Transcript of a Press Briefing by Jacques Artus, IMF European I Department Deputy Director
April 3, 2000
Monday, April 3, 2000
[TRANSCRIPT PREPARED FROM A TAPE RECORDING.]
MR. DAVID HAWLEY: Mr. Artus is the Deputy Director of the European I Department. I shall invite Mr. Artus to make a few opening remarks, if he would.
MR. JACQUES ARTUS: Thank you very much for coming this morning. What you have in front of you is composed of three separate documents. You have our own report, which is a report of the missions, staff missions which went to Europe, to Brussels and to Frankfurt, in December of 1999. So it's a report which was written in January-February of this year. Then you have, of course, what we call the PIN, which is really giving you the conclusions of the Executive Board of the IMF, not the staff but the Executive Board. And you also have, of course, a statement giving the views of the countries, euro countries, their own views on what we are saying.
Now, this report is part of normal Article IV consultations that we do every year. In the case of the euro countries, of course, in the case of monetary and exchange rate policies, we cannot do it country by country. It would not make any sense. Therefore, we do it directly for the 11 member countries concerned. We do it by going to Brussels to discuss with the European Commission. We meet with the economic financial committee of the European Union. We go to Frankfurt to meet with the European Central Bank. Ultimately, we present our conclusions to the euro 11 Ministers of Finance, as well, of course, as to the President of the ECB.
Now, the main topics, the main conclusions in this report, of course, focus on monetary and exchange rate policies. But you cannot assess monetary and exchange rate policies without clearly looking at the overall stance of policies. But you do also find a good deal about fiscal policies in this report, as well as about structural policies. But the focus is on monetary and exchange rate policies.
You do have our report, so I don't really need to spend time giving you the conclusion, but just in a nutshell, as far as monetary policy is concerned, our conclusion is that basically in 1999 the monetary policy followed by the ECB was indeed a very reasonable, very good monetary policy. I think it was appropriately supportive of economic activity, but while supportive of economic activity, certainly it was not a source of risk as far as possibility was concerned.
More recently, we have found that the recent increase in interest rates came a little bit early. As far as we are concerned, we don't really as of today see very much risk of inflation in the euro area. Therefore, our recommendations will be to be fairly slow, very gradual in terms of increasing interest rates. This is not at all an urgent matter as far as we can see.
On the exchange rate, as we indicate in this report, we are very concerned about the weakness of the euro. To some extent, we think we can explain it. To some extent, we believe that we cannot explain it, and, clearly, the market went too far and the weakness is to some extent quite unjustified.
On fiscal policy, we think that after major efforts up to 1997, there has been a little bit of a pause. The progress achieved has been maintained, has been kept, but the authorities in most countries have not gone all that much further in terms of what was achieved in 1997. We think that given the demographic shock coming--maybe ten years from now, five, ten years from now--given the fact that the debt is still very large, in particular in some countries still in excess of 60 percent of GDP, and given the fact mainly that the tax burden--tax and social security contributions are extremely high, given all of those factors, we believe the period of fiscal adjustment will not be over, but there should be a second phase which will start relatively soon. At least we will hope so.
On structural policies, we believe a lot has been achieved, which is not often acknowledged, recognized by the media. We believe progress has been made. At the same time, we believe that you do have some issues which, for political reasons, are not being tackled, and we believe they will have to be tackled relatively soon.
Now, this being said, you know, I should give you time for questions. I will stop there.
QUESTION: What kind of gaps are you talking about?
MR. ARTUS: To some extent, of course, the gaps are not the same in all of the 11 countries. You really have to look at it country by country. But in the context of this report, where we are focusing on the overall euro area, I will say one of the main gaps in most countries is that the authorities have not yet been willing to go very far in reforming the welfare system and in reforming the unemployment compensation system.
Our criticism is not with respect to the level of unemployment compensation or the level of welfare support. This is not at all our criticism. Our criticism is that in too many countries this is an unlimited assistance. There is no fixed limit. It can go on for many, many years. We think that you do need to move, as you have done in some countries, to a system where, after a limited period of time--say six months--that people are given the choice between going into some kind of training program, going into some kind of public work program, or not receiving any assistance anymore. But they should not be able to sit at home forever receiving a check in the mail. This is just one example.
