winding down of the magnitude of fiscal support.
As you know, there is very little government debt of the Chinese Government, and they have very large asset holdings, particularly in the form of foreign exchange reserves. So there is no reason to suspect any sort of immediate problem with financing of the fiscal stimulus that is being provided by the Chinese authorities.
With respect to the structural reform agenda, I think it is the case that there has been a slowdown in the reform process with respect to some of the state enterprises. However, the reform process has not stopped, by any means, and important steps have been taken to begin to restructure financially the Chinese banking system. Again, that is a project that will need to be ongoing over a more extended period of time, before the process is complete.
However, I think it is a mistake to characterize the situation as one in which the reform process has stopped in China. It is proceeding at a somewhat slower rate than was being envisioned a year or two ago.
QUESTION: You say in the WEO that had India reformed faster, it could have maintained a growth rate of 7 to 8 percent instead of 5.2 or 5.4. I was wondering whether the American sanctions and the sanctions in various places had an impact in slowing down the growth rate.
MR. LARSEN: It certainly is a very positive aspect of India's recent performance that India has avoided the worst of the Asian financial crisis, and growth has been maintained at a rate close to the average seen over the past decade. From a longer term perspective, however, we think it is important that India doesn't consider a growth rate of 5 to 6 percent to be the best that can be achieved. We think there is considerable scope for improving the allocation of resources through structural reforms, and also for increasing the rate of investment in the economy. And, of course, the first condition for increasing the rate of investment in the economy is to substantially reduce the very large public sector borrowing requirement, which has remained a drain on national savings and has diverted national savings away from productive investments.
So there is much to be happy about in terms of India's recent performance, and the limited impact of the financial crisis, but I think there is still a need for stronger policies over the medium term to increase India's growth potential.
QUESTION: Two questions. You welcome the euro, but we see that euro has lost something like 10 percent against the U.S. dollar, and Mr. Duisenberg told us yesterday that maybe it is because of the war. I would like to know if you agree with that evaluation.
Second, about Italy, don't you see that this slowing in the growth in Italy is a little bit bigger than in other countries in Europe, and that the central government balance is going too close to the 3 percent that the Maastricht required of all the countries.
MR. MUSSA: With respect to the foreign exchange value of the euro, I think the crisis in Kosovo has been something that has affected the euro recently. But before that crisis erupted the euro had declined 5 or 6 percent against the dollar. It is down another 3 or 4 percent since then. I think the main factor that has contributed to the weakening of the euro has been the difference in the relative cyclical performances in the United States and the euro area, where the U.S. economy has been significantly stronger than most people were expecting six months or three months ago, whereas the euro area economy has slowed down to a degree that was not anticipated three or six months ago.
Now, within the euro area, different economies are performing differently. Ireland is growing very strongly, Spain is doing quite well. France is in the middle and Germany and even more so Italy have experienced very significant slowdowns of growth in the latter part of last year that appear to be persisting, particularly in the case of Italy, into the first part of this year.
Because growth has been slower than anticipated, budget revenues have come in below expectations and that has caused the budget deficit to be somewhat larger than was earlier anticipated. And, we believe it would be appropriate in these circumstances for the Italian government to use the flexibility that it still has in the budget to see to it that the deficit does not exceed the Maastricht upper bound of 3 percent of GDP. This we do not believe would require dramatic or drastic action, and such action taken should be on the expenditure side rather than the revenue side of the budget.
QUESTION: Mr. Mussa, I have three rather specific questions about your forecast for Japan. First, the unemployment rate in Japan is projected to average 4.8 percent this year, and 4.9 percent next year. Now, are you expecting the unemployment in Japan to rise above 5 percent in any given month? How high will the unemployment go up, possibly?
Secondly, as you may know, the government in Tokyo still believes it is possible to achieve a 0.5 percent positive growth for the fiscal year which started this month. Now, you are forecasting 1.4 percent negative growth for the calendar year 1999 and small, 0.3 percent positive growth for next year. How about the possibility of Japan registering a small, positive growth during the fiscal year, which started three months after the calendar year.
