Transcript of a Conference Call with Michael Deppler on the Latest IMF Report on Euro Area Policies
August 3, 2005
August 3, 2005
MR. HAYDEN: Hello, I'm Jeff Hayden, Senior Press Officer with the IMF, and I would like to welcome all of you to this conference call by Michael Deppler, Director of the IMF's European Department.
Mr. Deppler is here to discuss the latest IMF report on euro area policies, which was reviewed by the IMF's Executive Board on Friday, July 29th. The Staff report and a public information notice, or PIN, summarizing the Board's discussion were posted on our password-protected Media Briefing Center last night, and I hope you have all had a chance to see them.
Before we begin, let me go over the ground rules briefly. This is an on-the-record conference call. Mr. Deppler's remarks, as well as the PIN, staff reports and Selected Issues Paper, are embargoed until 9:00 a.m. Washington time, or 1300 GMT.
Mr. Deppler has about 20 minutes and he'll take questions. With that, Michael, would you like to say a few words of introduction?
MR. DEPPLER: Yes, thank you. Good morning, everybody, and welcome. As you know, at the conclusion of these Article IVs we have a Board meeting and the staff's view is discussed. My basic reading is that the staff view was fully supported by the Board in all the main aspects. There are some differences of view here and there on some margins, but the broad—was basic agreement.
The staff's view is that pessimism about Europe is exaggerated, and that's been our view for some time. There are two aspects to this situation. One is the cyclical and one is the more fundamental structural situation in Europe. Let me speak first to the cyclical part.
The baseline forecast we have, and it's been there for some time even though it hasn't been public, is that growth in the euro area for this year will be of the order of 1-1/3, 1.3 or something like that, rising to something close to 2 in 2006. This is a revision downwards from the real numbers, which essentially were finalized last April which had a number of 1.6 for this year.
The point I would make about this revision is that the baseline view which we've had for several months now in fact is being confirmed by the incoming data. If you look on one of the early pages of our report, you will see the quarterly baseline, the quarterly path implied by those annual numbers, and you will see there was a very strong actual first quarter, a quite low second quarter, with growth around 1 percent at an annual rate, and then accelerating to 1-1/2 and then to 2 in the third and fourth quarters. Our reading is that this baseline scenario is in fact being borne out by the ongoing data over the past few months.
So basically our view is that the notion of the first half this year as having been the low point I think is bearing out and things should be improving from here.
On inflation, things are very quiet. The underlying inflation is very subdued. There are risks to the headline because of oil prices, but the basic situation is subdued. In that line, our view now is that monetary policy is appropriate and rates should remain where they are more or less indefinitely.
There are risks to the forecast, risks to the baseline, particularly from oil prices immediately. And from our point of view, the ECB should continue to be prepared to cut rates if in fact there's another faltering of the recovery.
The second dimension of our view is the structural, and here we think that while Euro certainly has plenty of problems to deal with, there is too much pessimism about the situation today in Europe. In our view, the policies of wage moderation and structural reform in the past has paid off, not in growth so much, unfortunately, but they've certainly paid off in terms of employment performance that is comparable to that of the United States. Europeans just lose sight of these aspects of their performance, and in our view, the pessimism there is just undue.
The related element is that those reforms in fact have continued up to very recently. The German reforms Hartz IV and the French pension reforms are major reforms and we expect these to undergird the performance going forward. So looking forward, the notion of Europe growing at 2-plus rates seems to us pretty much of a baseline.
That said, we certainly share the view that there's much left to be done, and basically as we all know, the social model is unsustainable and the issue is now to make it sustainable. Here the main elements in our view, and very much the Board's view, is you need fiscal consolidation. Europe should aim for basic balance in the next few years, essentially by 2010, which means that they need to consolidate by about a half a percent of GDP per year.
The Stability and Growth Pact (SGP) is viewed as a framework that can be made to work. There is more substance here than is commonly supposed, but everybody agrees that what's key is how this thing is going to be implemented, and not only implemented by the Council, but followed through in national capitals in terms of fulfilling their commitments they make under the SGP. This is the phase that's going to be critical to the implementation and the credibility of the SGP.
