Transcript of a conference call on the U.S. Article IV ConsultationWith Charles Kramer, Division Chief, and Marcello Estevao, Deputy Division Chief in our Western Hemisphere Department
Washington, D.C., Friday, July 31, 2009
MS. BECKMAN: Good morning. Welcome to the Conference Call on U.S. Article IV. My name is Jennifer Beckman from the External Relations Department. Speaking with us today we have Charles Kramer, Division Chief, and Marcello Estevao, Deputy Division Chief in our Western Hemisphere Department.
MR. KRAMER: Thank you. Why don't I start with a quick overview of the issues we have laid out in the report? Now thanks to the large monetary and fiscal stimulus and the measures to stabilize the financial system we see that the sharp fall in output seems to be ending and confidence in financial stability is coming back. That said, looking ahead, we still see some financial strains and the outlook is for a gradual recovery will risks still on the downside.
In this context, we see three interconnected policy challenges. One is completing the task of stabilization. The second is developing communication strategies for exit from the extraordinary policies that have been taken today. And third, addressing some of the long-term legacies of the crisis, particularly in the financial sector and on the fiscal side.
On stabilization we see a couple of priorities there. One is to complete the strengthening of the financial system where we've seen good progress including under the stress tests, but with downside risks on the horizon we see a need to closely monitor the financial system. Priorities are cleaning the balance sheets of banks and also undertaking regulatory reforms. I'll say a bit more about that in a moment. We see the possibility for more stimulus in a downside risk scenario, but if there were further fiscal stimulus, we think that would need to be set in a credible medium-term framework, and I'll say a bit more about fiscal policy in a moment.
On the exit strategy, what we should emphasize is: now is not the time to implement the exit, but we think it's a good time to be developing and communicating exit strategies to underpin confidence. For the Fed, we see a case for a diverse set of tools given that there is a lot of uncertainty about the conditions under which it would need to unwind once recovery is firmly in place. On the longer-term issues, we see the need to substantially strengthen financial supervision and regulation. On that, as you know, the administration has made a proposal to regulate all systemic firms and create a financial council. We think these are very good initiatives, and in that context we think regulation should discourage size and complexity to contain moral hazard and systemic risk. And we also see as very important the initiatives to restart private securitization which we see as really essential to restoring healthy credit flow over the medium term.
Another issue as I mentioned a moment ago are U.S. public finances which have deteriorated a lot as a result of the crisis. We think the FY 2010 budget lays out the right objectives particularly in early stabilization of debt relative to GDP. However, under our economic assumptions which again are for a gradual recovery and relatively modest growth for most of the period going forward, we see that additional measures are going to be needed to achieve that goal of stabilizing debt to GDP. In addition of course we see the coming pressures from entitlements. In this context, the administration's focus on health care reform is something that's very much welcome. Of course, the impact of specific measures to get costs under control are uncertain and so progress there will need to be closely monitored and further steps taken if that's needed.
The final issue I'd mention is the medium-term implications for the U.S. role in the global economy and one of the interesting features of the crisis is the sharp rise in household savings that has occurred on the back of the big drop in household wealth and that seems likely to continue which would cement the decline in the U.S. current account deficit to a more sustainable level. That also means that the U.S. consumer is unlikely to play the role of the global buyer of last resort, if you will, suggesting that other regions will need to play an increased role in supporting global growth and adjustment.
To summarize, we see an improved near-term outlook reflecting in good part an effective policy response, although again with the outlook for a gradual recovery with risks on the downside, and there are a number of serious challenges over the medium to longer term which call for continued strong policies and decisive implementation. With that shall we open up for questions?
QUESTIONER: I was just wondering if you could talk about the downside risks. The report says that they're still tilted to the downside. What are those? Is it mostly housing or is it the jobs picture?
MR. ESTEVAO: This is Marcello Estevao speaking. The main downside risk to the outlook is the interaction between financial conditions and the real side of the economy, which carries significant uncertainty. In that sense, you are completely right. We are pretty concerned about the weakness in the labor market and how it is going to reflect into weakness in the housing market because as people lose jobs, wages don't grow as much, and it's harder for them to pay their mortgages. We have some assumptions about this mechanism in our forecast, but there is substantial uncertainty about how exactly this feedback would play out. Actually, the real-financial feedback is one of the reasons we have this very gradual recovery outlook for the United States, as Mr. Kramer has just mentioned. We have GDP in the second half of the year growing a little bit, and a sustained recovery will happen only after the first quarter of 2010, so beginning more or less in mid 2010. The downside risks are that even this gradual recovery can be a bit more protracted if the feedback between the financial and the real side is stronger than we think.
