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Transcript of a Teleconference Call on the April 2004 World Economic Outlook Analytic Chapters
International Monetary Fund
Washington, D.C., April 14, 2004

Participants:

Raghuram Rajan, Economic Counsellor and Director, Research Department
David J. Robinson, Deputy Director, Research Department
James Morsink, Chief, World Economic Studies Division, Research Department
William Murray, Deputy Chief, Media Relations, External Relations Department

MR. MURRAY: Hi, good day. Before we open the briefing, let me just introduce who is currently around the table here with me. We have Raghu Rajan, who is Economic Counsellor and Director of the IMF's Research Department; David Robinson, the Deputy Director of the Research Department; James Morsink, who is the Chief of the World Economic Studies Division of the Research Department; along with a number of the authors of the WEO analytic chapters.

I assume by now you've received the chapters themselves plus the press points on those chapters. If you have not, I'd recommend you send an e-mail right now to media@imf.org, and one of my assistants can get you signed up for access to the password-protected site.

Let me just cover the ground rules. This is on the record. This briefing, however, along with the text, the documents, they are embargoed until 3:00 p.m. Washington time today, which is also 1900 GMT. So, again, 3:00 p.m. Washington time embargo, 1900 GMT embargo for today.

WEO Chapter 1, those are the Global Economic Forecasts, will be released on April 21st at 11:00 a.m. Washington time, or 1500 GMT. So today's briefing does not cover the Global Economic Forecasts. They will wait until next Wednesday.

Meanwhile, what I would like to underscore is that the launch of Chapter 1 will also mark the launch of the IMF's Media Briefing Center, which will be a permanent password-protected site for journalists. In addition, we'll have a "For Journalists" page on the public website of the IMF.

Registration for this site will be mandatory, and we will be opening registration this Friday. Further information will be circulated later today and tomorrow.

Now that I've covered that ground, let me turn the table over to Raghu Rajan, who will have some brief opening remarks before we take questions.

MR. RAJAN: Good morning. Let me give you a brief overview of what ties these chapters together and then describe each chapter in a little bit of detail.

The world economy, as you can see, is recovering very strongly, and next week's WEO presentation will amplify on this. However, we at the IMF have to focus on the potential risks to sustainable growth, and we see three broad issues at this point.

First, the world economy has come through some severe shocks in the recent past: the collapse of the asset price bubble, September 11th, and SARS. But we have sustained these shocks and recovered from them, partly because we had available policy options, and fiscal expansion and monetary expansion have been some of the tools that we've used to overcome these shocks.

The problem right now is that we've sort of maxed out on these tools. The policy options have been used in many situations and in many countries, and we've seen one of the challenges going forward as recovering some of these policy options where we can.

The second big issue is partly as a result of the use of these options. We have at present in the world serious global imbalances, and they heighten the risk exposure of the world economy, and we have to think about how we deal with these imbalances going forward.

And, third, which is more of a medium-term challenge, we have a number of big events which are going to affect the world economy going forward. "Events" is probably the wrong word. "Phenomena" is probably a better word. The integration of China and India into the world economy and the aging of populations in the developed world, these will create both challenges and opportunities, and we have to figure out how to deal with them.

So seeing these three big broad issues, we have developed this World Economic Outlook and its essays which address each of these in some way.

What we will see in just a while is that some of the essays address the short-term policy options. What should we start doing at this point in dealing with some of these challenges and deal with the longer-term policy options?

So with that as a brief introduction, let me move into the essays themselves. These are, first, Chapter 2, the first essay is entitled "How Will the U.S. Budget Deficit Affect the Rest of the World?" And briefly, as you know, there has been a great expansion in the U.S. fiscal deficit, and you know the numbers well enough. If anybody has questions on them, we can go back to them.

The essay itself attempts to see what would happen if the deficit is prolonged and doesn't close for a sustained period of time. And we look not just at the effects on the U.S. economy, but also on the rest of the world.

To summarize, if the U.S. deficit is not closed for a substantial period of time, we estimate that U.S. output would be reduced by about 3.75 percent below its baseline, while foreign growth will, in fact, be reduced—foreign output will be reduced by 4.25 percent below its baseline. So the rest of the world is affected seriously by the U.S. fiscal deficit.

And you may ask why, and the answer is the strongest effect works through interest rates. As you know, when the U.S. borrows money, it's going to withdraw from world savings, leaving less for the rest of the world. And to that extent, it's going to raise interest rates not just in the United States but in the rest of the world, and that's going to affect output throughout.

