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Transcript of a Press Briefing on the Economic Outlook and Issues in Europe, by Michael Deppler, Director, IMF European Department
April 18, 2007
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Ms. Stankova: Good afternoon, eveyone. I am Olga Stankova with the IMF's External Relations Department.
Welcome to the briefing on Economic Outlook and Issues in Europe. The briefing will be held by Michael Deppler, Director of the IMF European Department. Michael will make brief introductory remarks, and then we will take your questions.
I would also like to welcome media joining us via the Media Briefing Center, and we will take their questions as well.
Please, Michael.
Mr. Deppler: Thank you very much for joining us.
This is something of a first for the European Department. Our sister departments have done this before us. We will give you at the close of these proceedings a statement, sort of opening remarks, summarizing our views on various issues. I am just going to speak loosely from these in the next few minutes, but these are remarks—what is the phrase—"as prepared for delivery," I think the word is. I'm not very good at this stuff, so please.
Basically, what is the basic view? Clearly, Europe is doing quite well. The WEO forecast for Europe is lagging a bit behind. I would see the risks as being on the upside relative to that WEO forecast. There are still some uncertainties about what's happening in consumption in Germany, but in terms of when we look at what's happening to unemployment, what is happening to employment, what is happening to investment spending, what is happening to exports, we are certainly encouraged by what is going on.
The same applies not only to the Western states but also to Eastern Europe, where again you see investments, exports, employment, production, all moving in the upward direction.
So basically, the situation in Europe, which improved markedly last year, in our view is set for a sustained expansion. We are not talking about something that is fragile. Balance sheets are in reasonably good order. So the situation in Europe looks solid. And I would say that the internal dynamics in Europe are positive; that is, the risks from the internal dynamics are, if anything, on the upside.
When it comes to the external situation, there, of course, I think per the WEO, the risks are viewed on the downside, and this would have an impact on Europe. But frankly, I think you'd have to have a very large negative external shock to significantly derail recovery in Europe generally.
I think part of this is due to good policies. If you look at the last few years, monetary policy in our view has been appropriately conducted not only in the ECB but also in other member states of the EU. We see fiscal policies which obviously ran into difficulties a few years ago, basically having gotten back on track over the past few years and through this year, and then also, structural reforms. Clearly, countries did significant structural reforms. Pensions, benefit systems, reservation wages, and wages themselves have been quite good.
Looking forward, on policies, I'm not concerned about monetary policy, but I am concerned about fiscal policy. Europe has a tradition of performing well in bad times and not doing so well in good times, and this is the big risk going forward, I think, in terms of how I see the issues in Europe going forward.
I think countries need to absorb the fact that it wouldn't take too much if they misbehave in the upswing of the cycle to get back into the kind of mess they got into a few years ago. And it is very important to use these favorable conditions to continue to adjust on the fiscal side. And on the fiscal, let me say that again, it is not just Western Europe, but it is also Eastern Europe where these remarks apply.
Finally, the same thing applies to structural reforms. As I said, I think people under-appreciate the extent to which reforms in Europe have paid off. Let me ask you a question. If I were to ask you who created more business sector employment over the past decade between the euro area and the United States, what would be your answer? The United States—but you would be wrong.
Question: [Inaudible; no microphone.]
Mr. Deppler: I don't know. That would be a safe answer. That sounds suitable for the IMF in fact. But the fact is that there was about 14 percent employment growth in the euro area over the decade from 1995 to 2005, and it was about 12 percent in the U.S.
I point to this simply because I think Europeans underestimate the effect and the impact that they have had through their reform efforts. And I think we have also seen this in terms of the declines in unemployment that we are seeing today in much of Europe.
So, reforms have definitely paid off, but by the same token, they need to continue, both in terms of the labor market and in terms of the other chapter that has become very much a focus of attention over the past few years, which is productivity. There, the figures are pretty disappointing. Productivity in the euro area, to use that example, has lagged that of the United States by almost one percentage point per year for ten years.
Now, the recent performance is improving, but we don't know how much of that is cyclical and how much of that is structural. But the basic fact is that Europe has been lagging relative to the United States and needs to do things and needs to press ahead on its structural reform agenda.
This also applies to the new member states. In Europe, it is fashionable to think, oh, the new member states are doing so well. They are doing well relative to the old member states, if I may put it that way. But the fact is that relative to emerging market countries viewed over a decade, the new member states as emerging economies are not doing that well in an international comparison. So, both in the old and the new member states, there is quite an agenda to do to get these economies performing as well as they might.
Okay, I think I'm going to leave it right there.
Ms. Stankova: Thank you. Please identify yourself and your affiliation. Yes, the person in the third row.
Question: Actually, in your opinion, should Italy address the extra income, the fiscal extra income, to reduce debt or in addressing other targets?
Mr. Deppler: You know, over the past few days, I have had a number of conversations with finance ministers, and they are all saying we have extra revenues. Everybody is saying we have extra revenues. My advice to all of them is: Be extremely cautious in how you deal with these extra revenues. And I think in the case of Italy, the argument is in spades. Italy is barely out of—in fact, not even out of—the excessive deficit procedure, and it has a longer-term objective. It clearly needs to go much farther than it is now, and in our view, all of the windfall revenues ought to be dedicated to reducing the deficit or spent on reducing the debt, if you wish, to put it in terms of spending.
