Beyond the Crisis: Sustainable Growth and a Stable International Monetary System, Speech by Dominique Strauss-Kahn, Managing Director of the International Monetary Fund
IMF News, September 4, 2009
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- Beyond the Crisis: Sustainable Growth and a Stable International Monetary System, Speech by Dominique Strauss-Kahn, Managing Director of the International Monetary Fund
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- Published: September 4, 2009
Economic outlook and risks
- Global economy appears to be emerging from the worst economic downturn in our lifetimes, with several advanced economies (including France and Germany) returned to growth and emerging economies recovering more strongly.
- Expected recovery to be relatively sluggish; in advanced economies recovery largely driven by policy stimulus and restocking, with underlying private demand weak.
- Risks that the recovery could stall remain, though they appear to be receding; principal concern is premature exit from accommodative monetary and fiscal policies.
- Concern about a third phase of the crisis: high unemployment. Expect unemployment to continue rising through next year as economic growth falls short of potential; risk of a jobless recovery.
- Policy implication: policymakers should err on the side of caution when deciding when to exit crisis response policies, but should develop and clarify exit strategies now to avoid undermining confidence.
I. What will sustain the recovery — Demand-side issues
- National transition: baton must eventually pass from public to private sector as crisis response policies are unwound; timing depends on recovery of private sector demand.
- Global rebalancing: weaker demand in some economies must be offset by stronger foreign demand in others.
- Example statistic: household saving in the U.S. has risen to 5 percent of disposable income, from about zero a few years ago, reducing the U.S. current account deficit dramatically.
- Policy imperatives for rebalancing:
- In advanced economies: rapid progress toward fixing the financial system to support productivity and growth.
- In emerging Asia (notably China): accelerate structural efforts that boost domestic spending (improve access to credit for households and small-scale business); strengthen social security systems; increase spending on education and health to reduce precautionary saving.
- In emerging Asia and oil exporters: public investment spending concentrated on infrastructure and on “green” initiatives to boost domestic demand.
- More flexible exchange rate management in some countries to increase demand for imports in current-account surplus countries and encourage a shift from tradable to non-tradable sectors.
- Implication for investment and innovation: shift in global consumer composition may change production composition (potential decline in demand for high-technology goods); policy makers should accelerate reforms to reduce barriers to competition and support innovation.
I. What will sustain the recovery — Supply-side issues
- Financial crisis may inflict long-term damage on supply capacity via lower effective capital from sharp fall in investment and higher structural unemployment from job losses.
- Reforms to boost productivity are essential:
- Labor market reforms to increase flexibility and support job search and training for redeployment.
- Product market reforms—particularly in services—to create jobs and boost productivity.
- Financial sector reforms to boost efficiency (financial sectors likely to shrink in advanced economies).
- Europe-specific: recommit to the Lisbon agenda; room for improvement in service sector productivity in many EU economies (including Germany); reduce regulatory constraints.
- Green economy: “green” stimulus measures (e.g., improve energy efficiency) can sustain aggregate demand and employment and induce technological innovation; advances in “green” technology could have transformative effects.
I. What will sustain the recovery — Exit policies
- Major fiscal sustainability concern: advanced economies on an unsustainable path, with the average public debt-to-GDP ratio set to rise to 115 percent of GDP by 2014.
- Need for significant fiscal adjustment and plans now to anchor market expectations and contain long-term interest rates.
- Most important fiscal steps: contain pension and health care costs. Statistic: in advanced economies the net present value of future spending due to aging is more than 10 times the fiscal cost of the crisis.
- Other fiscal actions: reform spending beyond education and health in some countries; tax reform may be critical in others.
- Central bank challenges: timing and approach to tighten policy; inflation unlikely to reemerge until recovery is underway; complexity of unwinding expanded central bank balance sheets and unconventional measures (such as term lending facilities).
- Central bank independence risks: political pressure to “inflate the debt away” must be resisted; governments must assure support for central bank capital to avoid distractions from price stability and recovery.
- Exit guidance: continue supporting demand until recovery is firmly underway; launch exit policies only once clear indications that recovery has taken hold and unemployment is set to decline.
II. Reform of the financial sector — Crisis response measures
- Financial stabilization over the last year: credit and equity markets rebounded; bank liquidity plentiful due to central bank provisions; wholesale money markets reopened; capital markets contributing to recovery.
- Remaining concerns:
- Mounting delinquencies and continued strain on banks, with commercial real estate developments of particular concern.
- Private securitization markets still impaired; households and financial sector continue to deleverage.
- Risk of complacency as markets improve.
- Areas requiring accelerated progress:
- A comprehensive diagnosis of banking systems, given potential increase in non-performing loans.
- Launch asset-management programs to deal with assets on bank books and offset rising non-performing loans.