So what we estimate is that, if unchecked, this is going to have a serious adverse effect. And we also look then at different scenarios. What if, for example, the U.S. fiscal deficit is brought under control fairly quickly? And we can go into details of what that means. But the implications of the essay is that the sooner it's brought under control, the better it is for the rest of the world.

One certainly must not forget the positive effects that this fiscal expansion has had. It has increased the pace of recovery, both in the United States and then throughout the rest of the world, through U.S. imports from the rest of the world. But that said, it may be soon time to start thinking about scaling it back, given that the world has started growing.

The second essay in this chapter is on China's emergence and its impact on the world economy. As you know, there is increasing concern about China's impact, and what we wanted to do was first get a sense of the magnitude of China's impact on the world economy and then who does it benefit, who does it hurt.

And, briefly, over the last 20 years, China's GDP has grown at 9 percent per year on average, and its share of world trade has grown from 1 to 5.5 percent.

Now, this seems extraordinary, it seems a lot. But then if you look at the comparison with, for example, Japan's growth, when Japan was growing at similar rates, or the growth of the ASEAN 4, when they were growing rapidly, it turns out that China is not very much bigger; in fact, it's about the same size as these countries. It seems at this point as if China is taking over the world. That's not true. It has a time path of growth and of trade which doesn't look very different from when Japan or the ASEAN 4 or even the newly industrialized economies of Taiwan Province of China, Korea, when they were entering the world economy.

That said, China is a much bigger country and has a far longer way to go, and so eventually China's impact will be much larger than when these countries entered the world economy. But at this point, it's not very much different.

We then look in this essay about the impact on various countries, and, you know, far from being detrimental to countries, China by and large, China's accession has been beneficial. As you well know, in advanced countries, we all benefit from the cheap goods that China manufactured. But, equally important, we export from developed countries skill-intensive goods and services which China buys in large measure. The capital goods, for example, that they use to manufacture are bought from developed countries.

So we find that advanced countries benefit, and a number of developing countries also benefit. For example, the African commodity-exporting countries benefit tremendously from China's imports of their commodities.

The one group of countries that are hurt to some extent are the countries that compete in the same markets that China produces in, but the effect on these countries is relatively small, and the effect is diminished far more if these countries adopt forward-looking policies of creating flexibility in their labor markets, and also opening up their economies and integrating into the world economy faster.

All that said, you know, one can overestimate China's impact. China's impact, even taking into account how big it is and so on, is relatively small compared to, say, the effects of the opening up of trade that has taken place over the last 20, 25 years and will take place going forward over the next 10, 15 years. So one can overestimate China's impact, and it does come at us from all the papers, and what we're trying to say in this essay is one has to keep it in perspective.

Chapter 3 is on structural reforms in developed countries over the last 30 years, and the idea is that we want to see what kinds of conditions favored structural reforms and why, in fact, they have typically been slow. And one of the major findings in this chapter is that periods of weak or negative growth are really quite conducive to reform. And the idea is that weak growth makes people see the need for reform, or perhaps it weakens special interest groups; but whatever the reason, the weak growth tends to focus people's minds. And then if you're recovering from the weak growth, as we are doing nowadays, there is a greater ability to do reforms because the recovery lessens the burden of the reform.

Reform is also more easily accomplished when there is fiscal room to maneuver, when government budgets permit certain surpluses which can be used to pay off some of the people who are hurt by the reforms and, therefore, remove the opposition. This means that it's very important to conserve good fiscal positions so that they can be used to facilitate reform.

Also, some reforms are easier than others. Labor market reform is particularly hard because it involves costs to certain people. It also tends to increase unemployment and reduce growth in the short run. In the long run, of course, it's very beneficial, but it makes it harder for politicians to implement it because the long run may be way beyond their tenure.

That said, given that there are some reforms which do entail costs in the short run, there are other reforms which entail benefits very quickly. Financial market reforms and trade reforms fall into that category. And so one of the messages of this chapter is, if you want to reform, do the stuff that provides benefits quickly so that you build a constituency for reform and then try perhaps later down the line the harder reforms.

Finally, one of the interesting findings in this chapter is that it helps if your neighbors are reforming. If your neighbors are reforming, you're more likely to undertake your own reforms, and we well know that the discipline of multilateral agreements also is an important factor in forcing the pace of reforms. So this chapter basically has a number of interesting results which perhaps can enlighten reformers on how they can structure and sequence their reforms.

Finally, we examine credit booms in emerging markets to try and understand what kinds of situations these booms emerge in and what we should be looking out for now. Credit booms, as defined in the chapter, are periods of high, above trend credit growth. They're sharp blips upward in credit, and they should be distinguished from periods of just high trend credit growth. For example, when a country, an emerging market starts growing, there's going to be high-trend credit growth. That doesn't necessarily imply a credit boom because it's financial sector is deepening. On the other hand, if there's some blip upwards which then falls after that, that is a credit boom.

