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Transcript of a Press Briefing by Simon Johnson, Economic Counsellor and Director of the IMF's Research Department, on the Analytic Chapters of the World Economic Outlook
October 10, 2007
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MR. MURRAY: Good day. My name is William Murray, I'm Chief of Media Relations at the IMF, and this is the briefing on the World Economic Outlook analytic chapters. The briefing is live and of course on the record. To my right is Simon Johnson, the IMF's Economic Counsellor and Director of Research, and as we go right to left, Subir Lall, author of Chapter 4 on "Globalization and Inequality," Roberto Cardarelli, lead author of Chapter 3, "Managing Large Capital Inflows," and at the end of the table here, Nikola Spatafora, lead author of Chapter 5, "The Changing Dynamics of the Global Business Cycle." Simon will have some brief opening remarks and then we will take your questions. Thank you.
MR. JOHNSON: Thanks, Bill. Before I turn to the content of our analytical chapters, let me say just a few words about recent turmoil in financial markets and its implications for the global economy.
The past few months have provided a major test of global financial stability. Some unexpected vulnerabilities have surfaced and some of our traditional firebreaks, firebreaks that should prevent financial problems from spreading within countries and across countries, turned out to be less effective than in the past. Events remain fluid and we will continue to look carefully at what has happened and to draw lessons for the future.
In terms of the outlook, the immediate impact on global growth should be modest. As I see it, the repercussions are currently likely to be contained within the advanced economies, and the global expansion should continue albeit at a somewhat slower pace. This resiliency in large part reflects the growing importance of emerging markets in the global economy, and in these countries we expect expansions to remain broadly on track. Nevertheless, short-term risks have clearly risen. Over a longer period, macroeconomic issues in emerging markets take on increasing importance for the entire world economy, and this is a theme throughout this World Economic Outlook, although of course we devote serious attention to other countries, including industrialized ones as well. I will have much more to say about the consequences of recent financial market turbulence and the numbers in our global outlook at our World Economic Outlook press conference on October 17, and that is a week from today. Thus, I would like to keep the focus of today's discussion on the main issues raised in the three analytical chapters.
The analytical chapters in this report are for what I believe is a timely and broad perspective to help understand recent events in our likely future. In Chapter 3 we highlight a major challenge for many emerging markets in developing countries and this is how to manage large capital inflows. Such inflows slowed for a while during the summer. However, precisely because emerging markets proved much less affected in the past few months than during previous bouts of financial turbulence, recent indications are inflows are again picking up. In other words, there is a boom underway in emerging markets that remains based in part on substantial capital inflows.
This chapter looks at what lessons can be drawn from past episodes of surges and capital, and this has been the recurrent issue over the last 20 years of course, and it particularly looks at what kind of macro policies could help to ensure that growth remains robust after the capital flows stop, and again, the last 20 years suggest that capital flows always do stop at some point.
One big issue is intervention in foreign exchange markets. That is when the central bank buys foreign currency and sells domestic currency, hoping to prevent its currency from appreciating. Based on our analysis, we find that intervening in exchange markets has not been very successful either in limiting real exchange rate appreciation or in avoiding a hard landing in growth once capital flows stop. Intervention may help initially to contain exchange rate pressures from capital flows, but intervention is not effective when these inflows are persistent. To be clear, this statement is true even when the intervention is accompanied by sterilization, a somewhat technical term just used to mean that intervention is combined with measures that try at the same time to limit the growth in the domestic money supply.
What really helps in terms of sustaining growth after the capital flows stop is being careful with fiscal spending. Countries in which the growth in public spending was contained experienced less pressure on real exchange rates and growth was better sustained with inflows moderated. The lesson here is not, absolutely not that a country needs to cut spending when there are inflows but, rather, it needs to exercise fiscal restraint. Otherwise it risks over stimulating the economy through boosting domestic demand and exacerbating overheating pressures that raise the risk of a hard landing later on. The greater fiscal caution of some leading emerging markets since the late 1990s has been commendable and has definitely contributed in part to their resilience today. Hopefully, other countries will take away something from these lessons.
In Chapter 4, we take a longer-term perspective and investigate what has happened to inequality and to what globalization has contributed to recent trends in inequality. We find that inequality has increased in recent years in almost all countries, but as far as we can see, this is not due to increased trade. In fact, we find the direct effect of rising trade has helped lower inequality both in advanced and developing countries. Rather, it is the spread of new technology around the world that is the main factor behind higher inequality. We need to be careful with this point because the spread of new technology has also boosted growth. Thus, this is a tide that has raised all boats but has not raised all boats equally. In particular, more of the benefits have generally gone to people who are better educated. Financial globalization, including foreign direct investment, is also associated with rising inequality largely because it facilitates the adoption of new technology. The implication of course is not to pull back from the adoption of new technology or to erect new barriers to foreign direct investment. Any kind of protectionism would surely undermine the sustained growth that has raised global living standards. Rather, the policy aim should be to help, including through better access to education and affordable health care, to assure that as many people as possible participate in the opportunities that technological progress and globalization create.
