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Global Imbalances: A Saving and Investment Perspective
The objective of this chapter is to examine the changes in saving and investment behavior in the major industrial and emerging market economies that have resulted in this unprecedented widening of global imbalances and the low level of long term interest rates.
The chapter shows that, rather than being excessively high, global saving is actually near historic lows, having declined markedly since the late 1990s. This decline has been due both to factors that have commonly affected many countries--such as the impact on saving of increases in the availability of credit and rising asset prices--and to country and regional specific developments, including the fiscal deficits in the United States, population aging in Japan and Europe, and the slump in investment in Asia (excluding China).
At the same time, the fall in global investment rates has been even steeper and global investment appears to be unusually low for this stage of the economic cycle. This is because of the ongoing efforts from corporates in many countries to strengthen their balance sheets by paying down debt. Consequently, despite strong corporate profit growth, investment has generally remained weak. In emerging Asia, in particular, there is evidence that a number of countries are currently "underinvesting."
Based on these two findings, the chapter suggests that low long term interest rates are largely the result of low investment rates rather than of too much savings.
Another finding of the chapter is that differences in saving and investment behaviour across countries have had significant implications for global current account imbalances. In particular, with saving falling sharply in the United States, the current account deficit--the excess of investment over saving--has reached an unprecedented level (projected to be 6.1 percent of GDP or $760 billion in 2005). Elsewhere, rising saving in China and oil producing countries and weaker investment in Japan and emerging Asia (excluding China) have resulted in an excess of saving over investment (a current account surplus).
The current constellation of global imbalances thus involves a large and diverse group of countries. The current account deficit in the United States is matched by significant surpluses in several countries, including a number of emerging market and oil producing economies. This stands in contrast to the mid-1980s--the last time the global economy was faced by large current account imbalances--when the imbalances were largely concentrated between the United States, Japan, and Europe (mainly Germany).
What are the implications of these findings for the global economic outlook? The chapter suggests that:
First, the evolution of investment will be a critical factor in determining the path of long-term interest rates going forward. A revival of global investment--which might be expected to occur once corporations have reduced their debt to comfortable levels--is almost certain to send long-term interest rates higher. Such an increase in interest rates, however, would likely put pressure on overheated housing markets in a number of industrial countries, and could undercut private consumption.
Second, given the scale of current imbalances and the size of adjustment that is economically and politically feasible in any one country, there is no single "silver bullet" that will address the current situation. Rather, actions will be needed across many countries. In particular, the results in the chapter indicate that steps to increase saving in the United States, reforms to boost growth in Japan and Europe, and measures to raise investment in Asia and oil exporting countries would all move global current account imbalances in the right direction.
I want to talk to you about a chapter in the latest edition of the World Economic Outlook. This chapter examines how to build better institutions that will support strong, private sector-led growth in developing countries. I prepared it together with Martin Sommer and Nikola Spatafora, also of the IMF.
World leaders are meeting at the 2005 World Summit in September to discuss policies to achieve the Millennium Development Goal of reducing extreme poverty in half by 2015. Rapid and stable economic growth in poor countries is essential towards reducing poverty. In turn, growth depends critically on having high-quality domestic institutions, including strong property rights, solid public and private governance, and low levels of corruption. Research in the April 2003 World Economic Outlook emphasized that, if average institutional quality in Africa could be raised to the level prevailing in developing Asia, per capita GDP in the region might be expected to almost double over the long term.
If institutions are so important for growth, it is natural to ask whether, and if so, how they can be changed. To date, these critical issues have attracted little systematic analysis. Our work represents a first attempt by the IMF to address the topic. What are our key findings?
First, rapid institutional change is possible. It is commonly argued that institutions are largely the result of a country's history and culture, and are therefore almost impossible to change. Our evidence suggests otherwise. Over the past 30 years, noticeable institutional improvements have occurred in some 65 developing countries. Encouragingly, about one quarter of these "institutional transitions" occurred in Africa, demonstrating that progress is possible even in the poorest countries.
Second, many different institutional forms can deliver good institutional outcomes. So, reform strategies need to be country-specific, and recognize that the appropriate design of specific institutions may change over time. For instance, we find that China benefited from the creation of "township-village enterprises" as a transitional institution toward full-fledged private ownership. In contrast, many Central and Eastern European countries found it possible to adopt complete private ownership from the very onset of reforms.
