## CONSOLIDATED SPILLOVER REPORT — IMPLICATIONS FROM THE ANALYSIS OF THE SYSTEMIC-5 OVERVIEW ## Source details **Canonical URL:** [CONSOLIDATED SPILLOVER REPORT — IMPLICATIONS FROM THE ANALYSIS OF THE SYSTEMIC-5 OVERVIEW](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2011/_071111.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2011/_071111.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2011/_071111.pdf.json) --- ### Overview - Purpose: Spillover reports explore the external effects of policies in five systemic economies: China, Euro Area, Japan, United Kingdom and the United States. - High-level lessons: - Short-term policy spillovers hinge on their effects on financial markets; when the financial system is stressed and there is fiscal space, as in 2008-09, macroeconomic stimulus makes sense and yields significant positive spillovers. - Once fiscal space recedes, external demand spillovers from fiscal consolidation in advanced economies would be small in comparison to those that would follow from compromised fiscal credibility. - Given the importance of financial channels and the centrality of US-UK-European financial core, stronger and more coordinated regulation in the core is essential. - China and Japan spillovers are mostly expressed through real channels that take longer to play out; Japan’s fiscal strains could propagate rapidly via financial channels. - National and global goals are generally aligned in mitigating global tail risks, but different cyclical positions create tensions and tradeoffs (e.g., easy monetary policy in sluggish advanced countries vs. complications for booming emerging markets). - The task of using spillover analysis to formulate global policy prescriptions is for the Fund’s multilateral surveillance and should be presented to senior policy makers at forums such as the IMFC and G20. - Date on report: July 11, 2011 ### Context: scope and role - Role of spillover reports: - Articulate partner concerns, quantify external effects, and foster multilateral dialogue, filling a gap between country/bilateral surveillance (Article IVs) and global/multilateral surveillance (WEO-GFSR). - Not a recipe for global coordination at the Fund’s Executive Board or IMFC level; not a substitute for processes like the G-20 Mutual Assessment Process; not a surrogate “Multilateral Consultation” of 2006. - Provide granularity to Fund analysis and policy advice; topical focuses include quantitative easing (QE) impacts from the US and renminbi appreciation impacts from China. - Exercise design: - Emphasis on individual countries’ outward spillovers rather than policy interactions; global policy agenda to be addressed in upcoming multilateral surveillance. ### Implications for Policies — systemic differences and model insights - Systemic differences: - US and Euro Area are large; US is central to the global financial system. - China and Japan are smaller with different trade and financial linkages. - UK is far more important to global finance than to trade. - Unified-model insights: - Regional component to growth spillovers: Japanese shocks most affect China (and vice versa); Euro Area shocks most affect the UK (and vice versa); United States matters profoundly to everyone, especially Canada and Mexico. - US omnipresence stems from financial sector dominance and the dollar’s reserve role; UK financial heft explains its capacity to affect the United States comparably to the larger Euro Area. - When financial channels are traced (co-movement of yields and risk premia), spillovers are an order of magnitude higher. ### Financial channels and fiscal credibility - Financial channel centrality: - Near-term external impact from macroeconomic policy depends on its effect on financial conditions; when financial conditions are stressed and liquidity is uncertain, correlation in long-term bond yields rises and the impact of monetary and fiscal stimulus on others’ yields and currencies is especially powerful. - Historical examples: QE1 had a far more profound effect on the rest of the world than QE2; the 2009 fiscal stimulus was more globally stimulating than the 2010 stimulus. - Fiscal space and credibility: - If fiscal space recedes and financial conditions do not deteriorate, the demand spillover from reversing stimulus should be small, manageable, and even positive in some cases. - Conversely, loss of confidence in sovereign debt sustainability would have enormous consequences; example metrics shown for a large jump in US long-term Treasury yields and contagion risk from Japan. - For Europe, if sovereign-debt stresses in periphery spread to core EA banks, the global hit to bank risk premia could rival that from Lehman in 2008. ### Regulatory and supervisory implications - The immediacy of financial channels