Transcript of the interview granted by Maurice Obstfeld, IMF Economic Counsellor and Director of Research to a group of media

December 4, 2018

QUESTIONER:  You’ve been here for three years, and I was curious what you’ve learned or what has changed, in your view, about the global economy.  What do you think about differently now than when you started the job?  What parts of your view about how the global economy operates have evolved over the past three years?

MR. OBSTFELD: I think there are a number of areas where I see things differently.  One really big change has been in the political sphere.  When I came in, the institutions of multilateralism we had, the multilateral basis of international governance—while it always was imperfect and only extended so far, I don’t want to idealize it—it was basically unquestioned.  There were certainly issues of reform of various institutions.  Even here at the IMF we had quota reform and brought China into the SDR, so it was a dynamic situation. 

But there now seems to be more questioning of multilateralism, especially on the part of the U.S. government.  And while we all agree, and there is broad agreement coming out of the G-20, that institutions like the WTO can be improved and be made to better serve their members, there is a more conflictual approach to international economic relations now than we had seen recently.   That’s a really big change, and I don’t think we know how this will work out, whether it will stabilize after some adjustments have been made in trading relationships, or whether it will be an ongoing feature of the global economy. 

The other thing that has impressed me, and that is a change, is how the low growth of the advanced economies, the slow recovery from the global financial crisis, has been more protracted than I would have thought.  The U.S. stands out as an exception and that is, in part, due to a very procyclical fiscal policy.  But you do see a sharp divergence of growth performance, a fairly long-term divergence of emerging and developing economies from the advanced economies, with the former group growing more quickly.  This is coupled with a sense—in the advanced economies, particularly—of less social mobility, less dynamism.  Income inequalities there, while they are generally below those in emerging markets, have also proven persistent and sometimes have grown.  So, I think that’s feeding a lot of political developments that we’re seeing these days.  Those strains were barely visible when I started here three and a half years ago.

QUESTIONER:  Obviously the big conflict over the weekend, or maybe it wasn’t a conflict, but the big story that everyone was watching over the weekend was these talks between the U.S. and China.  The big question about that is, is it inevitable that China is going to become the world’s largest economy in a fairly short period of time?  And what will be the consequences to everyone else if that happens?

MR. OBSTFELD:  As a matter of algebra, if China keeps growing at close to its current rate and the U.S. keeps growing at close to its current rate, you can figure out how many years it will take for China to reach the size of the U.S.   I don’t think the size issue is itself that important, although it will clearly generate huge headlines, but it is not as important as the character of the Chinese economy and the forces that are fueling its growth.  Which increasingly rest on more advanced products and more technological sophistication. And that’s where, I think, there is a bigger question.  

We did a chapter in our World Economic Outlook last spring on technology spillovers between countries.  There is a relatively small group of advanced economies that are technological leaders—that are on the frontier—including, of course, the U.S., the UK, Japan, Germany, France.  But they have now been joined now by China and Korea.  Korea we consider an advanced economy, but China we still consider an emerging economy, so this is a major shift.  One of the big issues in the trade disputes between China and trading partners is the area of intellectual property, and reforming that regime is a big to-do for the global multilateral order.  But China is increasingly a producer of new technologies, and that is really a major, major change.

In terms of how this will play out over time, it’s really important that this not play out in a conflictual way because that will be destabilizing for the entire global economy as well as for global politics, potentially.  So, I think it is going to be important to try to entice China into a global framework that countries agree on, which naturally one would think would be the result of some multilateral negotiations under which China changes some of its trading practices.  There would also be accommodation of some of China’s legitimate economic goals.  But I don’t think conflict is going to be helpful in that evolution. 

Here in the Fund, we work very constructively with China as a member.  They’re open to our advice.  We feel that embedding them into the multilateral system is actually in everyone’s interest.  A number of our initiatives—again, I come back to the SDR initiative—have been attempts to keep them at the table.  I think that’s a very important, and should be a very important goal. 