MR. MUSSA: When you forecast for unemployment that it will be 4.8 or 4.9 percent on an annual average basis, it is probably better than 50/ 50 that in some month in that two-year period the unemployment rate will exceed 5 percent. I don't know what the figures are for Japan, but in the U.S., simply from the sampling error, the standard deviation on the monthly measurement of the unemployment rate, is at least one tenth of 1 percent on the monthly unemployment rate. So statistically, it would be difficult not to have at least a month or two where just on a measurement basis it would exceed 5 percent.
With respect to the growth forecast, the forecast for growth in Japan has an unusually high degree of uncertainty. In the consensus forecast, which is a panel of forecasters, the standard deviation of forecasts for this year in the most recent issue, is still 0.8 percent, and I think there is a 2 percentage point gap between the lowest forecast and the highest forecast. In contrast for the United States, for this years's forecast, the standard deviation is 0.2, not 0.8, and the forecasters are very heavily focused around the central number, and even more so for the euro area. So, a great deal of uncertainty remains about the growth rate of the Japanese economy both this year and next year.
That being said, I would say for the fiscal year, which excludes the first quarter where things still look pretty weak, growth of 0.5 percent is still achievable. It is above what our forecasts would be at this time. It is not sort of beyond all possibility of achievement. I think, however, for the calendar year it is going to be very difficult given what happened in the second half of last year and the weakness that seems to have persisted in the first quarter of this year to get above zero for the calendar year number in 1999.
For the year 2000, I think all bets are off. Growth for the year 2000 could easily be 2 percent rather than the 0.3 percent that we have in the forecast. If the economy stops contracting and consumer confidence recovers and the recovery starts moving, first from consumer spending and then some recovery in inventory investment and so forth, you could easily get a pop up in the growth rate to something which would still be below potential. On the other hand, if they don't get the turn around that we are anticipating, then an outcome below 0.3 percent positive is also highly feasible. So this is a stage at which it is particularly difficult to make a judgment about the economy.
Victor Zarnowitz taught me many years ago that when you believe that you know the turning point has happened or is about to happen, then forecast a big change, because the tendency is always when you've got a turning point on the upside, virtually all forecasts are too low. You have a turning point on the downside, all forecasts are too high. Our problem is we don't quite yet see the clear evidence that we have got the turning point in Japan. As soon as that becomes more apparent, then everybody is going to start writing up their forecast. But we need a little bit more information that the bottom has actually occurred and the upturn has started, and that is not yet in the numbers.
QUESTION: Mr. Mussa, can you give a sort of doomsday scenario, if you like, of what would happen if things go wrong. How seriously do you rate that chance and which part of the world are you losing sleep over the most?
MR. MUSSA: I don't want to paint an exceptionally gloomy picture. Once a couple years ago, somebody asked what might knock the forecast off track. I think if a 50-mile wide asteroid struck the earth, that would not be good for anybody's likely growth rate. We sort of exclude those possibilities from the economic forecast.
As I said, I think that the slightly stronger than 2 percent growth this year is probably a pretty solid expectation with the risks around it on both sides. I think it is also a pretty good bet that growth next year in the world economy will be stronger than growth this year. The issue is will it be a percentage point stronger than this year. And that is where the worries begin to emerge more seriously, because the U.S. economy really does need to slow down, and because, while I think growth in Europe will be sustained, at least the 2 percent rate, and very likely will move up to 2.5 percent or perhaps 3 percent, we don't yet see the upside above that. And because we don't yet see clear evidence of the bottom in Japan, we are not yet that confident of a strengthening of world growth from a little over 2 percent to about 3.5 percent.
I am not particularly worried at this stage, however, that we're going to see global recession in the year 2000, or growth next year weaker than this year. A major concern if that were to happen would be if the U.S. economy were to encounter serious difficulty. At present, however, I don't see any strong reason to expect that the U.S. economy would, say, fall into recession next year. I think there is good reason to believe that it is going to be growing a fair bit slower than in the past three years.
QUESTION: You are predicting a very impressive recovery for Argentina next year, from minus 1.5 percent to plus 3 percent. Could you go in a little detail as to why this is going to happen?
Second, could the upcoming Argentinean elections be a lagging factor in the recovery?
Third, Argentina is very dependent on external capital flows. Do you think it could be avoided in the not very long distant future, and if the next government should take any action to try to change this?
