Transcript of a Conference Call by Raghuram Rajan, Economic Counselor and Director of Research, with David J. Robinson, Deputy Director, Research, and Timothy Callen, Chief, World Economic Studies Division on the Analytic Chapters of the Spring 2006 World Economic Outlook

April 13, 2006

with Raghuram Rajan, Economic Counselor and Director of Research
David J. Robinson, Deputy Director, Research
Timothy Callen, Chief, World Economic Studies Division
International Monetary Fund
Washington, D.C.
Thursday, April 13, 2006

MR. MURRAY: Thank you, and good day. I'm Bill Murray, Deputy Chief of Media Relations here at the IMF. This is our conference call that will go over Chapters II, III, and IV of the latest World Economic Outlook. This conference call plus the contents of the World Economic Outlook that are currently on the Media Briefing Center are under embargo until 11:00 a.m. Washington time, 1500 GMT today.

Let me also note that Chapter I of the World Economic Outlook will be released live at 9:00 a.m. on April 19th. Journalists will have advanced access about 24 hours prior to that via the Media Briefing Center. Again, this briefing is on Chapters II, III and IV.

With me today is Raghu Rajan, Economic Counselor and Director of Research, David Robinson, the Deputy Director of Research, Timothy Callen, the Chief of the World Economic Studies Division, and the various authors of the essays that are contained in the chapters you now have available from the WEO.

Raghu will have some opening remarks, and then we will turn the floor over to questions from you. Raghu?

MR. RAJAN: Thank you. Good morning, and thank you for being with us. The world economy has done very well over the past few years. An important reason for this good performance has been the greater flows of goods, services, and capital across the world, a phenomenon known locally as globalization. The chapters in this outlook all try to make sense of this phenomenon.

Chapter III, entitled "How has Globalization Affected Inflation?" finds that globalization has held down inflation in the past decade in a number of ways. Most people think of globalization reducing inflation by reducing the price of imported goods. This has been important at times. For instance, after the 1997-1998 crisis in emerging markets, lower import prices probably shaved more than 1 percentage point of actual inflation in some advanced economies over a 1- to 2-year period. But in normal times, it is not as important as most people think. In fact, at this point, because of higher oil and commodities prices, imports are adding to headline inflation in most industrial countries.

Other channels through which globalization works have been more important and perhaps more consistently present. First, globalization may lower the inflationary response to domestic capacity constraints. Put another way, a sudden expansion in demand for goods now translates into higher imports rather than into higher prices, since in an integrated world, domestic supply constraints do not matter as much. This is partly why the U.S. can consume 7 percent more of its GDP than it produces without serious inflation.

Second, foreign competition has constrained wage increases in industries most open to global competition, and even lowered the sensitivity of wages to productivity increases. Of course, this does not mean globalization necessarily lowers wages, because it also spurs productivity growth itself. Nevertheless, the effect of globalization on wages will become an increasingly debated issue, especially as the share of labor income in total output of developed countries continues to fall.

The chapter concludes that despite being helpful in the past, globalization may not continue to be a crutch for central bankers to lean on. Spare capacity is decreasing worldwide, and tight domestic labor markets can also attenuate the effects of global competition on wages. Central bankers must, therefore, be prepared for their jobs to become more difficult in the period ahead.

Another aspect of globalization is an integrated market for world savings and borrowing. Interestingly, the identity of the savers and borrowers have shifted in the last few years. Corporations are usually net borrowers. In 2003 and 2004, though, total corporate excess savings which is their undistributed profit less any capital expenditure they might make, this number in the G7 countries amounted to US$1.3 trillion which is more than twice the combined current account surpluses of emerging markets in developing countries over the same period. The latter, of course, is something which has gained a lot of attention in the last few years.

This increase in corporate savings can be decomposed into two main components. First, there has been a substantial increase in corporate profits in the G7 since about 2000. In general, this has not been because of better operating profits, but because taxes and interest rates have come down so that profits after interest and taxes have gone up. In other words, profitability is more due to accommodative monetary and fiscal policy than perhaps greater efficiency.

The second and arguably more important component for excess corporate savings is falling capital spending. It accounted for as much as three-quarters of the total increase in corporate excess savings since 2000. One reason for lower capital spending is that the price of capital goods has declined sharply, so less has to be invested to increase the real capital stock by a given amount. Another reason is the drop in real capital spending. The United States and Germany are responsible for much of this decline.

Going forward, we expect one-off tax measures to lapse and interest rates to move higher as monetary policy tightens and the global liquidity cycle turns. Furthermore, given low investment in the past few years, corporate investment is likely to pick up somewhat as investment opportunities and pricing power improve. So it is unlikely that corporate savings will continue at their current pace, which will be yet another factor of pushing real interest rates higher.

