Raghuram G. Rajan
Raghuram G. Rajan

Transcripts

World Economic Outlook
Building Institutions
September 2005

Japan and the IMF

United States and the IMF

What does it mean?
Investment

Inflation

Current Account

Emerging Markets

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World Economic Outlook Conference Call
Wednesday, September 14, 2005

MR. HAYDEN: Hello. I'm Jeff Hayden, senior press officer with the IMF, and I want to welcome all of you to this conference call on chapters two, three, and four of the latest World Economic Outlook --- the so-called analytic chapters.

Before we begin, let me go over the ground rules briefly. This is an on-the-record call. The contents of the call, as well as the analytic chapters, are embargoed until 11:00 a.m. Washington, D.C. time today, or 1500 GMT.

Now let me introduce the three principals. Raghuram Rajan, Economic Counsellor and Director of the Research Department of the IMF is with me today, as are David Robinson, Deputy Director of the Research Department, and Timothy Callen, the chief of the World Economic Outlook studies division.

Also joining us are all of the lead authors of the essays in the four chapters of the World Economic Outlook.

The analytic chapters were made available to all of you under embargo, on Monday via our media briefing center, and I hope you've had the chance to take a look at them. I encourage you to ask as many questions as possible. Please take advantage of this opportunity to speak with Mr. Rajan and the other principals.

Mr. Rajan has an opening statement and then we'll take your questions.

MR. RAJAN: Thank you. Good morning. Let me give you a quick summary of the key points in each chapter, starting with chapter two. As you know, the difference between a country's savings and its investments is its current account balance. A country that saves more than it invests runs a current account surplus, while if it saves less than it invests, it runs a deficit.

The fact that the U.S. is running a large current account deficit has been ascribed to a savings glut --- that for some reason the rest of the world has started saving too much and this has to be absorbed by the United States and other deficit countries, by saving too little.

This chapter suggests that perhaps a better description of what has been going on worldwide is not so much a savings glut but investment restraint.

Now, how can we tell, given that it's a macroeconomic identity, that global savings should equal global investment, except perhaps from measurement error?

This chapter offers two main reasons. First, if it was a savings glut, we might expect world savings to be rising. Instead, total savings, or equivalently, total investment as a fraction of world GDP has been falling steadily over the last decade, rising only a little very recently.

Second, while we can explain the decline in savings country by country reasonably well, it's mainly due to larger government deficits, especially in the United States and Japan, and due to credit-fueled housing booms reducing household savings --- we find that investment seems to be below where it should be at this point in the cycle.

We suspect this investment restraint, especially by corporations in industrial countries, but also by emerging market countries, is a reaction to past investment excesses which ended in financial difficulties of crises.

Now you might ask, why does it matter whether we call this a savings glut or investment restraint? Well, if we call it a savings glut, then the onus is on countries with high savings rates to reduce incentives to save. But that is the wrong prescription if the problem is investment restraint, for if and when investment starts coming back there'll be too little savings, which will push up world interest rates higher than they should be.

So we suggest that thus far, world growth has held up due to growth in consumption, but it is time to shift from growth through consumption-driven growth to growth through investment.

There are signs that investment is indeed picking up, most notably and recently in Japan. But a pickup in investment is also necessary in a number of emerging markets, so that global current account imbalances can narrow. But what we don't need is a low- quality, government-led, or finance-fueled investment binge.

We've already experienced the consequences of those. Instead, we need structural reforms to product, labor, and financial markets, so that high-quality, private sector investment can emerge in those countries.

Of course in some countries, which are saving too little currently, we need an increase in savings and a reduction in consumption.

Now both in this chapter, and in appendix 1.2, we attempt to measure the effects of different policy measures on narrowing global current account imbalances.

The message that comes out clearly from both exercises is that actions by all parties --- that is, steps to increase savings in the United States, to boost growth in Europe and Japan, and to raise investment among oil producers and also in emerging Asia outside China, and to increase exchange rate flexibility in the Asian region --- all add up to deliver a meaningful reduction in the current account imbalances.

This will reduce the risk that investors will tire of financing it. There is another benefit in couching the global imbalances of the shared responsibility in which each country has a part to play. As appendix 1.2 suggests, one of the risks associated with imbalances is that politicians decide one or the other country's is to blame and espouse protectionist policies that precipitate the very economic downturn we all want to avoid.

If, instead, we all espouse the language of shared responsibility for these imbalances, it will help each country's policy makers guide the domestic debate away from the fingerpointing and the protectionist solutions that otherwise come naturally.

Let me turn to chapter three. World leaders are currently meeting to discuss ways to reduce the global scourge of poverty. Economists generally agree that good institutions, such as rule of law and protection of property are key to economic growth, which, in turn, is key to reducing poverty.

Yet this has led to pessimism, for it has been felt that institutions are historically determined and relatively unchanging.

Essentially, the academics say, you are who your colonizers were.

This chapter offers hope, for it shows rapid institutional change has taken place over relatively short spans of time in a number of countries. We document 65 institutional transitions in the last three decades, with over a quarter in Africa.