In general, more attention needs to be paid to the issue of growing inequality. While technological advances and globalization are key sources of rising world prosperity, more effective policy actions are needed to make sure that all segments of society can benefit from the increased wealth that is created including by providing a stronger and more effective safety net for those who may be dislocated in any way by the process of change.
Finally, Chapter 5 offers hope but also a strong note of caution with respect to the medium-term growth prospects for the global economy. It looks at the recent half-decade which has been the strongest and most broad-based span of global growth since the 1960s and focuses on whether this success is the result of good fortune or good design. The answer is some of both.
Among other things, strong growth has been supported by improved frameworks for both monetary and fiscal policies as well as substantial institutional improvements in many middle- and lower-income countries. More credible monetary policies generally have helped bring down inflation and keep inflation low around the world. This also reflects the availability of low-cost manufactured goods, itself an outcome of increased global competition.
But there has definitely also been some good luck. Countries have generally benefited from fewer adverse shocks to commodity prices, including oil supply shocks. At the same time, at least until the summer, financial conditions have generally been benign and private capital flows have been relatively stable.
It would be unwise to assume that the present expansion will continue indefinitely. The recent period of financial turbulence if anything has been a reminder of the shocks both negative and positive that can occur and spread in ways not fully anticipated, and it would be useful to remember that the very successful period of the 1960s was followed by the 1970s, a decade of disappointing economic performance. Thus, a more prudent approach is to help ensure that policy frameworks are resilient and attuned to mitigating the impact of adverse shocks so that any such shocks do not have major repercussions. The chapter offers some useful policy guideposts toward supporting sustained growth including continuing the efforts to improve institutional quality, implementing more stable fiscal policies, and building credible monetary policies that maintain low inflation.
In concluding, let me remind you that the time to prepare for shocks is now. Once a crisis breaks out, events move too fast and it is very hard to policy to catch up. But or course, in relatively tranquil times, no one wants to take hard decisions or take costly measures that might not be absolutely necessary so there is a temptation to wait, but this is a mistake because usually we wait too long. When a hurricane is approaching, it is too late to buy storm insurance.
In this sense, events in August and September should serve as a wakeup call. Weaknesses in the global financial and economic system were revealed, some clearly and some less clearly. We need to work hard to understand precisely what these weaknesses are and to fix them before it is too late. Hopefully, this edition of the World Economic Outlook provides some specific constructive suggestions in this direction. Thank you. We would now be happy to take your questions.
MR. MURRAY: Copies of Simon's prepared remarks will be posted on the Media Briefing Center at the conclusion of this press briefing, and we will have copies to distribute here as well.
Again, if you are watching via the Media Briefing Center, I would recommend that you start submitting your questions now so that we can get to them before the briefing wraps up. Are there any questions here from the audience? Let's start in the center here, the gentleman there.
QUESTION: You were talking about the wakeup call referring to what happened this past summer, but in the meantime you are not recommending some strong regulations approach apparently. Isn't it a contradiction of some sort?
MR. JOHNSON: I don't think there is any contradiction between saying on the one hand some weaknesses were exposed and we need to understand those and really spending more time I think focusing on them, and saying on the other hand that we don't yet have a ready easy answer and we don't know if more regulation or less regulation or the same regulation is going to be the answer. So I think we're still in the stage of waiting for these events to play themselves out fully and understanding how it happened and what are the implications, and at some point, you're right, we do have to take a view on regulations forward, but I think it would be premature or not a good idea to rush to judgment on that issue right now.
QUESTION: Simon, how does one apply what you've learned in studying these 100 episodes of large capital flows to what's going on in the current situation where you have largely a credit crunch happening mainly in the rich countries, and from what I understand and from what I see, there are still large flows going into many of these emerging markets? What would you think would be the right policy mix at this stage for those countries?
