Transcript of a Press Conference on the Analytic Chapters of the World Economic Outlook

With Jörg Decressin, Senior Advisor, IMF Research Department,
John Simon, Senior Economist, IMF Research Department,
Abdul de Guia Abiad, Deputy Chief of the World Economic Studies Division, Research Department, and
Gita Bhatt, External Relations Department
Wednesday, September 14, 2011
Washington, DC
Webcast of the press conference Webcast

MS. BHATT: Good morning. And good day to everybody on line. Welcome to this press briefing on the analytical chapters of the World Economic Outlook, Chapters 3 and 4. I’m Gita Bhatt, from the External Relations Department. Let me remind you that Chapters 1 and 2 of the World Economic Outlook, which includes the latest forecasts, will be released next week, on Tuesday, September 20th, just ahead of the annual meetings. The press briefing today will focus only on the two analytical chapters, which you have all received under embargo. Let me hand over now to Mr. Jörg Decressin, Senior Advisor of the IMF’s Research Department, who will make some brief introductory remarks, after which we will hear some of the main messages of the chapters from the team leaders.

MR. DECRESSIN: Thank you to those of you who are here, and those online. Our analytical chapters traditionally look at specific issues in more depth. And this time we’ve selected two issues: the implications of commodity price swings for monetary policy, and the implications of fiscal consolidation for global demand rebalancing. The lead author of the chapter on monetary policy sits to my immediate right and is John Simon. The lead author of the paper on fiscal consolidation and global demand rebalancing is Mr. Abdul Abiad. With this, I’m now passing the floor to John Simon.

MR. SIMON: Thank you, Jörg. Just to make it clear, this was a team effort, and I was assisted in writing this chapter by Daniel Leigh, Andrea Pescatori, Ali Alichi, Luis Catâo, Ondra Kamenik, Heejin Kim, Douglas Laxton, Rafael Portillo, and Felipe Zanna.

So, the main message of our chapter is to target what you can hit for central banks. Now, to spell this out in a bit more detail, what we mean is that central banks should focus on the medium-run element of inflation -- the element that is not affected by short-run commodity price volatility. So that boils down to targeting underlying inflation.

Now, what we mean by “underlying inflation” I’ve just explained, but how you measure that can vary from country to country. So in some countries you might target core inflation, which is a relatively well known measure where you exclude food and fuel from the index, but in other countries you might use different methods. Some countries target forecasts of inflation.

Our findings come from looking at the effects of commodity prices across a range of countries. And what we find is that these effects vary, depending on the nature of the country. And, in particular, there seems to be a separation between advanced countries, which tend to have highly credible central banks and relatively low shares of food in the consumption basket, and emerging and developing economies, where there is less credibility of the central bank, and generally higher shares of food in the consumption basket.

And what the effect of these means is that in these emerging and developing countries, food price shocks can have a much larger effect on headline inflation. And so the challenges that these banks face are much higher.

So the way we get at this is we then develop a model from these facts, and we find that what really matters is the credibility of the central bank. If the central bank can consistently hit its targets, this builds up its credibility which in turn leads wage and price setters to set their own prices on the basis of the target the central bank has -- and this actually makes it easier for the central bank to hit its targets.

We also examine the implications of these findings in light of current conditions, thinking about the particular circumstances that advanced and emerging and developing countries find themselves in today. We find that for advanced countries, which typically have credible central banks -- but also, at the moment, are dealing with relatively large output gaps, low demand -- that they can afford to look through current commodity price shocks, because all that would happen is that they would end up getting closer to their target.

Conversely, in areas where inflation may be above target, where there might be some overheating, we find that actually the effect of missing your target is magnified when you’re already above target -- which argues for a much more active policy response because the effects are greater than if you were at target or below target.

So to summarize, because of the effects on credibility, we suggest that central banks should target a measure that measures the medium-run, the underlying inflation. And, conversely, the difficulty that you can see in hitting a volatile headline target means that if you do target that, it’s going to be a very hard. So, target what you can hit.

MS BHATT: Abdul?

MR. ABIAD: Thanks very much. Chapter 4, which was co-authored with John Bluedorn, Jaime Guajardo, Michael Kumhof, and Daniel Leigh, looks at how fiscal policy affects the current account.

And the reason we’re looking at this question at present is that fiscal tightening will be one of the key factors shaping the global economy over the coming years. You have many advanced economies which are tightening substantially to strengthen fiscal sustainability, and you also have many emerging and developing economies which are tightening both to rebuild fiscal policy room and, in some cases, to restrain overheating pressures.

