Transcript

Washington DC
April 9, 2013

Panel:
Jörg Decressin, Deputy Director, IMF Research Department
Rupa Duttagupta, Deputy Division Chief, IMF Research Department
John Simon, Senior Economist, IMF Research Department
Gita Bhatt, EXR External Relations Department

MS. BHATT: Thank you for coming here to this press conference of the WEO Analytical Chapters 3 and 4. I just want to remind you that this press conference focuses on the WEO analytical chapters. Chapters 1 and 2 of the World Economic Outlook, which contains our forecasts, will be launched next week, on April 16th.

On the panel today are our lead authors of the chapters: Chapter 3, "The Dog that Didn't Bark: Has Inflation Been Muzzled, or Was It Just Sleeping?" was led by John Simon, who is to my extreme right. WEO Chapter 4, "Breaking Through the Frontier: Can Today's Dynamic Low-Income Countries Make It?" was led by Rupa Duttagupta.

Let me now turn over to Jörg Decressin, who is responsible for the World Economic Outlook, to give a few words of introduction before we hear from the chapter authors. Jörg?

MR. DECRESSIN: Good morning, ladies and gentlemen. We have two chapters today. John Simon's chapter is basically asking why inflation hasn't fallen further, given the large shocks to demand that we have seen in the advanced economies. And he then wonders, with his team, what this means for policy, going forward?

Rupa Duttagupta's chapter, deals with the low-income countries, and notices that many of these countries have lately been performing quite well. It compares their performance to the performance of low-income counties that took off during the 1960s and 1970s, and wonders about similarities and differences, and what these mean going forward. As you may remember, the growth spurts that many countries experienced in the 1960s and 1970s, later on came to stop, or were partly reversed. And so we're wondering is this time going to be different? With this, let me give the floor to John.

MR. SIMON: We understand that these topics can sometimes be a little bit dry, so we've tried to construct this one as a bit of mystery story, and we've made a reference to Sherlock Holmes and one of his famous cases about the dog that didn't bark.

But it's not just backwards-looking, it's not solely concerned with why didn't the dog bark, but is very much asking, what about the future? Is the dog likely to bark in the future, with the "dog" being inflation?

So, the basic mystery is that during the great recession, we've seen very large increases in unemployment. And, in the past, when you have something like that, inflation has fallen quite a lot. We show that in Figure 3.1, which shows that, really, there's been very little movement in inflation.

And the question is, why was this? There are two theories that account for it. One is that this rise in unemployment has actually been structural, and the consequence of that is, when we do get recovery, it may well be that either we have high unemployment or, as in the '70s, if governments try to lower unemployment below that structural rate, we may just get stagflation as inflation rises.

Alternatively, it's possible that the Phillips Curve—that is, the relationship between unemployment and inflation—is just much more muted. And you can have wide swings in unemployment, and very little effect of this on inflation.

Now, one of the reasons this might be is that we've got much more credible central banks today than we did in the 1970s. There's been an evolution in central banking, starting with the Bundesbank in the 1970s, which we refer to in the chapter, such that now it's very possible that we really are reaping the benefits of the low and stable inflation targets that central banks have set.

Let us give you the answer: Yes, it's credible central banks, it's anchored inflation expectations, and it's a much flatter Phillips Curve. One of the consequences is that we think there actually substantial cyclical unemployment gaps, which means that there is actually the scope for falls in unemployment as the recovery progresses, without there being corresponding bursts in inflation.

Now, one of the consequences of this is that, as you go forward -- and even if you make a mistake in that estimate of how much cyclical unemployment there is in the size of the output gap -- as has happened in the past, and we're all too aware could happen in the future, the inflationary consequences of that mistake are unlikely to be large.

One step further on the inferences in that, is that if you do make that mistake, there's not going to be much of a cost. But, if you don't pursue it, you're likely -- and, you know, there is actually a large output gap, you may end up with uncomfortably high unemployment for an extended period of time.

So we suggest that, really, when you're balancing the risks, we think that this fear of high inflation in the future shouldn't prevent monetary policy from being stimulative now.

One of the key message that we highlight to this anchoring of expectations in the flat Phillips Curve, is independent central banks. We highlight this by contrasting the Fed in the 1970s, and the Bundesbank in the 1970s.

And the relevance of this for today is that the frameworks many central banks are operating are very much like the framework that the Bundesbank developed in the 1970s. It's called "flexible inflation targeting," but it basically means you're talking about expectations of the future, you're managing people's expectations, you're trying to give people confidence that the central bank will effectively do what it takes to keep inflation around their target.