Another example is in a number of countries, clearly, the time has come to reform the civil service. In a number of countries, you have the possibility of achieving the same amount of public services with a more limited number of civil service. What you have had in the private sector in terms of productivity increase, you could have in the public services, too.
Again, it's not in all countries, but certainly in most countries. And, again, this is a gap today because politically it's so difficult to do.
In other countries, like in Germany, to a large extent, the gap is in terms of the reform of the labor market, in terms of the process of wage bargaining, in terms of the amount of wage flexibility, wage flexibility in terms of different level of skill, wage flexibility on a regional basis. A lot of the unemployment in Europe today is basically long-term unemployment of unskilled workers in specific regions. You have the south of Italy, you have the south of Spain, you have the eastern part of Germany, you have the French-speaking part of Belgium. The part which accounts for a huge share of structural unemployment--and clearly you won't be able to deal with this problem without introducing more wage flexibility--is a very separate issue from the average level of wage rate. We believe as far as the average level of wage rate you have had and you still have to do--you still have today a very impressive amount of wage moderations in most countries. This is certainly true in Germany, this is true in France, this is true in Italy, which is part of the reason why we don't really see very much inflation risk today.
But this is separate from the issue of the flexibility in terms of the structure of wages. Clearly, you have excess demand for some kind of labor and excess supply for other kinds of labor. And the labor market is not able to adjust.
QUESTION: If I could go back to your comments that you made on the need for reforms in the welfare and unemployment insurance situations, the type of reforms that you talked about, setting some limits on that sort of thing, are going to be very, very difficult politically, if not impossible. And I wonder what kind of response you got from the authorities when you raised this issue to them and asked them to begin thinking about ways that they can do this. Can they begin this process incrementally? Or is it just too politically sensitive to touch at this point?
MR. ARTUS: Again, I think it really depends, you have to look at it country by country. What is very striking is that you do have countries where this has been done. I'm not speaking of the United States. I'm speaking of European countries where those kinds of changes have taken place. And not only have they taken place, but they have led to measured changes, including measured cuts in the unemployment rate.
People can look at those countries, can look at those experiences. So the response is not a response from all countries saying it does not make sense in Europe. In fact, you have quite a number of countries in Europe where this has been done, and this is working reasonably well.
You do have, indeed, countries where politically today the response will be no, it cannot be done politically. You are correct. Political change will have to take place before this can be done.
QUESTION: You say in the report that the euro's weakness is undesirable. How much of that weakness is due to the policies of the European Central Bank? And what would you see as a more desirable rate for the euro? Where do you see a more appropriate level with the dollar?
MR. ARTUS: You do have a number of factors where I would say everyone will agree this is a contributing factor to the weakness of the euro. The main one is, of course, what's happening in the United States. If you go back to the end of 1998 when, of course, the euro was created, the expectation was that the period of rapid economic expansion in the United States was over, was coming to an end, and particularly everybody was projecting a relatively low rate of growth in the United States for 1999.
This has not taken place. In fact, economic growth in the United States has remained very, very strong. The financial market in the United States has remained very, very strong. And this is pulling in a lot of foreign investment, which also implies that it's pulling out foreign investment from the euro area.
And looking ahead, particularly looking at the medium term, many people are still very optimistic about the U.S. economy and more optimistic about the U.S. economy than the European economy. This is certainly one of the main contributing factors.
As the economic recovery is strengthening in Europe and the rate of growth is going up, we will expect that this factor may become less and less important. But in terms of explaining what has happened in 1999, this is certainly one of the main factors.
The second factor is probably that people are more aware of the structural issues that are not tackled in Europe than they are aware of those that are being tackled. This leads a little bit to a certain cynicism, if I may say, as to the medium-term prospect for economic growth in Europe. To some extent, we believe this is unfair, this is unjustified. But we will be the first ones to acknowledge that indeed you do have structural factors that today have not yet been addressed.
