June 22, 2007
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MR. MURRAY: I am William Murray, Chief of Media Relations in the IMF. This is the briefing on the preliminary findings on the 2007 U.S. Article IV Consultation.
The principal briefer today is First Deputy Managing Director John Lipsky. Joining Mr. Lipsky is the lead members of our Western Hemisphere Department, Director Anoop Singh, Deputy Director Ranjit Teja, and Tam Bayoumi, Chief of the North American Division.
The contents of this briefing and the concluding mission statement, which was posted on the Media Briefing Center, are under embargo until 11:00 a.m. Washington time, 1500 GMT.
Now let me turn the table over to Mr. Lipsky who will have some brief opening remarks before we take your questions.
MR. LIPSKY: Thanks, Bill, and thanks to all of you for coming here and to my colleagues for joining us.
As I am sure you all know, the IMF members engage with us in regular discussions about economic prospects and policies. Last week, we completed a set of fruitful meetings with the U.S. Treasury, with the Federal Reserve and other agencies in this year's Article IV Consultation as we call it because it derives from the Article IV of the Articles of Agreement of the Fund, its constitution. The Article IV Consultation for the U.S. will be discussed by our Executive Board on July 20th, and our staff report on these consultation discussions should be published shortly thereafter.
In the interim, we've prepared a concluding statement summarizing staff views, which has been distributed to you and following the practice in many other countries. We're very pleased to have this press conference today to highlight some of the main messages. So I'd like to begin by offering a very quick overview, and then we'll open the floor to questions both to folks here and the folks participating virtually.
First on the outlook, let me start by saying that we like the U.S. authorities and expect a favorable outcome for U.S. growth as we expect to see a gradual reacceleration towards a sustained pace of around 3 percent annual rate growth by mid-2008.
There are risks, however, and the recent increase in long-term interest rates and spreads warns us against any excessive complacency about the outlook. While the shakeout in the subprime mortgage sector seems to have been contained in the financial sense to that sector, changes in financing conditions could restrain demand growth while prolonged difficulties in the housing sector could weigh on consumption longer term.
But risks also extend into inflation. As we all know, oil prices have moved up again. Commodity and other aspects could eventually feed through more readily to prices in an environment in which the unemployment rate remains low.
Against this backdrop, we see the Federal Reserve's current policy stance as appropriate. While a deterioration in conditions would require a speedy response, we agree that it's sensible now to remain focused on keeping inflation expectations anchored. As one of our interlocutors put it, expansions are kept alive by keeping inflation in check.
I will turn now for a minute to the financial sector, which has been a major focus of this year's consultations. Rapid innovation has been key to U.S. economic success and easy funding of the current account deficit, but it has also created new regulatory challenges. We agree that prudential oversight should focus on core institutions while relying on market discipline to limit risks in general. At the same time, benign market conditions have encouraged risk-taking even as new instruments have made it more difficult to assess vulnerabilities with complete confidence as we have seen, of course, in the subprime market. This will put a particular premium on supervisory systems geared to careful risk management.
As a result, we welcome the Administration's new emphasis on improving the effectiveness of a financial regulatory system that involves numerous agencies often with overlapping responsibilities. Increasing the use of general principles as a guide to rulemaking can ease interagency coordination and make the system more nimble, and we would suggest also exploring options for rationalizing the regulatory structure. You'll find more details in the mission's concluding statement of which you have a received a copy.
Turning to fiscal policy, strong revenues from corporate taxes and capital gains have helped shrink the deficit faster than expected in recent years, and this is clearly good news. We also welcome the Administration's and Congress' commitment to a medium-term balanced budget target. The challenge now will be to reach consensus on how to attain that goal while providing for funding of the conflict in the Middle East and limiting the growing reach of the alternative minimum tax.
That said, the central fiscal challenge is the projected unsustainable rise in entitlement spending over time. This is going to eventually overwhelm, in quantitative terms, any other fiscal issues. Again, the concluding statement has some specific recommendations regarding related reforms such as linking contributions to benefits or income to be done to better understand and control the drivers of health costs. I think that's a factor that is widely recognized.
Turning for a moment to the U.S. external position, we anticipate only a modest narrowing in the current account deficit as a ratio to GDP in the near term. Right now, this is not problematic. Indeed, foreign investors have readily demanded the innovative products that the U.S. financial system is supplying. Not only has the current account deficit been easily financed, it has also been financed at low interest rates.