So, one natural question to ask is, what effect would these fiscal adjustments have on countries’ external balances?

To shed light on this question, we look at fiscal policy changes over the past 30 years in advanced economies, and we also conduct model simulations.

And what we found was that fiscal policy has a large and long-lasting effect on the current account. A one-percent-of-GDP fiscal consolidation typically improves the current account by just over half a percent of GDP within the first two years. And this improvement in the current account persists over the medium term.

The improvement in the current account takes place not just because imports fall as a result of lower consumption and investment. We also found that exports rise, because the currency tends to weaken following a fiscal tightening.

In countries where the exchange rate is fixed, or where monetary policy is limited or constrained, the good news is that one actually sees just as much of a current account improvement -- just as much of a current account response to fiscal policy.

The bad news is that it occurs in a more painful manner. And what we mean by that is that you tend to see a bigger decline in economic activity, because monetary stimulus can’t offset the negative effects of the fiscal tightening. In addition, the real exchange-rate depreciation takes place via a compression of domestic wages and prices, a process that’s sometimes referred to as “internal devaluation.”

There is one special case where fiscal policy has very small effects on the current account, and that’s when all countries are tightening by exactly the same amount. In that case, countries are buying less from the rest of the world, but the rest of the world is buying less from each country as well, and the net effect is lower global demand but not much change in current accounts.

That’s not the case we’re in at present. What we have now is many countries tightening, but some countries are tightening fiscal policy by a substantial amount, and other countries are tightening by much less. And in this case, what matters is how much tightening a country is doing relative to the others.

Germany, for example, is consolidating, but it’s doing so by less than the other eurozone economies. And as a result, these fiscal adjustments within the euro area will actually help reduce imbalances within the eurozone.

Similarly, emerging Asia is also planning to consolidate, but it’s going to do so by less than the rest of the world. As a result, that will help bring down that region’s large trade surplus.

And finally, in the United States, much of the tightening that’s in the pipeline is actually exit from stimulus, rather than more permanent measures, such as entitlement reform, that have the biggest impact on the current account. And this relative lack of permanent fiscal measures, alongside the fact that everybody else is also consolidating substantially, means the current U.S. fiscal plans will probably not contribute to reducing the U.S. current account deficit.

MS. BHATT: Thank you, Abdul. We can open the floor to questions.

QUESTIONER: My first question is on the fiscal chapter. And I’m wondering -- you note that you only take into account, for the U.S., the February budget plan, which was more or less in line with the first stage of the debt-ceiling, I guess, compromise. The second state is to come up with at least $1.2 billion in additional cuts. I’m just wondering, would that, under your model, bring down the current account deficit in any meaningful way?

MR. ABIAD: The chapter used as assumptions for the U.S. fiscal plans was the President’s February budget proposal, which had much more detail on what was going to be done, and was also of similar magnitude, as you noted, as the first stage in the plan passed on August 2.

So to the extent that additional measures are implemented -- yes, that will help, that would contribute to reducing the U.S. current account deficit. Obviously, the exact amount can’t be fleshed out until we know all the details.

QUESTIONER: And on the central bank issue, I was wondering if you could provide any real-world examples of central banks that you think should consider changing their inflation targeting? You know, for example, the ECB targets, from what I understand, strictly headline inflation.

MR. SIMON: What we note in the chapter is that a number of central banks actually target forecasts of headline. And that distinction between current and forecast is important, because the forecast will naturally tend to down-weigh the influences of temporary commodity price shocks.

So what the ECB does in that respect is in line with our advice. They’re targeting something that is relatively stable and is a good reading of the medium-term indications.

We also discuss that the choice might vary across countries, depending upon the way the public understands inflation. And we emphasize that a communication strategy is very important because it’s not sufficient for a central bank to change its target, they also need to have people focusing on that measure themselves.

But a forecast can have the effect of downplaying short-term volatility in commodity prices just as much as an underlying measure can.

MS. BHATT: I have a question online: “Does fiscal tightening have effects on exchange rate, if a country is experiencing massive capital inflows? Can you comment on effects on an exchange rate of the recent fiscal tightening in Brazil?”Abdul?

MR. ABIAD: The chapter looks specifically at the effects of fiscal policy. I won’t be able to comment on the impact of capital flows because that’s an additional layer. But what we do find, in the chapter, is that a fiscal tightening of 1 percent of GDP typically results in a real exchange rate depreciation of about 1 percent. So you do see a depreciation following a fiscal tightening, typically. We do look at three countries in the chapter -- the U.S., Germany and Japan -- because these are large. I’m unable to go into the country-specific details of what other countries’ fiscal plans are and what impact that will have. So, unfortunately, I can’t answer the question on Brazil.

