Transcript

Washington DC
September 30, 2013

Panel:
Thomas Helbling, Division Chief, IMF Research Department
Andrea Pescatori, Economist, IMF Research Department
John Simon, Senior Economist, IMF Research Department
Ismaila Dieng, Communications Department

MR. DIENG: Good morning everybody. Welcome to this Press Conference for the launch of the Analytical Chapters of the World Economic Outlook. These chapters are Chapter 3, Dancing together? Spillovers, Common shocks and the Role of Financial and Trade Linkages. And Chapter 4, “The Yin and Yang of capital flow management: Balancing capital inflows with capital outflows.

Let me now introduce our three speakers.

We have Thomas Helbling, head of the World Economic Studies Division here at the IMF, Andrea Pescatori, one of the authors of Chapter 3, and John Simon, lead author of Chapter 4. Let me turn it over now to Tom for a few words of introduction before we open it to questions. Tom.

MR. HELBLING: Good morning ladies and gentlemen. We have two analytical chapters in the forthcoming World Economic Outlook. The starting point for Chapter 3 is the observation that the world’s economies moved much more in lock step during the global financial crisis. The chapter team represented here to my right by Andrea Pescatori examined how this observation fits into the bigger picture of how the world’s economies move together, the so-called co-movement. The focus of the chapter is on the drivers of this co-movement, common shocks, linkages and spillovers, and how they can explain the changes of co-movement over time.

Chapter 4, here to my right is the lead author, John Simon, starts out with the observation that volatile capital flows have been long a concern for emerging market policymakers. The chapter starts with the notion that there are different ways to adjusting when there are capital inflow changes. It posits that there are stabilizing financial adjustment and there’s destabilizing real adjustment and the main question the chapter asks is how can countries encourage more stabilizing financial adjustment. With this, let me now turn it over to the authors and give the microphone to Andrea Pescatori.

MR. PESCATORI Thank you Thomas. I will give a short summary of Chapter 3, a work jointly done with a Abdula Abiad Davide Furceri and Sebnen Kalemli Ozcan. What can explain sharp spikes in the global outlook (inaudible). Or more loosely speaking, it seems like sometimes economies suddenly, they move together as if they were dancing together. So, the great recession motivated clearly these questions. In fact, it’s probably the most dramatic example recently of a sharp spike in global synchronization. During 2007 and 2009, GDP growth correlations increased dramatically as they never had done before. Not only in advanced economies but across all the regions in the world. After these big spikes, they went back to pre-crisis level, which show an audibly modest degree of synchronizations. So what we have found in the chapter, what we argue in the chapter, is that you can find a common pattern. Usually those big spikes (inaudible) tend to be associated with large financial shocks. There are basic samples in the past of large financial shocks like in 1987, the stock market crash or even regionally the Asian crisis or the Latin American sovereign debt crisis in the ‘80s which increased output synchronizations originally.

Now if the shock happens in a large economy, that is also global financial hub such as the United States, the effects on global output synchronization are disproportionately large. So the point is, what explains the transmission of those financial shocks across countries? So to study these questions, we have used an extensive data set (phonetic) that covers advanced economies and the emerging markets as well on trade and financial data. So we were able to construct the trade and financial linkages. So here we have three lessons from this analysis.

So the first lesson is the following: Trade doesn’t matter. So it doesn’t really matter to explain changes in global output synchronization. It may matter to explain the levels, of course. By itself, it would explain those big spikes. Financial linkages are more interesting, they have a dual role. During normal times when there are real shocks that prevail, financial linkages actually decrease synchronizations across countries.  This suggests that financial integration probably is facilitating the efficient allocation of capital internationally by shifting the capital where it is most productive.

During crises, things are overturned. So financial linkages in this case can transmit the financial shocks across countries. Finally, the third lesson is the importance of common shocks. Now even financial linkages cannot explain some of the increase in output synchronization. For example, during the Lehman crisis, the recent shock, there are other factors at play. Those factors are not transmitted through the traditional channels that I mentioned before. So we interpret those factors as global panics or sudden changes in better perception of risks. Those factors played a very important role to transmit the financial shocks especially during the Lehman shock. Now even though output correlations now are back to rather a more modest level, pre-crisis, a relatively lower level than before, does that not mean that external shocks -- that doesn’t mean that policymakers should not be concerned about how external shocks can affect their own economies.