Finally, Chapter II looks at the effects of higher oil prices on global current account imbalances. In some ways, this is the third act in the saga of imbalances. In the first act in the late 1990s, foreign capital was attracted to the United States causing a counterpart current account deficit. In the second act, expansionary policies in the U.S. caused the deficit to widen. And in the third act, which is what we are seeing now, higher oil prices will widen existing global current imbalances and prolong them. Because the inflationary consequences of oil prices have been limited partly as the result of globalization which we have talked about, and because financing conditions have been benign, oil consumers have not had to adjust as much as they did in the past. Oil producers are rightfully being more circumspect about spending, mindful of past waste. As a result, the oil price induced imbalances are likely to be with us for some time. This is yet another reason to start implementing the policies the IMF has recommended to support the smooth adjustment of global imbalances.

The bottom line is that a number of factors like global restraints on inflation and corporate savings have contributed to a benign environment which has supported global growth over the last few years. But internal and external imbalances are growing, and the environment could become less hospitable.

With that, let me invite questions.

QUESTION: I was wondering, in Chapter II, do you have an estimate on what kind of range we should expect in oil prices in the coming year or two?

MR. ROBINSON: This is David Robinson speaking. Let me take a stab at that question.

Of course, projecting the oil price is something that is fraught with uncertainty. One thing I can say to you is that when we look at the futures markets which include the expectations of what markets think are going to happen to prices, basically they see prices remaining at around the current level over the medium-term, a little bit of a rise in the short-term, a little bit of a decline in the longer-run, but around the same level overall. And I think that reflects the very tight fundamentals in the oil market, the low level of excess capacity that we have, and the fact that investment is not taking place in the oil sector as fast as we would like to see, given that demand in the world continues to increase. So I think we are looking at a period of continued sustained high oil prices, but there is a lot of uncertainty.

QUESTION: Thank you. I'm wondering how far of a risk it is, the possibility of a recession. This has something that has been spoken about by the Managing Director in the past and the whole idea if there are abrupt adjustments or a recession or something, that it could happen. Is there a likelihood of this, or is this something which a lot of things would have to come into play to reach that far of a point?

MR. RAJAN: I would love to answer this question today, but it is really a question which is more suited for next week when we talk about the outlook. If you do not mind, I would appreciate getting this question again in the Chapter 1 press conference next week.

QUESTION: Fair enough.

QUESTION: My question is over there was a discussion about corporate savings. Mr. Rajan said something about some of these tax breaks would expire. I was wondering, are we talking only about the United States there or is this in other industrial countries, and if it is in the United States are we sure they will expire?

MR. CARDARELLI: This is Roberto Cardarelli answering this question. The chapter actually focuses on the G7 countries, so it is not just the U.S., and slow growth trends in all these countries. But as part of your question is on taxes, we do not see a lot of scope for reduction in the shorter-term, there is actually a tax competition issue behind the generalized reduction in statutory corporate tax rates. So we do not actually expect a lot happening on that side. We see actually more of a risk of higher interest rate expenses as interest rates go up.

MR. MURRAY: Tim Callen?

MR. CALLEN: Just to add a more general context, I guess one of the things we see in many of the G7 countries is fiscal positions that we think are going to need to--fiscal deficits that will need to be reduced over time, and that is clearly going to limit the scope for further cuts in corporate tax rates and could over time require actually additional revenue raising measures to reduce those deficits.

QUESTION: So you are really talking more about raising taxes rather than things that you are certain will expire. I thought you were speaking very specifically about certain tax breaks.

MR. RAJAN: Some will definitely expire, but I guess the general trend will be towards certainly maintaining the existing taxes, if not increasing them. So the earlier trend of reducing taxes is not going to happen going forward, given the tight fiscal positions.

QUESTION: Thank you.

QUESTION: Good morning. I would just like to know if you could give some assessments about the awash with cash, the effects of that for countries in Latin America like Brazil regarding direct foreign investments.

MR. RAJAN: I'm sorry, could you repeat that question again?

QUESTION: Yes. What I would like to do is this cash that the companies have now, if we can expect that this money could come to countries like Brazil in foreign direct investments.

MR. RAJAN: Some of the excess-savings is already in the form of foreign direct investment. Part of the savings build-up is not just cash, but it is also financial assets which reflects ownership claims on companies in other countries. So certainly some of it is going away. For example, when we look at equity holdings of G7 companies which potentially could be in other countries, and add that back to investment in the United States, we find that U.S. investment is about where it should be, suggesting that part of what is going on is we are getting investment taking place in other countries.

However, we have commented earlier, in the last WEO, on the somewhat muted investment all over the world, especially in emerging markets. So part of what we are saying is the responsibility for increasing investment lies also with emerging markets in terms of improving the business environment and the climate so that some of these savings which are generated in developed countries can flow more readily into these emerging markets.

