Transcript of the WEO Analytical Chapters Press Briefing

Tuesday, April 10, 2012
Washington DC

Panel:
Jorge Decressin, Deputy Director of the Research Department, IMF
Rupa Duttagupta, Lead Author of Chapter 4, World Economic Studies Division, IMF
Daniel Leigh, Lead Author of Chapter 3, World Economic Studies Division, IMF
Gita Bhatt, External Relations Department

MS. BHATT: Good morning, and good day to everybody online. I'm Gita Bhatt from the IMF's External Relations Department. Welcome to this press briefing on the analytical chapters of the World Economic Outlook, Chapters 3 and 4. You've received that under embargo on Friday. I want to remind you that Chapters 1 and 2 of the World Economic Outlook which includes the latest forecasts will be released next week on Tuesday, April 17, just ahead of the Spring Meetings.

Our press briefing today will focus only on the two analytical chapters, Chapter 3 dealing with household debt, and Chapter 4, commodity price swings and commodity exporters. Now let me turn it over to Mr. Jörg Decressin, Deputy Director of the IMF's Research Department. He will make some brief introductory remarks and then we'll hear some of the main messages from the chapter team leaders.

MR. DECRESSIN: Good morning, ladies and gentlemen. We're here to discuss the two analytical chapters of the WEO, Chapters 3 and 4. Chapter 3 focuses on policies to help households with high debt which is a key issue today. The work on this chapter was led by Mr. Daniel Leigh who is sitting to my immediate right right here. Chapter 4 focuses on the economic and policy implications of commodity price swings for commodity exporters. This has been a key issues with respect to policies at this stage because commodity prices have fluctuated enormously over the past decade, but they have also seen a sustained run-up. Fluctuations will remain with us going forward. Whether there will be another run-up in commodity prices like we've had for the past decade is a much more open question. The work on this chapter which is Chapter 4 was led by Ms. Rupa Duttagupta who is sitting to my right. So without further ado, I pass the floor to Mr. Leigh.

MR. LEIGH: Thank you, Jörg. Our study is called "Dealing with Household Debt." This is work done with my colleagues Deniz Igan, John Simon, Petia Topolova and our colleagues in the Iceland office of the IMF Edda Ros Karlsdottir and Franek J. Rozwadowski.

In many economies today, households are grappling with a burden of household debt after suffering sharp falls in the value of their houses during the Great Recession. In this study we looked at what the burden of household debt does to growth and what can governments do about it. We looked at the experience of 25 economies over the last 30 years and we found that recessions and housing busts preceded by a larger increase in household debt tend to be more painful, long lasting, unemployment tends to go up more and GDP stays lower for up to 5 years. This is sobering for a number of economies today where households racked up a lot of debt before the Great Recession and where this debt is now holding back the recovery. This includes countries like Iceland, Ireland, Spain, the U.K. and the U.S.

Why might household debt have such an effect on growth? The key is that people that go into debt tend to react more to changes in their income and wealth so that when something happens like a collapse of a housing boom, these people cut back more on their spending. And in an economy with a lot of indebted households like that there is an overall fall in demand, less demand for products means less employment, unemployment goes up more and incomes of families fall. They find it harder to meet their debt payments and that sets off a negative chain reaction with more defaults, banks being more worried about lending, and there can be long-term damage to the economy.

Luckily we found that governments can do a number of things to stop this negative chain reaction. First of all, there is traditional macroeconomic policy support like paying unemployed households benefits so that their incomes don't fall too much and cutting interest rates to ease the burden of interest payments. Then there is support to the banking sector to help them shore up their finances when households default on loans. But there is only so much that these kinds of traditional policies can deliver. For example, you can only cut interest rates to zero. If you've got a lot of government debt that may put a constraint on the scope for paying for these unemployment benefits.

What we found, luckily, is that there are targeted household debt restructuring policies that have been used in the past that--at a much smaller cost--can significantly ease repayment burdens and stop foreclosures. For example, in the 1930s in the United States, you may not have heard about this, there was a very large-scale and bold debt restructuring program. In Iceland today there has been a huge amount of support provided to households through debt restructuring.
These kinds of policies are very relevant for economies today where scope for additional macroeconomic policy support may be constrained and where banks have already received support from the government.