What we also emphasize, however, is that this is a framework that doesn't rely on infallibility from the central bankers. You can make mistakes. The Bundesbank made mistakes in the 1970s and, still, it managed to keep inflation anchored in a way that the Fed, with its much lower level of independence, didn’t manag to do.

So that's why we emphasize, for the future, the key thing you want to see is that you have central banks with the independence and ability to do what it takes to keep inflation anchored, while also using that flexibility to stimulate the economic recovery.

MR. DECRESSIN: Thank you. Rupa?

MS. DUTTAGUPTA: Good morning. Let me summarize the main findings of Chapter 4 of the World Economic Outlook. This chapter focuses on low-income countries, and zooms in on strong growth spurts in these countries -- which basically entail an expansion in their per capita income levels for at least five years, entailing an average growth of at least 3-1/2 percent.

What we find is that these growth spurts in low-income countries (LICs) have occurred in two big waves in the last 60 years. One wave occurred in the '60s and the '70s, but then we saw many of these LICs deteriorate, in terms of their growth performance, during the '80s, when global economic conditions started deteriorating. Now we see a new wave of these takeoffs, or growth spurts in low-income countries again, starting from the 1990s.

So the question in many people's minds, is that, is this time different? This chapter tries to answer two related questions. One is, are these growth spurts important in any way? Do they have any long-run payoffs? And to this, it finds that, indeed, countries that have managed to take off have seen their income per capita levels rise by 50 to 60 percent within 10 years after takeoff, compared to countries that did not manage to jump-start growth, that saw their income levels rise by much less, less than 15 percent. So taking off does help.

And then, in terms of similarities across both generations of these countries that have managed to have these strong growth performances, we see that growth has been accompanied by strong investment and saving rates, strong export growth. And this corroborates the development literature that has emphasized the role of productive capital accumulation and trade integration.

The second lingering concern is whether today's takeoffs are based on better economic policies compared to the previous takeoffs, since, back in our minds, we think of many of those success stories which later on unraveled. And here, too, the chapter finds that indeed, the recent takeoffs since the 1990s are based on a stronger economic footing, as seen by external debt levels, domestic public debt levels falling after takeoff, inflation levels falling after takeoff -- whereas, in the previous generation takeoffs, these imbalances actually escalated or widened.

A part of the improvement in policy is because many of these growth spurts have relied much more on foreign direct investment, rather than investment that is financed by borrowing, sort of debt-financed investment. And a part of the story is also because these countries have managed to implement measures that improve the productivity -- for example, better infrastructure, higher number of years in schooling, and also more political stability.

In terms of "what next?" what the chapter does then is to look at historical case studies, which say that, basically, sustaining the effort is key to moving ahead. So, a number of low-income countries in the past managed to take off for a long period of time by reducing their macroeconomic risks, but not all of them were able to sustain their effort. And where things started going in the opposite direction, even after long periods of growth, they met with stagnation or disruptive ends to their growth takeoffs.

At this current juncture, even though many of these LICs have done very well, they also face a number of challenges. Not all of them have managed to translate their strong growth into a broad-based improvement in living standards or reductions in poverty levels. Many of them are seeing growth come out of a very narrow segment of the economy, and they need to diversify. And even though we have seen positive signs, their path to income convergence is still quite a way off.

But, given the positive signs, and given the stronger policy foundation we see in these takeoffs, there is some more assurance that these countries should be able to remain on course and meet their development agendas, especially if they continue their efforts.

MS. BHATT: Thank you. I just want to remind everybody, especially those online, that the focus of your question should be these chapters, 3 and 4. Our forecasts will only come next week, on April 16th. With that, we open the floor to your questions.

QUESTIONER: Thank you. I have two questions about Chapter 3. First, could you elaborate a little bit on why the Phillips Curve is becoming flatter since 1995? Second, you said ongoing accommodation, monetary accommodation, is unlikely to have a significant inflation rate consequence. Are we talking about a short term or long term?

MR. SIMON: We discuss a couple of theories as to why the Phillips Curve might be flatter, but essentially the chapter is an empirical finding. We notice it's been flatter. But it isn't something that happened dramatically in 1995. If you look at Figure 3.5, you'll see this is something that has been happening gradually since the 1970s.

And, certainly, there does seem to be a correlation with the level of inflation. That is, as you get down to lower levels of inflation, the Phillips Curve seems to be flatter.

Now, one of the reasons is that, as you get down to lower levels of inflation -- kind of nominal rigidities, the fact that people are unwilling to take nominal pay cuts -- start binding a lot more tightly. People, at low levels of inflation, decide to set their prices and forget them for an extended period of time.