MR. MUSSA: With the improved situation in Brazil, at least in terms of market sentiment, and with the likelihood that the Brazilian recession will now not be prolonged much longer--indeed should give way to a turnaround in the second half of this year--a forecast of a 3 percent recovery in Argentina for the year 2000 looks to me to be an entirely reasonable expectation. How deep the recession will be this year is, I think, a little bit more uncertain at this stage. I think the expectation of recovery in the year 2000 is certainly a very reasonable one at this stage. With respect to capital flows, Argentina has a significant current account deficit. This is not inappropriate for a country like Argentina that has been enjoying fairly strong growth and reasonably robust investment, leaving aside the issue of the present recession. And I think it would be appropriate in the future as the recovery comes that there will still be a significant current account deficit, which again will need to be financed.
Last autumn, the environment for private financing of all emerging market countries deteriorated really to an extraordinary degree. It is recovering now and I expect that if that recovery continues, Argentina will not have problems in terms of accessing private international capital flows.
It may be noted, however, that there is a limit to the size of the current account deficit which it is prudent for a country to run, and it certainly is possible that issue will need to be addressed by economic policy in the period ahead. Right now, however, we are reasonably well satisfied with the policies that the Argentine Government has in place, and it does not appear that the prospective election is as of yet pushing policy off course. People are watching very carefully what is going on, and Argentina has very transparent public accounts and very transparent monetary policy; so my suspicion is that discipline will be well maintained in the period running up to the presidential election.
QUESTION: My question is, do you mean the weak euro is not only due to the performance of the economy, but also to the unwillingness to make reforms in the Euroland? Next year, we have a higher euro with a weak performance in Euroland and a weak willingness to make reforms. What is this scenario, is this a risk scenario for you?
MR. MUSSA: I will ask Mr. Larsen to come in a bit on that. Let me say at the start that the problem of structural rigidities in Europe and of high and rising structural unemployment has been with us for a considerable period of time. During that considerable period of time, we have sometimes seen European currencies strong against the dollar and we have sometimes seen them weak against the dollar. The structural reform issue, on which I will ask Mr. Larsen to comment a little bit more, is a very important one in terms of European growth and prosperity and addressing key social issues in Europe. But I do not believe it is fundamentally an issue that has a large impact in terms of the exchange rate of the euro versus the dollar.
MR. LARSEN: The reason we have taken up the issue of unemployment in Europe on this particular occasion is partly because of the recent focus on this issue in Europe, but also because of the increased importance of structural reforms of European labor markets now with the introduction of a single common currency. This has made it much more important for individual countries to be able to adjust in response to unfavorable shocks and respond in a more dynamic fashion to policy stimulus, when they no longer have the possibility of adjusting their exchange rate vis-a-vis their partner countries. That makes the need for flexible labor markets much more acute.
The problems and the costs associated with inflexible labor markets are problems and costs that accumulate slowly over time. And I think this factor alone would be unlikely to provoke a significant growth slowdown or recession in Europe. I think it is more the scope that structural reforms have for increasing the responsiveness and the speed of adjustment in the future that make structural reform such an attractive policy option in dealing with the unemployment problem. Indeed, we believe the only policy option that is viable in the longer run.
QUESTION: Two questions. First of all, why are you so convinced that the U.S. economy really does need to slow down very significantly? The people in the Fed no longer seem to be as convinced of that as they appeared to be a year ago? There is no inflation, there is all this idea that perhaps the sustained rate of economic growth has gone up. Secondly, a more parochial question on the U.K. I see that you are forecasting a 0.7 percent growth this year whereas the British Government has stuck to its forecast of 1.25 growth, and most private forecasters are shading their forecasts up, therefore. Is this just a matter of timing that your figures were done earlier, or do you actually feel that there is more weakness in the U.K. economy than perhaps the British Government would believe?