QUESTIONER: You mentioned that now is not the time to unwind the stimulus. Do you care to venture a guess as to when the timing might be right? Is it sometime in the first half of 2010 or the second half of 2010?
MR. KRAMER: I think it's pretty hard to say with precision when that would be, and I think a number of factors would have to be taken into account. First of all obviously the broader performance of the economy, output, employment and so forth, but also the state of the financial system. As I mentioned before, financial strains while they've improved quite substantially from earlier this year and certainly from late last year still remain present. So I think a number of factors would have to be taken into account. There's also, as I believe I mentioned, a considerable amount of uncertainty going forward and I think you see this in private forecasts. If you look for example at the Consensus Panel, the range of forecasts for next year's growth is something like 4 percentage points which is highly unusual even for this stage of the cycle. So I think it will have to be an approach in which a number of indicators are evaluated in real time. Again this is something that we see would need to be implemented once the recovery is firmly underway.
QUESTIONER: Could you talk more about the team's assessment of the value of the dollar, please?
MR. KRAMER: We really haven't changed our analysis on the dollar. We have our standard analysis in the report. Another thing I would mention there again along the lines of my earlier remarks is that there is as we mentioned in the report substantial uncertainty. You can think back to what's happened during the crisis where we've seen some pretty sizable swings in the dollar, first among safe-haven flows that pushed the dollar up, and then the subsequent unwinding of that, but there's really nothing new in what we have in the report.
QUESTIONER: I haven't been able to find this in the report but I was told that this would be the place to ask. What do you think of the proposal by the Obama Administration of the economic effect of separating prudential regulation of banks from consumer protection? It's pending in the House. I was told that the IMF will have some view on that and you are the guys to ask. What can you say to that?
MR. KRAMER: There are two observations we'd make on that. First of all, the key principle is that prudential regulation needs to be strengthened and be uniformly strong across the board, and a clear message coming out of the crisis is that prudential regulation needs to be enhanced significantly. Part of your question goes to an organizational issue, and looking around the globe we see financial supervision and regulation organized in a number of different ways. In some places we see it organized along functional lines where you have regulators for insurance companies and securities companies individually and so forth, and in some countries we have regulation along conceptual lines you could say, so you have prudential regulation and consumer and investor protection regulation. We're not of the view that there is any one sort of magic bullet or any one formula for this. Again the key thing is that you need strong and sound prudential regulation across the system.
QUESTIONER: To the degree that unregulated subprime lending in some cases by bank affiliates at least triggered or started the rumblings of this. What protection do you think should be in place so that that doesn't happen again?
MR. KRAMER: Again I think the issue is that you need strong prudential regulation across the board. Consumer products are obviously one area, but there are a lot of others. You mentioned nonbanks, for example. We think it's very important that the administration has proposed to bring nonbanks under a stronger regulatory net to the extent that they're systemic, so we think that the proposal in particular to designate certain banks and nonbanks as tier one financial holding companies that would come under stronger regulation is a very good thing.
QUESTIONER: One last follow-up, and I appreciate it. Maybe you can react to this. The President at the Philadelphia Federal Reserve said that he thinks that it will distract the Federal Reserve System to regulate hedge funds and other nonbanks that are called system, that it may not be a good idea. Do you have any view on that?
MR. KRAMER: Again, there are a lot of different ways to organize financial supervision and regulation. We agree that there are institutions like hedge funds or like insurance companies that can be systemic, and I would again call to the broad principle that all those system institutions need to be brought under strong supervision and regulation again just to contain the systemic risks that we can emanate from those types of institutions.
QUESTIONER: It seems that you are extraordinarily anxious to pull your punches on the dollar, which you don't want to kick it while it's down. Can you go into a little more depth? Isn't the weakness of the dollar in your view absolutely necessary to solve the long-term imbalances, crisis or no crisis?
MR. KRAMER: Let me speak to the question of the dollar first and then the longer-term issues that I mentioned before, and I may ask Mr. Estevao to say a little bit about the longer-term issues on the fiscal.