MR. DECRESSIN: Thank you, Daniel. Rupa, why don't you introduce Chapter 4?

MS. DUTTAGUPTA: This chapter is called "Commodity Price Swings and Commodity Exporters" and the main authors are John Bluedorn, Andrea Pescatori, Stephen Snudden and myself. The setting is a familiar one-- commodity prices have been very resilient over the last decade, offering resilience to commodity exporters against the weakness in the global economy. A key concern is what would happen if this run-up in commodity prices does not sustain or even reverses, and what policies should commodity exporters adopt in order to handle such a situation. These are the key questions that this research focuses on.

We have four key takeaways. The first is that commodity exporters are vulnerable to commodity price swings. Domestic economic performance improves during commodity price upswings and deteriorates during downswings. Second, when we identify the underlying factors driving commodity prices we find a strong relation between drops in global activity and its effect on commodity prices and commodity exporters' economic performance. Third, given these stylized facts and empirical findings, our study suggests that for small exporters of commodities, a fiscal policy response that builds buffers during commodity price upswings to be used during subsequent downswings is generally a good policy response to cushion the economy from the volatility arising from commodity price fluctuations. Such policies work more effectively when debt levels are low and when monetary policy is independent and helps target inflation volatility with flexible nominal exchange rates.

Finally, if it is known with certainty that commodity price changes are going to be permanent in nature, then the key issue becomes how to adjust to the permanently higher commodity related fiscal revenues or permanently lower fiscal revenues and potentially also higher or lower potential output. For permanent price increases, we find that raising public investment or lowing taxes on capital and labor income helps improve private-sector productivity, incomes and thereby output and welfare.

So sum up given all of these findings, what is the key takeaway? I would say that although commodity prices are very high as Jörg mentioned, a number of risks weigh down on them, the key being the weak global economy and the risks around it. A cautious approach is to build institutions and the fiscal buffers needed while prices are still high and then use them should a downswing in commodity prices materialize, and at the same time gradually incorporate new information about the possible changes in the persistence of commodity prices and adjust to it smoothly. Thank you.

MS. BHATT: Thanks. The floor is open for questions.

QUESTIONER: Could your offer your assessment of the recent housing policy actions in the U.S. and Spain and other economies that have had huge housing booms and where have they failed to do what you're suggesting? What would they need to do now? And why have they fallen short?

MR. LEIGH: Those are a number of very interesting questions. We in this chapter focused on examples where substantial debt restructuring programs have been put in place, so I can focus on the U.S. in that respect. We've looked at what has been done recently in the U.S. and first of all as you may know, there are very stark facts about the U.S. housing market. About 2-1/2 million properties are in foreclosure. The banks have taken back the keys and this is even worse than that because another 1-1/2 million households are delinquent. These are staggering numbers. So the need to do something about is still there more than 3 years after some of the flagship debt restructuring programs were put into place like HAMP. So this need is there. What's encouraging is that given the need for more encouragement to write down mortgage amounts and to ease refinancing, the government, the authorities have recently announced a number of measures that go exactly in that direction. The key is to implement these aggressively because these can stop this negative cycle of foreclosures and lowering house prices. The banks for example received already a lot of support to keep them lending. Now it's time for the households to get more support as well.

You also asked about an assessment of what maybe explains the shortfall of the program's performance, so I can talk about that. What we looked at in particular is the flagship debt restructuring policy HAMP, the Home Affordable Modification Program. There are three things. One, this program so far had a very ambitious target. Three- to four-million homeowners were to receive help. Less than a million so far have received permanent modifications. They did not involve sufficient write-downs, sufficient reductions in the repayment burden. Even after getting modified by this program, households still have roughly 60 percent of their income going to service their debt, 60 percent of the paycheck and that's a lot. That helps explain why re-default rates are so high after getting the support. There is still a very high chance of defaulting.

The second thing is that lenders haven't received sufficient incentives to write down principal amounts on those balances which again explains why the administration correctly tripled the incentives recently to write down mortgage amounts. Also it's important to get the GSEs, Fannie and Freddie, to participate in this program because they hold 60 percent of all the mortgages, these GSEs, and they have not been participating in the write-down.

