Transcript of a Press Briefing on the Analytical Chapters of the October 2008 World Economic OutlookWith Charles Collyns, Deputy Director, Research Department, and Thomas Helbling, Subir Lall, Alasdair Scott, and Florence Jaumotte
Washington, DC, October 2, 2008
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MS. LOTZE: Good morning, everybody. I'm Conny Lotze of IMF Media Relations, and let me welcome you to our press briefing on the analytical chapters of the october 2008 World Economic Outlook, Chapters 3 to 6. As you know, Chapters 1 and 2 of the Global Economic Outlook will be released next week on Wednesday, October 8.
Let me introduce the panel before we start. In the center is Charles Collyns, Deputy Director of the Research Department. To Charles' left is Thomas Helbling, one of the authors of Chapter 3 on Commodity Prices and Inflation, and to my right is Subir Lall, one of the authors of Chapter 4 on Financial Stress and Economic Downturns. To Charles' right is Alasdair Scott, one of the authors of Chapter 5 on Fiscal Policy, and to Alasdair's right, on the other end, is Florence Jaumotte, one of the authors of Chapter 6 on Current Account Balances and Emerging Economies.
Charles will make some opening remarks, and then we will open the floor to your questions. Charles, please.
MR. COLLYNS: Thanks very much, Conny, and good morning.
Well, recent weeks have been a tumultuous period for global financial markets, and we in the Fund have been working hard to analyze implications for the World Economic Outlook against a backdrop of great uncertainty. We will present the details of our new projections, as Conny mentioned, at a press conference on October 8th-that's next Wednesday-and we'll be very pleased to respond at that point to all your questions on the Outlook and the policy implications.
The focus of today's event is on the key issues raised in what we call the analytical chapters of the WEO. These chapters are closely related to the challenges now facing the global economy and aim to look in greater depth at some key issues that we hope shed some light on recent developments and prospects.
Let me summarize the main findings very briefly before we turn to your questions.
Chapter 3 examines the threat that the boom in commodity prices in recent years could unwind the progress made in the last two decades against inflation. To be sure, the fall in some prices, notably for oil, since mid-July has eased some of the pressure, but our main conclusion is that it is still too early to relax.
Commodity prices are likely to remain much higher in real terms than we have experienced in recent decades because, in our view, the surge in commodity prices reflects primarily lasting shifts in supply and demand patterns. Thus, there has been a shift in relative prices that will need to be absorbed without triggering second round effects on price and wage formation.
This task is likely to be easier in the advanced economies where widening output gaps are helping to restrain inflation pressures. Moreover, these economies are much less commodities intensive than they were in the 1970s. They have more flexible labor markets, and they have well-established monetary policy frameworks that have largely succeeded in anchoring expectations.
However, emerging and developing economies are more vulnerable to inflationary spillovers from their resource intensity, from less well-established policy frameworks and from more rapid rates of growth. In many of these economies, second round effects are already increasingly visible.
Despite slowing global growth and softening commodity prices, substantive risks remain in a number of countries and inflation pressures will be persistent. This raises the concern that hard-earned inflation fighting credentials may be compromised, requiring even tougher action in the future.
Chapter 4 addresses what is, right now, a central concern for the global economy: What will be the impact of the current financial crisis on economic activity?
It is now all too clear that we are seeing a dangerous shock to mature financial markets since the 1930s, posing a major threat to global growth. Even though past periods of financial stress have not necessarily been followed by recessions, we find that when the banking system suffers major damage, as in the current episode, the likelihood of a severe and protracted downturn in activity increases.
Moreover, we find that recess risks are raised when financial stress is preceded by rising house prices and rapid expansion of credit, as has happened this time.
Furthermore, economies like the United States, with more arms-length financial systems, seem to be particularly vulnerable to sharp contractions in activity in the face of financial stress. This is because leverage tends to be more pro-cyclical in these economies, which means that when a shock hits the financial system the process of deleveraging can be more severe and the risks of a credit crunch are greater.
To limit the fallout on the real economy, it is therefore of paramount importance that the damage to the banking systems in the United States and Europe be swiftly contained by far-reaching and comprehensive measures. This lesson is clearly brought out by the experience of many economies that have struggled with virulent financial crises over the past decades, for example, in Nordic countries or Japan in the 1990s.