There is an appreciation of the refocusing of the Lisbon Agenda on national plans, but there again, directors are very concerned about the extent to which these things are actually going to be brought to bear. I would say that the staff and the Executive Directors have considerable regret at seeing the problems of the euro area over the past 6 to 18 months. They really want this to work, and they really want to see Europe get its act together and get out of the slump it's been in.
The main ingredients there are, as we've said, fiscal consolidation and structural reforms. Here on the structural reform front, much more of the emphasis than in the past is not only on labor market policies, but on policies which complement each other, with the complementation of the fiscal, the labor market policies and especially product market reforms, and most notable among those, the E.U. Service Directive.
The other big issue was financial sector reform, and there I think there's a general appreciation that much has been done and that more needs to be done going forward. But nonetheless, there is a concern again whether this piecemeal—in the sense of very much national-based—process of reform is going to deliver the kind of integrated financial system that is required. Then as the summing up says, many directors thought that a more integrated approach to supervision, including provision of up-to-date information on key groups through an existing area-wide structure deserves consideration. But it is again thought that in many of these issues there are strong spill-over effects on the European level that need to be taken seriously and acted upon.
I think those are the main points. The final issue, and here I would say there was more disagreement, was on fiscal councils. As you know, both the stability pact and the Lisbon Agenda foresee shifting a good part of the agenda setting and the accountability to the national level. We see this as quite appropriate in context of what's happening in Europe today, and we fully support this. But at the same time, we think there is a need to strengthen accountability at the national level, and to do so, we see a role for building up institutions—independent, nonpartisan institutions—that assess and monitor policies together in the first instance with national parliaments. But there is a need to build up the constituency and the framework for thinking about issues among national capitals in Europe, and we see these councils as useful steps in that direction. A very good model for our point of view in Europe is the Central Planning Bureau in the Netherlands.
Thank you very much, and I'll be glad to take your questions.
QUESTION: I just want to be clear on your stand on ECB monetary policy. Does that amount to a change of the IMF's position? Secondly, was there unanimous agreement among directors to say that policy at the moment was appropriate? In other words, stay pat on rates?
MR. DEPPLER: The staff's concerns about policy and about the need for a rate cut are not as great today as they were 2 or 3 months ago. Clearly, 2 or 3 months ago things were sort of falling apart and you didn't quite know when you were going to hit bottom.
This is no longer the situation today, and so from that point of view, whereas 2 or 3 months ago we were saying that you really did need to consider a cut because there seemed to be a problem in the development of the economy, the developments since them have pointed to that risk being less, and on top of that, oil prices have been pushing in the opposite direction as have the exchange rates.
So we would basically see the monetary policy today as appropriate, but it's only in the event that there's a renewed weakening of growth that we would see the underlying stability, inflation is around 1-1/2 right now, as arguing for a rate cut.
I'm not sure if it's the unanimous view of the Board. I think it's pretty much the unanimous view of the Board; certainly the large majority I would say. I think that answers that question.
QUESTION: Just on monetary policy, I'm having trouble understanding that monetary policy is fine. It hasn't changed since 2003, there's what looks like a fairly awful growth outcome this year, so I just don't quite understand the view that the monetary policy is about right. This seems odd.
The second question is, in the World Economic Outlook (WEO) there's lots of discussion of global imbalances and responsibility of different areas to respond to global imbalances and, again, it would seem fairly obvious that the euro's own part in this is boosting domestic demand as part of that global adjustment.
You said that sometimes people are too pessimistic on Europe, but it seems kind of pessimistic not to think that monetary policy can help in boosting domestic demand in Europe.
MR. DEPPLER: I disagree with the implications of what you said. The ECB, like other central banks, basically works within a monetary framework and we think it's quite important that within a given framework that policies be implemented consistent with that framework.
The ECB is working within a framework which the main part of it is very close to an inflation targeting framework. The basic reality is that they've run policies in an appropriate fashion relative to that framework.