MR. JOHNSON: I think that you're right to separate what's happening in the advanced economies from what's happening in the emerging markets. We see at least so far these are two related but quite separate developments. There is a credit crunch of some kind in some of the advanced economies, at the same time, credit is fairly easy or at least capital is flowing in and there are no signs of a credit crunch in emerging markets. So I think as long as the situation remains as you've outlined, the right thing to do is exactly what is suggested in the chapter which is to focus on fiscal restraint. Don't think we've got the capital flows, we're going to be great forever, we can afford to spend freely. The experience in the past is that capital comes and capital stops, sometimes capital leaves, from emerging markets, and the best way, and we have looked at lots of different ways of trying to prepare to handle that, and that the one thing that comes to us from this broad cross-country type of study is be careful on fiscal spending. Don't assume that capital is going to be coming in indefinitely and that the experience of the last 20 to 30 years is that that is not the case, but be careful on the fiscal side.
QUESTION: May I have a follow-up on the fiscal side? If during these large capital flows, for now it has been going on since the early 2000s as your report pointed out, what sort of leverage do you have? You've got to surely start using that capital to push growth and so on. So where does the restraint and the spending in the middle point come in?
MR. JOHNSON: I think in terms of looking for restraint and understanding who has been restrained and who has not, you have to go country by country, and that is something which we don't do as much in the World Economic Outlook, that is something you would look to, for example, the Article IV surveillance, the bilateral conversations with countries.
What we do say at this level is that many emerging markets have been careful up to this point and that we think is an important reason why they remain resilient in the light of changing global credit conditions, and also why the world economy remains resilient.
But I think what I'm trying to stress here is that going forward, they need to remain restrained, and not all countries have been equally restrained and we are trying with this chapter to encourage everyone to look at best practices in emerging markets and to think about whether they could actually improve their monetary frameworks, institutional conditions, and also their fiscal management and the care with which they control spending.
MR. MURRAY: We have a question here on the Media Briefing Center. It is again related to Chapter 3. It's country specific, which you touched upon in your response to [the last question]. This one is regarding China. "Your report talks about the need for countries to resist overspending when capital inflows rise and ensuring that the benefits of trade and technology are shared with all. In your assessment, how has China done in meeting these goals?"
MR. JOHNSON: I don't have time today to evaluate all of China's economic policies, it is a very, very broad question. I would say just looking at the dimensions that we're covering in the analytical chapters here, in terms of capital flows, China is obviously a very attractive destination for many capital flows. They have been really quite careful in terms of fiscal spending and I think that's encouraging and a potential lesson for other places. And the resilience of China's growth is an important reason why we think the global economy remains strong.
At the same time in terms of rising inequality, we show the data on China and some other specific leading countries, and you can see that inequality has increased in China, they have not been immune to this global process, and we think that this inequality, not just in China, but everywhere, is an issue that requires more attention. So I would say overall we think China has done well just in speaking about the policies I mentioned as discussed in the three chapters here, in terms of the macroeconomic policies they have done well, in terms of rising inequality, everyone is facing the same issue and everyone needs to focus more on how to deal with that.
MR. MURRAY: Thanks, Simon. The gentleman in the back of the room here?
QUESTION: Mr. Johnson, part of the delight of being an academic is that you can take a longer view and have a lot of data to look back, but when you mention the preliminary lessons of August and September, looking specifically at the advanced economies like the United States and Western Europe, what are the lessons that you already can identify from the credit squeeze?
MR. JOHNSON: I hesitate to say this is a new lessons because I think there's not much ever that is completely new, but certainly the ability of shocks to jump across certain firebreaks, the ability of shocks that we thought were initially just problems in the subprime mortgages to jump to high-quality mortgages, jumbo mortgages, the ability of shocks to jump from the United States to Europe, and the ability of shocks to jump from banks or financial intermediaries that are involved with a particular type of lending which was lending to the U.S. housing market, that jumped to Northern Rock which was a U.K. mortgage lender, as far as we know not involved at all in U.S. lending. So I think the unexpected way in which these shocks jumped is a reminder at least that there is a lot more potential for instability in the global economy than we often think in periods of tranquility, and this is exactly the point of Chapter 5 which is saying that there has been some absolutely good design and good progress with policy frameworks over the past 10 years, and that is really paid off in the last five years, but it would be a very big mistake to assume this is going to go on indefinitely. The lesson of the 1960s is you can have a very good run, you can have a 10-year run, a 15-year run, of strong global growth with many countries if not all countries participating, and then you can run into a big shocks that derails growth. Then you have to keep working on it and you have to try and stay ahead. What I was trying to say at the end was you have to got to try and stay ahead of this and prepare now, you cannot prepare, again, the lesson from August and September, it's too late once things start to happen. It's that you have the policy frameworks in place or you don't, and you find out in a stress test like what we saw whether those policy frameworks are strong enough. I think in the industrialized countries they are strong enough, they have proved strong enough, but they were seriously tested on some days, and emerging markets have made tremendous progress and I think that progress is partly why the shocks didn't jump that particular firebreak, the firebreaks that separates industrialized from emerging markets. Going forward, I would not to assume that that firebreak would always hold.
