Surplus countries must shift from external demand to domestic demand and reduce their dependence on exports, says IMF’s Blanchard (photo: Lee Jae-Won/Reuters)
GLOBAL ECONOMY IN 2011
In an assessment of the global economy at the end of 2010, and the prospects for 2011, Blanchard said that countries should continue to focus on rebalancing their economies in the coming year, including structural measures and exchange rate adjustments.
“Without this economic rebalancing, there will be no healthy recovery,” he told IMF Survey, the online magazine of the International Monetary Fund (IMF).
In an interview, Blanchard talked about the central role of the Group of Twenty (G-20) advanced and emerging market economies in helping during the global crisis and the need for continued cooperation to build on the recovery, as well as the prospects for both Europe and low-income countries. Following is the text of the interview:
IMF Survey online: What is your assessment of how the global economy turned out in 2010? What went better than you anticipated, and what does not look so good?
Blanchard: The short answer is that there were no major surprises. We had forecast positive but low growth in advanced economies, fast growth in emerging economies, and, lo and behold, this is how the year has turned out.
Indeed, I just went back and compared outcomes to our forecasts as of last January. For advanced countries, we were right on the dot for the United States; things turned out a bit better than expected for core Europe; Japan had higher growth than we had anticipated, but it looks like a one-time phenomenon. As for emerging countries, we were right on the mark for China; India did better than we had forecast.
To say that there were no major surprises, however, is not the same as saying that things are fine. They are not. The two-speed recovery, low in advanced countries, fast in emerging market countries, is striking and its features are increasingly stark. They will probably dominate 2011, and beyond.
IMF Survey online: What do you mean? Tell us more about this two-speed recovery.
Blanchard: Emerging market countries were affected by the crisis through both trade and financial channels. The turnaround in trade has been nearly as sharp as the earlier collapse. But while trade has not yet fully recovered, most emerging market countries have been able to increase domestic demand so as to return to high growth. In turn, their good performance has led capital flows to come back, in some cases, with much force. For many of these countries, the challenges are now how to avoid overheating and how to handle capital flows.
"The turnaround in trade has been nearly as sharp as the earlier collapse."
In many advanced economies, the crisis damage was much deeper. The financial system was badly broken. Securitization has to be reinvented. In many of these countries, markets are still uncertain about the true health of banks and financial intermediation is not working well. Combine this with the need to correct past excesses, from low saving to excess housing investment and the result is a slow recovery, barely strong enough to decrease unemployment. This is painful but not that surprising. The evidence, which we had documented in a chapter of the World Economic Outlook last year, is that recoveries from financial crises are long and slow.
IMF Survey online: For the past couple of years, the need for economic rebalancing has been the mantra of the IMF. As we begin 2011, where do we stand?
Blanchard: It should remain the mantra. Rebalancing, internal and external, continues to be crucial. Without this economic rebalancing, there will be no healthy recovery. The argument is very simple: Before the crisis, growth in many advanced countries came from excessive domestic demand, be it consumption, or housing investment. This could not go on. Those countries must rely on other sources of demand. Until now, they have used fiscal policy to prop up domestic demand. This was needed, but it is not sustainable. The deficit countries must rely more on external demand, on exports. And, by symmetry, surplus countries, many of them emerging markets, must do the reverse, shift from external demand to domestic demand and reduce their dependence on exports.
This is not to say that without rebalancing, the recovery cannot continue. Continued fiscal expansion, or a return by U.S. consumers to their old, low-saving ways can sustain demand and growth for some time. But they will recreate many of the problems that were at the root of the crisis. And guess what will come next …
IMF Survey online: What about exchange rate adjustments? Some argue that there is too much pressure on China to allow its currency, the yuan, to appreciate.
Blanchard: Rebalancing is a complex process. No single measure, no one country holds the solution on its own. Structural measures are required: for example, in Asia, measures to improve financial intermediation or provide more social insurance, in the United States, reforms of the financial intermediation system. But exchange rate adjustment is an integral part of the process.
IMF Survey online: Aren’t capital inflows to emerging market countries a growing worry?
Blanchard: If well used, these capital flows can help rather than hurt. By leading to an appreciation, they help shift countries away from external demand toward domestic demand. And, by making it easier and cheaper to borrow, they can boost domestic demand.