QUESTIONER:  A broad question on globalization.  I think it’s very, very important for China to figure out its future role in globalization.  I’m wondering, as some countries shift toward inward looking courses, what do you think the future of globalization looks like, and how do you respond to the argument that one may be entering a period of de-globalization.

MR. OBSTFELD:  I think the talk of de-globalization is a little bit overdone.  We certainly haven’t seen financial de-globalization.  A lot of the discussion has been about trade.  There are certain technological trends that are pushing some reshoring of formerly offshore industries, but I wouldn’t think of those as de-globalization.  It’s merely the structure of production responding to technological developments.

And clearly, while there has been more trade friction and an uptick in trade actions, international trade for most economies remains a key or even a dominant factor, and these trade actions would not really, in my view, take you back to the conditions of the Great Depression where trade absolutely collapsed under the pressure of trade restrictions.  So, I see the tensions now as being possibly damaging because so much of global investment and production are tied up with trade, but not liable to the kind of collapse we saw in the 1930s. 

QUESTIONER:  This year marks the 40-year anniversary of China’s reform and opening up.  I’m wondering how you look back on 40 years of China’s reform and other ways for Chinese authorities to push for further reform and opening up.

MR. OBSTFELD:  The opening up that began in the late seventies with Deng Xiaoping has had remarkable positive effects on China’s standard of living.  Many of those effects have spilled over to other countries, particularly in East Asia and elsewhere in the emerging world.  It is something that would have been very, very hard to predict.

That being said, there is significant room for China to open up further and to give markets an even bigger role in ways that might enhance not only its growth but economic stability.  I mentioned the sources of some of the trade tensions with partners, such as the intellectual property regime.  Given the advances in China’s technological capabilities, it may well be in their interest to move forward in this area in concert with their trade partners.  Opening up more to foreign investment could benefit China directly, and greatly.  And there is still too much official support of the state-owned enterprise system.  There remains a failure to enforce hard budget constraints, and, resulting from that, an excessively high rate of credit growth. Even though the authorities have taken steps to rein that in, they need to better oversee their financial sector in ways that we have advised and that they have also accepted in theory.  So, there is a big reform agenda there.

I think one of the biggest issues for China is also moving to a more flexible currency.  This is something that, again, is a stated goal of the authorities, but it would be very important in helping the economy adjust and, I think, also to ultimately defusing some of the trade tensions.

QUESTIONER: Thank you again, for doing this interview.  In the past, you said you are worried about increasing nationalist movements around the world,  because usually they are not very good for prosperity and global growth.  We take a look at Europe, like in regard to the European elections next year. What would a strong showing of populists mean for economic developments in Europe?  Do you have any outlook or opinion on that?

MR. OBSTFELD:  We can only speculate on how this would play out and what would be the channels through which the European parliament would influence national policies.  But I would expect there to be a push toward more national sovereignty and away from some of the rules of the EU.  Many of those rules exist to promote the single market and efficient allocation of resources within the single market.  And so, to the extent that there is backtracking there, that could be injurious.  There would certainly be some pressure to relax budgetary rules within Europe, and that could be problematic given how indebted some countries are currently.  The task in front of them is really to rebuild their fiscal buffers, not for governments to spend more recklessly.

QUESTIONER:  Talking about investment, talking about Europe, what would be the economic legacy of Angela Merkel from your point of view.  Did her economic policies advance Germany and Europe in an equal matter [OS1] because very soon she won’t be chancellor anymore?  Do you have an opinion on that, how she advanced Germany with her economic policies?

MR. OBSTFELD:  Her goal—and this she did not do single-handedly, she had help from the ECB, of course—she had a very clear goal of preserving the Euro.  One legacy of the Euro crisis is that the institutions of the single currency were strengthened quite a bit; and it’s an ongoing process, as we saw with the finance ministers’ announcement this morning.  Again, though, momentum for reform grows and it wanes and unfortunately, it sometimes takes crises to concentrate the minds and to create political will. 

