Transcript of a Conference Call on the 2011 United States Article IV Consultation
July 25, 2011Washington, D.C.
Monday, July 25, 2011
MS. BECKMAN: Welome to the call on the U.S. Article IV Consultation Staff Report and the Spillover Report. Today you will be hearing from Rodrigo Valdes, who is a senior advisor in the Western Hemisphere Department and Gian-Maria Milesi-Ferretti who is an assistant director in the in the Western Hemisphere Department. We’ll start with some brief comments from Rodrigo and then after that we will open up to questions.
MR. VALDES: Okay Jennifer, thank you, good morning. The concluding statement of this Article IV Consultation which was presented to authorities was published on June 20. Today we’re publishing the Article IV Staff Report and all the accompanying selected issued papers that are dealing with details of the report. And we’re also publishing the Spillover Report; this is a staff report on the effect of U.S. policies in the rest of the world, and selected issues papers around this report at the same time.
Let me offer you a brief summary of the most important issues in our view that were in this Article IV Report. As usual, we discussed the economic outlook for the country. And here we expect the recovery to regain some momentum in the second half of this year and going into early next year as the soft patch that we observed during the first half of this year will dissipate. However, as we have had in our baseline for quite some time already, we don’t expect a really fast recovery going forward. Importantly, we don’t expect that the economy will recuperate fully to the previous output trend.
With this outlook in mind, this Report examines in detail how policies can strike the right balance between exiting from the extraordinary support that they have been providing and sustaining the recovery amid these renewed headwinds that we have suffered this year.
Of course, we have examined with detail the fiscal situation. The message here is that the consolidation needs to proceed, the dynamics are unsustainable under current policies, and losing fiscal credibility for the U.S. would be extremely damaging for the U.S. and for the world economy. We think it’s urgent to have a political-backed strategy.
For the fiscal side we see some risks of a too front-loaded adjustment and at the same time, an overall adjustment that is insufficient to stabilize debt by mid-decade. This depends critically from our relative conservative assumptions that we have for the economy going forward.
The report, as usual, also discusses monetary policy. The view there is that, going forward, current accommodation will remain adequate for quite some time.
The report also discusses with some detail the status of the housing market. There we think that there is a case for further action from the authorities. And the same with the labor market, where we analyze long-term unemployment and how this raises a number of challenges going forward.
Finally, the report goes into some detail to the financial system. We discussed progress in Dodd-Frank implementation. The FSAP, the Financial Sector Assessment Program that the U.S. had last year, had several recommendations. We take stock of where those recommendations are. And finally, we deal with certain details also in the functioning of the Financial Stability Oversight Council, the FSOC.
With those brief remarks we can, I think, open for questions.
QUESTIONER: Hello, thanks for doing this call. I was wondering what do you see as the effects of a debt rating downgrade on U.S. debt for the rest of the world in terms of spillover effects if the debt rating is downgrading in the coming weeks?
MR. VALDES: It’s highly speculative at this stage to have precise effects. What we have said so far is that downgrade will be very damaging for both the U.S. economy and the rest of the world. The channels here are several, and we could elaborate a bit on those but what we have to be mindful of is there is a lot of uncertainty. This will be the first time that this happened so nobody really knows what will be the true effects. Of course, there are effects in the functioning of repo markets; other securities would be downgraded at the same time; most likely effects on interest rates; stock markets, etcetera. But the extent of those effects, I think, are very difficult to predict with certainty.
QUESTIONER: I have a question on the level of the exchange rate. I read three things in the document: one, that the dollar is at its lowest level in decades; two, that it’s overvalued; and three, that people around the world are concerned with the possibility of the U.S. dollar falling lower. So, can you explain to us how you reconciled these three things?
MR. MILESI-FERRETTI: The level of the exchange reference is a comparison over time of prices in the U.S. relative to its main trading partners. And what has happened is that over time the dollar has tended to weaken in price-adjusted terms relative to its main trading partners. This is why we refer to the weakness of the dollar from a real effective exchange rate perspective. When we assess whether a currency is undervalued, overvalued, or broadly aligned with fundamentals, we look at what happens to the real exchange rate and its underlying drivers, but also what happens to a country’s current account balance and net external position. That is, if a country is running a current account deficit that we deem to be too large relative to the underlying fundamentals -- demographics, growth in terms of trade, and so on -- we say that the currency may need to adjust for the current account to return to its fundamental level.
The U.S. is still running a current account deficit, much smaller than a few years ago but still non-trivial at over 3 percent of GDP. We think that such a level is not an ideal level consistent with the underlying fundamentals of the U.S. economy; the U.S. current account deficit should eventually decline. And for that reason we think that the dollar may still have some way to go to ensure that the U.S. current account returns to a level that is more consistent with underlying fundamentals.
QUESTIONER: But I read another sentence which is, “Consultations with other authorities on U.S. policy spillovers and their concerns with the possible international ramifications of lack of U.S. fiscal adjustment on long-term interest rate and the dollar. So there are other member countries which think that the dollar could fall lower and it would have ramifications all over the world. So how can you say, “we think that the dollar is overvalued” and in the meantime you say, “many people are concerned”?