Finally, I would say that the eligibility was very tight for these programs. If you suffered a big fall in your income, that made it harder for you to qualify. Of course, during the Great Recession a lot of households saw their incomes fall. That's why again it's good that eligibility was broadened in recent steps. It's important to implement these proposals.

QUESTIONER: Two questions. First, what moved your team to focus this year on the two topics, household debt and commodity prices? Secondly, also on the U.S. market what is a good option to help speed up the housing sector recovery? Secondly, will loosening the lending standards for some households cause some mortgage type crisis in the future? Will this risk be possible? Thank you.

MR. DECRESSIN: Maybe I'll focus just on the first question, why did we take these two topics. They are part of a string of papers that we've been writing on specific aspects. Take the paper on household debt. It is part of a series of papers we have written about this recession starting out about the past Great Recession, first starting out with a paper on what do recessions driven by financial market stress look like? That was followed by a paper on what recoveries from such recessions look like. That was followed by a paper on the medium-term consequences that such recessions have for output. Finally, we've now reached the stage where we are looking at specific aspects of these consequences, one very, very important one of which is household debt.

As far as the commodities paper is concerned, we had in the last WEO a paper on the effect of commodity prices on policies of commodity importers, so this time we felt like we'd follow this up by focusing on the exporters. So the choice of topics is driven by our medium-term research agenda, but always with the ambition to speak to current events. I'll leave you to answer the second question.

MR. LEIGH: Thank you. Why is it so important to write down the debts of households, in a sense to forgive some of the debt? As we emphasized, there is a relationship between the burden of debt and the speed of recovery from slumps. So because debt is acting as a brake on growth, it's important to address that brake to try to unstick the brake. We have found examples in the past from the U.S. 1930s to Iceland today where this has delivered meaning support. But as you also alluded to in your question, there is an issue that you need to address when you're designing the programs and that is the one of moral hazard. You don't want debt forgiveness to encourage households to take on too much debt the next time. Luckily, in all of the examples we looked at to some extent this is addressed. The key thing that countries have done is announcing clear timing. You already have to have defaulted by a certain date to benefit from the program. Then they monitor also that people really did default already. That stops people now deciding to default to take advantage of a new program.

The second thing is this is offered only for the owner-occupied house, not to the speculators who bought several houses. These kinds of issues can limit the risk of moral hazard or minimize it. Of course, there are always some costs, but it is possible to deliver meaningful support through these policies.

QUESTIONER: To follow-up on the moral hazard issue, it seems like your focus on the moral hazard impacts was more of a short-term study rather than say a longer-term horizon. I understand the argument in the short-term for helping to speed up the recovery. But say over a several decade period does the policy reliance not encourage banks to take on greater risk, lenders to take on greater risk, knowing that the federal government is there to help them out?

Secondly, on oil you say that in a geopolitical supply shortage oil prices could rise temporarily is the word you use and that that could force a decline in other commodity prices. Would that be a temporary increase in oil prices meaning that oil prices will fall after what period because of the global downturn that would result? Does that make sense?

MS. DUTTAGUPTA: Do you want to clarify the last part of your question?

QUESTIONER: Yes. I'm sorry. You say a temporary rise in oil prices would force a fall in other commodity prices. I assume by saying temporary you mean that oil prices will also fall. I'm wanting to know, one, what sort of timeframe you're talking about when you say temporary. Two, am I correct in assuming that oil prices will fall after rising? And three, is that fall because you're expecting a negative economic impact?

MS. DUTTAGUPTA: The findings are that commodity price swings including for oil lasts for between 2 to 3 years which is not necessarily very temporary. On the specific question that you mention, how exactly would large oil price shocks lead to commodity prices falling? The train of reason there was that a very large asymmetric shock could lead to the global activity falling sharply even though it improves terms of trade for commodity exporters and thereby maybe their real GDP. And a surprise large drop in global activity would eventually in the second round lead to a fall in commodity prices including that of oil and other commodities.

MR. LEIGH: On the moral hazard issue it's true that you had to address it. You can minimize it. You may not be able to eliminate it. It's not unique to household debt. Bailing out financial sector banks carried this kind of risk. There is always a tradeoff, do we want the economy to go into a long slump? More broadly, there are a number of studies that look at how you can prevent the kind of boom from occurring, prevention. There is the GFSR. There are some notes that will be coming. So stay tuned for more research on how to prevent an excessive boom in the first place.

