"Global and Regional Economic Outlook and Challenges for Central Banks after the Global Financial Crisis", Presentation at the 8th ASEAN Central Bank Governors’ Meeting by Naoyuki Shinohara, IMF Deputy Managing Director, March 29, 2012
IMF News, March 29, 2012
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- Published: March 29, 2012
Global economic setting and outlook
- Recent deterioration and partial stabilization:
- Global recovery suffered a sharp setback in late 2011; some positive signs emerged in recent weeks, including in the United States.
- Agreement on a new program for Greece provided relief; implementation of agreed actions is important.
- Acute financial tensions in the euro area eased in recent weeks, in large part thanks to the ECB’s 3-year long-term refinancing operations.
- Key vulnerabilities and risks:
- Repair of financial systems still has a long way to go.
- Public debt in many countries remains at all-time highs, constraining policy actions.
- Unemployment remains high in many countries.
- Oil price increases present a real risk given geopolitical tensions, low global inventories and spare capacity.
- The euro area crisis could escalate; downside risks are large.
- Policy directions for advanced and emerging economies:
- Advanced economies should use macroeconomic policies to support the recovery if they have the space to do so, and press ahead with financial and structural reforms.
- Emerging economies need to stay vigilant for spillovers from advanced economies while keeping overheating pressures in check where applicable.
- Forecasts and revisions:
- Latest projections (published in January) point to a small decline in global growth this year compared to 2011.
- Growth performance: United States expected to compare favorably with the euro area, where a mild contraction is expected.
- IMF in the process of revising forecasts and to publish new numbers in April.
- Risk to US fiscal consolidation in 2013 could range from below 1 percent of GDP to about 3 percent of GDP depending on political agreement.
Asia and ASEAN regional outlook, risks, and policy implications
- Recent developments:
- Activity across the region slowed sharply in Q4 2011 mainly due to external factors and natural disasters (supply chain disruptions).
- Domestic demand in emerging Asia generally remained strong, supported by low unemployment, high capacity utilization, and robust credit growth.
- Capital flows to emerging Asia have rebounded earlier this year although they remain very fragile.
- Growth expectations and drivers:
- Despite moderation in China, growth in Asia this year expected to remain broadly in line with the 2011 outcome.
- Continued capital inflows and reconstruction spending in parts of Asia would spur private investment and consumption.
- Exposure to external demand:
- For many smaller open Asian economies, more than 1/3 of GDP is linked to demand outside Asia, mostly from the United States and Europe.
- A sharp fall in external demand, or a reversal of foreign capital flows, would severely impact activity in Asia.
- Financial conditions and inflation risks:
- So far impact of EU deleveraging limited; large regional banks and relatively healthy balance sheets acted as buffers.
- Credit growth continued at double digit rates in the region; local bond markets continued to expand.
- Inflation risks from increasing oil prices due to geopolitical tensions and low inventories.
- Policy calibration for ASEAN central banks:
- Major near- and medium-term challenge: calibrating the right amount of insurance to support stable, non-inflationary growth.
- Policymakers need to remain vigilant: renewed deterioration in external conditions may require easing policies in countries with requisite policy space.
- With acute global risks receding earlier this year and signs slowdown bottoming out in most of Asia in Q1, policymakers should stand ready to return to more neutral macro policies.
- The balance of risks and the need for switching gears differs from country to country.
- There is generally enough space in ASEAN economies to counter a sharp downturn given lower public debt stocks relative to other regions.
- Regional risk-sharing mechanisms have been strengthened, particularly through currency swap arrangements.
- Medium-term structural priorities:
- Strengthening domestic sources of growth is crucial; not happening enough yet.
- Recent decline of current account surpluses in Asia is cyclical in part and reflects weaker external demand.
- For China: sharp decline in current account surplus also reflects secular deterioration in terms of trade and perhaps saturation of export markets given China’s already high market share.
- In China, imbalances have shifted to the domestic economy: excessively low consumption and strong investment have raised concerns about excess capacity and bank balance sheets.
Challenges for central banks after the crisis
- Changing responsibilities:
- Central banks emerged as main protagonists of policy response: lowered interest rates close to zero and expanded balance sheets through unconventional policies.
- In developing and emerging market countries, central banks eased liquidity to counter capital flight after Lehman Brothers.
- Two critical challenges ahead: role in macroprudential policy; preserving effectiveness of monetary policy in face of potential fiscal dominance.
- Macroprudential policy:
- Recognition that gaps in macroprudential framework allowed systemic vulnerabilities to grow.
- Central banks have played a critical role in design and implementation of macroprudential policy (examples cited: United Kingdom, Ireland, Thailand, Malaysia).
- Growing convergence around definition: policy that uses primarily prudential tools to limit systemic risks—the possibility of a major disruption of financial systems that may have a material adverse impact on economic activity.
- Reasons central banks are well positioned:
- Political independence and long-term horizons suit counter-cyclical macroprudential policy.
- Expertise in analysis of systemic risks due to pivotal role in the financial system.
- Experience communicating complex risks to markets and the public.
- Potential difficulties of central bank involvement:
- Interrelationship between macroprudential and monetary policies is not well understood and is often country-specific.
- Key unanswered questions: impact of monetary policy on financial stability; transmission channels through which monetary policy affects financial sector behavior, private sector balance sheets, and the real sector.
- No one-size-fits-all answers; outcomes may hinge on country characteristics such as financial system structure, exposures to domestic and external risks, or exchange rate regime.
- Fiscal dominance and monetary independence:
- Fiscal constraints and public debt:
- Gross debt to GDP of around 80 percent in most of the G7 economies—and much more in countries like Italy and Japan.
- Required fiscal adjustment to bring debt to sustainable levels and address aging-related fiscal pressures may pose significant challenges.
- Implications for monetary policy:
- In fiscal consolidation, the onus of stimulating aggregate demand falls on monetary policy.
- Typical response: lower short term interest rates, but effectiveness limited when rates are already very low.
- Central banks engaged in unconventional measures and expanded balance sheets; effectiveness depends on domestic circumstances such as risk premia and strength of central bank balance sheets.
- Institutional implications:
- Policymakers need to avoid undermining the independence of monetary policy.
- Roles of central bank, government and other entities need to be preserved and clearly delineated.
- Central banks should remain independent but accountable anchors of macroeconomic stability.
Key takeaways and policy recommendations
- Near-term:
- Continue efforts to contain the euro area crisis and implement agreed policy actions (including for Greece).
- Advanced economies with policy space should support recovery and push financial/structural reforms.
- Emerging economies should monitor spillovers and manage overheating risks.
- ASEAN central banks should calibrate insurance to support stable, non-inflationary growth and be prepared to switch policy quickly as country-specific conditions warrant.
- Medium- and long-term:
- Strengthen domestic sources of growth in Asia; rebalance away from excessive reliance on external demand.
- Address China’s domestic imbalances—boost consumption and manage investment-driven excess capacity and bank balance sheet risks.
- Enhance macroprudential frameworks and consider central banks’ role, while carefully managing interactions with monetary policy.
- Preserve monetary policy independence in the face of high public debt and fiscal consolidation pressures.
Presentation at the 8th ASEAN Central Bank Governors’ Meeting, Naoyuki Shinohara, IMF Deputy Managing Director, March 29, 2012