Chapter 5 takes a fresh look at an old debate over the value of fiscal policy as a counter-cyclical tool which has taken on new relevance in many countries as the global economy slows and as turbulence in financial markets has raised questions about the effectiveness of monetary policy. The key question is: How can the effectiveness of fiscal policy be maximized in combating downturns?
In general, fiscal multipliers, that is the impacts of discretionary fiscal stimulus on output, are found to be quite low and sometimes maybe even go in the wrong direction, especially in economies with high debt where a turn to expansionary fiscal policy may raise doubts about long-term debt sustainability.
But such results do not necessarily mean the policymakers should abandon fiscal policy as a counter-cyclical tool. Rather, they underline that fiscal initiatives need to be well targeted to have a maximum short-run impact when needed without undermining long-run fiscal rectitude.
It is also worthwhile to consider whether the role of fiscal policy as a macroeconomic stabilizer could be enhanced by strengthening the broader fiscal framework. Two directions are worth considering:
First, there is a possibility that automatic stabilizers could be boosted by making regular tax and transfer programs more cyclically responsive. For example, the generosity of unemployment insurance schemes could be automatically increased at a time when the economy is in a downturn and jobs are harder to find.
Second, steps to strengthen the overall governance structure of a fiscal policy could provide greater assurances that medium term objectives would be met and reduce the risks of debt bias. In particular, making sure that fiscal easing during a downturn is balanced by tightening during expansions could bolster the credibility of fiscal policy and thus the effectiveness of fiscal stimulus.
Finally, Chapter 6 raises concerns about large current account deficits, particularly in an environment of global deleveraging when the financing for such deficits can suddenly dry up. Over the last few years, we have witnessed a very diverse pattern in the evolution of current account balances of emerging economies with some economies in Asia registering large surpluses and others, particularly in Europe, sustaining very large deficits. There is no one single factor that explains this divergence, but the chapter suggests important contributors to the deficits in emerging Europe have been rapid financial liberalization, the opening of capital accounts and the opportunities for rapid growth in European countries integrating rapidly into the European Union.
When it comes to the Asian experience, there is some evidence that large surpluses have, at least in part, been related to the low level of exchange rates which could be a byproduct of export-led growth strategy or reflect a desire to build large stocks of international reserves as self-insurance following the Asia crisis.
This leaves open the question of whether recent patterns will be sustained. Certainly, the current turbulent global environment is putting strain on countries with large current account deficits and large external financing requirements. Some reassurance can be gained from the fact that large deficits in emerging Europe have reflected growth opportunities, but countries with large current account deficits and rigid exchange rate regimes and high financing requirements are subject to risks in the current period of financial stress.
Well, the main authors of the chapters are with me here on the stage, and we'll now be very happy to respond to your questions on these chapters. And, as a reminder, questions on the Outlook and our policy assessments should be left to next week. Thank you.
QUESTIONER: I had a question about current account deficits that the IMF hasn't been lending huge amounts of money in recent years. And with the financial crisis intensifying and spreading and many developing countries having large current account deficits, what do you think the prospects are that the IMF's lending function might become somewhat more active over coming years?
MR. COLLYNS: I think that's really a question for next week. One comment I could make is that so far at least, a year into this financial crisis, the emerging economies have weathered the storm reasonably well. This reflects, I think, the fact that they have made substantial progress towards strengthening their robustness to reduce their exposure and vulnerability through stronger policy frameworks. And, while countries have developed large current account deficits, they have also been able to attract to large amounts of foreign direct investment.
Nevertheless, many of these economies have relied, to some extent, on portfolio flows and on bank-related flows that could be quite volatile. And, with the recent intensification of the financial stress, certainly there are further questions about the financing of a number of countries, and that could well lead to increased demand for Fund resources, looking ahead.
But I think a more detailed response could wait for next week, including in the press conference by the Managing Director which is next Thursday.
QUESTIONER: Mr. Collyns, this morning, the European Central Bank left their rates unchanged, and there are rumors that the Fed could, instead, hold an extraordinary session to lower the rates maybe before October. I just wanted to know, in this context and with the risk of inflation, how the IMF sees both the European Central Bank's lack of action and possible Fed action.
