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The three percent ceiling should not be treated as an absolute limit
Horst Köhler, Managing Director of the International Monetary Fund, explains his reasons for advising the EU to let France and Germany
go unpunished in the current situation, despite their having breached the deficit limit.
Interview by Georg Hoffmann-Ostenhof and Liselotte Palme
PROFIL (46/03), November 10, 2003

[Translation prepared by the IMF's Bureau of Language Services at the request of the External Relations Department.]

profil: The Russian oil baron, Mikhail Khodorkovsky, was arrested just recently and his shareholdings were confiscated. Many people see that as a political act by President Vladimir Putin. In international circles, there is a fear that property rights in Russia could be at risk. Do you share those fears?

Köhler: For me the whole debate is rather too frenzied. I simply do not know yet whether a breach of the law has been committed, or whether the public prosecutor's office has contravened principles of the rule of law. It could be the case, but I would like to take a closer look at the situation and get to know the details, before I form and express my opinion.

profil: But isn't the public outcry abroad understandable, knowing as much as we do so far?

Köhler: Above all it is a matter that Russia itself must sort out. It was right for President Putin to make it clear upon taking office that a market economy that functions properly needs the rule of law. He will not be surprised that the international community takes him at his word.

profil: Law and order was a commodity in short supply in Russia in the wild 1990s. But at that time, the IMF, as the most significant donor, did not make this a condition of its financial support.

Köhler: That was always one of the key demands of the IMF. It also true, however, that the IMF, together with the World Bank and the entire international community, was more or less steamrollered by the method and dynamics of the privatization process. Mikhail Khodorkovsky did not pay too much attention to international standards at that time. Perhaps the IMF and others were too naïve. In any case it is hard for me to see Khodorkovsky now merely as a wide-eyed innocent. However, the clock cannot be turned back. We must look toward the future now.

profil: Is it conceivable that the IMF would call in its loans to Russia?

Köhler: The IMF is not a bank. Recalling loans prematurely is not one of our tools. If it emerges somewhere as a fact, and I emphasize a fact, that a country has contravened an existing agreement with us, of course we investigate it further and if necessary also suspend payments. In any case, Russia is not expecting any more payments from us. Russia is servicing its loans. There are no complaints on that score.

profil: US President George W. Bush says that he is concerned about developments in Russia.

Köhler: The entire international community naturally has an interest that Russia should not suffer a relapse in the areas of market economy and democracy. However I do have considerable confidence in President Putin in this respect. To my mind, some media are too quick to leap to conclusions. I will make a definitive statement once I have hard and fast information.

profil: Changing the subject, then, you have made several really positive statements about the global economic climate recently. Why are you so optimistic? After all, this year's good third quarter US growth numbers could turn out to be a temporary peak.

Köhler: First, we should all be glad that an economic recovery is now clearly underway in America—a recovery that once again precedes that in Europe. Once again the Europeans are hoping for help from the United States for their recovery. In answer to your question, of course there are still risks of a setback. However, all in all, I believe that the global economy is truly on the road to recovery. Even Europe's conditions for growth are better than they were, as essential structural reforms have been tackled in the mean time. The situation in Japan is developing positively, and Latin America appears to be stabilizing. I believe that the worst of the three-year stagnation phase is now behind us.

profil: What do you think of the argument that Europe could not pull itself out of the mire by structural reform alone, that demand is weak, and it is therefore appropriate to suspend the EU Stability Pact for a while?

Köhler: I consider it to be a serious policy failure, above all on the part of the major European countries, not to have done their fiscal homework—that is, to have reduced the budget deficits—during the good part of the economic cycle. If they had done so, we would not now be in this predicament with the Stability Pact. I might add that I am very much in favor of such a pact in principle. In essence I consider it to be definitely worth preserving to maintain fiscal discipline. Nevertheless, Europe has centralized monetary policy, while fiscal policy remains decentralized—and that is why it needs such an instrument.

profil: Does Europe's economic situation now call for a softening of the pact?

Köhler: It must now be applied in a way that is appropriate to the situation. There are currently considerable imbalances in global external trade positions, between the United States, Europe, and East Asia. The United States has a high current account deficit, while the EU and major East Asian countries are making external surpluses. Admittedly, EU countries, such as Germany, and Austria too, do tend to hope to a certain extent for a stimulus to exports whenever the economy is going badly.

profil: What is wrong with that?

Köhler: Nothing in principle. It is just that we are currently in a situation in which the international imbalances I have mentioned must be managed downward carefully. Countries with surpluses and deficits should not widen the gap between them further. Otherwise there will be an increasing risk of an adjustment in the form of a crash, possibly a dollar crash. That could be very serious. Nevertheless, imbalances cannot be sustained indefinitely.

profil: That means that not too much more can be expected for the recovery from increases in European exports?

