October 3, 2013
As prepared for delivery
Good morning. It is a real privilege to visit one of our closest neighbors. Let me thank President Knapp for graciously hosting me, as well as Gordon Gebert and Julia Susuni for kindly inviting me.
On behalf of the IMF, let me also express our appreciation to everyone at George Washington University for partnering with us—and providing this venue as well as others—for our Annual Meetings which kick off next week.
I am impressed to see so many students from such diverse backgrounds in this room today. Remember, your generation will shortly inherit the global economy. Looking at your faces, I know it will be in safe hands.
Let me begin by quoting Ralph Waldo Emerson, who said, “Not in his goals but in his transitions is man great”.
This might apply to your own lives, but it also applies to the global financial crisis—which is really the story of transitions on an epic scale.
Five years ago, the global economy avoided a second Great Depression. Five years on, the journey is not yet complete, but the fog of crisis is lifting—and we can see that its aftermath leaves us with multiple new transitions.
Two in particular stand out: a transition in the patterns of economic growth, and a transition toward a different kind of financial sector.
We at the IMF are very familiar with the ebb and flow of economic cycles, with the shift from recession to recovery. Experience tells us that this process usually takes a year or two, or a bit longer if the situation is especially severe.
The transitions I am talking about today are different. They will likely play out over the rest of the decade, if not longer.
They are different also because they will require not only active national policy management, but also active international policy collaboration.
So my main message today is: these new global transitions need a new global agenda.
This, of course, is precisely where the IMF—with our global membership of 188 countries—is uniquely well-placed to help. We provide a platform for global cooperation, as well as tools to support it—with our economic analysis, financial resources, and technical expertise.
One thing of which I am sure: with the right policies, these transitions can be managed. But of course, they can be derailed by the wrong policies.
Today, I will focus on two key transitions:
1. Transition in the pattern of economic growth
(i) Advanced economies
Let me start with the transition in the advanced economies. In a few days time, the IMF will release its latest economic forecasts. Overall, the global outlook remains subdued. In many of the advanced economies, however, we are finally seeing signs of hope. Growth is looking up, financial stability is returning, and fiscal accounts are looking healthier.
Notwithstanding the current development to which I will return later on, nowhere is this clearer than the United States. We see it all around us. Households are in better shape, the housing sector is looking brighter, and the private sector engine is humming again. And yet, growth this year will still be too low—below 2 percent—due to too much fiscal adjustment. This should ease up next year, with growth about a percentage point higher.
The Euro Area too is going through a major transition, following a banking and sovereign crisis that threatened the very fabric of the monetary union. Now, after six quarters of recession, the region came up for air last spring, and growth should be back in positive territory next year—almost 1 percent.
Yet unemployment—at 12 percent—is still far too high. In some countries, one in four people cannot find work, and one in two young people.
This challenge is nested in a more sweeping transition as the Euro Area pushes on with integration, based on the belief that the strongest house is the one that is built together. We are witnessing the march of history, with ever-closer European fiscal and financial integration—even if we recognize that much more still needs to be done.
Japan too is going through transition—as it seeks to overcome longstanding deflation and stagnation. The government’s aggressive stimulus policy seems to be working—boosting GDP by about 1 percent. Deflation is coming to an end and a newfound optimism is in the air. Yet this Japanese effort is not complete either.
What policies are needed to manage these transitions and ensure their success?
Let me start with monetary policy, which I believe rescued the global economy from the abyss and put it back on the road to recovery. Central bankers pushed policy to the limit, and beyond the limit—into the terra nova of unconventional policy. Clearly, it has a different role to play in each region.
Most people think that U.S. monetary policy has reached a turning point, where the exit from unconventional measures will begin soon. This “turn” needs to be managed very carefully.
Because the normalization of monetary policy affects so many markets and people across the globe, the U.S. has a special responsibility: to implement it in an orderly way, linking it to the pace of recovery and employment; to communicate clearly; and to conduct a dialogue with others.
This transition will be part of the global policy landscape for some time.
Beyond the United States, monetary policy might yet be called upon to do more—to further strengthen recovery in the Euro Area, and escape the deflation danger zone in Japan.
What is clear is that in all regions, monetary policy has bought time and space. The key now is to use this time wisely and not waste the space.
As the playwright Tom Stoppard said, “look on every exit as being an entrance somewhere else”.
This means different things in different countries. All advanced economies need to move on a broad policy front, but with different emphases—financial in the Euro Area, fiscal in the United States and Japan, structural in the Euro Area and Japan.
Starting with financial: we know that the recovery in many parts of Europe is still being hobbled by weak banks, high corporate debt, and a fragmented financial system. This is raising the cost of loans to small and medium enterprises by 1-2 percentage points in stressed regions.
So it is imperative to restore European banks to health by assessing and filling capital shortfalls—as the IMF has been recommending—and pushing ahead with banking union to make the entire edifice safer and sounder.