MR. MUSSA: I'm going to ask Mr. Hacche to respond on the U.K. forecast. In terms of the U.S. economy, I think we, like every other forecaster over the last three years, have forecast growth that is slower than what has actually turned out to be the case. We intend to continue doing it until the economy gets it right. That being said, productivity growth in the U.S. economy has picked up in the past three years, and somewhat unusually so toward the latter end of a business cycle. And that has led some, but not all analysts to upgrade somewhat their estimates of the potential growth rate of the U.S. economy. And that seems reasonable to me. Rather than talking about a 2.25 percent potential growth rate, perhaps 2.5 or 2.75 percent might now be more reasonable, if recent trends in productivity growth prove sustainable.
There is no one I know in the Federal Reserve who thinks that 4 percent growth--which is what we have had the last three years--is likely to prove sustainable. We have seen the unemployment rate come down very significantly over the past three years. Perhaps it can fall somewhat further. But, labor market conditions are already pretty tight, and to think of an unemployment rate at 2 percent, which is where it would be if the economy kept growing at a 4 percent rate for the next three years, seems unreasonable to expect.
Similarly, we have had unusually rapid growth of the labor force in terms of increased participation rates and there is some limit to that process as well.
So I think the reason to believe that there will be a slowdown--as I say when and exactly how much remains to be seen--is pretty solid. That would be consistent, however, with a view that the underlying growth rate of the U.S. economy may, indeed, be somewhat stronger than was believed to be the case a few years ago.
MR. HACCHE: Among the U.K. growth forecasts, I do not think I want to make too much of the difference between our projection and the official projection, which is a range of 1 to 1.5 percent for growth in 1999. You refer to the private sector forecasters. The latest private sector consensus released by the Treasury, I think last week, showed 0.7 percent, which is exactly where our forecast is. So we are pretty close to private forecasters.
You asked whether timing might be part of the explanation for the difference with the official forecast. It may. I think the official forecast was released before the last estimate of GDP in the fourth quarter of 1998. As far as our forecast is concerned, I think we believe that the worst of the slowdown in the U.K. is probably over, but the slowest growth will probably have been seen in the first quarter of this year and maybe the second quarter. And then we see growth picking up from there on.
QUESTION: Just to continue the previous rather parochial line of questioning, as he referred to it, do you think that Britain's real and nominal interest rates need to remain higher than most of the other G-7 countries much longer? Can there be a full-blown or good recovery all the time that sterling remains so strong, or does it need to be decoupled from the dollar and more linked toward the euro exchange rate?
Secondly, in a totally different area, you make some brief references at the start of the WEO to the conflict in Kosovo. I just wonder if you had any thoughts about fiscal and GDP impact of that on the European region.
MR. MUSSA: As you know, U.K. monetary policy targets primarily the inflation rate. I think it is probably fair to say it is not totally unconcerned with the real economy. And in a situation where the inflation rate seems now to be falling to the level of the targets, it has been entirely appropriate to cut nominal interest rates fairly aggressively, so far by 2.25 percentage points from their peak of 7.5 percent. That reduction in nominal interest rates will--and I think is already helping to--bring an end to the slowdown.
It remains the case that U.K.'s inflation is somewhat higher than in the euro area. There are different measures of inflation, so one needs to be a little bit careful on that score, but the difference in real interest rates is less than the difference in nominal interest rates.
Do we need further interest rate reductions in order to induce a resurgence of growth to the potential of the U.K. economy? I think the answer is I don't know for sure. It would probably be my guess that we will see some further easing of interest rates over coming months. I don't have a sense of urgency that they need to act particularly rapidly at the present moment. I think they can wait a little while and judge how conditions are moving. As I say, my guess would be that probably interest rates will have somewhat further to come down before the end of this year.
Relative to its performance over most of this decade, sterling is certainly unusually appreciated vis-a-vis key European trading partners, and again my expectation would be that over time sterling is likely to correct downward against the euro. I would note the dollar is also unusually strong at present vis-a-vis the euro or its synthetic predecessor. I wouldn't be surprised if over the medium term the dollar also corrects downward against the euro. So, I don't have particularly strong expectations of where the sterling-dollar exchange rate might be moving at this stage. The exchange rate floats in response to market forces. It is not something that is directly targeted by the policy authorities, nor do I think it would be appropriate for them to attempt to do that.