So what you see, then, is prices just become much less responsive to the instant economic situation, and become set on the basis of people's longer-term expectations. But also you'll see that wages don't fall nearly as much because, when you've got higher inflation, the prospect for getting real-wage cuts is larger, whereas, when you're at lower levels, it's much harder. People have wage freezes, but you'll notice nobody's really getting nominal wage cuts. And that has much more an effect at the low inflation rates that we've got now.

Now, is this is a short- or a long-term thing? I'd say it is a longer-term thing. Because, really, what we're talking about here is the anchoring of long-term expectations about inflation. We can see short-term fluctuations caused by, for example, exchange rate movements or commodity price shocks, but those really aren't translating into shifts in the longer-term lever of inflation that people are expecting. So this is very much a case of, while there might be some short-term or temporary deviation of inflation from targets, the way that inflation is behaving, our expectation is that this is very well anchored, and it will keep reverting back to these targets that have got great credibility.

QUESTIONER: Chapter 3, as I saw, was elaborated, based analysis on the advanced economies. But inflation nowadays, it is particularly a problem for several emerging countries, like Brazil and Argentina. I wonder you to explain us what is the expectations that IMF has on the control of the inflation in those countries.

MR. SIMON: We studied advanced economies, because they have a particular set of circumstances that are proving to be a problem, which is this combination of high unemployment and relatively stable inflation -- which is not what's happening in the emerging and developing economies. That said, I think our study suggests that there are great benefits and payoffs from having independent, credible central banks. You can see that evolution in the advanced economies from the '70s, when they were dealing with high inflation, stagflation, to today, as they have adopted these frameworks that give the central bank an inflation target, and give them, more importantly, this operational independence to go about achieving that, free from political influence.

We would suggest that this is a transition and a process that you see many, emerging and developing economies taking. Chile, for example, has made this transition towards a much more credible central bank. And this has helped them get a handle on inflation in their countries, and also to support economic growth in the way that low and stable inflation can.

QUESTIONER: I have a question about the Chapter 3 regarding Bank of Japan's recent activity. So, first, I would like to have a comment on this, the Bank of Japan's activity, which is very robust and accommodative policy that we have never seen. Secondly, this very robust policy has been implemented quickly. And after the change of the Japanese government, the administration changed. So, can you say, still, the independence of the Bank of Japan is preserved? Or have you got some kind of concern about the independence of the central bank in Japan?

MR. DECRESSIN: Our Managing Director, yesterday, I think, welcomed the robust monetary response in Japan. As you are aware, inflation in Japan has been negative for a prolonged period, and this has typically bad consequences for the economy.

And so, this change of tack is something that we hope will lift inflation durably into positive territory, which would help the economy. And we see in no way the operational independence of the BoJ compromised.

MR. SIMON: Yes, I suppose I was going to draw on that. "Operational independence" is the thing we make a point about, rather than say "target independence."

The Bank of Japan has full freedom to pursue, operationally, the target it has, and is clearly doing that now with great vigor, which is something that is entirely consistent with the stories we tell here, which is that, for example, the Bundesbank in the '70s pursued their target with great vigor, whereas the target itself was something that kind of evolved through the natural political processes.

QUESTIONER: Thank you. And I would like to raise a question to Mr. John Simon. It's about the Chinese economy and its inflation. Well, it seems now the inflation is not, like, the biggest threat to Chinese economy anymore, given the fact that its CPI figure has been stabilized at a level of about, like, 2 to 3 percent. But there are still some Chinese economists who are concerned about this issue that will come up in the second half of this year, especially the part that we called "important inflation," given the fact that U.S. and Japan are still, you know, keeping its monetary loose.So, do you have any research in your chapter that, you know, about the correlation between inflation and Chinese economy?

And also, a follow-up question, in the chapter, your Chapter 3, you mentioned that, you know, like high inflation should not prevent monetary authorities from pushing highly accommodative monetary policy. Can it be interpreted this way, but now you don't think it's a good time for central banks, like the Federal Reserve, to phase out its monetary easing? Can we understand it that way?

MR. DECRESSIN: I'll take the China question, and you can take the second one. China does not have a central bank with an inflation-targeting framework in place in the way we think about it in this chapter. In this chapter, the central banks that we look at are independent with inflation-targeting frameworks in place,and a freely floating exchange rate.

The setting in China is very different. And so, based on the research we've done in the chapter, there isn't much, I think, that we can say. John, you can say more? Otherwise we'll take the question about the Fed.