implies the world has a stake in stability and in avoiding regulatory and supervisory gaps and inconsistencies. - Despite efforts (Basel III, designation of global SIFIs), success is uncertain; market responses to Dodd-Frank differed across US vs. UK and Swiss bank shares, highlighting potential regulatory arbitrage and fragmentation. - Cross-border resolution of banks remains unresolved. - Policy implication: stronger and more coordinated regulation and cross-border supervisory cooperation in the financial core is essential to limit systemic spillovers. ### China-specific findings - Closed capital account does not eliminate important spillovers; China’s external effects manifest through real channels that take longer to play out. - Disruption to China’s steady growth, including from stresses in its unbalanced growth model, hurts partners and commodity producers. - Currency appreciation alone yields only modest growth spillovers; significant positive spillovers require broader reforms to cut savings and raise depressed factor costs. - Reserve build up may be pushing down advanced country yields and hence capital out to EMs, though the effect is likely smaller than from other push and pull factors. - Currency internationalization and financial opening would likely generate more financial effects beyond reserve build-up effects. ### Box 1 — Main Messages from the Five Spillover Reports (selected) - US: - With US shocks transmitted mainly via financial channels, strong regulation, supervision, and cross-border cooperation are crucial; implementation specifics of Dodd-Frank remain unclear, creating high risk of regulatory arbitrage. - QE: - QE1 yielded larger effects on foreign bond yields and currencies than QE2, reflecting more stressed financial conditions in 2009; main risk from monetary exit is reversal of EM capital inflows and currencies. - US fiscal consolidation: - Has manageable negative growth spillovers in current conditions and tackles a key global tail risk by enhancing US fiscal credibility. - Euro Area: - Direct spillovers from stress in EA program countries are manageable; but if stress casts doubt on core EA banks soundness, spillovers would be large—often as large as after Lehman and now with less policy space; EA fiscal consolidation has only minor contractionary demand effects on the rest of the world and could be positive if it lowers high sovereign risk premiums. - China: - Early adjustment in China’s growth model yields positive spillovers; unclear if China’s closed capital account is diverting capital flows to EMs. - UK: - UK financial system is key to global stability; need top-notch regulatory and supervisory regime; tighter liquidity, capital, and leverage rules and macro-prudential policies would lower systemic risk, though liquidity self-sufficiency requirements can trap costly pools of liquidity without cross-border protocols; risk of becoming a magnet for risks regulated out of other jurisdictions. - Japan: - Supply chain disruptions from the recent earthquake are transitory; spillovers from fiscal consolidation are mild, especially if accompanied by structural reforms and mostly confined to Asia; bigger risk is souring of confidence in sovereign debt, which could hit other high debt countries. ### Implications for Global Collaboration and process observations - Exercise focus and consultations: - Focused on each economy’s outward spillovers, based on consultations with systemic partners and a range of emerging market economies (Brazil, Hong Kong SAR, India, Indonesia, Korea, Mexico, Poland, Russia, Singapore, Thailand, and UAE). - The focus prompted some to declare themselves net importers of spillovers, but the tendency to downplay outward spillovers was generally resisted; discussions were positive and constructive even when disputed. - Alignment of national and global goals: - Spillover analysis confirms national and global interests are relatively aligned in mitigating global tail risks. - Examples: - Staff advice for credible fiscal consolidation in advanced countries is consistent with global interest in eliminating tail risk of financial instability from fiscal concerns. - Staff advice to accelerate currency adjustment and rebalancing in China tackles internal stresses and yields positive external spillovers. - Acknowledgement that near-term costs will be greater for countries undertaking consolidation or appreciation and that policies must account for cyclical factors. - Tension areas: - Monetary policy in advanced countries (notably the United States) creates tradeoffs: easy monetary policy to promote lending and risk-taking makes sense for sluggish advanced economies but complicates macroeconomic stabilization in booming, financially open emerging markets. - QE2 had modest direct