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Transcript of a Conference Call on the Staff Report of the Article IV Consultation and the Financial Sector Assessment Program with the United States
July 7, 2015
Nigel Chalk, Deputy Director of the Western Hemisphere Department and U.S. Mission Chief
Aditya Narain, Deputy Director of the Monetary and Capital Markets Department and FSAP Mission Chief
Andreas Adriano, Communications Department
MR. ADRIANO: Thank you very much and good morning and good afternoon to all of you listening to us today. This is the IMF Conference Call on the United States Article IV Consultation and Financial Sector Assessment Program. I’m Andreas Adriano with the Communications Department. Together with us here we have the two teams that have conducted these reports which are the IMF annual review of the U.S. economy and the five-year review of its financial sector.
We will start with some opening remarks from Nigel Chalk the leader of the team that conducted the Article IV review, and then some remarks from Aditya Narain who is the mission chief for the financial sector assessment program. We will then take your questions. So, Nigel, the floor is yours.
MR. CHALK: Thank you, Andreas. So you’ve all got hundreds of pages of papers, so I’m not going to repeat what’s in the paper. This embellishes a little bit more the views we presented in the concluding statement in June, and also provides you a perspective from the Executive Board. We’ve also released a set of working papers over the past two weeks. For some of them we’ve had blogs as well to highlight some of the main themes in the working papers.
Just to give the bigger messages from the Article IV. I think first quarter was a bad quarter for the U.S., but we see the underpinnings of growth are there, and we see a relatively strong outlook for the next several quarters as the output gap closes in the U.S., excess capacity is eroded, and unemployment falls back towards the natural rate. Clearly, a lot of focus right now is on the Fed’s decision in terms of its first rate hike. We’ve emphasized in the report the importance of remaining data dependent and weighing the risks of potentially slowing the U.S. recovery by moving too early versus creating a little bit more inflation by moving too late.
On balance, I think we would like to see more wage or price inflation before the first rate hike. Based on our own macroeconomic forecast, and assuming that there’s no upside surprise to either growth or inflation, for us this means you start a gradual pace of rate hikes in early 2016.
We’ve looked extensively at the financial sector during this consultation, and Mr. Narain will expand a little bit on that.
On fiscal policy, we continue to see the need for a medium-term consolidation plan in the U.S. The debt is falling, but will start rising again in 2019 as aging related spending starts rising. We feel that there’s a range of options to undertake that medium-term consolidation plan, but right now we see considerable fiscal dysfunction in the way the budgeting process is working.
Finally, the report outlines, as we’ve outlined many times in the past, a range of measures that we think will be helpful to the U.S. economy: to tackle poverty, to raise productivity, to increase labor force participation, and really address some of the supply side challenges that the U.S. economy faces. So with those broad messages I’ll turn it over to Mr. Narain.
MR. NARAIN: Thank you, Nigel, and good morning to all. A few remarks just to place the FSAP in context. This is the second FSAP for the U.S. The first was undertaken in 2010. The FSAP, which is a financial sector assessment program, and I’m going to refer to it as the FSAP henceforth, is intended to be a detailed health check of the financial system for IMF member countries, and for 29 jurisdictions that are deemed to by systemically important this is an exercise we conduct once every five years.
The objective of the exercise is to provide an independent analysis of emerging risks and volatilities, and to assess the resilience of the financial system, and the preparedness of the institutional and policy frameworks to deal with them. To this end, we employ a team of financial sector experts, some of whom we borrow from peer institutions, including central banks and officials of supervisory agencies to undertake comprehensive consultations with both the official sector and the industry. We also run our own stress test in collaboration with the regulators. The U.S. authorities, led by the Treasury, have extended full cooperation to us for this exercise, and the industry has also been very open and candid in discussions with us.
The reports from the FSAP discussed with the Board yesterday are being released today. So what are our main findings and recommendations? Very importantly, we find that the comprehensive reform agenda that has been undertaken over the past five years has enhanced the resilience of the financial system to recover from the crisis and to respond to systemic risk. The institutional architecture has been strengthened with the FSAP now providing a much needed forum for coordination and addressing overall risks to the system. The regulatory perimeter has expanded and information sharing among agencies has improved. Supervisory stress testing is leading changes in risk measurement, and new resolution powers have been established to deal with failures.