The Kosovo crisis. I think the fiscal and GDP impact of the Kosovo crisis on the United States and on the euro area are going to be very small. There are going to be very significant impacts, obviously, on the closely bordering countries of Albania and FYR Macedonia, and much smaller but still significant impacts on other bordering economies, Bulgaria, Romania, Hungary, and so forth. So, it is going to have very important economic effects on a couple of countries, significant effects on a somewhat broader array, but at the European level or at the global level it will not be a significant influencing factor in the performance of the economy.
QUESTION: A question about South Africa and Africa as a whole. You are predicting 1 percent growth for South Africa. I wonder if you could comment on what the Government might be able to do to spur greater growth and if you could evaluate how prepared you think South Africa is at this point to avoid being touched by possible further contagion?
As far as Africa as a whole, could you address the issue of commodity prices, of what your expectations in the coming months are for oil, gold, and steel and other commodity prices that affect Africa so much? Thank you.
MR. MUSSA: Let me say a word about commodity price and ask Mr. Hacche to say a little bit about Africa and South Africa.
Non-oil commodity prices continue to be very weak pretty much across the board. As the world economy stabilizes and begins to recover--and we have discussed already how rapidly it might recover--but my guess is we will see some firming in the non-oil commodity prices, particularly many of the industrial materials prices. There is a chart early on in chapter 1 of the WEO which shows world industrial production, and that chart shows what looks like the beginning of a modest upturn in world industrial production, most of the industrial commodities, their prices tightly linked to the cycle in world industrial production. That would include silver. Gold marches to its own drum and it remains to be seen whether the IMF is going to be selling a substantial amount of gold, which is unlikely, and whether central banks, which are net sellers of gold over the past couple of years, are going to continue that practice or not. I have absolutely no information what those central bank intentions are.
In the oil market, we have seen a significant strengthening recently. The futures prices which we use for our forecasts do not point to the likelihood of much further strengthening from present levels. If anything, there may be some concern that recent efforts to restrict output may, as in the past, not prove too durable. On the other hand, if we do see the recovery that is forecast in world growth, that would be a factor that would tend to firm a bit the world oil market.
MR. HACCHE: On Africa and South Africa, South Africa is a bit of an exception in Africa because it has been more affected than most countries by financial market turbulence associated with the emerging market crisis, and South Africa was affected particularly by the turmoil in global markets in early 1998 when there needed to be quite a sharp increase in interest rates. More recently, interest rates in South Africa have been coming back down reflecting quite sound monetary and fiscal policies. But real interest rates remain quite high, and that has been a major factor contributing to the weakness of economic activity.
Cautious fiscal policies are among the ingredients needed to restore confidence and raise growth, but also structural reforms need to be accelerated, especially perhaps in the labor market, given the very high rate of unemployment.
For Africa as a whole, we are projecting rather steady growth of about 3 to 3.5 percent in 1999, roughly the same as in 1998, with a pickup in growth in 2000.
QUESTION [INTERPRETED]: Mr. Mussa, recently the Mexican peso has appreciated considerably and is costing Mexicans dearly. I would like to hear your opinion on that issue. And second, with your permission, I would also like to know if you see any yellow or red lights at the end of President Zedillo’s administration which might alert Mexicans to the macroeconomic situation in view of the future of the new cycle.
MR. MUSSA: The Mexican peso floats, so it again is not a price that is directly under the control of government policy. The peso depreciated, depreciated very considerably last year, and some of what we have seen, I think, it is probably a desirable correction of that depreciation, which was otherwise tending to push the inflation rate in Mexico up. And the key objective of Mexican monetary policy is targeted on inflation. So, to some important degree, the appreciation of the peso is a welcome development.
I might also add that some of the depreciation of the peso that we saw in the latter part of last year reflected the sort of global financial crisis and the actual and expected constraint on financing flows to emerging market economies, including Mexico. With the recovery of sentiment and confidence, there is naturally some positive effect on the peso.
The downside, of course, is that it makes Mexican products more expensive in export markets, the dominant one of which is the United States. That is an issue of moderate concern. On the other hand, the U.S. economy continues to perform very strongly and has provided an expanding market for Mexican exports. So, on balance, at the present stage, I don't think I would worry too much about the recent appreciation of the peso. Obviously, if it were to appreciate substantially further, there might be more of an issue of concern.