But the situation is not without risks. For example, a sharp move out of dollar assets could disrupt financial markets which would have important negative consequences for both the U.S. and the rest of the world. Thus, the IMF has emphasized preemptive action by the major economies to reduce the size of deficits and surpluses on each side. On the U.S. side, policies to encourage savings outlined during the Fund's recent multilateral consultation on global imbalances are important for reducing this global vulnerability as is the Administration's commitment to free trade.
Now let me see if my colleagues have anything to add before we open up to questions.
MR. SINGH: Maybe we can ask Tam to give us a sense of the recent work that he has done as part of the consultations.
MR. BAYOUMI: Well, as part of our consultations, we always do background work on a number of issues. This year, in correspondence with the focus we have had, we've done some work on the U.S.'s role in the rest of the world, and here we've done a piece on the impact of U.S. activity on the rest of the world which indicates looking at both the size and the sources of this which suggests that U.S. activity has a large impact on the rest of the world which mainly goes through financial market.
We've also got a linked piece on the correlations of real bond returns across countries which to also suggest that financial markets may be a channel. We've also got a piece on the financing of the current account.
Turning to the financial sector, we have a couple of pieces looking at financial innovation. One is the evolution of the overall system towards what's called an originate and distribute model and also a piece on the subprime market.
Finally, fiscal issues were also covered. In particular, we looked at the drivers of the size of the general government over the last 50 years, and we have also got a piece on recent revenue buoyancy and what might be driving that.
MR. LIPSKY: These studies, by the way, will be included with the general publications on the consultations, so eventually you'll be able to take a look at these in detail.
MR. MURRAY: Let's open it up to questions. I would also recommend journalists watching via the Media Briefing Center to begin submitting questions now. Mr. Lipsky has a tight schedule today, so let's start sending questions in. Thanks.
QUESTIONER: The growth for this year will be 2 percent, I think is what the report says, which is down from the 2.2 percent estimated at the WEO in April. It's not a huge fall, but is there a reason for that?
As a follow-up, the subprime lending concerns, does that have any impact on it or is that pretty well contained and not as it was during the WEO?
MR. LIPSKY: Very simply, the modest adjustment really reflects the difference in the first quarter data relative to what we anticipated, so we're looking at a similar trajectory. In other words, the adjustment doesn't contain any substantive changes with regard to the outlook going forward nor a sense that, for example, in specific response to your question, that subprime problems are going to be more difficult than we had anticipated previously.
QUESTIONER: Could you speak a bit about what you regard as a sustainable current account deficit ratio?
Seven, 8 percent, that's worked all right thus far. Where should the target be and how long do you think the current ease of financing that can continue?
MR. LIPSKY: I'll respond briefly in a broad sense and see if my colleagues want to take this up in a more specific sense.
The issue of sustainability, of course, the question of over what time and what exactly does that concept, and it's been subject to substantial debate. Among other things, the dramatic change in opening in financial market globally has undoubtedly influenced notions of sustainability and has made it hard to be definitive about understanding where limits lie. It is obvious the recent degree of current deficits has been much larger than in the past would have been deemed feasible, let alone sustainable.
Let me put it in the following context if you'll allow me. In the late 1990s, the U.S. current deficit widened substantially in a context in which it was relatively easy to understand the source. The U.S. economy was simply growing much faster than had been expected and much faster than its major trading partners. It was, I think, conventionally anticipated that as global growth recovered more generally, the past 2000-2001, better balance in GDP growth would produce better balance in current account positions.
If there's been a surprise, of course, it's been that this past five years has been, and if our World Economic Outlook forecast is accurate, 2007-2008, this is going to mark the fastest sustained period of global growth in about four decades and that that growth at the level of GDP has been unusually well balanced. Yet, current account imbalances grew during the early part of this period and remain very large. So this has been a surprise and a challenge.
As you are undoubtedly well aware, back in 2004 in response, the Fund's IMFC, International Monetary and Financial Committee, agreed on a broad international strategy, a policy strategy for both deficit and surplus countries with a dual goal of sustaining global growth while reducing payments in balances and laid out a set of policies that would apply, as I say, different policies but appropriate to both deficit and surplus countries, oil exporters, et cetera.
That strategy underpinned the Fund's first multilateral consultation on global imbalances in which we, meeting in confidential discussions with the Euro Area, with Japan, with Saudi Arabia, with China and with the United States, laid out a series of policy programs for each of the participants that were designed to achieve this dual goal of sustaining global growth while reducing imbalances. So the U.S. has laid out a set of policy plans that are designed to achieve those goals.
