## Press Briefing by Michael Mussa, Economic Counselor and Director Research Department

_IMF News, September 30, 1998_

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## Bibliographic details
- Published: September 30, 1998

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### Global outlook and forecasts
- World GDP growth for 1998 is now expected to reach only 2 percent, versus 3.1 percent forecast last May.
- World GDP growth projected for 1999 is 2.5 percent, revised down from 3.7 percent in May.
- The balance of risk around the 1999 forecast remains significantly to the downside, especially if present acute pressures on financing flows to virtually all emerging market economies persist for an extended period.
- Financial-market driven tightening of financing to emerging markets is a key driver of the downward revisions.

### Major findings on regional prospects
- Asia (including Japan): the downturn is significantly deeper and more widespread than anticipated five months earlier.
  - Several Asian crisis economies (Korea, Thailand) could stabilize or stage modest recoveries in 1999 aided by easing monetary policy, restored exchange rate stability, and improved external positions.
  - China: growth next year will be supported by recent substantial easing of monetary policy and by large public works spending, but growth is expected to remain relatively subdued compared with earlier in the decade.
  - Singapore and Taiwan Province of China: supporting growth with easier monetary and fiscal policies.
- Japan:
  - Forecast assumes at least slightly positive growth for 1999; Fund forecast specified as positive one-half percent growth of GDP year over year in 1999.
  - Recovery conditional on highly accommodative monetary policy, sharply expansive fiscal policy, and a determined, credible program to address banking-sector weaknesses.
  - Fiscal stimulus judged appropriate given net debt figures and long-term borrowing costs now below 1 percent.
- United States and Canada:
  - Growth next year likely below the pace of 1998.
  - Federal Reserve signaled intention to ease monetary conditions; financial markets had been anticipating about 75 basis points of easing before the Fed action and were broadly anticipating another 50 basis points in coming months.
  - Mussa’s view: a further easing stance is appropriate; he personally preferred more aggressive easing than signaled.
- Euro area and continental Europe:
  - Growth likely to be reasonably well sustained next year with increasing support from domestic demand.
  - Risks from spreading emerging-market problems, mounting bank losses, and appreciating exchange rates.
  - Downward convergence of short-term interest rates in the euro area toward rates in the core countries should provide additional monetary support.
  - If external or internal demand growth weakens materially, explicit reductions in official interest rates below present core rates may become appropriate.
- United Kingdom:
  - Slowing more sharply than the United States; forecasted growth cited later as 1.2 percent.
  - Possibility of moving to easier monetary conditions if inflationary pressures wane.
- Emerging markets beyond East Asia:
  - Growth next year generally looks likely to fall well below 1998.
  - Russia crisis is part of the story; wider spike in pressures on virtually all emerging market economies from world financial markets is the main story.
  - Latin America forecasts for this year and next have been written down significantly since May.

### Policy recommendations and stances
- Monetary policy:
  - Fund staff recommends that monetary policies be eased or accommodative monetary policies be retained in countries accounting for 90 percent of world GDP.
  - For countries under considerable external-financing pressure and confidence/credibility problems (perhaps 10 percent of world GDP), tighter policies are recommended because easy policies cannot resolve their difficulties.
- Fiscal policy:
  - United States: budget surplus should not be squandered.
  - Continental Europe: most countries should pursue further consolidation at a gradual pace, while allowing automatic fiscal stabilizers to operate fully in face of slower growth.
  - Explicit discretionary fiscal easing supported for a number of countries, notably Japan and several East Asian emerging market economies.
  - For countries facing external-financing pressures, fiscal tightening may be needed to restore confidence despite short-term adverse effects on growth.
- Banking-sector resolution (Japan focus):
  - Public funds need to be injected into the banking system; government must stand behind deposit guarantees.
  - Credible recognition of problem loans and injection of sufficient capital, with appropriate haircuts to present shareholders and some creditors.
  - Some insolvent banks may need intervention/nationalization or closure; overall rationalization of an overbanked system is required.
  - Rapid, forceful, and credible steps needed to resolve longstanding banking problems.

### Financial markets, exchange rates, and adjustment
- U.S. current account and global adjustment:
  - WEO shows the U.S. current account deficit almost doubling, to $290 billion, while the euro area surplus is around $110 billion.
  - Mussa: currently this development is more of a solution than a problem, but in the medium term a U.S. current account deficit in excess of 3 percent of GDP is doubtful as sustainable.
  - Over time, dollar likely to correct downward against other currencies, implying some upward pressure on U.S. inflation and need for slower domestic demand growth in the U.S. with faster domestic demand growth elsewhere (e.g., euro area).
- Exchange-rate regimes and target zones:
  - Rigid, narrow target zones remove needed flexibility; a viable system would require significant monetary-policy commitment to defend zones.
  - Movements in major currency exchange rates can be sometimes unhelpful and warrant resistance, but at other times movements may be helpful cyclically.
- Recent market events and implications:
  - Since mid-August, capital flows to emerging markets collapsed (gross flows fell from about $20 billion a month through July to $2 ½ billion in August, and effectively zero new gross flows since mid-August in Fund measures).
  - Interest-rate spreads for emerging-market debt spiked, and lesser-quality credits in industrial countries widened; described as movements ten standard deviations out in the distribution.
  - These shifts generated substantial stresses (e.g., Long-Term Capital Management episode) and argue for alert and active monetary policy responses.