Putting everything together, do we get a full explanation for the weakness of the euro? I think the answer is no, we don't. There is still a significant part of the weakness which we will not be able to explain.
Are we concerned about it? Yes, I think we are concerned about it for a number of reasons. The main one is that if you go back and look at what has happened over the past 10, 20 years, sooner or later when an exchange rate is going too far in one direction, what happened is that it tended to move back very fast in the opposite direction at some later stage. Those very large swings can sometimes be very disturbing and have a very negative impact.
So, initially, in early 1999, when the European economy, the euro economy was very weak, the weakness of the euro was helpful. It was helpful to stimulate economic activity, and certainly one of the important factors behind the strong recovery in 1999. So it was welcome.
By now, it is much less welcome because we see the economy picking up strongly. You mentioned the rate of 3.1 percent, which is coming from a report which was issued on the basis of information available a few weeks ago. On the basis of information today, probably our World Economic Outlook, which is a separate document, is probably going to come out with a rate, of course, which is somewhat higher. That may explain your question.
Indeed, economic activity is picking up very strongly in the euro area. So the weakness of the euro, which was welcome a year ago, is not welcome anymore. In fact, it could be viewed as, at some stage, contributing to some inflation increase and possibly being a factor leading the ECB to a tightening of monetary policy or an increase in interest rates, which, I repeat, we would think will not really be a very good development at this stage. So, yes, we are concerned and we remain concerned.
In terms of the last part, fee amount, I think you have a statement somewhere in the report where--I don't remember exactly which part, but there is a paragraph where we indicate that we will view the euro as very undervalued. From a medium-term standpoint, we would view the euro needed to appreciate vis-a-vis the U.S. dollar by at least 22--at least 30 percent. The staff latest assessment was on the order of 10 to 20 percent in effective terms and 30 percent or more against the U.S. dollar. This was returned at the time when the euro was close to one, so obviously, if anything, it will be even larger today.
QUESTION: The fact that the U.S. economy has just accelerated to above 7 percent as well.
MR. ARTUS: But that's a factor explaining what's happening. Of course, it does not mean that the need for readjustment of the exchange rate over the medium term disappeared. It will have to take place.
QUESTION: So what's your projection regarding the development of the euro?
MR. ARTUS: As economists, we do not project exchange rates. I can tell you what will be desirable from an economic standpoint. But I'm totally unable to tell you what is exactly going to happen to the exchange rate. If I could, I would not be here. I would be so rich that I would be retired somewhere, in Florida or Arizona. But I would not be here.
So, I cannot answer your question, but what we are saying, is, if the euro did not appreciate very substantially over the medium term, this will have negative economic implications. From an international standpoint this will be a source of problems, including from a credit standpoint. At some stage, if the U.S. economy weakens, if the economic cycle has not been abolished forever in the United States and you have a weakening in economic activity in the United States, to have a very large trade deficit and a large current account deficit will not really be very good for U.S. policy with respect to foreign trade. This could lead to trade protectionism, obviously, at some stage. So it would not be a good thing.
QUESTION: On your criticism about the recent interest rate rises by the ECB: When you raise that with people in Europe, then economists there always say that you shouldn't just look at the level of change, but you should look at where the change comes from, it's still at a very low level, and if you look at the real increase, the real rate, it's very low in historical terms. Is that an argument which you would accept as valid?
MR. ARTUS: To some extent, yes. If you go back to what happened in 1999, remember, in late 1998 and then in early 1999, the ECB cut interest rates, particularly in early 1999, cut it by 50 basis points, and in explaining it, they said there is a certain risk of deflation. The economy was doing very badly. The rate of inflation was very low. It was certainly below 1 percent and moving down, and let's say there is a certain risk, maybe not very high, but there is a certain risk of deflation. On this basis, they cut the interest rate to a very low level, and this was the appropriate thing to do.