First of all, on the dollar as I mentioned, we've seen a lot of gyrations in the dollar recently. We saw it come up pretty strongly during the crisis with a lot of flows into the dollar of a safe-haven nature. More recently, as the outlook as improved and confidence in financial stability has come back, we've seen some of that come off, so we've seen some dollar weakening. I think one lesson about this is that it's just unusually hard to say what the outlook would be from that point of view.
But over the longer term I guess we see a couple of issues. Again one is on financial supervision and regulation as a structural issue that needs to be dealt with. But also on the fiscal side, maybe Marcello if you want to say just a few words about that.
MR. ESTEVAO: You mentioned the issue of global adjustment when asking about the dollar. The bigger issue here is that some regions of the world have "consumed too much”, while others have not “consumed enough”. One could put the issue in that way. What we actually see going forward is the savings rate in the United States going up a bit and that's an actual adjustment for this type of imbalance and that is currently happening.
In the same way, we do see an increase in the fiscal deficit in the next two fiscal years, but that is due to the measures that were taken to ameliorate the effects of the crisis. Going forward, as Mr. Kramer mentioned, the issue is how much of a fiscal adjustment there will be and then how much national savings the United States will produce and how those factors will contribute to unwind the imbalances that we've been seeing. We are of the view that to achieve more public savings going forward, reforms are needed, in particular the health care reform proposed by the administration is a good step and the desire to broaden health care coverage while at the same time making it deficit neutral is the way to go. So anything that goes in the direction of lowering the fiscal pressure in the long run is a good thing. I would invite you to think in these terms as well. There are other ways of thinking about global adjustments and some of the adjustments are going on right now.
QUESTIONER: I think more to the point we've all seen these projections by government and nongovernmental agencies about U.S. deficits incredibly large for years way beyond the 3-year horizon, but isn't there a silver lining from your point of view, from the global point of view, that a dollar weakening would help in the long term?
MR. ESTEVAO: Again we are one of the institutions, as you have seen in our report, foreseeing significant fiscal pressures in the future. One of our key lines is that after the recovery is well in place (maybe after 2012) we do see the need for a fiscal adjustment, probably in the form of increased tax revenues like we say in the report. That is actually because we have a worse macro scenario than many of the institutions out there, in particular the OMB and the CBO. We do see a need for a stronger adjustment than the administration has. The key for us is that the fiscal adjustment happens after the recovery is well in place and that there is a focus on measures that would increase welfare while, but at the same time, being budget neutral, including probably some increase in tax rates and compliance.
MR. KRAMER: Just to elaborate on what Mr. Estevao said, part of the reason as we say in the report that we see a need for some reliance on revenue measures and discretionary spending is already quite low. But at a general level I'd just reemphasize two things that he mentioned. One is just to be clear here, we see that now is the time for stimulus, so we're saying that the stimulus is good and should be maintained on both the fiscal and monetary side. The other is that over the medium term there are fiscal issues to be dealt with and we see fiscal steps as needed.
QUESTIONER: Earlier you mentioned that because of the higher savings that U.S. consumers were not going to be the buyers of last resort I think you said. I was wondering on the other side, are you expecting the U.S. economy to get any help from exports next year is that not a source of strength anytime soon?
MR. KRAMER: Mr. Estevao may want to add something. One thing I would refer to is our economic update that came out on July 8. I'm here looking at growth globally, that outlook had a contraction of 1.4 percent this year, and an expansion of 2.5 percent next year. Broadly, the update characterized the global economy as beginning to pull out of recession, but again, along the lines of what we've been saying on the U.S., recovery is expected to be sluggish, so some improvement but not necessarily to a very vigorous level in terms of global economic activity.
MR. ESTEVAO: I would see it in terms of the contribution of exports to U.S. growth. As Mr. Kramer just mentioned, the world outlook is not strong. We do see a recovery, but it's not a strong recovery. So the recovery in the United States is going to be more forceful only after 2010 Q1 on the strength of inventory buildup, modest strength of consumption and a turnaround in business fixed investment. That's the story, it's a domestic story, it's a story of slow recovery, it's a story of a downward adjustment which was very, very strong. You saw the GDP release today: there was another quarter of contraction in Q2. So there was already a lot of adjustment in the economy. Consumers have adjusted so much, and investment and inventories as well, that what you see going forward is a slow recovery, people going back to the housing market (instead of staying in the sidelines) as they get married or as they move, and consumers buying new refrigerators slowly. It's not a story about exports.