With respect to yellow and red lights as we approach the presidential election, well, in the last, I think, three or four presidential elections there has been a sort of economic crisis immediately following the election. This is a pattern that is so well known and so well ingrained that sort of everybody who looks at Mexico is looking for the signs that they're doing it again. And, I think for that reason, they're much less likely to do it again than they have in the past; so I don't see the yellow lights or red lights yet. But, we are looking and we're not the only ones who are looking. Those in the Mexican Government and central bank are certainly very well aware of this phenomenon and know that they are under very close scrutiny.
QUESTION: In view of the recent good results of Brazilian devaluation, highlighted in the World Economic Outlook, is it fair to say that maybe it was a mistake on the part of the IMF and Brazil not to include the change in exchange rate regime in their previous agreement in December? And the second question is, what are the downside risks in terms of Brazil?
MR. MUSSA: In October and November, when this issue was being discussed, the Brazilian authorities indicated their very, very strong preference to persevere with the Real Plan. I was quoted at the time, I believe in the New York Times, as saying the exchange rate is an issue. But I don't believe the issue was absolutely clear-cut at that time, nor have subsequent events clarified it absolutely, either. There was a choice. And persevering with the Real Plan really necessitated putting through the fiscal reforms without mishap in order to sustain confidence. When that did not happen, that strategy ceased to be viable. However, I think it is important to understand that a sustained defense of the currency peg may well have contributed to the success of the subsequent devaluation and stabilization effort. It is a sad thing that the Brazilian economy entered a steep recession in the second half of last year. The inflation rate in the last six months went to zero, and was even negative most of those months. So when the devaluation finally came, there were no domestic inflationary pressures in Brazil. Accordingly, the devaluation did not set off an immediate round of big price increases. And accordingly, it has been possible to contain the inflationary effects of the devaluation. So, I think Brazil has come out of this episode better than it would have if it had simply thrown in the towel and said we're giving up the Real Plan, trust me.
Also, I would note that the international financial environment last October and November was a very tense one. If the exchange rate had been let go at that time, the consequences for Brazil and more broadly emerging markets might not have been quite as salutary as we have seen them in the aftermath of the January depreciation. So I think it is not cut and dried that it would have been better to adjust the exchange rate in October or November.
QUESTION: Two quick questions, if I may. I'm still intrigued as to what the upside risks for this year are. Second of all, the report talks about Wall Street being overvalued and the risks of a sharp correction hampering domestic consumption in the U.S. How sharp a correction are we talking about for that to happen?
MR. MUSSA: In terms of the upside risks this year, the U.S. economy could well continue to perform above our forecast, 3.3 percent growth now. A number of other forecasts are 3.5 percent and 3.7 percent. So certainly an upside in the United States, also Canada. Japan, we're at minus 1.4 percent, and I could see upside to around minus a half. I think it is unlikely to go positive, but when you're at minus 1.4 percent, there is plenty of room for Japan to surprise on the upside of our forecast, as well as room to surprise on the downside.
Emerging Asia--Korea, Thailand, Malaysia, Philippines--again, a fair bit of room for them to recover more rapidly than we are seeing. The euro area, we are projecting an upturn, but it could be a little bit stronger than we have allowed for. So I think there is upside potential pretty much around the global economy. There are also downside risks. My point is, I don't see the risks at present as being unbalanced, either to the upside or the downside.
Wall Street correction. Well, we have been talking about this for more than two years now. The market's up 60 percent since "irrational exuberance" was coined into the English language. Maybe there is something that has changed fundamentally the relative valuation of stocks in comparison with earnings. A variety of factors have been suggested by analysts. Nevertheless, to virtually all economists whom I know, the market looks to be very handsomely priced at present. And bringing prices down to more normal relationship to earnings could easily suggest a 20 percent correction, or perhaps larger. I emphasize we have been talking about that for the last two and a half years or so, and it hasn't happened yet; so it is by no means a sure bet. But I think we have to regard the very high level of stock market valuations, and what might happen if they were to correct either exogenously or as a consequence of a needed change in monetary policy stance, as one of the risks to the outlook for the U.S. economy and to the global outlook going forward. We have so characterized it in the World Economic Outlook.