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The Global Outlook and the Evolving Role of the Fund: Speech by John Lipsky, First Deputy Managing Director, International Monetary Fund
July 11, 2007
Good Afternoon Ladies, and Gentlemen.
Thank you for your kind introduction. I'd also like to thank my friend Tom Hoenig who advised me to accept your gracious invitation to speak at this meeting. Like most of his colleagues in the Federal Reserve System, I learned long ago that it is a good idea to follow Tom's advice.
Today, I would like to share with you some thoughts regarding the global outlook, as well as to discuss the evolving role of the International Monetary Fund. We are an institution that is well known, but not so well understood. In any case, I have been informed that this is not a shy group. So I will keep my remarks short, in order to leave ample opportunity for discussion.
Beginning with the current situation, the global economy is producing an exceptional period of sustained growth. Not only has the current expansion been the fastest in decades, but it also has been unprecedented in its ubiquity. This extended period of growth also is notable for having been so unexpected. Who would have believed at the beginning of 2002 that the subsequent five years would usher in an historic period of resilient growth, low inflation, booming corporate profits and low interest rates? Is there any wonder why financial markets have performed so strongly over the same period?
In broad terms, the sources of this unexpected success are reasonably easy to discern. The combination of globalizing trade flows, financial market innovation, and in most major economies, improving budget policies and stability-oriented monetary policies each played a role. The importance of international trade and financial market liberalization is central. In fact, IMF research has demonstrated that there is simply no example of an economy that has produced sustained rapid growth that hasn't been supported by open-economy policies. Of course, technology played a pivotal role in creating new opportunities. But the key insight is that openness isn't either a fact of nature or inevitable—it reflects a conscious choice of economic policy. Thus, openness can't be taken for granted—but it can be replicated and sustained.
After this impressive five-year period of global growth, I am happy to report that the IMF's World Economic Outlook forecast anticipates that the current combination of solid growth and low inflation is likely to continue for the next few years. In fact, there is no obvious or necessary reason for the expansion to end any time soon. However, this does not imply that things simply can continue unchanged.
Rather, the underlying sources of growth will need to shift in almost all economies during the next few years if the expansion is to remain strong. In particular, the global expansion of the past decade has relied to an unusual degree on the strength of US domestic demand—consumption and investment spending. Indeed, the expansion has been associated with the emergence of unprecedented international payments imbalances and a record low US household saving rate out of current income.
In contrast, US economic growth in the coming years will depend to an unusual degree on the strength of domestic demand growth in the rest of the world. That is, US household saving out of current income will rise and renormalize—reflecting, among other things, an already evident slowdown in the pace of asset price appreciation. In this case, sustaining the global expansion will require stronger consumption and investment spending gains in the United States' trading partners. Fortunately, signs are evident that this needed shift in the sources of global growth is occurring. For example, both the euro area and Japanese economies are expected to grow faster this year than the United States. Consumption spending gains have slowed here, while export growth has strengthened. Thus, the US non-oil trade deficit has stabilized and may even have begun to retreat.
Of course, this positive outcome can't be taken for granted. In fact, there are several sources of potential risks that should not be ignored or neglected. First, financial market risks have increased. Most notably, the strains in the US subprime mortgage market have been more severe than most observers had anticipated, as has the impact on the housing market itself. While the financial market weakness has been confined so far mainly to the subprime sector, one can't rule out broader market challenges. In particular, the problems in this sector became evident only after the increase in underlying asset prices—that is, house prices—began to falter. If the same were to happen in other asset classes—for example, if corporate profit growth was to wane unexpectedly—credit spreads in other markets could be affected, dampening activity.
Let me be clear about this. I am not suggesting that more widespread serious credit problems are inevitable. But it is likely that US corporate credit quality has stopped improving and could weaken somewhat in the coming quarters. Thus, it is to be expected that investors in the coming quarters will be cautious relative to the past few years.
Second, there are risks to the global inflation outlook. Skillful management of monetary policy should help to contain these risks, but nonetheless there is the possibility that firms will attempt to respond to rising costs for energy, food and other inputs by increasing prices, rather than by sustaining profits through improved productivity. So far, however, it is striking that inflation expectations have remained contained.
Third, there is a small but potentially damaging risk of a loss in investor confidence in response to geopolitical shocks, and/or to a decline in the credibility of economic policies. In these circumstances, the mere scale of global payments imbalances could exacerbate concerns about future developments.