MR. MILESI-FERRETTI: Yes, you have a very good question. The issue for us is distinguishing between a loss of confidence, say, in the U.S. financial situation, particularly the fiscal one, which could lead to an abrupt increase in interest rates, a very sharp weakening of the dollar -- what we would call an overshooting -- and a gradual and relatively modest depreciation. Our assessment of the dollar’s overvaluation is very modest. We see a more gradual process in which currencies of countries that are running large current account surpluses would gradually appreciate and the dollar would gradually and modestly depreciate.
So these are two very different scenarios. One is a scenario whereby the U.S. has fiscal policies returning to a sustainable path. As a result there would be somewhat lower domestic demand the United States, a bit more fiscal contraction, and at the same time a somewhat weaker dollar which would allow exports to provide more impetus to U.S. growth.
The other scenario that likely reflects the concern of partner countries, is one which is more disruptive, with a loss of confidence in the U.S. and hence an abrupt and large depreciation of the dollar accompanied by disruptions in international financial markets.
MS. BECKMAN: Did you want to comment on the housing market while we’re waiting for the next question?
MR. MILESI-FERRETTI: Well, a few words on the housing market. We see there are clearly very strong interlinkages between the situations of the housing market, the labor market, and overall economic activity in the U.S. Our concerns with the housing market center primarily on the fact that the foreclosure process is an extremely costly way for the housing market to adjust. We see foreclosures are causing much more rapid declines in house prices. We know there is evidence that foreclosed houses sell at much, much lower prices than other houses and we think that the process is costly because you have foreclosed homes reducing the values of neighborhood properties, and more generally a loss of value that is caused by this process.
So we argued for policy efforts that would speed the adjustment of the housing market and help reduce the number of foreclosures. For example, proposals that would lead to a reduction in principal for underwater borrowers that would ease the adjustment of the housing market and could help avoid an overshooting of house prices downward and help sustain both confidence and private sector demand.
QUESTIONER: This is regarding the Spillover Report. In it you discuss the impacts of U.S. fiscal consolidation and looking on page 18, item 32, you talk about the long-term impact. I’m sorry - on page 20, item 35: “Looking ahead a gradual credible U.S. deficit reduction is unlikely to have major growth spillovers particularly compared to those from the loss of fiscal credibility.” Given the timing of this report, did you look at all at the possible impact of a U.S. debt downgrade and the potential spillover from such an event?
MR. VALDES: In calculating effects, the spillovers Report is assuming certain effects on interest rates from an eventual loss of credibility. That’s something different from the particular issue of a downgrade. More in perspective, what the Report does is to put the focus on fiscal consolidation. I would say that downgrades are a reflection of fiscal dynamics; and the Staff Report of the Article IV and the Spillover Report deal with thus deeper issue of fiscal dynamics. The Spillover Report tells the story that is consistent with what we told to U.S. authorities in the consultation, that is that the situation warrants a consolidation even if it has some negative short run effect because the alternative of losing credibility would be a very complex event, difficult to digest, and therefore it’s better not to go there.
Now, that doesn’t mean that everything has to be done in one year. The Report goes very forthright saying that spreading out the adjustment in many years is also important.
QUESTIONER: If I could just follow up on the subsequent item number 33, you refer to senior officials and there’s a discussion here of the impact of a severe and frontloaded U.S. fiscal tightening. I just want to be clear, does that refer to senior officials to whom U.S. officials stated in the Report was shown subsequent to its completion?
MR. VALDES: It reflects senior U.S. officials views, although let me clarify that we did not showed them the Report. The Report is actually first showed to our Board. These are the first people outside staff of the Fund to see the report. What authorities react to is really a discussion. We sit at a table, we can hand sometimes figures, some charts, but it’s around a discussion where they react to.
QUESTIONER: So that caution about the negative short-run impact, that reflects the caution that was expressed by --
MR. VALDES: By the authorities, exactly. They believe that there could be a short-run effect for the rest of the world that would be perhaps larger than what this Spillover Report argues.
MS. BECKMAN: Is there another point in the Report that you’d like to highlight?
MR. MILESI-FERRETTI: Something about financial sector reform. The implementation of the Dodd-Frank Act is proceeding and we think that financial sector reform is really key for ensuring that financial stability is maintained in the U.S. and the rest of the world. The U.S. financial market is really central to global financial markets and ensuring its resilience to shocks is extremely important. And it is also extremely important for the performance of the U.S. economy.
We see quite a lot of progress that has been done on implementation of the Dodd-Frank Act. We do hope that some headwinds to its implementation are going to be overcome, in particular that you can have appropriate funding for those agencies that require appropriations, because the implementation of the Dodd-Frank Act rules is an extremely elaborate and time intensive process. And depriving agencies of funding and staff tends to slow down the implementation process. And, of course, pressures to roll back the scope of financial sector reform ought to be resisted.
At the same time, it is extremely important that the U.S. continues to play a leading role as it has so far in the international coordination of financial sector reform. We know that international financial markets are extremely integrated and it is paramount to ensure that the process of financial sector regulation and reform proceed at a balanced pace across the globe so as to avoid to the extent possible the migration of risk or location arbitrage on the part of the financial sector.
MS. BECKMAN: Okay, I think then that we will conclude the conference call on the U.S. Staff Report and the Spillover Report. And just a reminder everything was on the record and embargo lifts at 11:00 Eastern Time.