Take-Off or Holding Pattern? Prospects for the Global Economy—An Address to the Confederation of British Industry Annual Conference, Remarks by Dominique Strauss-Kahn, Managing Director, International Monetary Fund

IMF News, November 23, 2009

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Take-Off or Holding Pattern? Prospects for the Global Economy—An Address to the Confederation of British Industry Annual Conference, Remarks by Dominique Strauss-Kahn, Managing Director, International Monetary Fund

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Bibliographic details

• Authors: Dominique Strauss-Kahn
• Published: November 23, 2009

Economic outlook

• The crisis unleashed by the collapse of Lehman Brothers caused economic activity to "collapse at rates not seen since the Great Depression."
• "The storm has passed. The worst has been averted." Global economic activity is "rising again" thanks to "a bold and rapid policy response" and "unprecedented policy cooperation."
• Nevertheless, the global economy remains "very much in a holding pattern—stable, and getting better, but still highly vulnerable."
• Key vulnerabilities in advanced economies:
  • Banking systems "under-capitalized" and "weighed down by leaden legacy assets" and "increasingly, non-performing loans."
  • Households face "weak financial positions and high unemployment" which will "damp down on consumption for some time."
  • "Large public deficits add to vulnerabilities."
• United Kingdom specifics:
  • "The overall outlook has improved" and "indications that job shedding is nearing an end."
  • Recovery may be "somewhat subdued, held back by balance sheet adjustment by banks and households."
• Unemployment remains a core concern: "it’s difficult to claim the crisis is over when unemployment is at historic highs, and getting higher still."
• "The sustainability of this recovery will depend on the decisions taken by policymakers in the months to come."

Exit strategies

• Timing and sequencing are critical: "Exit too soon, and you kill the recovery. Exit too late, and you sow the seeds for the next crisis."
• Recommendation: "It is still too early for a general exit."
  • Exit should "await a sustained recovery in private demand, as well as entrenched financial stability—a key litmus test."
  • "Erring on the side of caution, as exiting too early is costlier than exiting too late."
• Heterogeneous recoveries imply heterogeneous exits: "As the pace of recovery differs among countries, so must exit strategies differ."
• Need for cooperation to manage spillovers and avoid "unintended distortions caused by the unwinding of bank guarantees."
• Fiscal consolidation should be "the top priority, especially in advanced economies."
• Policy recommendations for fiscal policy:
  • "Design and communicate strategies for fiscal solvency."
  • "Reform fiscal institutions and frameworks so that adjustment can proceed smoothly when the time comes."
  • "Keeping stimulus measures temporary."
  • "Put entitlement programs on a sustainable path"—"some of these reforms can be done in advance without putting the recovery at risk."
  • "Further rationalize expenditure, and—in some cases—raise taxes."
  • Protect the vulnerable: "protect the poor and the unemployed, and pay attention to fairness—so, for example, we might prefer more progressive tax systems."
• Monetary policy view:
  • "Fewer problems with monetary policy, which is more nimble."
  • "Interest rates can be raised before unwinding unconventional measures."
  • "Monetary policy can afford to stay accommodative for some time" in many advanced economies due to "little sign of inflation on the horizon."
  • "Some emerging economies face different challenges, and monetary policy might need to move sooner."

Capital flows to emerging markets

• Mismatch: "Emerging market are ahead of the recovery curve, while interest rates in advanced economies need to stay low for some time."
• Consequence: heavy influx of capital to emerging markets as "investors are taking advantage of historically low interest rates and gobbling up assets in emerging markets."
• Risks from large capital inflows: "exchange rate overshooting, asset price bubbles, and financial instability."
• Policy toolkit is pragmatic and varied:
  • "Appreciation should be the key policy response" in many cases.
  • Other tools: "lower interest rates, reserves accumulation, tighter fiscal policy, and financial sector prudential measures."
  • "Capital controls can be part of the package of measures."
• "We are completely open minded" but recognize "all tools have their limitations."