There are views out there which are different basically taken off the U.S. case, and those comparisons are just very misleading. It's not realized that in fact the change in the--situation in the United States in a negative direction was several times what it was in the euro area. It is not appreciated enough the difference in the persistence of inflation between the United States and the euro area. And while you're correct to say that U.S. monetary policy has in a sense been more aggressive, it's not correct to say that that aggressiveness would have been appropriate for the euro area.
So basically while I agree with you that these rates have been there a long time, it doesn't follow that they've been inappropriate. Basically we and the ECB have seen a recovery in the works and these rates are compatible with this recovery and with achieving inflation at somewhat below 2 percent.
Question: Headline inflation or core inflation?
MR. DEPPLER: Headline inflation. Core inflation, and this is the main argument for a cut, is at 1-1/2 percent. So the fact is they've never achieved except in the very beginning headline inflation rates below 2 percent, and this remains a credibility problem for them.
We've been pressing the ECB to focus on underlying inflation without much resistance because they in fact put a lot of focus on this underlying inflation. But it's also true that we have been consistently wrong in forecasting inflation, not because we've been wrong on underlying inflation, but because the system has been repeatedly hit with shocks which have pushed headline inflation, and the most obvious have been oil prices, but also administered price increases and various weather-related shocks over time. So consistently headline inflation has been above 2 percent and this is part of the ECB's problem.
So taking all of that into account, we haven't had major differences with their point of view. However, if growth were moving off of the trajectory that said that growth was not going to go back to potential, then in our view they should cut. But the situation today is not that, that is, we see a reversion to something like 2 percent looking to the next four quarters.
QUESTION: Then is the conclusion from what you've said on the second part, on global imbalances, there's much rhetoric about this in the WEO, if there isn't a role for monetary policy short-term and fiscal policy is neutral and needs to be restrictive over the next several years, then is one right to conclude that there isn't really much of a role for the euro zone in terms of global rebalancing and they should just proceed as they are?
MR. DEPPLER: The answer to that again I would argue is no. The implication of your question is the only way that you can address global imbalances is through cyclical demand management policies. In our view, the scope of cyclical demand management policies in Europe is rather limited, but that doesn't mean that there is not a lot to do on structural policies that would help global imbalances.
There is an argument about whether certain structural reforms would in fact lead to a resolution, reduce the global imbalances on the current account, and I can see some arguments for that. In the paper we say the signs could be ambiguous. But in many ways, that is only if you accept the premise that Europe should think small as opposed to think large. I think in terms of an ambitious and coherent strategy to accelerate growth and address the underlying unsustainability, there is no question in our minds that what you get out of that is a strong strengthening of prospects, a view of Europe that turns around, basically the current account goes wherever it is, but the world is far better off, including the resolution of the imbalances.
QUESTION: So in the time frame there would be not the one policymakers sometimes talk about at the G7 and elsewhere which seems to be talking about months and years, but amounts to several years into the future?
MR. DEPPLER: Our view on the imbalances is we don't need to solve the problem today. What we need is a credible strategy that says that this problem is going to get solved over the medium term. We're not expecting the U.S. to cut its deficits immediately today. What we want are policy assurances that say this problem is being addressed in the medium-term context and if that credibility is there, then we think the bad scenarios will be avoided.
So we don't need immediate policy actions. What we need is a credible commitment to policies which will address the problem in the medium term. Policies in Europe and in Japan certainly could fulfill that role.
QUESTION: I have a question regarding one of the special issues that you dealt with in the report, and specifically on the housing markets. I wonder if you could tell us how dangerous is this boom in Europe and especially in Spain.
MR. DEPPLER: I think on issues having to do with individual countries, I'm going to refer you to the corresponding national Article IVs, because they're in a much better position to discuss those issues.
But I would say that this is an issue we looked into primarily from the point of view of what are its implications for monetary policy. There is some concern out there that monetary policy at the area-wide level should be preemptively increasing rates in order to address these pockets, there are not just one or two, of rapid increases in housing prices.
Our view is that at the area-wide level we do not see a problem in this regard and, hence, the problem is better resolved at the national level. But we would also make the point that the ECB has this rather controversial monetary analysis part of its framework and we see this as a useful framework to think about some of these issues and we support that framework. What we do not support is the notion that that framework today argues for increasing interest rates because of risks in housing for the area as a whole.