And what we find is that credit booms seem to be more likely when there are high capital inflows, and these credit booms typically tend to be associated with both banking crises and currency crises. And one of the interesting findings of this chapter is that credit booms tend to be associated with an appreciation of the real exchange rate and a disproportionate amount of lending to the non-tradables sector. So while these chapter itself doesn't give us a cast-iron way of identifying credit booms, it tells us some of the telltale signals of the kinds of trends that accompany these booms and give us a way of keeping our eyes open.

In terms of what to do to control these booms, the important point made in this chapter is perhaps inflation is going to be less of a signal about when these booms are taking place. And as a result, monetary policy and tightening monetary policy may be less effective. What is perhaps more effective is tight supervision, and that may be key to controlling these booms.

So, with that introduction, let me start taking questions.

MR. MURRAY: Great. Thanks, Raghu.

QUESTION: Hi there. Good morning. Just on the first—two quick things. First, on your fiscal policy, the IMF has sounded warnings before in previous World Economic Outlooks. There seems to be some quite blunt language in this chapter. I just wanted to see how you see the situation having changed over the past year since the last WEO.

And the second thing was just on China, and I haven't read the whole of the chapter yet, I'm afraid. But I just wanted to know, on the question of exchange rates, just what the Fund's analysis is of the need for Chinese flexibility in exchange rates, which is, of course, is a big political issue.

MR. RAJAN: Okay. The first question is how have things changed since last year on the U.S. fiscal front.

QUESTION: And in the way the Fund sees this.

MR. RAJAN: Well, first, the fiscal expansion was, I think, useful and contributed to bringing the U.S. economy out of recession, and thereby the rest of the world. So that, I think, the positive side has become more clear over this period.

That said, as the recovery has strengthened, the need for consolidation also becomes more clear. And I would say that at this point increasingly we see the need for consolidation. Coupled with this, if you ask about a change over the last year, it would be the demands on the budget have increased with the defense expenditures that have taken place in Iraq and Afghanistan and so, again, even greater need for a sound look at the budget, there is an even greater need at this point.

So I would say there is nothing dramatic which has changed. It's just the emphasis has become stronger on fiscal consolidation.

As far as the flexibility of the Chinese exchange rate, as you know, part of what's going on in China is there is some sort of—you know, there are some signs of overheating. There's a tremendous amount of investment that's been going on. Credit has expanded tremendously, and the Chinese authorities are trying to control this. And the jury is still out on whether they have brought it fully under control.

The question is: Will exchange rate flexibility help in this process and will it reduce the amount of leakage that's going on from the exchange intervention into domestic credit? And my sense is one of the biggest problems the Chinese authorities have at this point is not so much centralized control over the credit allocation, but really the fact that reining in some of the credit allocation by the banks and the bank branches is really the biggest problem they have. And whether more limited exchange intervention will help solve that problem I think is an open question.

So I think in the long run, exchange flexibility is certainly a very—is very important for China, and it will make China better off in its own right. And the various channels that it will make China better off, it will make prices in China reflect true prices much better. It will allow China, the Chinese people to consume more when the exchange rate is more appropriate. It will reduce the costs of Chinese inputs when the exchange rate is allowed to reach its appropriate level. So there are a variety of reasons why China will be better off in the long run.

In the shorter run, which is what I think might be prompting your question, there are a number of concerns that the Chinese have which have to be taken into account. That said, I think the Fund policy is any move towards exchange rate flexibility would be a good thing.

QUESTION: Yes, I just have a brief question regarding the budget deficit in the U.S. and its effects on the interest rates. Dr. Rajan, why do you think, haven't we seen a surge in interest rates so far? Only very recently there has been a bit of an increase after the most recent labor market data have been released. And is it entirely possible that there is no effect on interest rates whatsoever?

MR. RAJAN: Well, you know, anything is possible, but I don't think it's sound economics, because part of the reason, I think, interest rates have been relatively low is that private demand has been relatively muted. I think with the recovery, as investment demand grows, I think you will see the private sector competing with the public sector for funds, and, therefore, you will see a pressure upwards on interest rates. And eventually it will show up, and I think it's just a matter of time.

Do you want to add anything, David?

MR. ROBINSON: Just one point to bolster what Raghu was saying, which is, quite unusually, the U.S. corporate sector is now saving more than it invests, so it's actually contributing to the savings in the economy in net terms. That's one of the reasons why U.S. interest rates haven't picked up. But once investment starts to rise more solidly, as Raghu has just said, that is going to change.