Growth model

• The prior global growth paradigm is effectively over: "the old paradigm is dead, or at least on its last legs."
  • That model relied on household consumption (especially in the United States) fueled by "an addiction to cheap and easy credit."
  • The financial crisis cut off that financing and "the tap will not be turned back on any time soon."
• Persistent effects on consumption:
  • "Problems with household balance sheets and lingering unemployment will push up savings."
  • Psychological effects: crisis experience may lead consumers to be "more cautious, less inclined to take on debt, more likely to save."
• Need for new engines of global demand: "Somebody else needs to step into the breach. The leading candidates are the surplus countries."
• Positive shifts: "China and other emerging Asian economies are shifting from exports toward domestic demand, aided by expansionary fiscal policy."
• Policy measures to support rebalancing in surplus countries:
  • "Stronger social security systems and higher spending on health and education."
  • "Reforms to boost access to credit."
  • "An appreciation of China’s exchange rate, along with some other Asian currencies, will also need to be part of the package."
• Benefits of rebalancing: "Everybody gains from this new paradigm" and "by reducing global imbalances, the world will be a safer place, less prone to crises."
• Open questions: "Can emerging markets be persuaded to change a strategy that it has served them well in the past? Will the United States be able to make headway in reducing its fiscal deficit and taming its financial sector as the recovery strengthens?"

Financial sector regulation

• Cause of crisis: "pre-crisis environment encouraged excessive risk taking and leverage" and the financial sector "brought down the whole global economy."
• Reform objectives: "make the financial sector a safer, more stable, place" while not "kill[ing] financial innovation completely."
• IMF priorities and prescriptions:
  • "Widen the perimeter" of regulation to cover activities in the "financial wild west beyond the regulatory frontier."
  • Increase "the amount and quality of capital and liquidity buffers... especially in good times."
  • "Pay more attention to systemically important institutions, and to their cross-border interactions"—this "calls for heightened policy coordination."
  • "Beefing up supervision and supervisory capacity" to improve application of rules and avoid "capture and complacency."
  • Address "risk management in the financial sector, and break the link between risky behavior and compensation."
• Financial sector taxation:
  • G-20 has asked the IMF "to look into financial sector taxes."
  • Questions: "Can the tax system help reduce excessive risk-taking in the financial sector? Can it be used to further the legitimate goals of fairness and equity?"
  • The financial sector "should contribute to the cost of the rescue and to limiting recourse to public financing in the event of a future crisis."
• Timing and sequencing tension:
  • Financial sector is "still in bad shape" and "will continue to need more capital as asset quality deteriorates."
  • Imposing tougher standards too early "could jeopardize the recovery."
  • Danger of regulatory uncertainty provoking a "Mardi Gras effect" where institutions "party now in expectation of lean times to come."
  • Recommendation: "Lay out the future requirements and the timescale for implementation" to reduce perverse incentives and speed reform.

Conclusion

• The recovery reflects "remarkable progress over the past year," but "new and complex challenges are already popping up."
• Fundamental prescription: "to persevere with the spirit of cooperation that has brought us to this point."
  • During the crisis, countries "came together to face common challenges with common solutions"—this cooperation "was spearheaded by the G-20."
  • Praise for the United Kingdom's leadership during a critical period and "Gordon Brown and his team."
• Continued cooperation needed across:
  • "Exit strategies."
  • "The new growth model."
  • "Financial sector regulation."
• Final synthesis: "We live in a single, interconnected world where the dividing line between domestic interests and global interests is becoming increasingly blurred. There can be no going back."

Source: Remarks by Dominique Strauss-Kahn, Managing Director, International Monetary Fund; London, November 23, 2009.

References

• United Kingdom and the IMF
• People's Republic of China and the IMF
• United States and the IMF
• Speeches
• Dominique Strauss-Kahn
• IMF Managing Director Strauss-Kahn Says Policymakers Globally Must Remain Committed to Collaboration to Effectively Face Key Challenges Ahead
• PRESS CENTER
• https://www.imf.org/en/home