At this point, it is appropriate to bring the International Monetary Fund into the picture. After all, one of the Fund's primary tasks is to encourage the implementation of sound economic policies, such as those have been successful in supporting the global expansion during the past five years. At the same time, the Fund is responsible for helping minimize the risks to the outlook that I have just discussed.
For those who are not very well acquainted with the IMF, let me briefly explain our goals and our structure. The Fund was established in 1944 with the aim of creating an open and fair economic and financial system. All of our 185 member countries have accepted a set of obligations detailed in our constitution, the Fund's Articles of Agreement. The Fund's resident Executive Board, representing the member governments, comprises the system's legislature. (The Board of Governors—Ministerial-level authorities who meet once a year—are responsible for the most important policy issues, such as proposed ammendments to the Articles). The Fund's management and staff comprise the executive branch. The Executive Board also serves as the system's judiciary, as it has the responsibility of determining if member countries are fulfilling their obligations to support a stable and open international system.
While Fund members originally were required to maintain fixed exchange rates, this evolved during the 1970s into an open system in which each member is free to choose their preferred exchange system—either fixed, floating or pegged rates. However, the guiding "legislation" (formally, the relevant Executive Board Decision) that governed staff assessments of members' policies predated the 1978 amendment to the Articles that granted members the freedom to choose their preferred exchange rate system. Thus, the Decision itself became inceasingly irrelevant to the actual practice of IMF surveillance of member's policies. (Surveillance is the Fund's unique "term of art" for the process of reviewing economic developments and policies in its member countries).
The expansion of Fund membership since 1990, the rapid expansion in global trade, and the explosive growth in international capital flows have made more complex the process of judging whether member countries are fulfilling their obligations to support openness and systemic stability. In response, the Fund's Executive Board just last month adopted a new Decision on Bilateral Surveillance. Through this Decision, the Board made explicit its standards of satisfactory economic policy conduct in regard to exchange rates and related policies.
In essence, the Board has instructed the Fund staff and management to pay close attention to its member countries' exchange rate policies—a sort of "back to basics" move. At the same time, we were told to exercise greater candor—that is, employ our best judgment—in analyzing countries' exchange rates and other economic policies. We were also enjoined to maintain evenhandedness. That is, we were reminded to apply the same standards to all members.
Another fundamental reform currently underway is the rebalancing of membership quotas—that determine member's voting shares, as well as determining their financial contribution to the Fund. According to the Articles, quotas should reflect member country's economic weight. These shares have not been rebalanced for more than three decades, despite the significant changes that have occurred over that period. The reform process began last year with ad hoc quota increases for four of the most underrepresented dynamic economies—China, Korea, Mexico, and Turkey. At present, we are at work on developing an agreed formula that will govern a new round of increases. We hope to have this process completed by our Annual Meetings later this year, or by the Spring Meetings of 2008, at the latest.
We also developed a new tool—called Multilateral Consultations —that allows us to flexibly convene groups of relevant member countries to address specific challenges to global stability and prosperity.
The first Multilateral Consultation addressed the dual goals of sustaining global growth while reducing global imbalances. The participants included five systemically relevant economies—China, the euro area, Japan, Saudi Arabia, and the United States.
Each participant in this first Multilateral Consultation committed to a specific set of medium-term policies, which if fully implemented, should help promote a re-balancing of the global economy along the lines I outlined earlier. The particulars of the participants' policy plans were reported to the rest of the Fund membership, and are available on the Fund's website. We are hopeful that the Multilateral Consultation will prove to be a useful addition to the Fund's policy toolkit.
Besides these evolving roles, the Fund will continue, to provide other public goods for the global community—from data standards and dissemination, to technical assistance—all of which combine with the broader functions I mentioned before, to go to the heart of our goal—to facilitate and maintain an orderly multilateral economic and financial system through the smooth functioning of an international system governed by the rule of law.
I would underscore that together these constitute our primary functions—not the large lending programs for which we became known in the 1990s and earlier this decade. Those arrangements, while not always perfect, were needed in exceptionally difficult times. It does not stand to reason that an international institution entrusted with safeguarding global economic stability and prosperity should have its long-term role and relevance gauged relative to a period of exceptional challenges. This is especially true as there is general agreement that the international system was inadequately prepared for the challenges of that time.
In contrast, in these exceptionally favorable times the Fund and its member countries need to do whatever they can to preserve and sustain the latest gains. At the same time, we are utilizing the current opportunity to adopt the reforms and adjustments that I have just outlined in order to prepare the Fund to deal with potential future challenges to systemic stability and economic progress.
Thank you for your attention. I will be happy to answer any of your questions, or to discuss any topic of interest.
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