MR. MURRAY: Again, I remind those watching via the Media Briefing Center to begin submitting their questions so that we get them in before we wrap up. We do have another question. And the question is more Chapter 1 and Chapter 2 focused, but I will give it to you anyway, "How do policymakers resolve conflict between on the one hand the need to address the credit crunch in OECD countries and lower GDP growth, and on the other hand, the inflationary impact of oil prices globally?"
MR. JOHNSON: We will talk about Chapter 1 and Chapter 2 next week, and will talk about the numbers which I think is the most specific answer to this kind of question. But broadly, at this point I would say that in the industrialized countries that are facing difficult credit conditions, we think that inflation remains moderate, and to the extent that these economies are slowing down, we would expect inflation to moderate. So we think that the increase in oil prices which we have seen, with oil prices obviously going up and down, but they have increased since the early summer, we don't think that is feeding through into inflation. So I think for policymakers in industrialized countries, the course remains clear, and I think they have responded well and effectively to what has happened.
There is an inflationary issue more in emerging markets because these economies are growing fast and food prices are increasing. There the policy task is more difficult, and we will talk more about that next week.
MR. MURRAY: Thank you. Are there any questions here from the audience? The gentleman there in the front.
QUESTION: Are we specifically on the three articles of the WEO?
MR. MURRAY: That's correct. You can ask any question you want. I'm not going to stop you from asking questions, but this is on Chapters 3 through 5.
QUESTION: So in this case it gets to be then a question for whoever if anybody wants to answer, and that relates to with the approach of the semiannual meeting, a question that has been asked by my editors is the perception inside of the Fund of the relevance of the Fund as a source both of funds for stabilization and as a kind of arbiter for the performance of the economies in the world. There are voices that say that the relevance has greatly decreased, so I would like to throw that out if I can get an answer to that.
MR. MURRAY: Thanks for posing that question. It's a fascinating question. This is something that is going to be dealt with by the Managing Director in his pre-meetings press briefings which will begin next week, and certainly the International Monetary and Financial Committee which meets on Saturday, October 20, will be looking at the course of the IMF since the Medium-Term Strategy was endorsed by the committee more than a year ago. There will be a stock-taking. So at this point in time this is not the right venue to get into that. What we're talking about here is some of the detailed analysis that the Fund is doing about key and critical issues facing the global economy.
I'm happy to take others. If there are questions, please go right ahead. I'll turn the table over to Simon. Do you have anything you want to add before we conclude? We did release this in a few stages, and we had the release last night and now this briefing this morning. We'll wrap this up in a second if there are no further questions.
QUESTION: Can you talk specifically about the economic outlook for Latin America, anyone?
MR. JOHNSON: The specifics we will really give you next week on Wednesday, but broadly speaking, when I've talked about the strength of emerging markets, that included Latin America. So we think that the global economy remains strong, we think commodity prices are likely to remain pretty robust, and we think that this combination of circumstances will help most of Latin America have continued strong economic performance. But we will give you the real specifics next week.
QUESTION: Two or three countries, please, a couple of details?
MR. JOHNSON: I think next week you will see all our country-by-country numbers.
MR. MURRAY: Since there is so much interest, let me reiterate, on October 17 at 9 o'clock there will be a press briefing by Mr. Johnson and the World Economic Studies team on Chapters 1 and 2 of the latest World Economic Outlook. That will be detailed analysis of global growth forecasts at the country level. So I recommend that everybody come back on October 17, it will be web cast live, and you are certainly welcome to ask any questions you want at that moment. Right now we are really focusing on Chapter 3, 4, and 5.
QUESTION: Perhaps you can answer this one. What do you foresee will be the impact of Chavez's initiative of Banco Del Sur, the Southern Bank, in the region?
MR. MURRAY: This is not really germane to the World Economic Outlook at this time. That is something you certainly are welcome to pose to the Managing Director when he meets with the press next week on October 18 here at the Fund.
MR. JOHNSON: I would like to just correct one or two misimpressions that may have come in stories that have already been written about the World Economic Outlook. I think in particular there are some shock and surprise that the IMF would think about inequality. I think it is a relatively new topic for us to write about in the World Economic Outlook. It is not a new issue to us, but it is a new one perhaps to write about in this forum.