But on your questions about individual markets, I think I'll have to refer you to the national Article IVs.
QUESTION: If I may, what kind of message should countries take who are suffering this boom to withhold the prices?
MR. DEPPLER: You can do things in the prudential area on controlling the growth of mortgages. You can do things in terms of fiscal policy, the attractiveness of mortgages and these sorts of things. But our view is these problems are essentially for the time being at least problems that should be dealt with at the national level and not at the area-wide level.
QUESTION: I just had a question. What I don't quite get is your stance on fiscal policy. I just wondered, like growth is really low, there's lots of unemployment and Germany and France come to mind, and I don't see how that the advice is politically sustainable. How can it get through to the no vote on the constitution in France, for example, that showed very clearly probably people weren't so keen on reforms? So how do you think that could go through?
MR. DEPPLER: In the Fund's experience, the main thing that is important about an economic strategy is that it hangs together, that the parts are consistent and people get a clear vision of where they're going and what's going to be happening looking over time.
This is simply not the case in Europe today. The signals are left and right and up and down and people are confused. The notion that you address those issues by avoiding confronting the basic problems facing the situation is something we do not agree on. If you think of the sustainability problems in Europe and the increases in indebtedness which you see in a number of countries, people clearly are aware of problems. They see these reforms and they see some of their benefits being cut back, and yet at the same time they see governments spending more, having higher deficits at least, and incurring higher debt, and people are confused.
In our view, it's not a fact that a policy is reducing a deficit that it's necessarily, and this is the implication of your question, bad for the economy.
I work on Turkey, for instance, and if you look at Turkey, this is in the European Department, and you apply your view of the world, you'll never get to understanding anything. Basically there was a huge fiscal correction and at the same time a huge boom in the economy.
QUESTION: I don't think Turkish employment markets have the same rigidity than in France, for example. That's why I just wondered how it would turn out. Do you know what I mean?
MR. DEPPLER: Yes. Frankly, this is a bit a question of what I phrased earlier, thinking small versus thinking big. Europe has big underlying problems and people recognize that. If you increase public dissavings at a time when all of the medium-term views call for decreasing public dissavings, what are you achieving? So our basic view is Europe needs to take a longer-term view and focus less on the very short term.
I know this is not politically very easy. There are issues about educating people about the basic issues and showing them a way forward. In our experience, if you do that, you can succeed very well.
In this regard, this is one of our reasons for pressing for fiscal councils. The state of the debate in Europe about some of these issues, it doesn't think in a wide enough framework about a consistent policy package, and these fiscal councils would be intended to provide some sort of longer-term view of what's appropriate.
QUESTION: I have a question on wage policy. You just said that wage restraint contributed to your view of Europe becoming more optimistic, but then you are writing a special chapter on why wage restraints didn't work as many expected it to do because product markets are not as flexible.
Could you expand on what exactly your view is on wages?
MR. DEPPLER: The backdrop to your question is of course that the subdued behavior of wages is anchoring the path of consumption on a very low level and that is a concern and it's something you have to accept in thinking about the forecasts. This is one of the reasons why the forecasts are relatively subdued.
This does not mean that policies of wage moderation have not worked. Everybody complains about unemployment, but in general in Europe, unemployment is down relative to what it was in the early-1990s. The exception is Germany.
In general what you see is the employment performance is much better than it has been in past cycles. The increase in unemployment this year for the area as a whole from about 8 to 9 is small relative to what it was in the early-1990s when it must have been something like I would imagine 9 to 11 or something of that order. I don't know the exact figures. So the point is, the employment behavior of the euro area has greatly improved over the years.
Going forward, and this is what this paper you've referred to says, we shouldn't think simply in terms of labor market reforms and wage moderation. It turns out to be very important that you merge both reforms, wage moderation and labor market reforms, with product market reforms because the payoff to each of them is increased when you do that.