QUESTION: Hi, Raghu. Yesterday, John Taylor from U.S. Treasury said the world economic outlook is better because of U.S. fiscal policies. It sounds like you agree with that, and I want to be clear.

But the second thing he said was that he seems—he said that it seems to him, speaking as an economist and not wearing his public policy hat, that things are on track with respect to U.S. fiscal policy, and it sounds like you don't agree with that. And I want to just clarify that, that you don't agree that U.S. fiscal policy is on track.

And with regard to China, I just wanted to—something in the WEO, if there is a point that a more flexible exchange rate for China is something that needs to happen in order for the U.S. to be able to further narrow its U.S. current account deficit.

MR. RAJAN: Okay. Both very good questions.

First, I do agree that the U.S. has been helpful in its fiscal expansion in lifting both the U.S. and the world economy. That said, the assumptions about deficit that the U.S. administration had, that it will fall to half its fiscal year 2004 level in the next five years, relies on a number of assumptions which could be questioned: the comeback in revenue buoyancy, no reform of the AMT, no further costs from the Iraq operations, and a strict containment on non-defense and non-homeland security expenditure.

So I think these are strong assumptions, and, you know, there is—it's within the realm of possibility, but I think that it would be good if there were stronger measures put in place so as to contain the deficit. And that is what we are looking for.

On China, the—the question was?

MR. ROBINSON: More flexible exchange rate.

MR. RAJAN: Right. The Chinese exchange rate, to my mind, there's a lot of blame put on it for the U.S. current account deficit, which I think there's too much in the following sense: that a lot of China's exports, bilateral exports to the United States, reflect to some extent goods that were flowing directly from other Asian economies to the United States, going now to China for finishing and then going to the United States. So what was a direct export from Asia to the United States now goes via China and shows up as the U.S. bilateral deficit with respect to China. So I think there is excessive blame put on China.

That said, I think if the Chinese show some flexibility, it will lead the way for other Asian economies to show some flexibility and will have some overall impact on the U.S. current account deficit.

That said, will it completely eliminate it? No. There are a number—first, it's not necessary that the U.S. has to eliminate that current account deficit. It has to bring it down. But also, there are a number of other factors which need to take place to bring it down in a serious way.

QUESTION: I just want to be clear. If you could be more specific, do you think U.S. fiscal policies are on track or off track at this point?

MR. RAJAN: Well, my sense is that in order to get it on track, they would need stronger measures going forward. If we want a high probability of the U.S. fiscal deficit being halved, I think we need stronger measures going forward.

QUESTION: Yes, could you give a sense of what kind of urgency we need to be looking at for the U.S. deficit? When you talk about stronger measures, how soon does this have to happen before you start seeing the adverse impact on global interest rates?

MR. ROBINSON: Well, I think we present—this is David Robinson speaking—I think we present a number of scenarios on this, actually, in the chapter. And if you look at Figure 2.4, which is on pages 12 and 13 of the chapter, that will provide you some guidance on this. Essentially we look at three different scenarios: one where there is actually no consolidation, there are real slippages in the U.S. budget deficit; and, second, the consolidation scenario, which is what the authorities have in mind themselves in the FY2005 budget; and then a somewhat faster consolidation scenario, which is called early consolidation, which is, as I say, somewhat faster than the FY2005 budget.

And we see actually some advantages—and this is one of the messages of the chapter—in that early consolidation scenario, somewhat faster than the U.S. authorities anticipate because, while there will be some short-run costs for GDP, the gains over the longer run from lower interest rates would be significant. And you can see that by comparing the relevant lines in that chart that I referenced.

So I guess my general answer would be that this is a good opportunity to take advantage of the recovery to, as Raghu said, sort of opportunistically make more progress on the U.S. budget deficit, partly because there are those long-term gains and partly, going back again to his earlier point, so that more room can be built for policy maneuver if—and let's hope there are not, but if—there were further shocks that needed to be dealt with.

MR. MURRAY: Okay. I think that's about it. Again, I just want to reiterate that there's a 3:00 p.m., 1900 GMT embargo today. If you have any follow-up questions that come to mind once you get through the chapters, drop me an e-mail at wmurray—m-u-r-r-a-y—@imf.org, and I'll follow up with Raghu, David Robinson, and Jim Morsink. And, again, thank you, everybody. Thank you to the authors of the chapters for joining us today. And, again, see you next week at the WEO press conference at IMF headquarters.

[Whereupon, the conference call was concluded.]




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