In the fall of 1999, it was very clear indeed that the risk of deflation had disappeared. The euro economy had strengthened considerably. The price of oil had been going up. The euro had been going down with inflation, with import prices going up. The risk of deflation was not there anymore, and the ECB said, well, in this case, we will reverse our cut and go back to where we were before, and it increased the interest rate by 50 basis points. This was totally and fully appropriate.
Once we move into the year 2000, the recovery is becoming stronger and stronger, and given that the price of oil has gone up probably more than anybody expected, this does justify that gradually the interest rate should go back to something which can be considered to be a neutral--cyclically neutral level.
Of course, it's very difficult to know what this means, to quantify what this means. But we do not disagree with this point. The only thing we are saying is, as of today, if we look at the prospect for inflation over the medium term, even taking into account the increase in the price of oil, even taking into account the depreciation of the euro, the prospect remains fairly favorable, in particular because of the wage moderations, but not only the wage moderations, because you have a large increase in competition in many markets where you had no competition before, including telecommunications, including various rate for public utilities or previous public utilities.
The result of this and the fact that unemployment remained very high--yes, the economy is picking up, but in the three major countries, unemployment today is still very high. We don't know what the structural rate of unemployment may be, but we will think that the current rate is certainly above it. How much I don't know, but it's certainly above it.
So we still think that looking ahead there is not a pressing need for increasing interest rates. But as the recovery develops further, interest rates certainly will have to go up and not down. This is pretty clear. It's a question of pace and a question of nuances.
We are also coming back to the exchange rate of the euro, and our explanation for the weakness of the euro, a partial explanation, if it's true that financial markets are mainly focusing on economic growth in the United States and in Europe and the prospect for economic growth, then an excessive degree of monetary tightening which will be viewed by financial markets as reducing the prospects for economic growth could be counterproductive as far as the exchange rate is concerned.
If you have monetary tightening because you see an inflation risk, then financial markets certainly will react positively to this monetary tightening. They think it's needed; therefore, they welcome it. This will strengthen the euro. But if you are in a situation where you have only very limited inflation risk and financial markets see that the increase in interest rates will be a deliberate attempt to strengthen the exchange rate rather than to fight against prospective inflation, then the effect may be the opposite. It could weaken the euro rather than strengthen it.
QUESTION: You said just a moment ago that the recovery is getting stronger and stronger in Europe. Last year the weakness of the euro helped obviously the export sector to take the lead in the recovery of growth in the area as a whole. Do you believe that the path of domestic demand in the euro area is increasing to positive levels? That's been one of the main complaints of some of Europe's trading partners, is that domestic demand is not keeping up with the pace of export, and also this wage moderation that you've spoken to, is that hurting domestic demand?
MR. ARTUS: Well, going back to 1998 and the first part of 1999, the weakening of economic activity was to a very large extent coming from the weakening of exports, not from a weakening of domestic demand. Again, of course, it depends on the country. But if I look at the euro economy as a whole, then the decline in the rate of growth in the second half of 1998 and early 1999 was to a very large extent due to a sharp fall in exports, not a sharp fall in domestic demand. But, yes, in a number of countries, domestic demand was relatively weak, but it was not the main cause for the weakening of economic activity.
What has been taking place throughout 1999 is that you have had a strong recovery of exports as the situation has improved a great deal in Asia, in a number of countries, including the United States. And, of course, employment has been doing relatively well, in part because exports have picked up, but also because of some of the structural policies followed. This is coming back to what I was saying before. While we are very critical that some of the things are not being done, we should not forget that some of the things are beinng done. For example, there has been a very large increase in flexibility in most European countries in terms of part-time work, half-time work. Similarly, in terms of part-time contracts, limited contracts.
As a result of this and of some of the more direct labor market policies, increasing training programs, things like this, employment has been going up, and this has led to a strong recovery of consumer confidence. Household confidence has picked up a great deal.
It never weakened tremendously. It remained relatively strong. But generally it still picked up throughout 1999, and as exports were recovering, as consumer confidence picked up, then investment picked up, too, which is not surprising. And now you have both exports and domestic demand doing relatively well. So you have a fairly broad-based expansion taking place.
