Transcript of a Press Briefing on World Economic Outlook
With Jörg Decressin, Assistant Director, Research Department
Petya Koeva Brooks, Chief, World Economic Studies Division
Daniel Leigh, Economist and Team Leader on Chapter 3, Research Department
Abdul de Guia Abiad, Senior Economist and Main Author on Chapter 4, Research Department
Conny Lotze, Deputy Chief, External Relations Department
Wednesday, September 30, 2010
|Webcast of the press conference|
MS. LOTZE: Good morning, and good day to everybody online. Welcome to this press briefing on the analytical chapters of the World Economic Outlook, Chapters 3 and 4. I’m Conny Lotze from the External Relations Department. Chapters 1 and 2 of the WEO, which includes latest forecasts, will be released next week on Wednesday, October 6, ahead of the annual meetings.
Let me introduce the speakers today who some of them will make short introductory remarks. To my right is Jörg Decressin, Assistant Director of the Research Department; to his right, Petya Koeva, Division Chief of the World Economic Studies Division; to her right, Daniel Leigh, Team Leader on Chapter 3 on the “Macroeconomic Effects of Fiscal Consolidation;” and last but not least, Abdul Abiad, main author of the Chapter 4 on “Effects of Financial Crisis on Trade.”
So let’s begin with introductory remarks and then we will take your questions. Jörg, please?
MR. DECRESSIN: Thank you to all of you who are here or are online for your interest in today’s press conference which will cover the analytical chapters of the WEO, Chapters 3 and 4. As Conny said, the growth projections, the conjunctional analysis, and the specific country policy challenges will be presented in Chapters 1 and 2 of the WEO next week.
Chapter 3 focuses on one major policy challenge facing advanced economies today which is fiscal consolidation. The title of the chapter is “Will It Hurt Macroeconomic Effects of Fiscal Consolidation?” The main authors are Daniel Leigh, Pete Devries, Charles Freedman, Jaime Guajardo, Douglas Laxton, and Andrea Pescatori. Clearly, today’s high fiscal deficits cannot be sustained indefinitely without doing some harm to the economy. So what this chapter tries to do is to inform the debate on when and how to consolidate.
Chapter 4 focuses on another important issue facing the global economy today, the prospects for trade in the coming years. Trade has already begun to recover from the sharp collapse in late 2008 and early 2009, and the chapter looks at whether trade is back to normal and where trade is headed from here. The title of the chapter is, “Do Financial Crises Have Lasting Effects on Trade?” The main authors of this chapter are Abdul Abiad, Prachi Mishra, and Petia Topalova.
Without further ado, let me pass over to Daniel Leigh who will talk about Chapter 3 before Abdul will take over and present Chapter 4. We will then open the floor for questions. Thank you.
MR. LEIGH: Thanks, Jörg. So Chapter 3 starts out by noting that we’ve had a very rapid increase in budget deficits and government debt levels to levels we haven’t seen in half a century during the Great Recession. And in the future there will also be age-related spending pressures that are going to probably put more pressure on public finances. And so for advanced countries, a key priority is fiscal consolidation. It’s necessary and unavoidable, but the question is, will it hurt? Will the tax hikes and spending cuts slow growth?
It’s such an important question that we’re not the first to look at it. And there are a number of studies that present interesting evidence that when you cut the budget deficit, it makes growth accelerate right away. So the first thing we did was we examined, reexamined, the evidence and we found that standard approach that these studies use basically biases the analysis towards underplaying the costs and overstating the expansionary effects. So we started from scratch. We created a new dataset of fiscal actions based on budget documents and the historical record.
And what we found was the following: Fiscal contractions, fiscal consolidation, typically reduce growth and raises the unemployment rate in the short term. A one percent of GDP budget deficit cut reduces GDP by half a percent and raises the unemployment rate by a third of a percentage point within two years.
Now we also looked at things that shape the outcome around this average experience. A very important thing is that monetary policy provides a lot of support during fiscal consolidations. Normally, interest rates go down and the exchange rate loses value and that fall in value of the currency boosts exports. That provides a key cushioning role because it partly offsets the fall in consumption and investment.
Also, governments that are under pressure from the financial markets, when they do the adjustment they typically experience a smaller contraction. So that’s another thing.
Also, tax cuts versus spending cuts: It turns out that governments that cut spending experience smaller contractions than those that raise taxes. And we found an interesting reason for that. Central banks typically cut interest rates more following spending cuts. So those are the factors that shape the outcome.
What about the long term? We also looked at the long term. There we found that debt reduction typically stimulates output because government debt going down reduces real interest rates and that stimulates private spending. Also, lower interest rates mean lower interest payments on the debt and that creates space in the budget, permitting tax cuts and that provides a further boost to activity—so long-run gains.
Now what does all this mean for today? Well, if interest rates are near zero as they are in many advanced countries, then the costs are likely to be greater than they were in the past in the short term. Also, because not everybody can reduce the value of the currency at the same time and increase their net exports at the same time. If everybody does it together, if a lot of countries do consolidation at the same time, that’s going to increase the costs. Our simulations suggest that interest rates being near zero, everybody doing it together, that could more than double the costs that we’ve seen in the past in the short term.
At the same time the silver lining is that today countries that are under pressure from the markets are likely to have a smaller cost from doing the fiscal consolidation. Also there are ways that countries can shield the recovery by legislating measures today that reduce the deficit in the future when the recovery is well underway. And these include, for example, linking the retirement age to life expectancy and making entitlement programs more efficient.
So overall it’s important to have realistic expectations. Almost all advanced economies need to do fiscal consolidation, and it’s going to have long-run benefits. But we shouldn’t kid ourselves. In the short term, tax hikes and spending cuts are going to probably reduce growth and raise the unemployment rate. Thank you very much.