I know it's very hard for governments to make these kinds of decisions in these political circumstances, but there is no question but that in terms of a cautious approach and a medium-term approach to policies, this is what is needed.
Question: The ECB and the European Commission said that the potential growth for Europe may be moving up. It is estimated at about 2 to 2-1/4 percent—
Mr. Deppler: Potential growth?
Question: Potential growth.
Mr. Deppler: Okay.
Question: I was wondering what will be the implications for monetary policy if that is true, if we have potential growth in Europe thanks to structural reforms moving up, because on one hand, some people say you could have lower interest rates because inflation is not going to be a problem, but on the other hand, other people say your neutral point of the monetary policy should be higher, because you can grow also at a faster rate.
What is your opinion on that?
Mr. Deppler: Views on potential rates should be free of the cycle, but the reality is, both technically but also in terms of perceptions, that they are not. Simply the rebound in investment argues that there is a cyclical pattern to the growth potential.
Now, we are not at a juncture where we really know what the answer to your question is. Has there been an increase, or has there not been an increase? We just simply do not know. It is true that if you look at some of the data, we are seeing an improvement in productivity which is somewhat promising, but frankly, it is very difficult to ascertain whether that is a cyclical phenomenon—there certainly will be some cyclical component there—or whether there is a structural component.
When I think of the kinds of policies Europe has been following, Europe has been following policies designed to increase employment for about ten years, and we have seen the results of that. The focus on increasing productivity is fairly recent, and simply in terms of the lags, in terms of the effectiveness of these policies on productivity, it seems to me it is a bit early to be assuming that the improvements we are seeing are due to structural factors.
Question: Mr. Deppler, you said that there will be a very large external shock needed to derail the European economy, so my question is given the recent volatility in Wall Street and oil markets around the world and the growing presence of hedge funds and other complex financial instruments, is it possible that this shock could come from the financial markets instead of a deterioration of economic fundamentals?
Thank you.
Mr. Deppler: Well, there is certainly a risk of that, but frankly, if you look at the volatility in markets that we have seen, in the historical perspective, this is small potatoes. We are not talking about—you have to really look at the charts or look at something in a very short time span to see things that would even register in terms of it being a problem.
It is not to say that this couldn't happen, but I think what we have to understand is what is going on—and it is quite positive in my mind—in Europe is that savings are being redistributed toward places where the return on those savings is the highest. And you clearly see that in the movement between Eastern and Western Europe.
This leads to concerns about current account deficits and these sorts of things, but basically, these are very positive developments from the point of view of growth and seeing a revitalization in Europe.
Now, it is equally true that these things can go overboard, and governments have to be cautious in terms of managing their fiscal policies and their supervision policies to address these issues. But I don't see anything—unlike in 2001-2002—or 2000, sorry—where there was this shock to equity prices which was a significant contributing factor to the deceleration of growth early in this millennium, I don't see anything like that here today.
Question: I would like to move to the extreme east of the continent and ask you about Ukraine and Russia. On Ukraine, very simply, are you concerned about the economy in view of the current political turmoil in the country?
And in Russia, I'd like to also ask you to reflect a little bit. First, it is also an election season, basically, and that creates concerns for inflation, aside from the fact that the country is awash in money. So is there a concern as to what they should be doing in terms of precautions? Also, now they are awash in money, and they are all happy with themselves, but history teaches us it doesn't last. So do you think it is prudent for Russia to go back to the external debt markets? The ones who are really trying to do that are the Russian private banks, and for them, the question is the opposite—are they prudent enough in going out? Do they really have guarantees of repayment of their money?
Thank you.
Mr. Deppler: First of all on Ukraine, Ukraine is doing fine in terms of the immediate situation. I'm talking in broad terms here. Needless to say, we think inflation is a bit too high and these sorts of things, but leaving those nuances apart, the basic situation, economic situation, is fine.
But Ukraine needs to address its own longer-term challenges in terms of its policies, and there are a number of those, and until this political situation settles down, those are not going to be addressed, and that's a concern.
Turning to Russia, inflation has been coming down, and it is sort of on a gradual deceleration path. In our view, it needs to continue to do so, and given the pressures on the economy, frankly, at the end of the day, a lot of this is going to have to be borne by the exchange rate and by allowing some flexibility in the exchange rate. But as I said, the authorities have been bringing inflation down, and we would expect them to continue to do so.
Now, in terms of spending, the fiscal authorities have been fairly prudent in their management of the fiscal situation, and in our view, this is quite appropriate, because it clearly is an overheating situation underlying the situation there, so the fiscal budget, which is in surplus, needs to remain in surplus, and basically use this money later basically to try to implement reforms and strengthen the supply side of the economy.