I think there is a change in the mindset about what sort of economic institutions we need to support a single currency, institutions that were not there in the original Maastricht Treaty. I think Merkel saw, as many did—but she provided leadership— that the institutions that the Maastricht Treaty created were not completely fit for purpose.  So, for example, you have the single supervisory mechanism now, the single resolution mechanism.  There were reforms in the way the economic commission does its surveillance, which had not been accepted before the crisis. 

Now, the work is not complete and there is a recognition of that, but there has been a tremendous evolution in views.  Now, it’s even accepted widely as a matter of principle (although it’s not necessarily accepted by all that the preconditions are yet right), [OS2] that you need some sort of common deposit insurance, a full banking union, and capital markets union.  This is huge progress and I believe people will look back on that as partly being the result of Merkel’s leadership. 

QUESTIONER:  I guess you can start going down a list of countries where arguably central bank independence is at least being questioned more than it maybe was in the eighties and nineties.  U.S., India, Turkey, Argentina, maybe you can add to it.  How significant a challenge is this to the paradigm of independent central banks that we’ve seen over the past couple of decades?

MR. OBSTFELD:  I would take issue with the question in the sense that I don’t think you can compare Turkey or Argentina which didn’t really ever have the strong institutions that you have, for example, in the U.S.  So, I think these are in very different buckets.  But your basic premise of central bank independence being reconsidered is a valid one. 

The crisis had a huge effect on thinking about central bank independence.  Before the crisis, we had the view that we could put the central bank in this neat bucket where its job was to manage the policy interest rate and, by doing so, it could control inflation.  If you thought of the central bank as doing this in a flexible manner that took account of the Phillips curve, you could think of it as being a “flexible inflation targeter” that also paid attention to fluctuations in output.  And this was a simple and clear intellectual framework.

And that proved to be a very incomplete view of what the central bank is responsible for.  Historically, if you look back to the gold standard period, central banks didn’t play a countercyclical role but they certainly had responsibility for the payments system, for financial stability, and the whole discussion of lender of last resort comes from that period.  And somehow in the 2000s, with talk of the “great moderation,” I think we lost sight of that.

So, the financial crisis did two things.  First of all, it made the public and the politicians aware how very powerful central banks are and that they could do things that went far beyond simply deciding what the policy interest rate is.  Think of the whole range of special facilities, unconventional policies of other kinds, negative interest rates, LTROs in Europe, just an immense range of powers.  And this naturally made politicians stand up and take notice and say “Well, these guys are unelected bureaucrats.”  While there had been a very strong intellectual case that you need an independent central bank, or you’ll end up with a lot of inflation, here we were with central banks doing all this stuff with the threat being deflation and therefore with a very different sort of policy landscape.

Second, central banks were also very involved in matters that verged on fiscal policy.  Lending to specific segments of the economy: doing LTROs, which, you could argue, were a form of fiscal policy giving subsidized credit to get lending going; buying huge amounts of sovereign debt.  Within Europe, there was a special situation because there were criticisms that the ECB was essentially providing fiscal support to some Euro members. 

Again, this is not something that in theory we didn’t know about, but naturally it was very much masked by the very favorable economic conditions in the early and mid-2000s.  So, you have a situation where it’s obvious that the central bank has much greater power than you thought.  The central bank is fundamentally involved in financial stability policy, in fiscal policy, and this clouds the remit and it clouds the idealized picture of this sort of philosopher king just setting the interest rate to control inflation.  Instead, you had the central bank making a lot of discretionary decisions that affect broad parts of the economy. 

Now, if you look at the record, the decisions that were taken did stabilize the economy.  They avoided, in my view, much worse losses in output and employment.  But they also raised the question of transparency and accountability.  So, it’s not a shock that people raise these questions, and it does create a challenge for central banks to be more transparent and to communicate more effectively with the wider public about what they’re about and what they’re doing.  In the UK, Andy Haldane has pushed this at the Bank of England.  A number of central banks are doing reassessments of monetary policy.  The Fed is planning a big reassessment for June in Chicago, a conference that will highlight some of the thinking that they are doing. 