But at the same time, we also find that the transition to a safer financial system is still a work in progress. There is a risk of a loss of momentum as the recovery progresses. The rule making under the Dodd-Frank Act provisions is not yet complete. Where it has been completed, in some cases, the implementation has yet to begin, and there are some areas which were at the epicenter of the crisis where reforms have not gone far enough.
More importantly, we find that while the banking system has become healthier and more resilient to severe shocks, new pockets of vulnerabilities have emerged in the non-banks. This is also borne out by our stress test which simulated effects of the 2008-10 recession in banks, insurers, and mutual funds.
The team has made several recommendations aimed at strengthening the micro and macro prudential framework for both banks and non-banks to support the stability of the overall financial system, and for developing credible resolution plans for all systemically important financial institutions, and also, for clarifying the crisis preparedness and management arrangements. I look forward to your questions.
MR. ADRIANO: Thank you very much. We’re ready for questions.
QUESTIONER: Hi, good morning everyone. My first question regards macro prudential frameworks that, Aditya, you were just mentioning. There’s the prospect of new tools is raised, particularly to address market resilience to run risks and fire sales. I would appreciate if you could talk through just what those tools might look like and where you imagine them sitting? So which institution might be deploying?
MR. NARAIN: Thank you very much for this question. As you know, there are currently at the same point of time, consultations ongoing at the Financial Stability Board which are discussing what might be the macro prudential tools that might be employed in such situations. But typically, these are tools which are aimed at both addressing redemption pricing and addressing the fire sale risk and run risk in these points.
These tools are a wide range of tools. They go all the way from, of course, other than pricing tools, these are gates(inaudible) and there are fees, and how they might be employed, and in what situations might be employed are also the subject of discussions. So these are some of the tools that we have referred to and mentioned in the technical systemic risk oversight in the discussion of systemic risk management and major points.
MR. ADRIANO: Thank you. Next question, please.
QUESTIONER: Good morning everyone. A question on your call for a tougher regulation. What you’re asking for tallies very closely with what many members of the Democratic Party want and seems to run in direct opposition to what a lot of Republicans want, so two questions on that. To what extent have you considered the politics in your assessment, and what do you view of the chances of Dodd-Frank reforms actually being diluted on Capitol Hill?
MR. NARAIN: The first question, of course, we do not in all the FSAP exercises we conduct in the member countries, we do not make any specific reference to politics of specific legislative actions or who might be promoting them and what might be the interest behind these actions. Our recommendations are made taking into account what are the best international practices and standards, and as they might be applied in the national context.
So it is likely that there may be some support for some of the recommendations, and there may be some support for going back on some of the recommendations. Our essential call is that there should be, essentially, that the Dodd-Frank Act and the provisions were enacted to deal with specific instances of excesses that led to the financial crisis and that these recommendations, therefore, need to be implemented in order that these situations and these events do not reoccur. If there is a need to review provisions of the Dodd-Frank Act there should be a comprehensive review, a systematic review which will take into account all situations, and be more of a technical review than a political exercise. That’s what we could say on these issues.
MR. ADRIANO: Thank you. Next question, please.
QUESTIONER: Morning, everyone. A couple questions on the Article IV. On the dollar commentary, I’m interested as to why you are emphasizing this risk of cyclical divergence giving an upward leg to the dollar. I mean, arguably, if you look at the Euro Area and Japan, cyclical divergences with the U.S. are somewhat diminished. In terms of the Federal Reserve policy aside of this, would a delay of four or five months make a particular difference to the risks of a big, new surge in the dollar?
Second question, just a specific one on Puerto Rico. I realize this isn’t really IMF territory, but I just wondered if you had any thoughts on a legal change to allow a Chapter 9 for Puerto Rico would be a sensible policy for the U.S. to pursue in this area. Thanks.
MR. CHALK: Okay. Thanks. On the first one, on the dollar commentary. We do, every year, an assessment of where the dollar is relative to medium-term fundamentals, and as part of that we make an adjustment for the near-term cyclical position of the U.S. economy and all of its trading partners. So when we wash all of those things out, we find the dollar to be moderately overvalued, and a little bit stronger than what would be suggested by fundamentals.