effects on EM yields and currencies, but concurrent improvement in global conditions contributed to asset and commodity price pressures in EMs. ### Section 2 — Scope and key policy questions - Key policy questions: - Is there an externality or special circumstance that warrants advanced country central banks to take a broader view of their financial stability mandate? - From a spillover perspective, does action to address fiscal credibility in advanced markets create more leeway for easy monetary policy in advanced countries? - Through what combination of currency-macroeconomic-macroprudential action should EMs respond, and what would be the associated spillovers? ### Limitations of current country/Article IV spillover reports - By construction, as part of country/Article IV surveillance, spillover reports do not examine how policy spillovers across countries interact with one another. - Illustrative interaction issues: - Uncertainty from advanced country financial stress may have dampened the effectiveness of policies to decrease precautionary savings by households in China. - The interruption of RMB appreciation in 2008 may have limited China’s support to global demand at a time of a generalized demand shortage. ### Need for multilateral surveillance of policy interactions - The Fund’s multilateral surveillance should address how policies add up and interact—e.g., is simultaneous fiscal consolidation as benign as individual actions?—including contributions to the G20 Mutual Assessment Process. - A discussion with senior policy makers is critical to the traction and future of spillover analysis as a surveillance tool. - The planned discussion at the IMFC, as part of the consolidated report on multilateral surveillance, is identified as an important next step. ### Decision points on continuing the exercise - Timing: The Board will need to decide if and how to continue the exercise, preferably in the Fall after the upcoming Triennial Review of Surveillance. - Specific issues for decision: - Frequency—annual or longer? - Annual spillover reports are feasible, but it may be difficult to add much new content for some countries at this frequency, potentially undermining traction. - Coverage—S5 or wider? - Covering more than a handful of economies will be costly, even accounting for fixed costs already incurred in setting up processes and basic economic models. - It is estimated that the exercise has involved 8 full time equivalents in staff time and travel costs across the Fund. - Consideration should be given to including other large players from time to time—e.g., oil producers, other BRICS economies. - The impact on smaller EMs and low income countries also warrants better coverage in future. - Context—multilateral or Article IV? - The current spillover exercise has been conducted in the context of bilateral surveillance, allowing staff to use an existing modality for discussions with officials and to bring a global perspective to policy advice in Article IVs. - The goal of the exercise is inherently multilateral in nature, and it should arguably be undertaken in the context of multilateral surveillance, especially if policy interactions and coordination issues are to be explored. ### Concluding assessment - Status of the initiative: - Spillover reports are still in their infancy and their value as a surveillance tool has yet to be established. - Many of the models and methodologies developed for the exercise are relatively new. - There remains the unfinished task of systematically exploring policy interactions and combinations. - Appropriate vehicles for multilateral work: - WEO, GFSR, and the new Consolidated Multilateral Surveillance Report, as well as related initiatives such as the G20 Mutual Assessment Process. - Strengths of the initiative: - Addresses issues raised by partner countries in a confidential setting that allows airing views otherwise papered over in Fund surveillance. - Brings a more multilateral perspective to policy advice in Article IVs, meeting a long-standing demand of the membership. - Key substantive finding from the first round: - Spillover reports highlighted the importance of the financial channel as a key determinant of what near-term effect any given policy change has on others. - Spillover analysis confirms that national and global goals are relatively aligned in the case of fiscal and regulatory policies insofar as they attenuate tail risks to the global economy from the loss of confidence in fiscal sustainability and financial stability. - Advanced country monetary policy is more complex, given differing cyclical positions. - Even where domestic and external goals seem to converge, more spillover analysis, discussion, and cooperation would still be needed (examples: financial regulation and the resolution of global imbalances). *Prepared by Ranjit Teja and Rishi Goyal, with input from Tamim Bayoumi, David Marston, Aasim Husain, and Martin Mühleisen (all SPR).