We have here at the Fund, using our global economic model, sought to simulate what we thought would be a rough approximation of the impact of the implementation by all participants of their policy programs. At least from our point of view, our simulation indicates that these policies, when implemented, will in fact or should produce that effect, in other words, of sustaining growth while producing a significant reduction in payments in balances.
Now I know this is an awfully long-winded way of answering your rather more pointed question, but the sense of my answer in broad terms is the following, that we don't know in the current context exactly what the limits of sustainability are, but we can see a set of concrete policy proposals that have been endorsed by governments including the U.S., that would both be deemed beneficial for the individual participants, i.e., for the U.S. in this context, and enhance the sustainability of the expansion by reducing imbalances while sustaining growth.
So, again, we don't know the limits of sustainability. There's broad agreement that it's possible to produce a set of policies that will enhance sustainability and the likelihood of global stability while producing good economic outcomes.
Anoop, anybody want to add anything to that? Did I beat that one to death?
MR. MURRAY: We have a question from the Media Briefing Center. She's looking for some elaboration on the forecast. Her question is: How recent is the data you were using for this forecast?
And: Does the recent stronger than expected data suggest an upgrading of the forecast?
MR. LIPSKY: Who wants to take that?
MR. BAYOUMI: I think that what one can say is that the recent relatively strong set of data has reduced our concerns about downside risks. In the last WEO, we did voice significant concerns about risks from spillovers from the housing market, for example.
I think that the way I would put it is our forecast remains the same, but our assessment of the risks to activity are somewhat less than they were earlier. Therefore, the recent run of data has changed our views, but it's changed our views in terms of the balance around our central forecast rather than moving our forecast.
MR. MURRAY: Any other additional questions?
QUESTIONER: I was wondering, could you address that issue you mention about revenue buoyancy and what may be driving that? You said there would be some materials on that, but I wasn't sure when they would be available.
MR. BAYOUMI: Well, starting from the back, they will be available with the publication of the staff report, soon after the Board meeting on July 20th.
In terms of basically what we did, we spent a lot of time looking at taking out the impact of policies on revenues and finding out what the underlying revenue path would have been, excluding policies. Then we've looked at what's caused the recent rise in revenues, and there appear to be two major drivers. One is the rise in profits as a ratio of GDP. Second is aN associated factor which is the rise in capital gains revenues. Those seem to be the major drivers. They explain around three-quarters of the recent revenue buoyancy since 2004.
QUESTIONER: 2004?
MR. BAYOUMI: Yes.
QUESTIONER: Three-quarters?
MR. BAYOUMI: Around three-quarters, yes.
MR. MURRAY: Thanks, Tam.
Again, a reminder to the Media Briefing Center participants, I'd recommend submitting questions now.
A follow-up here.
QUESTIONER: A follow-up on growth estimates, in the report, you mention here that it's dangerously close to the 2 percent stall speed which puts in a recession, puts the U.S. in a recession, but you're saying on the other hand that you're very optimistic that it's going to be 3 percent next year, that growth is looking pretty good now. It seems there's something of a disconnect. What's happening between now and next year when we hit 3 percent?
How is the economy going to accelerate in that time?
MR. SINGH: On this thing of the stall speed, historically, whenever the U.S. has entered around 2 percent growth rate, you've tended to see recessions, but this time that is not our forecast. In fact, we expect something of a soft landing, and the reason is because some of the other factors that you associated with recessions are not in place. Real interest rates, in particular, are actually quite low and unemployment, most importantly, is also very low. So we have, I think, the fundamentals that are needed, that we see as supporting the economy.
In addition, there are a few other factors that are very strong. Reflecting the low unemployment, consumption growth is strong. As Tam mentioned, the position of the corporate sector is also unusually strong. Profit growth is still high. Margins are high. So that should permit a recovery in business investment. Finally, the global situation is rather good in terms of the U.S.'s trading partners, so there should be more opportunity for exports to also support U.S. growth.
Altogether, the stars are well aligned for a soft landing for the U.S. and to pick up now, to recover from the soft patch that it's been in.
MR. LIPSKY: Let me elaborate just a slight bit. When we made the Last WEO forecast, and why we characterize it as having downside risks was that our base case forecast assumed a change in direction for two important variables in the economy. Of course, it's always easy to forecast things continuing on as they have been, and it's always more adventurous to say we're forecasting a change in direction.