Our concern, in terms of monetary policy, is the balance of risks. We see some potential for the first move in the Fed funds’ rate to create a tightening of financial conditions that goes beyond just a 25 basis points move in the Fed Funds’ rate, that might manifest itself in terms of a move upwards in the dollar. It could also manifest itself in terms of an unwinding of term premium and a rise in long term rates or in a decline in equity markets. All of those things would tighten financial conditions in the U.S. and weigh on the economy.
In terms of whether a few months makes much difference. No. I think what you’re intimating in the delay I don’t think it is that tangibly important. I think for us it’s more a case of, looking right now, we see inflation indicators actually declining in the U.S. They’re still relatively far from the Fed’s medium-term goal of 2%. If we look at, say core personal consumption expenditure deflators, average wages are declining in the U.S. The growth in average wages have been declining in the U.S., so we feel that there’s some space for them to wait and see some more wage or price inflation before moving. As I said, under our forecast that would mean -- our forecast was relatively benign on inflation -- which would mean that that would probably be in the early part of next year. But it’s very possible that if we saw more wage or price inflation in the next few months that would lay solid ground for the first rate hike. Thanks.
QUESTIONER: On Puerto Rico?
MR. CHALK: Yes, on Puerto Rico, Clearly we’ve been looking quite carefully at the fiscal situation which does appear quite difficult for Puerto Rico. I think it’s generally viewed that the institutional and legal framework for Puerto Rico to undertake any kind of work out process with its creditors is made much more difficult by the fact there’s no real legal framework, like Chapter 9, particularly for some of the government agencies like the electricity company.
As to the solutions to that, I don’t think we have a strong view. Whether it’s a legislative solution, whether it’s a solution that involves some cooperative work out with its creditors, which seems to be the process that’s happening now. But I think the lack of a strong and consistent legal framework is a problem in a case where it’s likely to need some, at least, reprofiling of the debt.
MR. ADRIANO: Thank you. Next question, please.
QUESTIONER: Great. Thanks a lot. Actually, I wanted to ask you about, I read the section about Dodd-Frank and being careful about, as you’ve now clarified it, you know, being careful about changing it without sinking of the whole thing. I wanted to ask you about, there’s a proposal to raise the definition of systemically important financial institutions from $50 billion to up to $500 billion, and I wanted to know from an IMF perspective can you speak to that, to the idea of if it were done how it should be done?
On money laundering, I saw your side paper about anti-money laundering. One impact of the U.S. regulation has been, for example, to cut or the closing down of remittances to Somalia, people trying to send money back to that country due to fears of terrorism financing. Does the IMF think that the U.S. regulation may have either gone too far or banks are misunderstanding the regulation? Thanks a lot.
MR. NARAIN: Sure. On the first one, our belief is that supervisory approaches should be risk-based, and therefore, the materiality and proportionality of institutions should be taken into account to develop supervisory frameworks. At the same point in time, we all recognize that it’s important to have some clear rules regarding, for instance in this case, size of institutions because not only does it set a baseline for the expectations, but it also provides a useful framework for everybody to anchor their expectations on. So, in a sense, we would agree that it’s important to make these approaches risk-based, and therefore, not dependent on size alone.
I should add also in response to the question that you raised, as well as the point which was made in the earlier question, that our only political ideology is financial stability for the purpose of this exercise.
On the remittances, this is a very important point you’ve raised. This is an issue which has been discussed in several forums where the IMF has been participating. This is an issue not just for the U.S., although it has been most discussed in the context of the U.S., but the effects of the, sort of, diminishing remittances as a result of the application of stringent AMLCFT standards has led to a concern more globally that this much be affecting the flow of remittances to some,. particularly, those jurisdictions where banking systems are more in their infancy and where such remittances and the channels through which they flow are more important.
I cannot at this point say more. While we have not discussed this in the course of the FSAP, there’s work ongoing in the Fund, including in collaboration with other institutions like the World Bank and at the level of the Financial Stability Board. We expect to be able to have more information on this in a few months’ time.
MR. ADRIANO: Thank you. Next question, please.
QUESTIONER: Hi, thanks for taking my question. I was just curious if you floated the idea of setting up a federal insurance supervisor before? That seems like something, at least the U.S. government has kind of talked about? If you could elaborate a bit on why you think that’s necessary given what exists now? Thank you.