MS. BHATT: I have another question online: “What is the likely current account effect of simultaneous fiscal tightening in the eurozone periphery?”

MR. ABIAD: As mentioned earlier, when one looks at the current fiscal plans of the eurozone economies, many of the economies in the periphery of the eurozone have substantial fiscal tightening plans -- and more than you see, for example, in Germany. And as a result, this improvement in fiscal balances in these other countries will help improve their current accounts. And because Germany is doing less – then the trade surplus of Germany is likely to be reduced as a result of these fiscal policies. Again, this only looks at the impact of fiscal policy, and not at all the other factors.

But, by and large, fiscal policy plans within the eurozone will contribute to reducing eurozone imbalances.

MS. BHATT: Thanks, Abdul. Do we have any other questions?

QUESTIONER: Just three questions, very short. One is, when you say “1 percent of GDP,” I always ask that, because there’s a confusion. Is it 1 percentage point?

MR. ABIAD: Yes, 1 percentage point.

QUESTIONER: And if you can -- and every time you say “percentage,” it’s percentage points?

MR. ABIAD: Well, it’s 1 percent of GDP. So, you have fiscal policy of a certain amount, and you have to measure it relative to something. It’s a change in fiscal policy divided by GDP.

QUESTIONER: So, say, if your deficit is 5 percent of GDP, do you mean then it goes to 4 percent of GDP? Is that what you mean? Of GDP?


QUESTIONER: Okay. So, the U.S. example you have here is the budget as of February. Anything that’s been discussed since is not in the scope of the study.

MR. ABIAD: The February budget proposal from the President had much more detail in terms of specific measures and their impact.

The first stage of August agreement, by IMF staff estimates, will have roughly the same impact as the President’s February budget proposal. But, again, there’s that second stage, where the Congressional committee needs to decide on further measures, and there’s a large uncertainty about exactly what that will deliver.

QUESTIONER: The Super Committee and the $1.5 trillion is what’s not in the scope.

MR. ABIAD: Yes. Because we can’t quantify it.

QUESTIONER: So is it very important right now, in the state of global economy, to reduce current account deficits? Is that a priority? Is that what matters right now? Or, are there other priorities to focus on?

MR. ABIAD: The chapter is not trying to say that fiscal policy should target the current account. You know, fiscal policy has many objectives, including ensuring public debt sustainability, rebuilding fiscal room, responding to cyclical developments -- not to mention, longer term objectives of spending on infrastructure, health and education.

The points of the chapter are, one, to emphasize that fiscal policy has non-trivial effects on the current account that policy-makers need to be aware of. It quantifies exactly what these impacts are. And, third, it also highlights the fact that it’s not just the country’s fiscal policy that matters. What other countries are doing in terms of fiscal policy also matters.

So I would say that at the current juncture, actually, yes, there are many more pressing issues that are facing policy-makers as they try to set fiscal policy. But they do need to keep in mind what kind of effects these fiscal policy choices will have on their current accounts.

MR. DECRESSIN: Maybe let me just add that we’ve always said, in some countries, as a result of the crisis, demand will be permanently lower relative to pre-crisis trends. And therefore if you would like to sustain a relatively healthy global output growth rate, you would have to have demand growing stronger in other countries that have not been hit by the crisis. And that, of course, has implications for current account adjustment in a global context.

QUESTIONER: Yes, just to follow up on that point -- based on this chapter and what you’ve found, would you say there’s growing concern that the G20 goal of reducing global imbalances is at risk? It’s getting further away?

MR. DECRESSIN: I think we can’t comment on that in this context. All we can tell you is we’ve looked specifically at the Euro area and, as Abdul has emphasized --there is a big challenge in terms of narrowing Euro area imbalances. And their fiscal policy is moving in the same direction as external requirements demand.

MS. BHATT: I have another question online: “Can you picture the fiscal tightening in Germany as a beggar-thy-neighbor policy, when you consider effects on other parts of the world than Europe?”

MR. ABIAD: No. When we did the model simulations, it doesn’t just look at the Euro Zone. I was describing the impacts of these fiscal adjustments on the Euro Zone because that is one thing that policy-makers are worried about. Germany has to set its fiscal policy, again, with multiple objectives in mind, including what is happening to its public debt. And -- so, no, I wouldn’t characterize it as a “beggar-thy-neighbor” policy. Again, many countries are consolidating at this point. And Germany’s consolidation is actually relatively small relative to what other countries are doing.

MS. BHATT: Any other questions? Then, thank you you all for coming and to those online.

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