MR. ABIAD: The fourth chapter of the WEO focuses on what happens to imports and exports of a country following a financial crisis. This is particularly relevant at present because the countries that recently went through such crises include large advanced economies such as the United States and much of Western Europe, and these economies account for almost half of global demand. So what happens to the imports and exports of these countries in both the near and the medium term matters not just for the countries themselves, but for their trading partners and for the global economy.
One feature of the recent global downturn was the sudden, severe, and synchronized collapse in global trade in late 2008 and early 2009. Since mid 2009, trade has been recovering pretty strongly. However, the recovery of trade is not yet complete and importantly, it’s been pretty uneven across economies. One important distinction is whether a country had a financial crisis recently or not. For countries that did not have a banking crisis, imports are pretty much back to their pre-crisis levels although they still remain slightly below the pre-crisis trends. For countries that had the crisis, however, it’s a different story. Imports fell by much more, and the level of imports is still below pre-crisis levels and well below pre-crisis trends.
So to help us understand where trade might be headed from here, what our WEO chapter does is look at what happened to trade following banking and debt crisis over the past 40 years. And what we found was that the imports of a crisis country can fall substantially in the first two years of a crisis, very much like we saw in this recent global downturn. We also found that imports do not recover quickly after those first years. In fact, what tends to happen is that imports stay depressed over the medium term. Importantly, this is not just because crises tend to lower output and, hence, lower the demand for imports. That is an important factor—lower output accounts for about half of the post-crisis decline in imports. But even after accounting for lower output, imports remain about almost 10 percent below normal even five years after a crisis.
So the chapter looks at other factors including weak credit growth in the years following a banking crisis and the increased exchange rate volatility and currency depreciation that one often observes in the immediate aftermath of a crisis, and we found that these were also associated with post-crisis import losses.
Exports on the other hand are not as badly affected as the imports of a crisis country. In fact, once you account for decreased production and output, export levels are really not different from normal following a crisis. What these findings suggest is that the recovery of import demand in the United States and in much of Western Europe is likely to be pretty subdued and pretty anemic over the coming years, even more than suggested by their temperate output projections. It also suggests that the narrowing of the current account deficits in the United States that we saw in 2009 is likely to prove quite durable.
And finally, for the trading partners of these countries that have relied heavily on demand from these countries for their growth, what the chapter’s findings highlight is the urgency of lessening their dependence on external demand and strengthening domestic sources of growth. And I’ll end there.
MS. LOTZE: Thank you very much. We have a few questions online here, and I would like to take two of them together. They are country-related and as you know, we’re having Chapters 1 and 2 out next week which pertain more to these country questions. However, we can probably answer them more in general terms.
Let me take the first two: One is the question of whether Ireland can go it alone and whether “given what we are learning about the country and the downgrade of Spain, how much second guessing is there about the austerity push?” The other one is on Portugal. “The Portuguese government announced yesterday new austerity measures. Does the IMF consider those measures necessary? Is Portugal on track with these measures to endorse the fiscal deficit?”
Now let me hand over to Daniel who will answer them in a general way.
MR. LEIGH: Thank you very much. I’m not going to get into country specifics now. That’s going to happen next week, but what I can tell you based on our study is we tried to assess how much these kind of budget deficit cuts are going to affect unemployment and growth in the short term. And we found that it tends to hurt in the short run. But we also found, and that’s particularly relevant here, is that for countries that are under pressure from the markets to do something, when they conduct the fiscal consolidation, it tends to have lighter effects, smaller costs, than when there’s no pressure from the markets. So there is a silver lining for these countries.
MS. LOTZE: Another question which also goes to Europe is a little bit broader: “But given the protests across Europe, is this the message the public needs to hear now as governments attempt austerity?”
MR. LEIGH: Thanks. Our role here is to look at history and come to the table with some estimates of what are the likely consequences in the short term and in the long run. And as we’ve said, there’s some short-term pain, but there are longer-term gains, and this is going to help think about what softens the pain. There are a number of things that governments can do to soften the pain. This is our role, to inform the debate.
QUESTIONER: Thank you very much. I would like to ask you if you believe that the Greek government is powerful to promote the necessary structural reforms on the Greek economy? Although there are very strong reactions from the people in Greece, are you sure that the Greek government is able to promote and to implement these reforms on the Greek economy?
MR. DECRESSIN: Again, this is a country-specific question which we will answer next week at the press briefing for WEO Chapter 1 and 2.
In general, what this chapter shows is there are clearly long-term benefits to fiscal consolidation. But there is also some unavoidable short-term pain. And that pain is, however, much smaller for governments that are facing market pressures to consolidate than for governments that do not face such strong pressures.
QUESTIONER: And the last one. Are you concerned about the people’s reaction all over Europe against these hard economic measures that you propose to be implemented?
MR. DECRESSIN: What we are trying to do is to inform the public about both the benefits and the costs. And the benefits come up in the long term, and it’s very important for us to spread that message, that consolidation is necessary. When you have large fiscal deficits, it’s like a family that is constantly spending more than it earns. It cannot go on forever, right? And it does have costs. And this chapter gives some information on the costs such behavior has, and that’s a role we have to play.
But we should also be clear that there is short-term pain.That is why people are concerned at this stage. But if we have a good assessment of the long-term gains, then we hope that this will help carry forward the debate in Europe.
MS. LOTZE: Also, let me just add on Greece, we have a lot of statements on Greece on the Web site.
Okay, there are no more questions. Thank you very much to our speakers and thank you very much for participating.