### Costs, risks, and downside scenarios
- Crisis cost estimate:
  - Shortfall in world growth to an estimated 2 percent in 1998 vs a trend of between 3 3/4 and 4 percent implies a shortfall of 1 3/4 to 2 percent of world GDP.
  - With world GDP producing goods and services at a value of $30 trillion per year (about $40 trillion on a purchasing power basis), this shortfall corresponds to income losses between $600 and $800 billion.
  - Analogy: the output loss is approximately the size of Canada’s economy not producing for a year.
- Recession risk:
  - No world recession (defined as negative year-over-year world GDP growth) forecast; historically the weakest recent years had world GDP growth under 1 percent (e.g., 1991 just under 1 percent, 1982 barely 0.5 percent).
  - Fund’s central view does not see world growth falling to 1 percent or less next year, but acknowledges that outcome is a non-negligible downside risk (an outlier in the probability distribution, not an extreme outlier).
- Employment cost:
  - Fund did not quantify jobs lost; acknowledged huge job losses implied by the $600–$800 billion output shortfall but no precise employment estimate given.

### WEO Part II analytic chapters (Chapters 3–5) — brief overview
- Chapter 3: Asia’s long-term growth prospects
  - Examines whether crisis countries face a cyclical episode or a structural slowdown.
  - Evidence suggests pre-crisis trends were unsustainable: growing capital intensity, declining efficiency of new investments, growing burden of nonperforming assets, industrial overcapacity, overbuilding and asset price inflation.
  - Conclusion: Asia can return to impressive growth trends but likely not as steep as before unless fundamental reforms foster stronger productivity growth and slower, more sustainable capital accumulation.
- Chapter 4: Origins of Japan’s problems
  - Links current problems to the late 1980s asset price boom and bust.
  - Reviews policy roles in attempts to stimulate the economy and evaluates scope for monetary and fiscal measures.
  - Emphasizes problems in the financial sector and discusses proposals for cleaning up the banking system as essential for durable recovery.
- Chapter 5: Policy issues for the euro area
  - Discusses challenges of a single currency and the need for policy adaptation.
  - Argues fiscal policy must play a more countercyclical role in the future; meeting Stability and Growth Pact objectives is important to create fiscal room.
  - Structural and labor-market reforms needed to realize growth and employment benefits from EMU.

### Country-specific notes and salient figures
- United States:
  - Markets anticipated about 75 basis points of easing before the Federal Reserve action; broadly anticipating about 50 basis points after that action.
  - Mussa’s view: Fed signaled correct direction; he personally favored somewhat more aggressive easing.
- Japan:
  - Fund forecast for 1999: positive one-half percent growth of GDP year over year.
  - Long-term government borrowing costs are now below 1 percent.
- China:
  - IMF forecast for China this year is a GDP growth rate of 5.5 percent and a CPI forecast of zero percent.
- Brazil:
  - Debt-to-GDP ratio cited as 40 percent.
  - Urgent fiscal action needed; a substantial external financial package could help but will not substitute for strong domestic policy measures.
- United Kingdom:
  - Forecast for British growth given as 1.2 percent.
- WEO global numbers and comparisons:
  - World GDP value noted as $30 trillion per year, or as much as $40 trillion on a purchasing-power basis.
  - Estimated aggregate output/income loss from crisis: between $600 and $800 billion.

*Press Briefing by Michael Mussa, Economic Counselor and Director Research Department, September 30, 1998*

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## References

- [Argentina and the IMF](http://www.imf.org/external/country/ARG/index.htm)
- [Brazil and the IMF](http://www.imf.org/external/country/BRA/index.htm)
- [Canada and the IMF](http://www.imf.org/external/country/CAN/index.htm)
- [People's Republic of China and the IMF](http://www.imf.org/external/country/CHN/index.htm)
- [United Kingdom and the IMF](http://www.imf.org/external/country/GBR/index.htm)
- [People's Republic of China - Hong Kong Special Administrative Region and the IMF](http://www.imf.org/external/country/HKG/index.htm)
- [Japan and the IMF](http://www.imf.org/external/country/JPN/index.htm)
- [Republic of Korea and the IMF](http://www.imf.org/external/country/KOR/index.htm)
- [Mexico and the IMF](http://www.imf.org/external/country/MEX/index.htm)
- [Russian Federation and the IMF](http://www.imf.org/external/country/RUS/index.htm)
- [Thailand and the IMF](http://www.imf.org/external/country/THA/index.htm)
- [United States and the IMF](http://www.imf.org/external/country/USA/index.htm)
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