This change is something that we have to contend with as a policymaking community.  Clearly, we don’t want politicians manipulating the central bank for political ends.  At the same time, if the central bank cannot communicate more effectively about what it’s doing, then there is a possibility of a different sort of political manipulation where politicians attack the central bank and undermine it. 

So, we are in a new terrain where, I think, the simple life that we thought we were living in the 2000s is probably gone forever.  We need to take the questioning of central bank accountability seriously.  We have to distinguish the legitimate questions from those that are purely politically motivated.  But again, that’s something that is by definition going to be subject to debate and to a nuanced discussion.  We’re certainly in more ambiguous territory.

QUESTIONER:  How significant is the slowdown that you’re apparently seeing in the U.S. and more globally?  And, in particular, I guess we’ve seen the economy, which is kind of juiced by fiscal policy, in particular this year, and that fiscal stimulant begins to fall away next year.  How significant do you think the slowdown may turn out to be as we see this going on?

MR. OBSTFELD:  We’ve long been predicting somewhat lower growth for 2019 than what we’re seeing this year.  And part of that is the reversal of some fiscal incentives and public spending.  That’s going to be sharper probably in 2020 than in 2019, according to the data we’re seeing.  But the slowdown outside the U.S., to the extent we’re seeing signs of that, seems to be more dramatic.  We’re certainly seeing some negative data from Asia, where a number of countries have had pretty disappointing Q3 outcomes.  But also from Europe, Germany had disappointing Q3 growth—negative, in fact.  There is a story about Germany related to auto emissions standards but we don’t know if that’s the whole story.  So, for the rest of the world, there seems to be some air coming out of the balloon and that, I think, will come back and also affect the U.S. 

The nightmare scenario would be that inflation picks up in the U.S. and quite strongly, the Fed responds with high interest rates and hits that high interest rate level just as fiscal policy goes into reverse.  If anything, what we’re seeing from what the Fed is saying and from markets is expectations for a more moderate pace of interest rate increases than we would have thought a couple of months ago.  So, we still foresee that the U.S. will grow well above potential next year but on a slowing path into 2020.  We’re not predicting a recession anytime soon.  The probabilities say that could occur, but it’s far from being our baseline scenario.

QUESTIONER:  I wanted to ask you about India.  What is the assessment of India’s economic situation?  How do you see the economic situation as improved or not improved in the last four and a half years of the Modi government?

MR. OBSTFELD:  India, under the Modi government, has carried out some really fundamental reforms.  These include the goods and services tax, and the insolvency and bankruptcy code.  A lot of what they’ve done on financial inclusion has been really important.  The growth performance has been very solid.  Not so much in the third quarter of this year, but generally it has been quite solid. 

There are important vulnerabilities though, and it is important for the reform momentum to be maintained, even as an election comes, up and for the path of fiscal adjustment to be maintained in these circumstances.  One risk that has become much more evident in the last few years has been non-bank finance, usually called shadow banking.  There is a big challenge of stricter oversight. 

There has long been a legacy of corporate debt associated with bad infrastructure projects that has been very concentrated in the banking system, but as the government has tried to better oversee the banking system, these loans have migrated to shadow banking.  More needs to be done to contain financial pressures, which we’re beginning to see in India.  Now again, with an election coming up, there is a reluctance to do anything that would slow the economy.  But the lesson of experience is that financial vulnerabilities can go south very quickly.

QUESTIONER:  And when I was walking, I saw you with Gita Gopinath.  Based on that interaction, how do you see her as an economist?  How do you see the challenges for the first female chief economist of the IMF?

