Resolving The Crisis And Restoring Healthy Growth: Why Deleveraging Matters? — David Lipton, IMF First Deputy Managing Director
IMF News, November 12, 2012
Source details
- Canonical URL
- Resolving The Crisis And Restoring Healthy Growth: Why Deleveraging Matters? — David Lipton, IMF First Deputy Managing Director
Other formats
Bibliographic details
- Published: November 12, 2012
Context and purpose
- Keynote speech, Chatham House City Series Conference: “Deleveraging the West: The Impact on Global Growth”, Royal Institute of International Affairs, Chatham House, London.
- As prepared for delivery; date: November 12, 2012.
- Central question: how to reconcile the twin objectives of resolving the crisis (restore growth and jobs) and ensuring it does not happen again (sustainable deleveraging), given that measures for one objective can undermine the other.
Deleveraging trade-offs and macroeconomic dynamics
- Households:
- Need to work off debt to restore financial positions and support sustainable spending later.
- Short-run effect: higher saving, lower consumption, and economic slowdown (Keynes’ “paradox of thrift”).
- Banks:
- Need to deleverage, secure more stable funding, and build higher capital buffers.
- Two mechanisms: raise capital levels; reduce assets by tightening lending.
- Risk: reduced credit to SMEs and households can undercut recovery.
- Public sector:
- Early countercyclical fiscal responses raised deficits and public debt to support demand and relieve private-sector stress (bank recapitalization).
- High public sector indebtedness requires major, sustained consolidation over the medium term to restore sound finances and rebuild fiscal space.
- Simultaneity problem:
- When many countries deleverage at once, fiscal consolidation plus private sector deleveraging dampen demand and can produce larger-than-expected near-term activity losses.
Fiscal policy guidance and recommendations
- Where financing conditions permit:
- Fiscal consolidation should be gradual and sustained, guided by structural targets.
- In case of large negative shocks or growth disappointments, the pace of consolidation should be smoothed in countries that can afford it.
- Fiscal plans:
- Anchor adjustment with concrete and ambitious medium-term consolidation plans.
- Emphasize quality and growth-friendliness of adjustment.
- Robust fiscal frameworks to support credibility.
- Access to funding:
- Access to funding at reasonable costs is essential for European periphery economies to adjust, facilitate balance sheet repair, and support growth.
- Specific country notes:
- Market concerns remain heightened about policy adjustment in periphery countries, which will still take many years to complete.
- The U.S. lacks agreement on a concrete and ambitious medium-term fiscal consolidation plan.
- Japan’s plan needs to be strengthened further despite recent approval of a timetable for doubling the consumption tax rate.
- Aging-related expenditures:
- Move early to reduce growth of aging-related expenditures.
- More can be done to lower health-related spending in all advanced economies.
Financial sector policy guidance and recommendations
- Balance required:
- Strike a proper balance between strengthening financial resilience and cushioning adjustment’s impact on economic activity.
- Speed and sequencing of financial reform matter for growth; more stringent lending standards will affect credit availability.
- Bank recapitalization and resolution:
- Prefer cutting leverage by raising capital levels where possible.
- Viable banks may need restructuring; non-viable institutions should be resolved, potentially including bailing-in of creditors, respecting investor seniority.
- Where recapitalization threatens public debt sustainability, direct equity injections from the ESM into banks can cut adverse bank-sovereign loops.
- Central banks:
- Should continue providing liquidity support and stand ready to do more to support activity if needed.
- Financial regulatory reform:
- Pre-crisis regulation/supervision failed to prevent unhealthy leverage buildup and mispricing.
- Reform agenda advanced but implementation still in early stages; hard to be confident the global system is appreciably safer.
- Key attention areas: cross-border resolution and supervision; the too-important-to-fail issue; consistent implementation in over-the-counter derivatives markets; closing critical information gaps.
- Euro-area banking union:
- A banking union is indispensable for smooth functioning of integrated financial markets in EMU and should rest on:
- a single supervisory-regulatory framework;
- a pan euro area resolution mechanism with common backstops;
- a pan euro area deposit guarantee scheme.
- Reform momentum must continue; greater fiscal integration is also needed to backstop a banking union.
Progress to date and remaining gaps
- Fiscal consolidation:
- Considerable consolidation has occurred, but many advanced economies still have a long way to go.
- Market concerns persistent for periphery countries; adjustment will take many years.
- Bank deleveraging:
- EBA’s October 2011 recapitalization exercise helped strengthen many European banks to date.
- Further deleveraging will be needed due to high funding costs, weaker outlook, and new regulations.
- Rebuilding capital is especially needed in periphery countries; external support may be instrumental to avoid deeper credit crunch.
- Financial sector reform:
- Implementation is still early; cross-border coordination risks regulatory arbitrage and gaps.
- Euro area architecture:
- Firewall strengthened with activation of the ESM and introduction of OMT; uncertainty remains on timely recourse to ESM and OMT for countries that need it.
- Critical decisions remain on EMU contours and making the pan-European firewall more flexible.
Growth implications and scenarios
- Near-term global outlook:
- Global output projected to expand by 3.3 percent in 2012 and 3.6 percent in 2013.
- This projection is predicated on two critical assumptions:
- Decisive policy implementation in the euro area to restore confidence and ease financial conditions.
- U.S. policymakers effectively avoid the fiscal cliff and raise the debt ceiling.
- U.S. fiscal cliff risk:
- If timely action is not taken to avoid the fiscal cliff and raise the debt ceiling, fiscal policy could tighten by over 4 percent of GDP in 2013, pushing the country into a recession with large international spillovers.
- Downside scenario:
- Absent decisive actions, the world could slide into another downturn, with deep recession in the euro area periphery, and contraction or stagnation in the core and other advanced economies.
- Current momentum:
- Some stabilization signs and positive momentum from past decisions; forces supporting recovery will predominate only if policymakers act to remove remaining uncertainties.
Role of international cooperation and the IMF
- Collective action:
- International cooperation can help boost global demand, ensure healthier allocation of demand, and avoid re-emergence of vulnerabilities.
- Both deficit and surplus economies must adjust: deficit economies continue fiscal consolidation and private deleveraging while implementing structural reforms; surplus economies boost investment, broaden social safety nets in key emerging economies, and where appropriate cut back reserve accumulation and allow more exchange rate flexibility.
- These adjustments serve individual country interests and lower global imbalances.
- IMF contributions:
- Strengthen surveillance: launched “spillover reports” for China, the Euro area, Japan, the United Kingdom and the United States to assess policy impacts on the rest of the world.
- IMF Board approved a new Integrated Surveillance Decision to better integrate bilateral and multilateral surveillance.
- Need for harmonized regulatory implementation to avoid regulatory arbitrage and protect financial stability.
Speech by David Lipton, IMF First Deputy Managing Director, Chatham House City Series Conference, November 12, 2012.