I think the key point is that this is also a part of series of studies that we have been doing including work we did on labor and labor markets and the labor share of income in the Spring World Economic Outlook. The very important point to get across is that we should look at globalization, the process of trade and financial globalization, with all its positives and all its negatives. We at the IMF are absolutely not in the business of trying to be cheerleaders for any process at all. We think globalization has real benefits and we have written about those. We think it has side effects such as the effects on inequality that are unfortunate and may lead on to more serious issues. We don't get into that in the chapter, but we think that if inequality continues to widen, it's a serious problem and it's going to make many kinds of policy more difficult.
I think it is very important that nobody tries to throw the baby out with the bathwater, a point that my wife emphasizes to me repeatedly. So there is something very good going on which is the process of globalization and Chapter 5 tells you in considerable detail that arguably more countries are participating today including more lower-income countries than at any time in the past. The best comparison is with the 1960s. In the 1960s, many countries that are now independent and weren't independent, we don't have much data on some of the low-income members of the IMF, so it's at least as good as the 1960s and perhaps better in terms of the participation of growth.
At the same time, we should recognize there are adverse side effects, there are some health warnings that should be attached. There are not unavoidable and they can be addressed by policies, and the chapter on inequality goes into the kinds of policies that will make a difference. I don't think that necessarily we have come up with completely new policies, I think we are endorsing some sensible policies that are already on the agenda, but I think we should look at both sides of globalization.
The other point which I think is slightly misunderstood is the point about emerging markets and capital flows. I think that we are very positive on what emerging markets have done to this point and we're supportive of the progress they have made with policies that are making these capital flows continue. But I would again caution that financial globalization is beginning to enter territory that we have not yet seen before. In terms of the amount of flows between countries, it is becoming very large, and again, this is a point that we should all take away from the summer's experience which is the interconnections between different kinds of financial institutions and between countries are becoming more complex and when sparks fly they fly quite a long way and they jump over firebreaks. So with emerging markets we are positive, we are encouraging, but we also have a note of caution there where we are saying that capital flows for as long as we have had records of capital flows start and they stop and you should be ready for when capital flows stop. They may stop through no fault of your own and the chapter takes you through all different kinds of capital stops. You need to be prepared for when the capital stops, and you need to be prepared in industrialized countries also, by the way, but there it is less likely to be damaging to economic performance.
MR. CARDARELLI: Maybe a clarification on a question that was asked before on the importance of fiscal restraint of avoiding overspending during periods of large capital inflows. What the chapter say is that the appropriate policy responses to these episodes of course is country specific, so it depends on specific country's circumstances. We do find that avoiding overspending helps, but it helps more in special cases and probably less in other cases. For example, it helps especially in countries where large capital inflows occur in the context of current account deficits which is probably not surprising if you think that these countries are probably the ones that less need a real appreciation of the currency and probably less need of further pressure on aggregate demand. So in this sense, keeping the line of avoiding overspending during the capital inflows is very likely to help avoiding real appreciation and help achieving a soft landing when the capital inflows abate. But still, a very important lesson that shouldn't be forgotten is that the appropriate policy response depends on country-specific circumstances so we want to sort of avoid giving the impression that we recommend a one-size-fits-all kind of recommendation here.
MR. MURRAY: Thank you very much, Roberto. The gentleman here?
QUESTION: Mr. Johnson, a clarification on what you said about the negative side effects of globalization, if you could give us a scenario of what those side effects should be the ones to look for.
MR. JOHNSON: What we show in the chapter is a fairly general phenomenon. It is hard to find countries that are immune to this, to be honest. What happens is that as new technologies arrive, people with more education like I would guess mostly everyone in this room, find that they can take advantage of these new opportunities, computers would be the leading example, but it's not the only example. These make us more productive, we're able to generate more income for ourselves, for our companies, for our families, and you have a rising income for those people, people with the education to be able to benefit.
At the same time that, incomes go up for people lower down the income scale, but they do not go up by as much. These people, people without as much education, for example, do not find it easy to become as productive, more productive, as the technology improves. So everybody's income is going up and we have a lot of data showing this, but it is going up more for people at the upper end of the income distribution. So that's what I mean by side effects. Then you see a lot of inequality, and then in some cases, it varies country by country, people become resentful of that, in some cases there's pressure to increase wages for the people lower down, and so this is a source of potential social conflict and controversy that can make it more difficult to run your economy at its potential growth rate.
MR. MURRAY: Thank you all for coming. Just a quick reminder, if you have any follow-up questions, send an email to media@imf.org and we will follow-up with Simon and his team. I look forward to seeing you again on October 17 for the World Economic Outlook Global Forecast press conference at 9:00 a.m. Washington time. Thank you for coming.
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