- Strengthen formal policy coordination across countries, especially as exit strategies are designed.
- Need for clarity in communicating policy intentions to shore up confidence.
II. Reform of the financial sector — Regulatory reform
- Broad agreement on lessons: regulation and supervision must better mitigate systemic risks; preventive measures to reduce crisis likelihood are needed.
- Preventive measures include:
- Widen and make the regulatory perimeter more flexible.
- Increase the amount and quality of bank capital and liquidity buffers.
- Allow prudential frameworks to play a greater stabilizing role over the business cycle.
- Intensify regulation and supervision of systemically important institutions.
- Improve crisis management, including cross-border resolution issues.
- Current shortcomings:
- Reform effort not proceeding as quickly as necessary.
- Progress on microprudential regulation (e.g., Basel Committee recommendations) but more work needed.
- Capital requirements must not be lenient: they must be increased and made more variable to prevent excessive risk taking.
- Development of operational macroprudential supervision framework remains a work in progress; methodological issues hinder international agreement.
- Cross-border resolution issues among the greatest challenges; absence of agreement increases risk of national interests prevailing over global good.
- Compensation policies: decisive action needed to reform compensation culture that rewards short-term profits and encourages procyclicality; international coordination required to address competitiveness concerns.
II. Reform of the financial sector — The IMF’s role
- The IMF is not a global financial regulator; national regulatory and supervisory agencies hold that responsibility.
- IMF roles:
- Support national and multilateral efforts to strengthen financial regulation.
- Contribute to formulation of new regulations and provide technical assistance.
- Surveillance of the financial sector and step up monitoring of adoption and implementation of new standards and regulatory changes, including evolving macroprudential frameworks, as requested by the G-20.
III. Bolstering the stability of the international monetary system
- Current debate: concerns that the U.S. dollar’s role may be undermined by U.S. economic and financial problems; large fiscal imbalances seen as risk to the dollar and potential source of disorderly adjustment.
- Counterpoint: the U.S. dollar strengthened during the crisis, reflecting its status as an unrivaled safe haven asset.
- Possible future systems:
- Creation of a super-sovereign currency (e.g., “bancor” proposed by Keynes).
- A new world reserve currency possibly based on the SDR.
- A multi-reserve currency system with currencies like the euro, the yen, and the renminbi as co-equal anchors.
- Likely timeline: evolution over the coming decade influenced by political as well as economic factors.
- Current system assessment: working better than often said; proved resilient during the crisis; durably anchoring fiscal, monetary and financial regulatory policies of the main reserve issuer would help stabilize the IMS.
- Central problem: countries’ appetite for self-insurance increases demand for reserves, complicating the main reserve issuer’s ability to provide sufficient safe assets while maintaining fiscal and external balance (the “Triffin dilemma”).
- Costs of large reserve stockpiles: opportunity cost of foregone domestic investments (education, infrastructure); large reserves breed uncertainty if managed for non-market reasons.
- Ways to reduce self-insurance demand:
- Country-level: sound economic policies to build policy credibility and confidence in currencies.
- Global-level: reduce impact of volatile capital flows to limit disruption to financial systems.
- Third-party insurance in theory efficient, but pricing uncertainties and counterparty risks have prevented market emergence.
- Practical alternatives: borrowing from global or regional reserves pools, or access to a lender of last resort.
- Recent multilateral steps: G-20 leaders called for a near tripling of IMF lending resources to $750 billion; steps taken to reform and expand the Fund’s lending facilities.
- Further IMF actions suggested:
- Modify procedures for accessing the short-term Flexible Credit Line and other lending facilities to make insurance more predictable.
- Make SDR allocations more responsive to global developments and flexible to country circumstances.
- Increase the Fund’s resource base (insurance pool) further; even after its recent tripling, it is still smaller as a share of global GDP—and smaller as a share of global capital flows—than when the Fund was created.
IV. Concluding thoughts and policy recommendations
- Recovery so far mainly due to massive policy support; exit policies should be formulated now but not implemented until clear signs of a firm recovery exist.
- Given the high and lasting cost of unemployment, policymakers should err on the side of caution.
- Financial system reforms must continue: capital requirements need to be strengthened (larger and better reflecting riskiness of bank activities).
- Compensation policy reforms required to align bankers’ incentives with longer-term performance rather than short-term profits.
- Renewed call for international policy coordination: crisis demonstrated the essential role of coordinated policy actions and multilateral institutions in avoiding a depression and in reshaping the international financial system.
- Multilateral institutions must remain central to future reform and crisis response.
Speech by Dominique Strauss-Kahn, At the Sixth Annual Bundesbank Lecture, Berlin, September 4, 2009. As Prepared for Delivery.