Third, good economic institutions are most likely to flourish in an environment where economic "rents" are relatively small, that is, where small groups cannot take advantage of, say, monopoly positions in a particular industry or activity, or privileged access to natural resources. Good economic institutions are also likely to be accompanied by good political institutions, so that those who wield power are subject to checks and balances. Specifically, we find that rapid institutional improvements are more likely to occur in countries that are more open to international trade, and where the political executive is subject to a greater degree of accountability. A high level of education among the broad population, and being close to other countries with relatively good institutions, also help.
Overall, our analysis reinforces the case for developing countries to undertake ambitious trade liberalization under the Doha Round. Beyond that, strong regional leadership can play an important part in strengthening institutions, as shown by the European Union's role in underpinning institutional reform in Central and Eastern Europe. This underscores the importance of strengthening existing arrangements in other regions, such as the New Partnership for Africa's Development. Greater transparency is also crucial, especially in countries with large natural-resource wealth, since this can often have a corrosive effect on institutions.
Well, I hope my brief remarks stimulated your interest in the area of institutions and the importance it has in fostering growth and alleviating poverty. Many of you will want to find out more about building high-quality institutions, and I hope the analysis in the chapter will help contribute to understanding this issue better.
Does Inflation Targeting Work in Emerging Markets?
Let me start with some background. Today inflation targeting is a popular strategy for monetary policy. Inflation targeting was first adopted in the early 1990s by industrial countries like New Zealand, the United Kingdom and Canada. Under inflation targeting, low inflation is the primary goal of monetary policy, and the only one for which a numerical target is announced, although other goals like full employment or low exchange rate volatility may be pursued on a secondary basis.
Another characteristic of inflation targeting is that the forecast of inflation serves as a guidepost for policy, providing early warnings of inflationary pressures. Normally, inflation is partially predetermined due to outstanding price and wage contracts and indexation to past inflation, hence monetary policy can only influence inflation with a lag. Setting monetary conditions such that the inflation forecast at some horizon is in line with the inflation target can help bypass this lag, because it aligns the policy instrument with the ultimate goal of monetary policy.
21 countries (of which 8 industrial and 13 emerging markets) are now inflation targeters. Following in their footsteps, many other countries are considering inflation targeting. Yet, while there have been numerous studies of inflation targeting in industrial countries, there has been little analysis of the effects of inflation targeting in emerging market countries. This chapter makes a first attempt to fill this void. A new and detailed survey of 31 central banks (21 inflation targeters plus 10 non-inflation targeters) was conducted to support the analysis in the chapter.
The first question that we ask in the chapter is: Does inflation targeting work in emerging market economies?
Our answer is yes.
The evidence presented in the chapter suggests that inflation targeting is associated with a significant 4.8 percentage point reduction in average inflation, and a reduction in its standard deviation of 3.6 percentage points relative to other strategies, giving also a "bonus" in terms of lower inflation expectations. These benefits come with no adverse effects on output. In addition, under inflation targeting interest rates, exchange rates, and international reserves are less volatile, and the risk of currency crises relative to money or exchange rate targets is smaller.
Interestingly, inflation targeting seems to outperform exchange rate pegs--even when only successful pegs are chosen in comparison.
Results appear robust under different partitionings of the historical sample or when the control group was made more homogenous to the inflation targeting group by past inflation records, per capita income levels, level of external indebtness or fiscal outlook.
The second question that we ask is: Do countries have to be in good institutional and economic shape to adopt inflation targeting? Our answer is no. The survey evidence indicates that it is unnecessary for countries to meet a stringent set of institutional, technical, and economic "preconditions" for the successful adoption of inflation targeting.
Before the adoption of inflation targeting, all but two of the emerging market prospective adopters were less than half the way on their path towards ideal conditions-lacking, for example, technical capability of the central bank in implementing inflation targeting, financial market soundness, and an efficient institutional set up to support and motivate the commitment to low inflation. Mexico and South Africa were just about half way. However, conditions improved dramatically in all countries in the years following the adoption, suggesting that the success of an inflation targeting regime appears to depend more on a country's commitment and ability to plan and drive institutional change after the launch of inflation targets.
In short: inflation targeting is a promising strategy for non-industrial countries and advice should concentrate on what institutional progress after adoption can guarantee success. Inflation targeting is a relatively new monetary policy framework for emerging markets, but the evidence from the initial years of operation is encouraging. Because it enables to reduce inflation fast and on a durable basis without hurting economic activity, inflation targeting is a natural appeal for emerging markets where poor past inflation records make it more difficult to build credibility and where keeping to a minimum the output costs of reducing inflation is imperative both for social and political reasons. Policy advice for prospective inflation targeters could focus on the institutional and technical goals central banks should strive for during and after the adoption of inflation targeting in order to maximize its potential benefits.
This is the end of my presentation, and I hope you enjoy reading this chapter.