So I think one of the bottom lines of chapter is the need to increase investment is across the globe, not just in the G7 countries.

QUESTION: Thank you. I would like to know if there are any estimates on how much high oil prices could impact on general growth.

MR. ROBINSON: This is David Robinson speaking again. We do have broad estimates of that. If you are going to use a very rough rule of thumb, I would say a 10 percent rise in oil prices reduces global growth by .1 to .15 percent. It does vary, of course, according to the reason why oil prices increase, but you are going to take a very broad rule of thumb, that is the one we use.

QUESTION: Thank you.

QUESTION: Good morning. Just an editorial note before I ask my question, as I really like the summaries that were included this time with the chapters, because that really helped. Sometimes you can read 40 pages and you kind of forget what's going on. Anyway, thanks for that.

I guess I would take another crack, if you wouldn't mind, Rajan, on the theme of trying to tie these three chapters together. Were you saying that globalization--I don't know, could you try one more time? I didn't understand.

MR. RAJAN: I guess what I am saying is, globalization has been very beneficial in the past and is partly responsible for these good years we are having. The chapters point to at least a couple of channels. One is the fact that with the global market for goods, we have managed to keep inflation down because spare capacity in some parts of the world, certainly in Asia, for example, has been utilized by countries that have not had as much spare capacity. As a result, we have tapped into global capacity. That has been a good thing.

Similarly, we have tapped into global savings, the low interest rates the world over in part are because of the excess savings that are being generated by corporations, and also excess savings generated by emerging markets. So we have, in a sense, the global market holding down interest rates.

However, one of the things that I would like to caution about is that these things are not infinite. At some point they come to an end for a variety of reasons. For the corporate savings, part of what is going on is investment opportunities look far better now than they looked a few years ago. They are picking up, not just in industrial countries, but also in emerging markets, and as the Brazilian reporter asked, there will be also investment by industrial country corporations in emerging markets.

So by and large we expect investment to start picking up which means greater demand in the market for global savings which would suggest interest rates will push up, and then naturally affect some of the other things that depend on savings. So that is potentially one cause for concern.

The other is, global capacity is also limited. We see that in oil, and what we see is high oil prices because we have hit global capacity without too much investment taking place in oil in the last few years. That, again, is probably something which we are going to see more of in other markets going forward which would suggest the effects of globalization on inflation will not be as helpful as in the past, and inflationary pressures have to be watched out for because they will be there.

Of course, what has happened over the last 10 years is that central banks have gained a lot of credibility for managing inflation, and if you look at inflation expectations, they are pretty well anchored. But what this means is they may have to work harder in order to keep them anchored going forward than they had to in the past.

QUESTION: Where do petrodollars fit into this equation then?

MR. RAJAN: Petrodollars in part are part of the global savings pool, right?


MR. RAJAN: If they weren't fueled back into the global savings pool as much as they have been, perhaps we would have seen a much sharper adjustment, interest rates may have had to have gone up higher, and the countries that are running deficits as a result of higher oil would find it harder to finance those deficits.

In a sense, what we have, and this is the point the chapter makes, is because of the operation of the global market, we have less adjustment on the real side than we had in the past. As a result, the imbalances are widening rather than narrowing at this point. This is in part a good thing. It suggests that the market has more flexibility, there is more rope, but more rope can be used in many ways, and it might be more rope with which eventually, unless we work on narrowing imbalances, ... You know what other uses rope can be used for.

QUESTION: What should they be doing with these reserves now? They should invest in their own economies?

MR. RAJAN: I think over time they have to make sensible investments in their own economies because some fraction of the petrodollars they are earning now are permanent. To the extent that they do not use them, that is a subtraction from world demand. If they are using them only in building up financial assets, that is in a sense a subtraction from world demand. So what they would need to do over time is think about useful ways of using them.

However, they have to be very conscious of the fact that the last time they earned these petrodollars, some of the uses weren't the wisest, and so what we have been suggesting to these countries is a careful ramp-up of spending, and, in fact, that is what they are doing. There are a number of things that they have to do, including diversifying away from oil, but also investing in their own people through more education and so on.

So these are things that are happening, but what we have to be conscious of is they will take time, and they should be allowed time to happen.

QUESTION: Thank you so much.

MR. MURRAY: Thank you very much for joining us today. Let me give you my Email address. If you do have follow-up questions, drop me a note and I will chase them for you. My Email is That's I want to thank everybody for joining us, including Raghu Rajan, David Robinson, Tim Callen, and the authors of these chapters. Again, everything here is under embargo until 11:00, or 1500 GMT today. Thank you very much.


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