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Address to Finance Ministers of the Americas and Caribbean, By Dominique Strauss-Kahn, Managing Director, International Monetary Fund
May 28, 2010
As Prepared for Delivery
Good morning. It’s a great privilege to be here. I would like to thank Minister Araoz and the Peruvian government for inviting me to share my thoughts on the global and regional outlook, as well as pending challenges.
The global economy has come a long way since the onset of the global financial crisis. As we all know, the crisis erupted in the U.S. housing market and soon engulfed the whole world. Especially after the collapse of Lehman Brothers, economic activity all over the world began to tumble at a dizzying rate, and a second Great Depression became a very real possibility.
But it hasn’t happened. Instead, thanks to a bold and rapid policy response by policymakers all over the world, delivered in an atmosphere of unprecedented policy cooperation, global economic activity is rising again. And as the world emerges from crisis, a key lesson is that global recovery comes from global cooperation. This will be the great legacy of these troubled times.
This spirit of solidarity must be sustained as the post-crisis world takes shape. Indeed, tackling the complex and daunting challenges of the post-crisis era will require even more cooperation than before. And as recent events in Europe remind us, the dark clouds have not yet passed. What happens in one country can easily reverberate across borders, often at lightning speed. There can be no going it alone.
Global and regional outlook
The global recovery is proceeding, although at different speeds. We now expect global growth to hit 4¼ percent in 2010 and 2011, faster than previously expected. But it is still fragile. And markets have been unsettled by the significant fiscal consolidation challenges faced by some countries. The world is still a dangerous place, as downside risks still dominate and tail risks remain ever-present. Events in Europe only reinforce this message.
In the advanced economies, the recovery is lukewarm, given high unemployment, lasting damage to banking systems, and weak financial positions of households. Here, the recovery will be more sluggish than in the past, as repairing the damage will take time.
The situation is markedly different in emerging markets. Here, the recovery is far more robust, reflecting strong internal demand and the rebound in global trade. Of course, the countries that did not make policy mistakes—such as those in Asia or Latin America—are ahead of the recovery curve, while others—such as some in emerging Europe—lag further behind.
The effect of the crisis on Latin America and the Caribbean region has been uneven. Countries that followed sound policies, like Peru, fared rather well—better than countries in other regions and better than in the past. On the other hand, countries in Central America took longer to recover and the tourism-dependent Caribbean countries are still suffering.
Good performance was generally associated with a good starting position. These countries did not make the mistakes of many advanced countries by going on a debt-fueled spending binge or using complex financial engineering to magnify risk. Rather, they learned from past mistakes, and embraced cautious and prudent macroeconomic policies.
Here, when the storm arrived, the levies were firmly in place. Countries had saved for a rainy day, so they could use fiscal policy to cushion the downturn and support employment. Indeed, for the first time in history, many countries in the region were able to implement countercyclical monetary and fiscal policies. They also benefited from flexible exchange rates, significant international reserve buffers, and a more credible monetary policy than before. And because banking systems and corporate sectors were generally healthy, the region did not have a financial crisis of its own. Peru provides a perfect example of strong fundamentals and proactive policies preserving gains in growth, employment, and poverty reduction.
The recovery is so strong in these countries that they face challenges associated with strong capital inflows and overheating. In some ways, they are a victim of their own success.
Policy challenges
Let me now turn to key policy challenges for Latin America and the Caribbean in particular.
Let me start with the issue of removing macroeconomic stimulus as the recovery proceeds. This will be a delicate balancing act—exit too soon, and you could kill the recovery, exit too late, and you may sow the seeds of the next crisis.
Right now, the key priority must be to reduce sovereign vulnerabilities, especially in advanced economies. In these countries, public debt is expected to reach a staggering 120 percent of GDP by 2015—about 40 percentage points above pre-crisis levels. Most of this comes from the recession itself, from falling revenues, and not from discretionary stimulus. But if untreated, concerns about fiscal sustainability can undermine the recovery and jeopardize financial stability. What should be done? Policymakers should implement the fiscal stimulus planned for 2010 fully, except in countries facing financing pressures. And if the recovery proceeds as expected, most advanced economies should start adjusting in 2011. Entitlement reforms that do not affect demand can be implemented sooner.