Köhler: It can at least be assumed that Europe cannot go on increasing its exports to the United States indefinitely.

profil: What does that mean for compliance with the EU Stability Pact?

Köhler: Let me paint the overall picture from the global point of view once again. First, it is a fact that the economies of the major regions of the world other than the United States are currently not showing as much domestic growth as they need for a sound recovery. Second, it is a fact that these economies with weak domestic demand are reaching the limits of their alternative strategy of forced export stimulus. So in my view, now that it is too late and major European countries have missed the opportunity to make provisions during good times, this is not the moment to treat the three percent ceiling as an absolute limit.

profil: So there should be no sanctions for the offending countries?

Köhler: What is lacking, and what is desired, is domestic demand in Europe. If the offending countries were now to attempt to bring their government deficits down to below the Maastricht three percent limit by year-end, it could even bring about the opposite of the desired effect, that is, an economic slowdown.

profil: Does that mean that you welcome the deficits in France and Germany?

Köhler: As I said earlier, I very much regret that some countries did not get their homework done in good time.

profil: Okay, but now that has happened, and now, as you said, that it is too late for precautionary measures, do you welcome the Franco-German approach?

Köhler: No, I do not want to pardon these countries. I think the EU Commission's proposal is reasonable, requiring that the member countries now reduce what is seen as the "structural deficit" in their budgets by at least half a percent each year. The Stability Pact can therefore be retained in its essence, if bold structural reforms are now carried out in Europe to make the labor market more flexible and to improve the competitiveness of the economy.

profil: But you would consider it harmful to adhere rigidly to the Maastricht three percent ceiling for the overall deficit in the current situation?

Köhler: I would accept another breach of the Maastricht three percent limit in the coming year so long as structural reforms were introduced at the same time that would reliably lead to a balanced budget in the medium term.

profil: Do you see a real danger of the dollar crash that you have not completely ruled out?

Köhler: There is a risk that the dollar could depreciate in a disorderly fashion. It is not however all that probable. So far the dollar depreciation has not only been orderly, but it is also going in the right direction from the economic point of view, helping to reduce the large current account deficit of the United States.

profil: That has however already assumed huge proportions, and the budget deficit has exploded.

Köhler: The International Monetary Fund and I, myself, are the first to say that this situation is not sustainable. I fear that the US government is pinning too much hope on the current account deficit problem solving itself through growth alone. I believe the Americans must also think about expenditure cuts, but they must do this in a way that does not damage or make the necessary reforms of their health and pensions systems even more difficult. For this reason, I do not rule out that if necessary, they must also review their tax reduction policy.

profil: The United States has a double deficit, both in the external sector and now also in the federal budget again. Surely they, too, now urgently need other countries to go on quietly financing their deficit for the time being.

Köhler: What the Americans need above all is strong productivity growth. And they have the best possible conditions for this. The productivity of the US economy increased enormously in the 1990s. Analysts see this as the reason why the dollar is not collapsing. Strong productivity growth always provides the best guarantee that capital flowing to the United States earns a good return. After all if capital providers were suddenly to get the idea that they were not getting a decent return in the United States, then the Americans and the world economy as a whole would really have a massive problem.

profil: In his best-seller, After the Empire: The Breakdown of the American Order, the French political scientist Emmanuel Todd put forward the theory that America is increasingly deindustrialising, is in an economic downtrend, and is pursuing a warlike world policy by way of compensation. Is there anything in that?

Köhler: What is worth considering in that theory is that America must take care not to overextend itself, with actions and wars. However, it is, after all, not the case that production of more cars or more steel proves that an economy is modern and productive. On the contrary, modern increasingly means knowledge, technology, and services. Take Bill Gates or the strength of the financial services sector—in those cases it would be wrong to say that America is on the decline.

profil: Even serious-minded people are sketching out negative scenarios for the global economic trend. Are you still optimistic?

Köhler: Look, we had the financial bubble in the United States and the bursting of that bubble, which was a huge shock. Then we had September 11, 2001. After that we had Enron and other corporate scandals. Then finally we had the Iraq war. The fact that we have survived the turbulent events of the past three years relatively well shows that the international economic system, including that of the United States, is more resilient, and more flexible, than had perhaps been assumed in abstract analyses. Of course some lessons were obviously learned from the crises prior to 2000. While we cannot say that everything is absolutely fine, there is sufficient reason not to overindulge in pessimism.

Interview by Georg Hoffmann-Ostenhof, Liselotte Palme


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