QUESTIONER: I have a specific question for Greece and the household market in Greece. Since many people over the last 18 months cannot pay their mortgages, what is the outlook for the housing market in Greece if you can tell us? And do you see the need for a haircut for these mortgages of the common people at least?

MR. LEIGH: What I can tell you is that indeed our findings are sobering for an economy where there has been a large increase in household debt. Without getting into the specifics of the Greek economy which we did not focus on, that is a sobering effect. To the extent that our programs, that the household debt restructuring examples that we've looked at, have a small budgetary cost, that makes it more relevant for economies in general where there is constrained space for big government debt-sponsored programs. You may not know, but some of these household debt restructuring programs have no fiscal cost. Legal reforms to give power to the courts and judges to write down mortgages, so-called cram downs, have no direct cost to the taxpayer and can deliver meaningful support.

MS. BHATT: I have a question online which is again a fairly specific question. Rupa, perhaps you can respond in a more general way. This is from Ana Baron, "Clarin," Argentina. What can happen in Argentina if commodities go down? Do you think that Argentina is well prepared to face a disruption in commodity prices such as soy?

MS. DUTTAGUPTA: I will answer it a little more generally. In general if governments do not use the opportunity provided by strong commodity prices to build the savings and buffers, then if those prices fall suddenly then according to our findings the domestic economy would take a hit. So the bottom line is really not only is building buffers during high commodity prices important to cushion the economy from that kind of a boom-bust cycle, it's also important to be prepared for a downswing.

MS. BHATT: Thank you. I have another question online. Regarding Chapter 3, how long will it take to recover household debt to sustainable levels in these fragile markets and banking environment?

MR. LEIGH: That's a very important question. We found that household debt can act as a brake on economic activity for a long time. What we've seen so far since the Great Recession is that the increase in debt has been reduced in some countries. So-called deleveraging, paying off the debts or defaulting on them has happened in a number of economies but particularly strongly in the U.S. where debt today in percent of household income is back to 2003 levels. In other economies, in Europe, that process has not really occurred yet so that it could take several more years. I would mention on the U.S. that one very interesting fact is that two-thirds of the reduction in debt has been through defaults and that has contributed to this negative feedback loop of lower house prices.

QUESTIONER: The commodities chapter, I wanted to see, you forecast a slowdown or even a decrease in commodity prices. Do you see that as short-lived or a longer-term sort of decrease? In terms of what countries should be doing, do you find that overall most exporters are prepared for this decease and do you have country examples that have done the right things?

MS. DUTTAGUPTA: We talk about forces that could impose downward pressures on commodity prices in the immediate near-term, and there the conclusion is that it's a very uncertain environment for commodity prices. The global outlook which you have read about in most of the recent WEO reports is pretty grim still and there are downside risks to the outlook. All of these weigh down on commodity prices in the near term. But even looking further ahead, a number of facts, for example, increasing efficiency in the use of commodities, unwinding of previous constraints in the supply side, could lead to commodity prices being at current levels or prices may even go down. The main lesson is to be prepared for such a situation and not to take the recent decade’s run-up for granted.

You asked about how do countries fare vis-à-vis our main message. A lot of commodity exporting countries have moved in the right directionFor example, a number of OPEC countries have used high prices to lower their debt levels and our findings indicate that adopting fiscal rules are much more effective when debt levels are low. Others have moved toward inflation targeting regimes. Again our research shows that countercyclical fiscal responses work more effectively than monetary policy is able to help in lowering inflation volatility. And a few have also adopted the exact kind of fiscal policy response that we talk about. Take the example of Chile or Norway and some others.

MR. DECRESSIN: In short, many emerging economies that are exporting commodities are now much better prepared than during the previous commodity price boom in the 1970s and the 1980s. Policies have been strengthened considerably.

QUESTIONER: To follow-up the previous question in the inverse. What countries' exporters are most at risk if you could name say three? Secondly, on the house debt issue, looking at the U.S., what's your estimation of the cost if the U.S. would aggressively implement the program you suggest and what would the boost to GDP over say a 1-year time period be?