MR. COLLYNS: That's a perfect question for next week. At this point, it would be premature for me to anticipate a response on that one.
QUESTIONER: A question about the financial crisis story in your report: You mentioned that governments should take action to restore capital into the financial sectors, and I'm just wondering what your view is on the current plan for the U.S. bailout.
And my other question is about Europe, whether recent problems in the banking sector there have raised concerns that there could be a recession there as well instead of just a slowdown.
MR. COLLYNS: Yes, I think this is not the right place to comment in detail on the present plans in the United States or in Europe. There will be an opportunity to get into the details of our views, our assessment, not only in the WEO press conference on Wednesday but also the GFSR press conference on Tuesday.
But relating to the chapter, there is a discussion there about how countries have dealt with previous periods of financial stress, and we attempt to draw some lessons from that experience. I think the key lesson that we draw which is relevant to this experience is the need to act early and to act in a far-reaching and comprehensive manner rather than to let the problems drift on and to allow the financial system to go through a lengthy period of stress of undercapitalization.
So I think it is welcome that financial authorities around the world are moving quickly and aggressively to try to stabilize the present situation.
But in terms of a more detailed assessment, please ask that question next week.
QUESTIONER: I have a question combining the two reports on the fiscal stimulus and the monetary policy and inflation. I'm just curious about for developing economies in the current situation if their task is made more difficult, as John Lipsky and some other officials have pointed out, by the fact that they're facing more pervasive inflation pressures than advanced economies and, as your report suggests, fiscal stimulus could be counterproductive in those countries. If you could just address that.
MR. COLLYNS: Yes, I think it's important to recognize there are significant differences across the emerging and developing economies.
As we'll discuss in more detail next week, we do see many of these economies slowing in the face of a global slowdown in activity, particularly those that are manufacturing exporters or countries that have been heavily reliant on bank-related inflows that are no longer so easily available. For those countries, the risks are clearly the downside risks to output, and in the context of slowing economies the inflation risks are less.
But we do continue to see a number of emerging and developing economies that do face these inflationary risks, particularly those that are commodity exporters. And, while commodity prices have declined somewhat from the peaks in July, they do remain very high in real terms, providing high levels of income that have stimulated strong growth of demand including government as well as private consumption.
A number of these countries do not have much exchange rate flexibility, and that has constrained monetary policy responses. And, if we look around the world, we see a wide swath of countries that now have inflation in double digits. So a number of these countries where we still see a strong dimension of domestic demand, there is indeed more of an inflation challenge. And, despite the slowing global environment, we think these countries will still need to take actions to control inflation.
One of the encouraging features of recent years, as I mentioned before, is that many emerging and developing economies have developed stronger policy frameworks, and that applies to fiscal as well as to monetary policies. There has been substantial fiscal consolidation in the emerging economies, not always as much as we would have liked.
But one of the key messages of the chapter is that in order to have fiscal policy as a useful counter-cyclical tool, it is important to bring debt levels down to more sustainable levels that allow for an increased in spending or a reduction in taxes without raising concerns about longer-term fiscal sustainability that could make the fiscal action self-defeating.
QUESTIONER: Thanks very much. I'm just trying to think of how to phrase this.
I had a historical question which is you mentioned that you looked at many examples of banking crises and tried to assess their impact. Can you think of an example of an episode of this variety-of course, they'll never be perfectly comparable-n which the U.S. has a severe banking a crisis, a big asset price bubble and actually managed to avoid a recession after it?
MR. Lall: Well, our sample just goes back to the last 30 years or so. And, if you look at the history of that, we haven't actually found good examples where the whole confluence of factors that you mentioned came together at the same time.
For example, in 1998 around the time of LTC, it was really a focus on securities markets and the banking systems were quite sound, and there was no recession after that. In 2001, as well, it was after the IT bubble collapsed.The S&L crisis was in the early 90s and, in fact, in the late 80s, and we know there was a recession.
So, I mean the short answer is no, there is not an example where you have all these things coming together and, in fact, with such intensity for this protracted period of time.