Now, on debt—so the implication of all this is that the government has very few, if any, external debts. I don't know the precise figure, but we're talking very small. You are right that what is going on here is an increase in private debt and capital inflows, but this is a phenomenon we see across all of Eastern Europe, and as long as the private investors that are doing this are conscious of the risks they are taking, and they are putting their money into things that have viable long-term deterrence, then it should be fine, and it is good.
Question: France has been the only country in the Euro Zone for which you have downgraded your forecast. I want to know if you could elaborate on the reasons for that, and also, what is the impact of the coming presidential election for French growth? Do you think it is slowing the economy now because of awaiting the outcome, and do you expect a new dynamic afterward?
Mr. Deppler: I forget the precise details of the revision in the French forecast, but you are right—there is some tapering down from our own number. As I recall, the main sources of the revisions were in exports, which have turned out to be weaker than we had expected, and also some moderation in consumption growth.
I think there are issues here that the next government is going to have to address, but we need to keep the performance of the French economy in perspective. For many years now, we have been saying how France has been doing as good as or better than the euro area average, and for the outcome not to match that in one particular year really needs to be kept in perspective.
In terms of—I think everybody is awaiting the outcome of this French election. Everywhere I go, there is a great deal of interest in this election, and we have to see what's going on. These are new players in the French political scene, and I hope it leads to a new start for French policies. I think you know more or less what our policies would be, our advice would be, and that will continue to be.
Question: I wonder if you see the current strength of the euro as a threat to European or euro land recovery.
Also, if I may, on interest rates, several of your colleagues in the past few days, including the Managing Director, sort of accepted the rationale for the next increase that is all but announced by the ECB in June. I was wondering if you could look a bit further ahead and if you see a further need for more tightening from the ECB. Several members of the Board of the ECB here in Washington have sounded pretty hawkish in the past few days on inflation, and I was wondering if you shared that view.
Mr. Deppler: Can you remind me of the first part of your question?
Question: The euro strength and the threat to the recovery.
Mr. Deppler: We have said many times, and we continue to say, that we view the euro as fairly valued in effective terms. That is, we think it is at about the right level for a sustained development of the euro area and the euro area economy. Simply looking at the data, frankly, I don't understand why this question keeps arising, because exports in Europe are very strong, the current account is in balance, and growth is stronger than it has been in years.
So in our view, there is—and as I said in the beginning, we view this recovery as quite robust, so I don't have those concerns that you have or that you raised.
In terms of the ECB, basically, our view is that there should be a withdrawal of stimulus, which is what they have been doing and will continue to do in June is the market's expectation.
Looking forward, it is a bit harder to say. It depends on how we see the recovery and the inflation risks changing over the forecast period. But if you take the view that this recovery is going to be fairly sustained and will continue at rates which will be on the upper end if not above some of the estimates of potential output, then there is scope for some cautious tightening beyond simply the withdrawal of stimulus.
MODERATOR: I would like to remind those who are joining us on line to send their questions before the end of the briefing, so we'll have a chance to answer them.
Please.
Question: Just a very quick follow-up on Alexander's question on the ECB and the euro map.
You said that there will be scope for cautious tightening. Do you mean going to the restrictive side of monetary policy, and where do you see a restriction on monetary policy? I mean, if the ECB goes above 4 or 4.5, would you say that that's going to be restrictive?
Thank you.
Mr. Deppler: We don't know where the demarcation line is in between withdrawal and moving into restrictive. We are approaching that zone, for sure. The statement I made was a contingent statement. It was a statement that if we see the growth continue at above potential rates and for inflation—and see some signs of that in raising inflation—then in our judgment, there would be a case for further moving beyond 4. But frankly, as of now, it is a contingent statement. It is dependent on what happens going forward.
Ms. Stankova: We have time for one or two more questions, and we'll call the briefing.
Yes, please.
Question: What do you think Europe can do to increase productivity?
Mr. Deppler: Let me start by saying that I think Europe underestimates how well it responds to competition. I know you have problems with closures of enterprises and turnover, but if you look at the tradable goods sector of Europe and you ask the question where is the strongest growth that has happened over the years in Europe, it's clearly in the export sector. This is the strongest influence on growth. And if you look at the size of the sector relative to other industrial countries, Europe is doing very much per the others.
So our view is that the sectors exposed to competition in Europe do quite well. The problems have been in the sectors sheltered from competition, and what are those? Well, it is parts of the financial services sector, and it is the rest of the services sector. We have data that says—I think I mentioned a while back that there was a shortfall of 1 percent, or close to 1 percent—I think .8 is the precise figure—per annum between the euro area and the U.S. on productivity growth. Half of that is due to the financial sector, and the other half is due to the rest of the service sector, retail and wholesale trade.
So basically, what Europe needs to do in our judgment in terms of strengthening its performance, leaving aside the labor market, is basically to inject more competition and contestability in these sheltered sectors. I'm not saying that this is the only avenue you should pursue, but in our judgment, it is one that is not getting enough emphasis in some of the plans of government—although some steps have been taken. I think the service directive is very good in that regard. The service directive will sort of make for greater competition across the area.
Ms. Stankova: Thank you.
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