* ### Section 1 ### CONSOLIDATED SPILLOVER REPORT — IMPLICATIONS FROM THE ANALYSIS OF THE SYSTEMIC-5 OVERVIEW ### Overview - Purpose: Spillover reports explore the external effects of policies in five systemic economies: China, Euro Area, Japan, United Kingdom and the United States. - High-level lessons: - Short-term policy spillovers hinge on their effects on financial markets; when the financial system is stressed and there is fiscal space, as in 2008-09, macroeconomic stimulus makes sense and yields significant positive spillovers. - Once fiscal space recedes, external demand spillovers from fiscal consolidation in advanced economies would be small in comparison to those that would follow from compromised fiscal credibility. - Given the importance of financial channels and the centrality of US-UK-European financial core, stronger and more coordinated regulation in the core is essential. - China and Japan spillovers are mostly expressed through real channels that take longer to play out; Japan’s fiscal strains could propagate rapidly via financial channels. - National and global goals are generally aligned in mitigating global tail risks, but different cyclical positions create tensions and tradeoffs (e.g., easy monetary policy in sluggish advanced countries vs. complications for booming emerging markets). - The task of using spillover analysis to formulate global policy prescriptions is for the Fund’s multilateral surveillance and should be presented to senior policy makers at forums such as the IMFC and G20. - Date on report: July 11, 2011 ### Context - Scope and role: - Spillover reports articulate partner concerns, quantify external effects, and foster multilateral dialogue, filling a gap between country/bilateral surveillance (Article IVs) and global/multilateral surveillance (WEO-GFSR). - Not a recipe for global coordination at the Fund’s Executive Board or IMFC level; not a substitute for processes like the G-20 Mutual Assessment Process; not a surrogate “Multilateral Consultation” of 2006. - Provide granularity to Fund analysis and policy advice; example topical focuses include quantitative easing (QE) impacts from the US and renminbi appreciation impacts from China. - Exercise design: Emphasis on individual countries’ outward spillovers rather than policy interactions; global policy agenda to be addressed in upcoming multilateral surveillance. ### Implications for Policies - Systemic differences across the five economies: - US and Euro Area are large; US is central to the global financial system. - China and Japan are smaller with different trade and financial linkages. - UK is far more important to global finance than to trade. - Unified-model insights: - Regional component to growth spillovers (Figure 1): Japanese shocks most affect China (and vice versa); Euro Area shocks most affect the UK (and vice versa); United States matters profoundly to everyone, especially Canada and Mexico. - US omnipresence stems from financial sector dominance and the dollar’s reserve role; UK financial heft explains its capacity to affect the United States comparably to the larger Euro Area. - When financial channels are traced (co-movement of yields and risk premia), spillovers are an order of magnitude higher (Figure 2). - Financial channel centrality: - Near-term external impact from macroeconomic policy depends on its effect on financial conditions; when financial conditions are stressed and liquidity is uncertain, correlation in long-term bond yields rises and the impact of monetary and fiscal stimulus on others’ yields and currencies is especially powerful. - Historical examples: QE1 had a far more profound effect on the rest of the world than QE2; the 2009 fiscal stimulus was more globally stimulating than the 2010 stimulus. - Fiscal space and credibility: - If fiscal space recedes and financial conditions do not deteriorate, the demand spillover from reversing stimulus should be small, manageable, and even positive in some cases (Figure 3). - Conversely, loss of confidence in sovereign debt sustainability would have enormous consequences; example metrics shown for a large jump in US long-term Treasury yields (Figure 4) and contagion risk from Japan (Figure 5). - For Europe, if sovereign-debt stresses in periphery spread to core EA banks, the global hit to bank risk premia could rival that from Lehman in 2008 (Figure 6). - Regulatory and supervisory concerns: - The immediacy of financial channels implies the world has a stake in stability and in avoiding regulatory and supervisory gaps and inconsistencies. - Despite efforts (Basel III, designation