MR. SIMON: Yes, that seems to cover it. The thing we emphasize is this anchoring of inflation expectations. It's very much conditional upon seeing long-term inflation expectations' being anchored. And this is a product we see of credible central banks.

Now, in the case of the Fed, they have clearly been innovative, and using their operational independence to the full extent, in order to meet their target. And so, in that respect, they are behaving exactly in line with the recommendations of this chapter.

QUESTIONER: Just turning to the euro zone, obviously the problem the euro zone has right now is its debt levels, and also unemployment that's continuing to rise. What's your analysis of the relationship between the inflation rate in Europe, which -- as I understand, you know, that the European Central Bank, for years, wants to keep fairly low. But, you know, could one make the argument that higher inflation rate would help on the debt crisis, to some regard? You seem to indicate that it's like a problem for Europe that you have this weird combination of, you know, low inflation with high unemployment, and high debt, as well. So I'm just wondering, what's your policy prescription, say, for the European Central Bank, with this combination?

MR. SIMON: I'm not going to comment on the debt angle. But what we're going to say with respect to monetary policy is that the benefits of the central bank doing as much as it can to hit its target, sufficient that -- and also, its credibility is such that it should not fear temporarily overshooting the target.

The idea here is that if you do find that you end up closing up the gaps very quickly, and suddenly you're getting a little bit of overstimulation of the economy -- with anchored expectations, the central bank can notice that and reverse course, and really, there will be no lasting effect of that, because expectations have been anchored.

We point to the experiences of, for example, Spain and Ireland in the early 2000s. This is when they were faced with ECB policy rates that, for their particular circumstances, were too stimulatory. What you see is they had very sharp falls in unemployment, well below their NAIRUs. They were operating with significant excess demand in those economies. And long-term expectations remained remarkably anchored at 2 percent. Inflation itself, for example, in Spain was about 3 percent over a decade.

We are saying that that kind of experience gives us great confidence that the ECB, if it was to experience something similar going forward in the recovery, that would not cause any particular harm to their long-term credibility, and so we would suggest that taking that path would be a good course of action, given the fact that there is this high -- and, indeed, rising -- unemployment there.

QUESTIONER: A follow up. Just why won't you comment on the debt, relationship with Europe's debt, and potentially higher inflation helping lower their debt problem?

MR. SIMON: Because we didn't cover that in the chapter.

MR. DECRESSIN: The ECB has a certain inflation target and this chapter doesn't raise any questions about that inflation target. What it stresses is that the central banks have to have the full operational independence to achieve this target. They need not be concerned, if they have high credibility, about overshooting temporarily the target. Inflation expectations are very well anchored, according to the findings of the chapter. And this should influence, of course, the way central banks do policy, because one of their tasks is to make sure that unemployment is not unnecessarily high provided that inflation remains under control.

QUESTIONER: I have two quick questions. The first one, do the findings in Chapter 3 support U.S. and Japanese recent monetary policy developments? And the second one is, the Brazilian Central Bank operates under an inflation-targeting regime, but it doesn't have formal independency. The inflation now is high. It's over 6 percent in 12 months, and the expectations dis-anchored. To what extent the absence of formal independency can explain this dis-anchoring of expectations and the high inflation?

MR. SIMON: Yes, as I've said, the actions that we see in Japan and the U.S. are consistent with the recommendations in this chapter. For Brazil, perhaps I'd make a point that there is a distinction between de facto and de jure independence. The Fed had legal independence in the 1970s but, in practice, it felt itself constrained by the political dynamics of the time, and felt that it needed to support government policy, which was to lower unemployment.

What really matters is the practical independence, rather than the legal. Now, the legal can obviously help, and it can perhaps make marked changes towards practical independence. But that alone is not sufficient. It needs to actually be a practical and real independence, so that they can then make those decisions independently.

QUESTIONER: Just a quick follow-up -- do you see Brazilian Central Bank as de facto independent?

MR. SIMON: I couldn't comment.

Ms. BHATT: I have a question online." It says, "Can you please tell me what do you think will be the effects of quantitative easing on inflation over the long term?"

MR. SIMON: QE is just using the full range of tools that a central bank can come up with, within its operational independence, to achieve its target. And so it is consistent with the findings of the chapter. Indeed, when we look at the Bundesbank, they actually had a brief period of doing QE in the mid-'70s, when they were concerned about a recession in their economy. There was great controversy about it then, as there is about it today.

But, of itself, we see it as just the central bank using whatever tools it can find at its disposal, flexibly, in order to achieve its mandated targets.