In emerging markets, including in Latin America and the Caribbean, the concerns are a bit different. With the recovery more advanced, a natural starting point would be to remove temporary fiscal stimulus. Fiscal correction can take some heat off monetary tightening, which in turn can dampen excessive capital inflows.
What about monetary policy? At least in the major advanced economies, monetary tightening can take a back seat to fiscal adjustment, especially since inflation expectations remain low and well anchored. But in economies ahead of the recovery curve—including in emerging markets—overheating risks have increased, signaling the need for more timely action.
The second key issue—of direct relevance to this region—is the challenge of rebounding capital inflows. Countries with strong fundamentals, like Peru and others in the region, will likely receive large and sustained capital inflows over the coming years. The challenge will be to absorb these flows effectively and avoid the build-up of vulnerabilities. Any policy response must be pragmatic. A range of tools can be deployed, including exchange rate appreciation, reserve accumulation, tighter fiscal policy, and macro-prudential measures. Capital controls can sometimes play a role too, but should not be used to avoid needed adjustment.
The third challenge relates to social issues. As unemployment stays high, an economic crisis can quickly turn into a social crisis. Specific labor market policies can help limit the damage—adequate unemployment benefits can support confidence, protect household incomes, and avoid increases in poverty. Education and training programs can also help.
During this recession, many countries preserved basic social spending and social safety nets. This is something the IMF pushed for in country programs. I think this was incredibly important. Not only did it protect the most vulnerable from the ravages of the crisis, but it also contributed to social and political stability.
Here, in the Latin American and Caribbean region, countries like Peru have made immense social progress over the past decade or so, reducing poverty to a historic low and bringing down inequality. In Peru, for example, the incidence of poverty fell from 55 percent in 2000 to 36 percent in 2008. This is a remarkable achievement. In the past, big external shocks had dramatic social consequences. It took the region a quarter century to undo the jump in poverty that followed the 1980s debt crisis. But this time was different, because countries allocated funds to social policies, and social safety nets provided a crucial lifeline.
Historically, inequality has been a Latin American curse. Not only did it prevent large swaths of the population from sharing in income gains, but it also contributed to widespread social and political instability—which in turn hurt economic prospects. But today, all over the region, the tide is turning. A number of countries still have some way to go. In many, inequality remains high, and there is a need to spend more on education and healthcare. This complements and supports macroeconomic stability.
Conclusion
To conclude this morning, I would like to leave you with a few thoughts.
First, we need more international cooperation than ever before. The challenges are becoming more complex, the world is becoming smaller, and centers of growth are becoming more diverse. But for this to happen, global governance must become more representative. The more representative, the more legitimate, and the more legitimate, the more effective. The coordination shown by the G-20 during the crisis was a huge step forward. And while the G-20 is more representative than seen before, it still leaves many countries out.
Second, I believe the IMF can play an important role in harnessing global cooperation, emphasizing the public good of global financial stability. We are now reforming our governance structure to enhance the voice of emerging markets and developing countries. During the crisis, our response was fast and flexible—we dramatically stepped up lending, we revamped our crisis prevention toolkit with the Flexible Credit Line, and we streamlined conditionality. We want to listen to our members, including in this region, and to continue adapting to meet their needs. But our members also need to commit to collaboration and to putting the global interest first. Our recent partnership with Europe represents a new mode of cooperation that I hope can provide a precedent for how we might work with other regions—including here in Latin America. Let me note, though, that IMF lending in Europe works just like it would in any part of the world—we do not play favorites.
Third, the economic strategy chosen by countries in this region was vindicated by the crisis. You were right, and others were wrong. The lesson here is that this commitment to macroeconomic stability must be defended, and buffers rebuilt, so that the region can be ready for any future economic dislocation.
And finally, social progress must always go hand-in-hand with macroeconomic stability. Growth must benefit the many, not just the few, and social safety nets must provide needed economic security. The twinning of macroeconomic stability with social progress is a sure recipe for success. It augurs a new era for Latin America and the Caribbean, in which strong growth can raise the living standards of all, shifting the region to a virtuous cycle of prosperity and stability.
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