Turning to fiscal: I have said many times before that the U.S. needs to “slow down and hurry up”—by that I mean less fiscal adjustment today and more tomorrow. That means replacing the sequester with more back-loaded measures that do not hurt the recovery. At the same time, the U.S. needs to do more to make debt sustainable down the road—by containing the growth of entitlement spending and raising revenues.
In the midst of this fiscal challenge, the ongoing political uncertainty over the budget and the debt ceiling does not help. The government shutdown is bad enough, but failure to raise the debt ceiling would be far worse, and could very seriously damage not only the U.S. economy, but the entire global economy.
So it is “mission-critical” that this be resolved as soon as possible.
Japan also needs a credible plan to bring down its debt, which is approaching 250 percent of GDP—and amounts to about $90,000 for every man, woman, and child in Japan. The initial consumption tax increase is a welcome first step. Entitlement reform is the next one. Without these policy fundamentals, any gains made so far could easily melt away.
The fiscal and financial efforts must be complemented by structural reforms—to make sure that policies to boost demand are supported by policies to boost supply. We know this can pay off where it matters most—in terms of growth and jobs. For the Euro Area, the IMF estimates that comprehensive and coordinated reforms of product and labor markets could boost GDP by 3¾ percent after five years. For Japan, increasing female participation in the labor force to match the G7 average would boost per capita GDP by 4 percent by 2030.
We should remember that this group of economies accounts for about 40 percent of world GDP. So what happens in these regions has profound implications for the rest of the world. This makes engagement with the international community all the more important. National policies alone cannot do it.
(ii) Emerging markets and developing countries
Let me now turn to emerging markets and developing countries.
Emerging markets
Today’s emerging markets are much stronger than in the past, having come a long way since the crises of the 80’s and 90’s —with flexible exchange rates, higher reserves, and lower external debt. For the past five years, they drove the recovery and kept the global economy afloat—accounting for three-quarters of total growth.
The ultimate goal of their transition is clear—living standards that are closer to the advanced economies. They can get there, but they face new obstacles in their way. Momentum is slowing, with growth 2½ percentage points lower than in 2010. A lot of this reflects the turn of the economic cycle, but part of it reflects deep-rooted structural impediments too.
These countries are also facing a more challenging external environment. Over the past five years, capital flooded into emerging markets—partly due to loose monetary policy in the advanced economies. Bond inflows alone rose by over $1 trillion—more than 2 percentage points of GDP a year for the recipient countries. Now, with markets getting jittery over the perceived end of easy money, this financial tide is starting to recede.
This, in turn, is exposing tensions that were less visible when times were good—including from easy credit and growing corporate debt. By IMF estimates, the turbulence in train since last May could reduce GDP by ½ to 1 percent in major emerging markets. Of course, some countries are more vulnerable than others.
What does it mean for policies?
The immediate priority is to ride out the turbulence as smoothly as possible. Currencies should be allowed to depreciate. Liquidity provision can help deal with dysfunctional market behavior. Looser monetary policy can also help, although there is less room for maneuver in countries with inflation pressures—such as Brazil, India, Indonesia, and Russia. Likewise, there is not much space left across many emerging markets for using fiscal policy, given high debt and deficits.
Some countries also need to knock down lingering barriers to long-term growth—pushing ahead with infrastructure investment in places like India and Brazil, deepening financial markets, and opening up trade regimes.
In this vein, China needs to keep moving to a growth path based less on credit—which hit 180 percent of GDP this year—and more on higher productivity, higher incomes, and higher consumption. This means liberalizing interest rates, ramping up financial sector oversight, opening up protected sectors to private initiative, and further strengthening the social safety net.
This emerging market transition will not be fast or easy. These countries will likely spend the rest of the decade adjusting to the new reality. As part of this adjustment, they need to keep cooperating—among themselves and with others. Again, international collaboration is the only way forward.
Low-income countries
The same holds true for the low-income countries. These too are in the process of profound transition. In many cases, the developing countries of yesterday are poised to become to the frontier economies of tomorrow.
Sub-Saharan Africa is now the second most dynamic region in the world after developing Asia, and is getting ever closer to the beating heart of the global economy. Growth rates over the past several years have been around 5 percent.
Their transition, however, is not without risk. The low-income countries sit between the advanced country rock and the emerging market hard place. More fragility in these regions means more fragility in the low-income countries.
So these countries need to take action, by having enough foreign and fiscal reserves to deploy when necessary, including by mobilizing more revenue. Beyond that, they need to make growth more inclusive—including by boosting public investment and making sure that all have access to decent healthcare, education, and finance.
Again, this will take most of the next decade and will require deeper engagement with—and the support of—the international community and multilateral institutions like the IMF.
Arab transition countries
There is one more transition that I must mention: the Arab countries and their ongoing quest to build more open and inclusive societies.In this region, economic transition is deeply entwined with social and political transition, and has become increasingly challenging. Much of this is wrenching. How can we not be deeply concerned by the tragedy in Syria, when so many people have lost their lives or homes?