And these transitions have led to significant increases in growth. Institutional transitions in Benin and Zambia led to increases in output growth of 4 percent or more in each of these countries.

Three factors that seem to particularly enhance the chance that an economy will experience institutional improvement are, first, greater openness to international trade; second, a higher level of education among the people; and, third, better institutions among neighbors.

From a policy perspective, this implies we should emphasize trade and aid, not either one to the exclusion of the other. In particular, even as we exalt rich countries to open their markets to poor country goods and work for an ambitious Doha round, we should also press poor countries to open their markets to each other's goods.

Better and wider education is a no-brainer and this is a key element of the policy advice the IMF and The World Bank offer to poor countries.

Finally, reasonably arrangements to monitor and strengthen institutions, such as the new partnership for Africa's development, can create a virtuous cycle of institutional development in a neighborhood.

Let me turn finally to the chapter on inflation targeting. As you know, inflation targeting is a framework for monetary policy that directly targets the inflation rate, hence the monetary aggregates.

Critics of inflation targeting have suggested that it is overly restrictive and it can hurt growth. They've also said that it is impractical for emerging market countries because it requires a level of sophistication, a set of preconditions, so to speak, that they simply do not have.

This chapter reports the results of a detailed survey of central banks, comparing the experience of a number of emerging market countries that have taken up inflation targeting with those that have not.

With the caveat that the time period is short, we find countries adopting inflation targeting have a 5 percent lower average inflation rate with no apparent adverse effects on growth.

Equally important, we find that it's not necessary to meet a stringent set of preconditions before adopting inflation targeting --- so long as the country has the commitment and ability to drive change after the adoption of the framework, it can manage.

In other words, many countries learn successfully to implement inflation targeting on the job.

Thank you.

MR. HAYDEN: Okay. We're ready to take questions now.

QUESTION: It's not strictly about the World Economic Outlook but more widely about the global imbalances. I'm sure that Mr. Rajan is aware of the controversy surrounding the governor of Bank of Italy which has been on the headlines in the United States. I would like to ask him if he thinks that this affair may bring some imbalances in the Italian or European economy, or if it may have some negative effect of any kind. Thank you very much.

MR. RAJAN: Well, it's a very nice attempt to make the question relevant but I'm afraid I can't take this question today.

QUESTION: I mean, not commenting on Mr. Fazio himself, but on a wider perspective.

MR. RAJAN: I can certainly take questions like this next Wednesday but today, we're talking about the analytical chapters. Sorry.

QUESTION: Okay.

QUESTION: Good afternoon. I have a question on the issue about your low long-term interest rates, whether that is something that is caused by low savings or high savings on the one side, or otherwise, by low investments.

I took a look at the chapter and what I was wondering, if the IMF is measuring savings, those savings include wealth that is owned by individuals, wealth meaning stocks and bonds, or is this just savings accounts with banks?

MR. CALLEN: I mean, the way the savings are measured is the national account definition of savings through S&A 93. We could check after the conference call, exactly how that's defined for you. I think we can do an e-mail through EXR sources to check the definition.

QUESTION: Could I respond to that.

MR. ROBINSON: Let me give you an additional response. Well, just one further point. It doesn't include changes in wealth directly. For instance, it doesn't include the valuation changes as stock prices change or valuation changes as house prices change.

MR. RAJAN: A simple way of thinking about it is it's low savings. You have a certain amount of income and you save a certain portion of it. That's what we're picking up here.

And to the extent--I mean, worldwide, there is an equality between these savings and investments. What we're arguing is that because these have been coming down, it is more likely that the low level of interest rates at this point is because we've had, in some sense, too little investment.

QUESTION: I understand that fully. That would certainly hold, unless people are putting more of their money in stocks and bonds, because the other alternative explanation is that a lot of people say, well, there's a lot of liquidity flowing around in the world because of accommodative central bank policy, and people are not putting it in savings accounts but putting it in bonds and stocks, and so it doesn't show up in the saving rate.

Is that a possible explanation or is it in that saving rate that you have calculated?

MR. CALLEN: The saving is defined as basically what you don't consume.

QUESTION: Okay.

MR. CALLEN: So it includes--you know--in whatever instrument you save, it's counted in savings. As Mr. Robinson has said, you know, sort of wealth effects through increasing house prices, stock prices, won't be captured in the national accounts measures.

QUESTION: Okay; thank you.

MR. HAYDEN: As I mentioned, please take the opportunity to ask any questions. Mr. Rajan is here as are the principals. If you have any questions on these chapters, this is your last chance to ask.

MR. HAYDEN: Okay. If there are no further questions, then we will conclude this conference call. Thank you for joining us. I want to give you my e-mail address. That's jhayden, h-a-y-d-e-n, at imf.org. You can send an e-mail message to me if you have any follow-up questions about this conference call.

Also a reminder. This conference call as well as the chapters are embargoed until 11:00 a.m. today Washington time. That's 1500 GMT.

And as a final reminder, I just want to announce that we will be releasing chapter one of the WEO, the global forecast, next week, on Wednesday, September 21st, at 9:00 a.m.

Thank you all for joining us.

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