The Two Rebalancing Acts
IMF Blog, October 6, 2010
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Bibliographic details
- Authors: Olivier Blanchard
- Published: October 6, 2010
Overview
- Author: Olivier Blanchard
- Date: October 6, 2010
- Goal referenced: achieving a “strong, balanced, and sustained world recovery”—phrase set in Pittsburgh by the G-20.
- Core thesis: the world recovery requires two fundamental and complex economic rebalancing acts:
- Internal rebalancing: private demand must become strong enough to take the lead and sustain growth while fiscal stimulus gives way to fiscal consolidation.
- External rebalancing: advanced countries (most notably the United States) must rely more on net exports; many emerging markets (most notably China) must shift from reliance on net exports toward greater domestic demand.
Current assessment: pace of rebalancing ("Too slow")
- Private domestic demand in advanced countries remains weak due to:
- Correction of pre-crisis excesses and scars of the crisis.
- U.S. consumers saving more and consuming less after overborrowing before the crisis.
- Housing booms giving way to housing slumps; housing investment expected to remain depressed for some time.
- Financial system weaknesses constraining credit.
- External rebalancing limited:
- Net exports are not contributing to growth in advanced countries; the US trade deficit remains large.
- Many emerging markets continue to run large current account surpluses and respond to capital inflows primarily through reserve accumulation rather than exchange rate appreciation.
- International reserves are higher than they have ever been and continue to increase.
- Resulting macroeconomic picture:
- Recovery described as neither strong, nor balanced, and at risk of not being sustained.
- For the last year or so, inventory accumulation and fiscal stimulus were driving the recovery; inventory accumulation is ending and fiscal stimulus is being phased out.
- Consumption and investment now need to take the lead, but in most advanced economies weak consumption and investment, together with little improvement in net exports, are leading to low growth.
- Unemployment is high and barely decreasing.
- By contrast, many emerging market countries—where excesses were limited and the scars of the crisis are few—have consumption, investment, and net exports all contributing to strong growth, and output is back close to potential.
Policy implications and recommendations
- Monetary policy:
- Wherever private demand is weak, central banks should continue with accommodating monetary policy.
- Be realistic: not much more can be done; should not expect too much from further quantitative or credit easing.
- If sustained low interest rates lead to excessive risk taking, address such risks through macro prudential measures, not through increases in policy rates.
- Financial sector repair and reform:
- Governments must continue both financial repairs and financial reforms where needed.
- Many banks do not have enough capital; tight credit is constraining segments of demand.
- Securitization, important for future financial systems, remains moribund.
- Financial reforms are proceeding, but questions remain about “too big to fail” institutions, the perimeter of regulation, and cross border issues.
- Faster reduction of reform uncertainty will help the financial system support demand and growth.
- Fiscal consolidation:
- Governments must address fiscal consolidation where needed.
- Essential element: offer a credible medium term plan for debt stabilization and, eventually, debt reduction—not simply phase out fiscal stimulus now.
- Credible plans may involve fiscal rules, creation of independent fiscal agencies, and phased-in entitlement reforms.
- Such plans have not yet been offered in most countries but are essential to give governments more fiscal flexibility to sustain growth in the short run.
- Rebalancing in emerging markets with large surpluses:
- These countries must accelerate rebalancing; this is in the world economy’s interest and in their own.
- Distortions in many of these countries have led to too low a level of consumption or too low a level of investment; removing distortions to allow consumption and investment to increase is highly desirable.
- Market forces in the form of large capital inflows are pushing some countries in the right direction.
- Where countries do not allow sufficient exchange rate adjustment, this exacerbates problems for others.
- Use of reserves should be limited.
- Role of capital controls, if any, should be to direct flows in accord with macroprudential concerns, not to prevent necessary exchange rate shifts.
Interconnections and global coordination
- All policy pieces are interconnected:
- Advanced countries need stronger private demand—both domestic and foreign—to achieve fiscal consolidation.
- Worries about sovereign risks can derail growth.
- If growth stops in advanced countries, emerging market countries will have a hard time decoupling.
- Downside risks described in the GFSR should not be ignored.
- The need for careful national design and global coordination may be even more important today than at the peak of the crisis a year and a half ago.
Source: The Two Rebalancing Acts — Olivier Blanchard, October 6, 2010.