Through this, we must help them to keep up the drumbeat for economic reform. This means breaking down vested interests so that the energy of the private sector can be released to help create jobs for all who need them. It also means bringing down fiscal deficits, which are in the 5-15 percent range across the region—but at the right pace and with the support of external financing, to lessen the hardship faced by ordinary people.
In many ways, this may be the most complicated transition of all, and will probably take the longest to play out. Again, to succeed, it needs the unwavering support of the international community. The IMF is highly engaged—we are partnering with Jordan, Morocco, and Tunisia through financing arrangements and are in discussions with Yemen.
2. Transition in the financial sector
So far I have talked about the first of the big transitions, the economic one: for advanced economies, emerging markets, low-income countries. Yet as I said at the beginning, there is a second fundamental transition taking place in parallel—in the global financial sector.
Under the old model, the financial sector took on outsized risk in pursuit of outsized rewards, causing outsized ruin—and precipitating the crisis we have been experiencing for the last five years.
Since then, the international community has been struggling to build something better. This is not easy. It means throwing away old blueprints and designing new ones. It means dealing with the perverse incentives of financial firms and the inability or unwillingness of authorities to act.
How is this transition doing? In the IMF’s assessment, it remains a case of “mission not yet accomplished”.
Yes, we have seen progress. The tougher capital standards, agreed under Basel III, are being implemented. We have agreement on new liquidity standards, and plans for a leverage ratio to keep excess risk in check. We have moved forward in identifying the systemically-important financial institutions—the ones whose failure has the largest global fallout—and holding them to a higher standard for both regulation and resolution.
Yet progress is still too slow. It is being held back by complexity, but also by delay and divergence across countries.
Delay is a real problem. A key concern, for example, is the lack of progress in establishing effective cross-border resolution regimes—frameworks and agreements to unwind the global systemically-important institutions and market infrastructures in an orderly way.
The same is true for derivatives market reform, where lack of transparency is still a huge issue. At the end of last year, total outstanding derivatives amounted to $633 trillion, of which only $24 trillion were traded on organized exchanges. Adequate supervision of the remaining part requires countries and markets to speedily implement the agreed derivatives reforms.
Another danger zone is shadow banking, which is attracting a lot of riskier activity. In the United States, the nonbanking sector is now twice the size of the banking sector. In China too, about half of the new credit extended so far this year has come through the shadow banking system.
There has been some progress—with the adoption of principles for money market funds and proposals for regulating securities lending and repos. For sure, non-bank financial intermediation can provide a valuable alternative to banks in providing credit, but it needs more oversight.
What about divergence? The problem here is that when countries pull in different directions, the fabric rips apart. We have already seen some evidence of discrepancies in capital requirements. Different countries have also taken different approaches to business model restrictions—such as the Volcker Rule in the United States.
Putting this all together in a globalized world is a headache. And yet, it must be done—nothing less than global financial stability depends on it.
Building a new financial sector is not the job of policymakers alone. It is also the responsibility of the financial industry.
We know that as the sands shift, business models shift too, sometimes in unpredictable ways. The new rules are changing the economics of banking. For example, some large banks might no longer be in the business of project or infrastructure financing, or mortgage lending—and their geographical footprints might shift substantially.
This must be taken into account when designing the new framework. What is ultimately important, however, is that the financial sector stays focused on its true purpose—serving the real economy: financing the investment and innovation that drive us forward.
This transition too will take time. It can be managed—only if all parties unite around shared goals. This means industry and regulators accepting co-responsibility for the public good. It means countries acting in harmony, so that the new financial framework looks more like a color-coordinated mosaic than a clash of unmatched colors.
It means international collaboration.
Conclusion: Mutual help is the best form of self-help
Let me conclude. In each of the two major transitions that I have discussed—economic and financial—the international community faces a common challenge: to make sure that all can gain from globalization and prosper in our increasingly interconnected world.
The global financial crisis has shaken the faith of many in the virtues of being open and engaged with the world. Managing these transitions well is the best way to demonstrate the benefits of interconnectedness—through trade, well-regulated finance, and more equitable growth.
This can only be done if countries work together, sincere in the belief that mutual help is the best form of self help. As they say in Latin, pro omnibus et singulis—for all and for each.
As I said at the outset, this is exactly the function of the IMF. Our job is to help countries manage transition—and to help the world solve common problems with common purpose. We have done it before—for instance, when we helped the world transition after World War II, and again after the Cold War.
Now the world is transitioning to the new global economy of the 21st century—your economy, your century. In this world, cooperation will be needed more than ever before, which means that the IMF will need to be more helpful than ever before.
I began with Emerson, an American, so let me end with a Frenchman, Albert Camus, who once said: “Don't walk in front of me, I may not follow. Don't walk behind me, I may not lead. Walk beside me and be my friend.”
That is how I see the IMF—not leading, not following, but helping.
Thank you very much.
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