The two changes that we had anticipated were at the time, of course, housing was still exerting a down draft on the economy and that seemed quite straightforward. What was uncertain were the dimensions of the depth and the duration of that drag. The more puzzling aspect at the time was the weak data for business capital spending. The positives were very clear. Global growth remained strong, in fact, if anything was coming in on the strong side. Therefore, external demand was going to be supportive of U.S. net export performance.
Secondly, income growth continued to be solid and, as a result, there was no obvious reason to anticipate a substantial weakening in consumption expenditure.
Happily, what we have seen more recently is the data have pointed towards a reacceleration of business investment and business capital spending in line with what you would have expected, given the strong profit performance and the good liquidity of the corporate sector and availability of credit, et cetera. We're feeling more comfortable that the assumptions that we've made about the reacceleration, in fact, are justified.
We still have questions, of course, as I'm sure all of us do, on the depth and duration of the housing drag on the economy, but we've gained perhaps more confidence that it is remaining contained in terms of its impact on household spending and on its impact in financial markets more generally. But that's not to say that risks don't remain. Let me make it positive. Risks still remain in that regard.
MR. MURRAY: We have a Media Briefing Center question related to bond yields.
If growth is uncomfortably close to a 2 percent stall speed and the housing correction is the principal drag on growth, how significant a risk is the recent jump in bond yields for any acceleration in growth?
MR. LIPSKY: Mr. Singh.
MR. SINGH: Well, I think that question probably has been answered just now by John and by Ranjit, but let me just try to answer that perhaps in one or two more ways.
I mean the first point is it is a surprise that long-term rates have remained so low for so long. So the effect is not surprising. As we just explained, we still have real interest rates around 3 percent. This is historically quite low. These are not the high level for real interest rates.
I think I would interpret the up-tick in bond yields, in fact, as conveying market conviction of a soft landing. Some may trace the effects on household balance sheets, but although household debt has been going up in recent years, the increase in financial obligations has been quite low because of low inflation and interest rates. So we do not expect that this up-tick is going to significantly affect household balance sheets and therefore affect consumption growth.
MR. LIPSKY: I suppose for someone who spent a few years looking at bond growth, I should say a word that what was most notable about the recent backup in long-term rates in the U.S. was not the magnitude but the speed at which that occurred. You don't normally expect to see 10-year yields jumping 50 basis points in a matter.
On the other hand, it seemed to me at the time, and I think subsequent events have tended to underscore, that what was latent there was, I think, the unfolding of more positive U.S. data. Remember, you had that surprise figure on U.S. growth in the first quarter marked to well under 1 percent. That was certainly slower than consensus expectations had anticipated.
I don't want to get into too much detail. Subsequent data confirming that the growth outlook remained positive. It seemed to me, more than anything, that underpinned the change in direction of bond markets.
Today, I didn't look at a screen on my way down here, but where are we, about 5.14, 5.13 on the 10-year or something like that? So we've moved back from the highs reached a couple weeks ago. As it fades back, as that jump fades back into the past, at least right now, it doesn't look like it's all that worrisome or significant, at least so far.
QUESTIONER: You say core inflation will be below 2 percent. Is that in both 2007 and 2008?
MR. BAYOUMI: Yes is the short answer. Core inflation, there are various subtleties here, one of which is which measure of core inflation you're talking about, whether you're talking about the PCE deflator, which is the Fed's preferred measure, or the CPI, which is another measure of core.
We tend to focus, as the Fed does, on the PCE deflator as a better measure. That's already at 2 percent. We foresee a gradual fall, and I think that we would certainly see that coming down in 2007 and 2008.
I think the core CPI deflator, which tends to be slightly higher and is at present at 2.3 percent, will also come down gradually. Certainly over the course of 2007, we would predict that it would come down to 2 or below.
MR. LIPSKY: Let me speak clearLY. That's with an assumption of energy prices that are broadly constant from current levels.
MR. MURRAY: Thanks. I think we're getting close to wrapping this up. If there are any more questions from the Media Briefing Center participants, please submit right now. Do we have any further questions from the floor?
Okay, thanks for joining us today. Again, the embargo is 11:00 a.m. Washington time, 1500 GMT.
If you do happen to have any follow-up questions, please drop me an email at wmurray@imf.org. I'll follow up for you. Additionally, for broadcasters, video clips will be posted later today on the NewsMarket distribution system.
Again, thanks to Messrs. Lipsky, Singh, Teja and Bayoumi for joining us today.
MR. LIPSKY: Thank you all for coming.
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