QUESTION: Could you elaborate a little bit on why the IMF would advise the ECB to test the limits of maximum sustainable growth? That's not the kind of advice the IMF tends to give.
MR. ARTUS: Let me put it this way: If you look at what has happened over the past 20 or 30 years in Europe, what you have had is you have had a number of periods where the economy was picking up strongly. What you have today is not the first time over the past 20 or 30 years. You have had several periods of fairly strong economic recovery. Each time what has happened is fairly quickly, despite the fact that the unemployment rate was relatively high, inflation went up. The central banks--and this really meant to a large extent the Bundesbank--tightened monetary policy. The other central banks as part of the European system of exchange rate, had to do the same. And relatively quickly, the strong period of economic recovery was followed by recessions.
This has happened at least three times over the past 20 years, with the net result over the 20 or 30 years, in fact, the unemployment rate has continuously been going up. Now, we are again in a period of strong economic recovery, and if all of the social partners behave exactly as they did in previous periods of economic recovery, we all know what's going to happen. The past will repeat itself. It's unavoidable.
What we can see today is that, in fact, you have some very favorable signs and that maybe the past is not going to repeat itself. The wage moderation that you have today is a new development. It's certainly a new development by comparison to previous periods of strong economic expansion in the euro area.
What you have in terms of increasing competition, including in many markets such as telecommunications or services, is new. It was not there before. So we think there is a chance--we are not sure, of course--but there is a chance that what's taking place in Europe today could, to some extent, match what has taken place in the United States.
Now, we don't know. Nobody can be sure. But there is reasonable prospect that this will be the case. And if this is going to be a possibility, this is a possibility which will not really be eliminated through a monetary policy that will be following exactly the same rules that you had in the past.
You were mentioning that the interest rate remained relatively low today by comparison with the average of the past 20, 30 years. True, absolutely true. But remember, over the past 20 or 30 years, continuously the central banks have been acting to reduce inflation. They have spent the past 20 or 30 years trying to squeeze inflation out of the system. This, to a large extent, has been done. The task today is not to squeeze inflation out of the system. The task is just to avoid that it will come back. That is very different.
So this is really what we mean by testing. We mean if you do have some sign, objective sign that you have inflation risk, then the ECB should not hesitate at all to tighten monetary policy. But it should not do it before it's absolutely needed.
QUESTION: What do you think the implementation of the 35-hours law in France is doing to productivity and inflation? The IMF was very much against it. What is your position now?
MR. ARTUS: It's taking us a little bit away from this current report, but it also happens that I was the mission chief of France over the past three or four years. So when you are saying the IMF was very critical, I was not all that critical. Let me be very clear. You have one part of the policy which is limited to saying we are going to pay over time after 35 rather than paying over time after, what, 38 or 39--39. This is one main part of the change in the legislation. When we are saying you change the length of the work week, in fact, from a legal standpoint, it means you change the point at which you pay people overtime.
This part per se we don't really think that it will lead to any serious inflation risk, for example, or any strong negative effect on economic activity. The only thing that will happen is what's happening today. In renegotiating labor contracts, people will get wage increases that they would have gotten otherwise. So ultimately they are going to work a little bit less, but they will be paid a little bit less, too.
The average wage rate is coming down, but you get paid overtime after 35 rather than after 39. It will not boil down to any measure of significant economic effect. But problems come from very specific issues, like: What do you do with the SMIG. You have people who are paid at the SMIG, and the SMIG, as you know, was minimum wage, which is not a monthly wage but an hourly wage. So what do you do when you change the work week?
The other aspect which we were really critical and remain very critical, but there is another aspect to the legislation. This other aspect is, look, whether you like it or not, you are forbidden to do more than so many hours of overtime. We don't care whether you like to work hard or whether you don't like to work hard. It is legally forbidden to work more than so many hours of overtime. This we really think is a very bad aspect of the legislation.
QUESTION: A quick clarification. You said you saw a need for the euro to appreciate 30 percent in the medium term. What do you define as the medium term?
MR. ARTUS: Three, four years.
[Whereupon the press briefing was concluded.]