Blanchard: “Rebalancing, internal and external, continues to be crucial. Without this economic rebalancing, there will be no healthy recovery” (IMF photo)
This being said, some emerging market countries rightly worry that capital flows will come and go. They worry about their ability to intermediate the high flows and in some cases they worry about the risks of over-appreciation as well as overheating. So far, we have not seen the tsunami of flows that is sometimes described in the press. But, agreeing on broad “rules of the road” that take into account both country circumstances as well as global links will be one of the major challenges in the year to come.
IMF Survey online: What about low-income countries? What are their prospects?
Blanchard: Because of their more limited financial integration with the world economy, low-income countries were mostly affected by the crisis through the trade channel. As trade has largely recovered, and as strong growth in emerging market countries has pushed up commodity prices, many of them are doing well. Sub-Saharan Africa, for example, grew at more than 5 percent in 2010, and we forecast roughly the same for next year. Their performance, however, is not only due to exports. Previous sound policies allowed many to use fiscal measures to support their economies. And private domestic demand typically has also been quite strong.
IMF Survey online: Let us turn to Europe. What’s the outlook there, particularly for some of the countries on what is termed the periphery Europe?
Blanchard: There is no question that a number of countries in Europe face a tough and long macroeconomic adjustment. In most cases, they would have had to do so whether or not the global crisis had taken place. The global crisis only makes it tougher.
"For those countries in the euro and thus operating under a fixed exchange rate, this is going to be a long and tough slog."
They had, based on what turned out to be unduly optimistic expectations, increased domestic demand excessively, and some had run very large current account deficits. Like others, but more so than others, they must shift from domestic demand to external demand. For those countries in the euro and thus operating under a fixed exchange rate, this is going to be a long and tough slog.
Stronger growth in core Europe, if it comes, will strengthen their exports and help the adjustment. But, based on past experience, a full return to health will likely take a long time. Social programs are essential, both for their own sake and to maintain broad political support.
IMF Survey online: What about fiscal and banking problems?
Blanchard: Except for Greece, the fiscal woes are the result of the macro slump, not of irresponsible fiscal behavior. Can the countries achieve fiscal sustainability? They can, but another IMF fiscal mantra should be repeated here: What is essential is not so much dramatic cuts now but medium-term anchoring, a credible path to debt stabilization, and eventually debt reduction.
Can they do it on their own? I fully understand the reluctance of countries to ask for a joint program from the European Union and the IMF. But such programs can help, in two ways: First, by putting a ceiling on the interest rate at which governments can borrow, the programs eliminate the risk of multiple equilibria—that is the risk that investors, right or wrong, ask for high interest rates, making it impossible for the countries to repay, and making the investors’ fears self fulfilling. Second, even if the programs do not ask for more than the country intended to do on its own, they reinforce the credibility of these commitments, and reassure markets about the medium run.
In addition to fiscal worries are the current fears about the banking system. I suspect these are overstated. But, the only way to decrease those fears is increased transparency, and, for this, the sooner the better. In practice, this means new, more credible stress tests, together with clearer rules about burden sharing: How much of the losses will be absorbed by creditors, by national governments, by the EU. There is a lot of loose talk about bailouts. My belief is that the bailout component, either by national governments, or the European Union, can be quite limited. But we shall only know that once the homework has been done.
IMF Survey online: You have talked about rebalancing, and what countries have to do. What can we expect from the G-20, and in particular from the G-20 mutual assessment process, the so-called MAP?
Blanchard: There is no question that the Group of Twenty has played a central role in the crisis. So long as the crisis was acute, it provided just the right forum for strong and fast action. Now that the crisis is less acute, and countries increasingly face different problems, agreement is clearly harder to achieve, and, as we saw in the buildup to Seoul, discussions can be intense.
But discussions take place as part of the G-20 process, both in public view and behind the scenes. And here, the G-20 MAP process, in which the Fund acts as an expert consultant to the G-20, can play a central role. It can give national policymakers a sense of the world economy landscape, show the implications of current policies, show the dangers of an unbalanced recovery, explore alternative policies, and make for a much more informed dialogue. This does not guarantee success. But it surely improves the odds.