MR. COLLYNS: Just to add an addendum, I think one of the key messages of the chapter is that it's banking-related financial stress that is particularly damaging to economic prospects. There certainly have been a number of episodes of very volatile and stressful conditions. In securities markets, for example, the 1987 stock market crash, that was fairly quickly reversed in part with the help of a monetary policy reaction that did not have a major impact on the economy.
But I can't think of a ready example of a country that has a major banking system failure that has not suffered serious economic consequences as a result.
QUESTIONER: In Chapter 4, when you talk about there remains a substantial likelihood of a sharp downturn in the United States, could you please articulate this better? I mean we already see a downturn in the United States.
MR. COLLYNS: Again, I'll give a partial answer to that question. Then next week, we can a give a fuller answer to our views on the outlook for the U.S.
So far the U.S. economy has certainly slowed, but it has not entered into recession, at least through the second quarter. We do see, however, substantial risk factors as being identified by the analysis in the chapter.
I think one of the contributions of the chapter is that it tries to identify the factors that mean that a period of financial stress is translated into an economic downturn and identifies as key prior conditions a buildup in housing prices, the rapid expansion of credit and a reliance on financing by the non-financial corporate sector and the household sector.
In the U.S., three of those conditions are met. We've had a large increase in house prices. We've had an expansion of credit. We're seeing vulnerability in the household sector.
The one area of support up to now has been the quite strong position of the non-financial corporate sector. I think that has been one of the factors that have helped to buttress the U.S. economy over the past year. There's also been the quite rapid response of the monetary authorities to cut interest rates quite sharply after the turbulence began a year ago.
However, what is striking is that this period of turbulence has continued. It has been persistent. The chart that we include in the chapter goes through the first quarter. It shows very high turbulence particularly in the first quarter of 2008. We've now extended our calculations, and it shows-you won't be surprised to learn-it shows that the extremely high degrees of stress are continuing into the third quarter.
And, one of the econometric results that's quite strong in the paper is when you have an extended period of financial stress, that does tend to be associated with sharp economic downturns.
MS. LOTZE: I have a question here from the Media Briefing Center. Let me read this out:
What is the expected inflation rate for advanced and developing countries, or the impact from the commodity price increases in 2008 to 2009, including the second round effects? When do you see it receding?
MR. COLLYNS: Again, the specifics on our inflation forecast, we leave to next week, but maybe I can ask Thomas to respond on this issue of how commodity price increases is feeding through into inflation and the second round effects that we are seeing.
MR. HELBLING: There are two issues I would like to distinguish. I think in many countries, it's very important to look at first the pass-through of international commodity prices into domestic commodity prices.
To the two main elements, on the one hand, it's the exchange rate; on the other hand, it's often government intervention. In particular, what we have seen for fuels, for oil, there are often tax changes or changes in subsidies to break the link between domestic and international prices. So, to the extent that this link is broken, an important issue is whether countries will adjust this link eventually.
But, nevertheless, we have seen in many countries across the world the domestic food and fuel prices go up rapidly. So, to the extent that these price exchanges have been passed through, we would see some relief.
A second question is then the second round effects, the general pass-through into inflation or underlying inflation, and there in the chapter we point out two important factors: On the one hand, it's just how commodity-intensive an economy is. And the larger the share of commodities in final expenditure, the more commodities, particularly oil, into the supply chain, the higher is the likelihood of general second round effects.
The other factor is to the extent that commodity prices or changes in commodity prices are really relative price effects. Then it also depends on the monetary policy credibility if these price changes only have temporary effects on inflation or whether they have more lasting effects.
So one point that the chapter makes is we are more concerned about countries where monetary policy credibility is limited, and Charles already pointed out that one key factor here are exchange rate constraints on monetary policy. That limits the flexibility of monetary authorities to respond to rising inflation.
The other challenge many emerging and developing countries still face is a limited track record of inflation credentials. So the higher your inflation has been just in the recent past is one deteriorating factor.
MS. LOTZE: Do we have any more questions? Let me remind you of the press conference on the Global Financial Stability Report next week on Tuesday and on the World Economic Outlook, as we said several times, on Wednesday morning.
This concludes the press conference. Thank you very much.
IMF EXTERNAL RELATIONS DEPARTMENT
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