of global SIFIs), success is uncertain; market responses to Dodd-Frank differed across US vs. UK and Swiss bank shares, highlighting potential regulatory arbitrage and fragmentation (Figure 7). - Cross-border resolution of banks remains unresolved. - China-specific points: - Closed capital account does not eliminate important spillovers; China’s external effects manifest through real channels that take longer to play out. - Disruption to China’s steady growth, including from stresses in its unbalanced growth model, hurts partners and commodity producers. - Currency appreciation alone yields only modest growth spillovers; significant positive spillovers require broader reforms to cut savings and raise depressed factor costs. - Reserve build up may be pushing down advanced country yields and hence capital out to EMs, though the effect is likely smaller than from other push and pull factors. - Currency internationalization and financial opening would likely generate more financial effects beyond reserve build-up effects. - Box 1 — Main Messages from the Five Spillover Reports (selected) - US: With US shocks transmitted mainly via financial channels, strong regulation, supervision, and cross-border cooperation are crucial; implementation specifics of Dodd-Frank remain unclear, creating high risk of regulatory arbitrage. - QE: QE1 yielded larger effects on foreign bond yields and currencies than QE2, reflecting more stressed financial conditions in 2009; main risk from monetary exit is reversal of EM capital inflows and currencies. - US fiscal consolidation: Has manageable negative growth spillovers in current conditions and tackles a key global tail risk by enhancing US fiscal credibility. - Euro Area: Direct spillovers from stress in EA program countries are manageable; but if stress casts doubt on core EA banks soundness, spillovers would be large—often as large as after Lehman and now with less policy space; EA fiscal consolidation has only minor contractionary demand effects on the rest of the world and could be positive if it lowers high sovereign risk premiums. - China: Early adjustment in China’s growth model yields positive spillovers; unclear if China’s closed capital account is diverting capital flows to EMs. - UK: UK financial system is key to global stability; need top-notch regulatory and supervisory regime; tighter liquidity, capital, and leverage rules and macro-prudential policies would lower systemic risk, though liquidity self-sufficiency requirements can trap costly pools of liquidity without cross-border protocols; risk of becoming a magnet for risks regulated out of other jurisdictions. - Japan: Supply chain disruptions from the recent earthquake are transitory; spillovers from fiscal consolidation are mild, especially if accompanied by structural reforms and mostly confined to Asia; bigger risk is souring of confidence in sovereign debt, which could hit other high debt countries. ### Implications for Global Collaboration - Process observations: - Focused on each economy’s outward spillovers, based on consultations with systemic partners and a range of emerging market economies (Brazil, Hong Kong SAR, India, Indonesia, Korea, Mexico, Poland, Russia, Singapore, Thailand, and UAE). - The focus prompted some to declare themselves net importers of spillovers, but the tendency to downplay outward spillovers was generally resisted; discussions were positive and constructive even when disputed. - Alignment of national and global goals: - Spillover analysis confirms national and global interests are relatively aligned in mitigating global tail risks. - Examples: - Staff advice for credible fiscal consolidation in advanced countries is consistent with global interest in eliminating tail risk of financial instability from fiscal concerns. - Staff advice to accelerate currency adjustment and rebalancing in China tackles internal stresses and yields positive external spillovers. - Acknowledgement that near-term costs will be greater for countries undertaking consolidation or appreciation and that policies must account for cyclical factors. - Tension areas: - Monetary policy in advanced countries (notably the United States) creates tradeoffs: easy monetary policy to promote lending and risk-taking makes sense for sluggish advanced economies but complicates macroeconomic stabilization in booming, financially open emerging markets. - QE2 had modest direct effects on EM yields and currencies, but concurrent improvement in global conditions contributed to asset and commodity price pressures in EMs—raising debate points. *Prepared by Ranjit Teja and Rishi Goyal, with input from Tamim Bayoumi, David Marston, Aasim Husain, and Martin Mühleisen (all SPR).