So the implication of this paper is not you should rethink wage moderation but, rather, that you need to sort of combine the strategy with a greater emphasis on product market reform. And here again is where the E.U. Service Directive is the most obvious thing in our minds which would enhance performance.
QUESTION: I was wondering if you see recent events in the Italian banking sector as a confirmation of your call for a more integrated approach to supervision.
Also you mentioned the need for a more integrated financial services market, and I wonder if you see cross-border banking consolidation as part of that, if you think that's crucial to the emergence of a more integrated market.
MR. DEPPLER: As is implicit, explicit in fact, in what I said about the service directive, we are strong believers in competition as a way of improving performance across the euro area. These are basic long-term payoffs, and this applies to the financial sector area as well. The issues about supervision are somewhat different from the issues of cross-border mergers and acquisitions. But in our view, there are still sheltered markets and this is a process in the banking sector in particular has progressed quite slowly, and in our view there's payoffs to an acceleration in that process.
Therefore, and you'll see it in the summing up of the Executive Directors, and it says "the onus now is on all member states to take a pan-European view to make this process work effectively and on the Commission to enforce existing rules including competition policies."
So in our view you need a level playing field across the area, and this will generate improvements and efficiency which will basically generate the performance going forward.
QUESTION: I was wondering how the euro's recent depreciation feeds into your quote forecasts for this year and next. You note in the staff report that euro appreciation was a drag on growth last year. Why aren't we seeing any payback from its depreciation this year?
MR. DEPPLER: I think certainly if you look at the business confidence indicators, part of the turnaround in that stems from belief of the steady depreciations they've been experiencing, and we would certainly see this movement as being helpful.
However, we've always had the view that the underlying equilibrium for the dollar was in the 120 to 130 range, the lower end of that range, and so we haven't seen the movement of the past 6 months as particularly telling.
So while it's a plus, we wouldn't see it as a major factor at least in relation to the large appreciation of the euro prior to this period which was much larger, and in fact, I think may have had a somewhat larger impact than we had initially thought. So this is relief. The euro is recently in the viable range, anywhere between 120 and 130.
QUESTION: In the discussion of wage moderation and product market escalation, do you get the feeling at the moment that there's a bit of a tradeoff, that businesses particularly in Germany are pursuing some changes and cutting wages and getting longer working hours but yet we've yet to see that have the positive effect on the economy because at the same time it also dampens consumer confidence and consumer spending?
MR. DEPPLER: Actually, your question reminds me of the incompleteness of my answer to an earlier question, which is in our view the growth and the signs of whether or not the recovery is succeeding is not going to come from wage behavior, but it's going to come from employment behavior. If employment responds, then I think we're hitting pay dirt.
In this sense, I agree with you that the developments in Germany are basically strengthening the position of firms but in a way that weakens the immediate impact on consumption.
Frankly, the real question is whether that behavior is going to lead to a strengthening of employment in those sectors or in the economy more generally would leave the employment indicators not as good as we'd like, nonetheless, more positive than anything you would have thought of in this kind of an environment. So we are more hopeful that in fact these suggestions will generate employment growth and really set the recovery on a sustainable basis.
I think we have room for one more question.
QUESTION: I just wanted to go back, it was quite a ways back when you were talking about whether there is a need for a rate cut and you said if we saw growth fall below potential then we would recommend a rate cut. Could you clarify what your view of potential is, please?
MR. DEPPLER: Our view of potential right now is around 2. We would expect the second quarter numbers to be somewhere around 1 percent at an annual rate, and we would expect given that table I referred to earlier the third quarter to be somewhere around 1-1/2.
You shouldn't use these numbers too precisely in relation to that 2 percent. The real issue is, is there a recovery in train or is there no recovery in train? So it's the view in the baseline forecast that determines whether or not you see a need for a rate cut in that particular set of circumstances.
Our view is basically the baseline which we have is being fulfilled, and as I said, the news on the inflation side because of the exchange rate and oil is a bit in the opposite direction. So we don't see a need for a rate cut right now.
MR. HAYDEN: Thank you very much for joining us. Again, the embargo will be lifted at 9:00 a.m. Washington time, that's 1300 GMT. Thank you again for joining us.
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