MR. NARAIN: Thanks a lot. Yes, we have floated the idea of having a regulator with nationwide remit earlier, including in the 2010 FSAP. In this FSAP we have reiterated this point and, in fact, considered it even more imperative at this stage. The reason why we think it’s very important is because our assessment of the insurance supervisory and regulatory framework against the international standards set out by the IAIS shows that there are several gaps in the framework. At the same point of time, as we point out there are now risks emerging in the insurance sector, and our stress tests suggest that in a severe scenario they might be susceptible to major losses, primarily on account of the way they have reprofiled some of their activities into taking on and assuming more risks.
Why do we think they currently cannot deal with this? One, what we find is that while the NAIC and the state commissioners have made very concerted efforts in an effort to have a more harmonized regulatory and supervisory approaches across all the jurisdictions, but we do find that there are still inconsistent applications. There are differences in all matters, including independence funding, accountability, regulatory approaches, supervisory approaches which also, in some instances, provide for opportunities for arbitrage. For instance, as evidenced by the increase in the affiliate reinsurers, and the fact that despite their best efforts they still have not yet succeeded in fully modernizing the valuation standards, an exercise which has been ongoing for a while now. This, of course, you know, leads to very differing interpretations of the capital adequacy of the insurance firms.
Now, all of this suggests that it’s important for there to be a consistent regulatory and supervisory approach to insurance firms in the United States which is able to address the key risks which the industry is facing in a consistent manor, and applying the international standards. We know that the FIO has been set up to achieve part of this goal, but its role is limited. It’s intended more as a monitoring agency at this point of time. Unless there is an independent regulator which has a nationwide remit to deal with these issues we don’t think that these issues can be addressed by the current configuration.
MR. ADRIANO: Thank you very much, Aditya. Just before taking the next question I just wanted to remind something that was mentioned in our media advisory is that the contents of this conference call have the same embargo of the documents that were posted earlier, so that’s 10:30 Eastern time, so in about 35 minutes. Okay. So next question, please.
QUESTIONER: Hi. I’d like to ask about the prospect of a quarterly monetary policy report at the Fed which is something I know you’ve explored further in a working paper entitled: Avoiding Dark Corners. Now, in the Staff Report, you note that the U.S. authorities highlighted the practical challenges involved in such an undertaking. So were they saying that it was impossible to put out such a report in and FOMC endorsed forecast or were they just saying that the transparency gains aren’t worth the hassle?
MR. CHALK: I’m not going to speak for the Fed on what they think. What we’ve indicated in the report, what we have some sympathy for is, to some extent, is that it’s a large Open Market Committee with a range of differing views across that committee. I think that, which we indicate in the Staff Report, the idea of reaching a majority view among such a diverse committee on a path for growth, path for unemployment, inflation, path for the policy rate would be quite daunting. You know, while we recognize that, we still think that this report would have some value in terms of communication.
In the staff report we point out, for example, that there’s been a lot of emphasis put on, not just the liftoff date, but the whole path of future policy rates. I think such a report, such as we’ve suggested, would perhaps shift some attention away from the liftoff date, and put much more attention on the entire path going forward and the consensus view on the committee of that path going forward.
As you know, right now there is a device that sort of serves this purpose in the sense of the “dot plots”. But the dot plots represent not a consensus view, but an aggregation of individual views of members of the committee. Those members are probably making quite different assumptions. They have different views on growth, and on inflation, and the appropriate policy rate Their own individual set of dots are internally consistent, but it’s not necessarily true that the aggregation of those sets of dots would be internally consistent.
So, we think there’s a process that could be put in place, we outlined in the working paper, where the Fed staff could produce what they see as their best forecast. That could then be endorsed by the committee. Also a quarterly report could provide some scope to show some dissenting views among the committee of where committee members think the risks are. For example, being behind the curve or where there’s a risk of moving too quickly. It would give the public a much broader range and sense of texture of the views of the FOMC.
MR. ADRIANO: Thank you. If there are no further questions we will conclude this conference call. Thank you all very much for participating today, and let me remind you once more that the contents of the conference and of the report are embargoed until 10:30 Eastern time. That’s 1530 Central Eastern Europe time. Thank you very much and have a good day.
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