QUESTIONER: If the "dog doesn't bark" in the inflation way, in the long term, wouldn't it bark, will the dog bark in other ways? Like can the ongoing monetary accommodation affect normal market mechanisms, push up asset prices, and encourage risk-taking?

MR. SIMON: Well, perhaps we'll take that analogy, and suggest if the dog's being muzzled, you shouldn't use it as a guard dog -- which means that if you don't see inflation rising or falling, that's not necessarily a sign that there's nothing to worry about. So you need to adjust to this new reality, where the dog isn't barking nearly as much.

MR. DECRESSIN: The Spain example -is a good one. In Spain you didn't see inflation rising much, but you saw a significant increase in asset prices. And so low inflation, in and of itself, does not mean that everything's fine.

QUESTIONER: I was wondering, do you see any sign that central banks' independence is being threatened at the moment in the world? And how do you put that in the context of -- there were interesting comments from Olivier Blanchard a couple of weeks ago at a conference, saying, with all the new powers that central banks have, there's a risk they could be too powerful, and their independence could be a problem -- you know, with all the macroprudential, like, mandate they're given.

MR. SIMON: I'm not familiar with all the central banks in the world, or particular details of Olivier's comments. But perhaps I'll say that there's a box in our chapter that I might point you towards, which is saying that, in this new world, where we've got a flatter Phillips Curve, and we've got the possibility that banks' pursuing inflation-only targets might become incompatible with, for example, closing output gaps, reducing unemployment, there is a case to think about whether inflation targets, as they're currently constituted, are the best way of maximizing the welfare of an economy.

This is not to say that there's any predetermined answer here, it's just saying that you can see, for example, in the U.K., they've been thinking, is this inflation-targeting regime we have, and the precise way we've implemented it, the best way to go about maximizing economic wealth, happiness in our economy? And we think that this is perhaps a good time to have that discussion, and think about, going forward, whether there might not be modifications to it, but still making sure that independence of the central bank is maintained -- because as we saw in the '70s, if you start tinkering with that, you can end up with much worse outcomes.

Ms BHATT: I'm going to take one question online: "Are the innovative macroprudential instruments created by the emerging market central banks, like the Central Bank of Turkey, enough to compensate the capital flows to emerging market countries in this monetary expansion time?

MR. DECRESSIN: I guess the question illustrates what John has said. With inflation not necessarily signaling that you may have problems in your economy, you need to look also at other variables and think about other instruments. And that's what some of the inflation-targeting, central banks in emerging economies are doing right now.

QUESTIONER: Well, there's inflation garget regime under kind of attack, or at least criticism. There are some important economists defending nominal GDP targeting instead of inflation-targeting. But in the report, in the chapter, I think you have not directly, but inflation-targeting -- did you kind of rescue inflation-targeting? Because the anchoring expectations, how was it related to an inflation-targeting regime?

MR. SIMON: We don't formally tie it down. It's perhaps, a coincidence of timing that the adoption of these inflation-targeting regimes with relatively low inflation targets is coincident with the anchoring of expectations around those inflation targets.

And, I think the benefits we have today of low and stable inflation shouldn't be understated. And a lot of that comes from the actions of central banks that have been independent, and have used that independence in order to generate a very stable economy, which is very good. What we talk about here are whether there are ways that we can refine what we've done, that was developed in perhaps more stable times when we didn't have quite as high unemployment, in order to make things even better?

Ms. BHATT: An online question: "In which countries did the IMF see the independence of central banks endangered?"

MR. SIMON: We didn't take a survey of that.

QUESTIONER: I think that you have this focus on the independence of central banks, but there are more factors influence the inflation and the stability in several countries, as the case of my country, and Argentina, too. I would like to know how important it is to have a fiscal balance, and to achieve the target of the inflation. So, I mean, why didn't you consider the fiscal policies as real complement of the inflation?

MR. SIMON: I think we've emphasized that independence is a necessary condition, but we haven't explored all the other possibilities that are out there. And there are some limits on what central banks can do. They cannot do everything, we're saying, but within those limits, if they've got operational independence to pursue stable inflation, then there's quite a lot they could do. And we are encouraging, at least, in the advanced economies, that they should use all tools at their disposal to achieve their targets.

MR. DECRESSIN: The chapter did consider, indirectly, fiscal policy, in the sense that it studies the relationship between inflation, on the one hand, and the output gap, on the other hand -- activity. And activity is very much influenced by fiscal policy. So, indirectly, it has taken it into account.

MS. BHATT: All right. If there are no other questions, thank you very much for coming. And thank you to the chapter authors—John Simon and Rupa Duttagupta.

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