MS. DUTTAGUPTA: We don't go into the specifics of countries, but what I can say is that despite countries having improved their policies over time, even when we focus just on the last decade, swings in commodity prices have been associated with swings in GDP performance, in credit growth and in external balances. So obviously it has not been good enough in many cases and I'll leave it at that.

MR. LEIGH: On your question on the cost of the household debt restructuring program that would be meaningful. Actually what I can tell you is that the Making Home Affordable Program which started in 2009 had an allocation of $30 billion and so far amazingly only about $2 billion of that has been used for mortgage modifications, the program that we looked at, the flagship restructuring program. So the first thing is there is still a lot of money that can be spent on that -- if they could spend that full amount, that would make a meaningful difference. And in work done here at the IMF we've found that if you can avoid 1 million foreclosures, then that supports house prices by 3 to 4 percent and boosts GDP by about 0.3 to 0.4 percent by preventing the house prices to fall and by boosting demand

MS. BHATT: I'm taking another question online which is also very specific and is for Daniel. Should IMF program country Ireland introduce a household debt restructuring policy as it has recapitalized banks and has limited fiscal space for expansionary policies?

MR. LEIGH: I'm not going to get into the specifics of Ireland because we're drawing lessons from cases where there has already been a lot of household debt restructuring and what this can bring to the table. When there is constrained space, when government debt cannot be increased, this is where these targeted programs can be relevant and especially when they involve case-by-case restructuring done in the courts. So that that's what I would say on that.

MR. DECRESSIN: A general answer and not Ireland specific, I think in Ireland there are some reforms to the personal bankruptcy system that are ongoing and that are important to implement and there is work being done by the central bank in conjunction with the banks to address mortgage arrears, but we don't want to comment on that in particular.

QUESTIONER: I wonder your perspective is specifically on the prices of commodity -- for the commodity prices and how this can be -- can complicate the situation -- the economic situation for the -- exporters. And also I'd like to know do you think that the American program to solve the housing sector's problems came too late?

MS. DUTTAGUPTA: On food prices along with other commodity prices, we find that global activity does play a significant role in affecting food prices. We focus specifically on two food items – actually two agricultural commodities, cotton and coffee. For coffee exporters which is a lot of Latin American countries also African countries export, we find that global activity driven coffee price shocks have significant effects on GDP and external current account balances.

MR. LEIGH: -- U.S. programs, actually they came quite early on. Already in 2009 there was this whole Making Home Affordable initiative. The issue there is one of implementation. As I said, $30 billion was allocated and so far only $2 billion has been spent on modifying mortgages. That's why the ambitions were very large from the start, 3 to 4 million homeowners to get help, but so far 950,000 only have received permanent modifications. That's why in response to this disappointing performance the authorities did announce a number of steps just recently that are going in exactly the right direction.

MS. BHATT: I have a question online again for Daniel. He asks do you see signs that the U.S. housing market is bottoming? Should the strategic defaulters currently not paying but still living in their homes be included in debt relief?

MR. LEIGH: On the first part, what I can say is that this process of foreclosures and defaults has helped to reduce prices a lot, and by some indicators house prices on average in the U.S. are already near their long-term levels or even by some indicators already below. And there is a risk that more foreclosures and defaults will push prices not just to reach normal but to undershoot and that would be unnecessarily painful. That's why the policies are needed. On the second part of the question. This is an issue that goes back again to moral hazard and you don't want to encourage defaulting and the features of the programs that can address that include setting a clear time by which you already have to have defaulted. You can't then decide to default to take advantage of programs like that.

MS. BHATT: Thank you. Are there any other questions? Any final messages you, as chapter team leaders want to give?

MR. LEIGH: My message: household debt can be a big burden on growth, but that there are things that governments can do to unstick that brake.

MS. DUTTAGUPTA: I'll comment on one of the questions asked on why we chose this topic on commodity prices. It relates to--besides the factors that Jörg mentioned—the fact that emerging market and developing countries have so far been remarkably resilient to the global crisis and we have talked about two-speed recoveries in the recent WEO reports. Commodity prices are a large factor behind it and commodity prices are still strong, so this is an opportunity for commodity exporting emerging and developing economies to use those strong prices to build up all the institutions and buffers needed in case situations become worse.

MS. BHATT: Thank you very much, and thank you all for coming.



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