MR. OBSTFELD:  I think she’s going to be a fantastic appointment.  I’ve actually known Gita since roughly 1996 or 97.  Ken Rogoff and I wrote a graduate textbook in international macroeconomics back then, and the very last thing we did in the book came when the publisher said: You need problems at the end of the chapters for the graduate students to solve.  We had finished the book text, we were exhausted, but we thought, okay, now we have to write some problems.  We did write them but we actually had no idea if we could really solve these problems. Then, once the book was out, the publisher, MIT Press, came to us and said: You need to do a solutions manual for the problems.  “How are we going to do that,” we said, “we don’t even know if we can solve these problems.”  Luckily Ken then volunteered, “I have a great idea.  I have this really smart graduate student and she can help us do this.”  Her name was Gita Gopinath. 

So, there is actually this item which, I think, you can find on Ken’s website, which is the solutions manual by Ken, me, and Gita. She was great, and I’m not surprised that she went on to an illustrious career. 

Back to the question that you asked at the start about what has changed: I think she is going to face a world that looks a little different from the world I came in to.  When I showed up, a big challenge was that China seemed to be slowing, and questions surrounded its handling of its exchange rate.  But Europe had come through the Euro crisis.  For U.S. growth, 2015 was a pretty big year (2.9%), so things didn’t look bad.  And then in sharp succession, you have Brexit, you have the troubles in Europe that we’ve been discussing.  You have the U.S. moving to a very different view of the international order that, in some sense, has increased policy uncertainty a lot in the global economy.  And so this is going to be a tough landscape to navigate. 

I think we here in the Research Department and in the Fund more generally have started looking at a lot of issues that are very, very important in understanding these changes, including income distribution, market power, the determinants of trade, the effects of trade, the tensions that trade has caused.  I think these will be ongoing themes, and I’m sure new themes are going to come up. 

I can think of two that stand out as likely challenges. One is climate change.  There has been a series of alarming climate reports, including even one from the U.S. government.  As someone who has a home base in California where I was last week, I can say that although we had rain, which was great because it washed all the smoke out of the air, we are still in an increasingly worrisome situation.  I think we are going to see more and more macro effects coming from climate change and extreme weather events.

The other really big issue, which is just hanging out there waiting to happen, is some major cyber event with cascading network effects that could actually have major financial and macroeconomic consequences.  And again, particularly in our Money and Capital Markets department, we’ve started to write more about this and talk more about this, as it remains a major vulnerability.  Like climate, it’s a public good problem.  If you as a firm or financial institution are attacked and have to shut down your systems, that’s a big financial loss for you.  But there are important network effects that damage the whole economy.  So, economic theory tells you that the private sector is not doing enough here, that they’re not taking account of all the extraneities.

So, governments really need to step in and they need to raise the alarm.  We as an international organization have to focus on the spillovers between countries.  People are talking about it more, but I don’t think the threat is being taken seriously enough yet.  So, I think those are going to be frontline issues for Gita in the next few years.

QUESTIONER:  So, you have the solutions for it in the macro book?

MR. OBSTFELD:  I feel like in these three years, we’ve written out the problems and she’ll have to write the solutions. 

QUESTIONER:  A follow up question on the central bank.  India’s central bank (inaudible).  How do you see that development, is it under pressure from the government or has it actively been (inaudible)?

MR. OBSTFELD:  I think they’ve reached an agreement on how to proceed.  Again, I think the RBI message that financial stability is important is correct, and it’s important for the government to heed that.  Again, this is one of these examples that fits in with what I was saying in response to Sam’s question [on central bank independence].  We have come to understand that the central bank’s role as a financial regulator is critical.  Again, there is debate over whether it is better for financial stability to be in the primary remit of the central bank or an independent regulator.  The UK in 1997 split them and then put them back together again.  I’m not going to take a position on that.  I think most people would agree that the central bank does have to be intimately concerned with financial stability to some degree and with the payments system.  So, this is likely to be a much more politically charged question, particularly around elections, than even the setting of interest rates. 

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