* ### Section 2 ### _071111 - Section 2 ### Scope and key policy questions - Is there an externality or special circumstance that warrants advanced country central banks to take a broader view of their financial stability mandate? - From a spillover perspective, does action to address fiscal credibility in advanced markets create more leeway for easy monetary policy in advanced countries? - Through what combination of currency-macroeconomic-macroprudential action should EMs respond, and what would be the associated spillovers? ### Limitations of current country/Article IV spillover reports - By construction, as part of country/Article IV surveillance, spillover reports do not examine how policy spillovers across countries interact with one another. - Illustrative interaction issues: - Uncertainty from advanced country financial stress may have dampened the effectiveness of policies to decrease precautionary savings by households in China. - The interruption of RMB appreciation in 2008 may have limited China’s support to global demand at a time of a generalized demand shortage. ### Need for multilateral surveillance of policy interactions - How policies add up and interact—e.g., is simultaneous fiscal consolidation as benign as individual actions?—must be tackled by the Fund’s multilateral surveillance, including contributions to the G20 Mutual Assessment Process. - A discussion with senior policy makers is critical to the traction and future of spillover analysis as a surveillance tool. - The planned discussion at the IMFC, as part of the consolidated report on multilateral surveillance, is identified as an important next step. ### Decision points on continuing the exercise - Timing: The Board will need to decide if and how to continue the exercise, preferably in the Fall after the upcoming Triennial Review of Surveillance. - Specific issues for decision: - Frequency—annual or longer? - Annual spillover reports are feasible, but it may be difficult to add much new content for some countries at this frequency, potentially undermining traction. - Coverage—S5 or wider? - Covering more than a handful of economies will be costly, even accounting for fixed costs already incurred in setting up processes and basic economic models. - It is estimated that the exercise has involved 8 full time equivalents in staff time and travel costs across the Fund. - Consideration should be given to including other large players from time to time—e.g., oil producers, other BRICS economies. - The impact on smaller EMs and low income countries also warrants better coverage in future. - Context—multilateral or Article IV? - The current spillover exercise has been conducted in the context of bilateral surveillance, allowing staff to use an existing modality for discussions with officials and to bring a global perspective to policy advice in Article IVs. - The goal of the exercise is inherently multilateral in nature, and it should arguably be undertaken in the context of multilateral surveillance, especially if policy interactions and coordination issues are to be explored. ### Concluding assessment - Spillover reports are still in their infancy and their value as a surveillance tool has yet to be established. - Many of the models and methodologies developed for the exercise are relatively new. - There remains the unfinished task of systematically exploring policy interactions and combinations. - Appropriate vehicles for this multilateral work include the Fund’s multilateral surveillance products: WEO, GFSR, and the new Consolidated Multilateral Surveillance Report, as well as related initiatives such as the G20 Mutual Assessment Process. - Strengths of the initiative: - The exercise addresses issues raised by partner countries in a confidential setting that allows airing views otherwise papered over in Fund surveillance. - It brings a more multilateral perspective to policy advice in Article IVs, meeting a long-standing demand of the membership. - Key substantive finding from the first round: - Spillover reports highlighted the importance of the financial channel as a key determinant of what near-term effect any given policy change has on others. - Spillover analysis confirms that national and global goals are relatively aligned in the case of fiscal and regulatory policies insofar as they attenuate tail risks to the global economy from the loss of confidence in fiscal sustainability and financial stability. - Advanced country monetary policy is more complex, given differing cyclical positions. - Even where domestic and external goals seem to converge, more spillover analysis, discussion, and cooperation would still be needed (examples: financial regulation and the resolution of global imbalances). *Consolidated Spillover Report — Section 2* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2011/_071111.pdf_