And so we have also studied an impact of spillovers, some specific spillovers, and here we have two lessons. Well first of all, size matters. Shocks stemming from the United States still matters more than shocks stemming from the euro area, China or Japan, even though the shocks matter in their own region. Second, the nature of the shock also matters. Fiscal shocks are transmitted through trade. So we have started fiscal tightening (phonetic) shock in the euro area of in the U.S. So for example, if sudden fiscal tightening in the euro area is going to impact the most countries they trade that are substantially linked to trade, to the euro area. Second, we have also studied U.S. monetary policy shock. Here what we found is that first of all, they are transmitted through interest rates and countries that back their currency to the U.S. dollars are the ones that are the most affected. Countries that let their currency to float, vis a vis the dollar instead they have the exchange rate to play the role of the shock absorber.

So to conclude, I have two remarks. So the conventional wisdom debt financial globalization necessarily induces greater co-movement, across country is not true until you hit a crisis. So here the crucial point is that we should preserve the benefit of financial integration while at the same time minimizing the attendance risk through better financial regulation and prudential oversight. The second point is that since crises are often driven by common factors, there are also gains from policy coordination. There are gains as we have seen during the recent crisis from the financial side like central banks coordinating to minimize the market disruptions. But it also gains from the side and also to coordinate fiscal policy to have a joint fiscal stimulus that is fairly distributed across countries to sustain the global economy and global trade it would definitely have. Thank you very much.

MR. SIMON: Thank you. This is joint work with Jaromir Benes, Jaime Guajardo and Damiano Sandri, and this was very much joint work. So let me summarize the problem we’re looking at and the answers we come up with. So the Asian crisis, but also the global financial crisis, led to increased focus on hot money inflows to countries and the effect this can have particularly on emerging market economies where there’s this concern that the money comes in. There’s a credit boom. There’s a current account blowout. The exchange rate appreciates. There’s a loss of competitiveness. And then it all reverses and there’s a crisis just as we saw in the Asian crisis. And what we’re looking at here is what can countries do about it? How can they react to these kinds of hot money inflows, the capital inflows to their countries? And what we find is that there are two ways countries can deal with it and this is almost an accounting thing. Yes. One is that the current account expands because money comes in, feeds consumption, and a bit of a blowout there and a boom. But the other way is that you can offset it with financial flows. One of those that I think people are particularly familiar with is reserve accumulation. So instead of the money getting into the economy, you’ve just got the central bank accumulating reserves, but the other one, and the one that is actually quite prevalent in advanced economies and as we point out, in some emerging economies, is actually offsetting flows by residents. So when foreigners send money into the country, the residents balance this by investing overseas.

And what the net effect of all of this is, is instead of having current account blowouts and all those kinds of classical boom, bust cycles, what you see is a very stable situation where hot money comes in and indeed money goes out. But when it reverses, instead of a very rapid and hard adjustment that can lead to financial crisis, all that happens is residents repatriate their funds from overseas and this balances it all out. And what we notice when we have a look at countries through the global financial crisis and we kind of separate them by the degree to which they did this, we find that the countries that actually had this balancing effect, the offsetting of the inflows with resident outflows fared much better. GDP was much better even though it did fall in all cases. Consumption was much better and the net effect on unemployment was also much better.

So what we are suggesting is this is kind of a complimentary and perhaps a longer-run way to think about capital flows. Instead of looking at what do you do when net flows are crashing, when all the money is turning around, what can you actually do to kind of avoid that in the first place. And so we look at the countries that have actually managed that and we look at the reforms they did and how they got there as a way of drawing some lessons for countries worried about that question today. And what we find is that the countries that have managed to do this best are countries that have certain characteristics. It’s almost the obvious things, the good institutions, independent central banks, running countercyclical monetary policy, good fiscal institutions, running countercyclical fiscal policy. So they’ve got lower inflation, more countercyclical fiscal policy. They can spend it when there’s a down turn.

Now we also find that they have more flexible exchange rates and generally less restrictions on capital flows. Because what’s going on there is in order to allow your residents to move money in and out to balance the inflows, they need to have a bit of a freedom there in order to move their own money in and out to offset it. But what we highlight is the fact that when you have these institutions in place, the incentives are there for your domestic residents to move money in and out. There are some questions about what’s going on, but the one we focused on in the chapter and the one we suggest might be going on is that broadly speaking, it’s not nationalistic motives. It’s the profit motive, but it’s because domestic residents understand their own economy better. And because they understand their own economy better, that means when foreigners are pulling out they see buying opportunities. The exchange rates adjust and they see this as an opportunity to bring their money back home.

So that’s what’s going on. It’s a very simple invisible hand market work. It doesn’t require any appeals to sentiments of protecting your country. It’s just this is what naturally happens and so we then look at the process by which countries achieve this. And we find that it can actually be done quite quickly. In the case of say the Czech Republic, it was practically done overnight, in that they had to fix the exchange rate regime that came under attack back in ’97, ’98, and they adopted good fiscal institutions, an independent inflation targeting central bank practically overnight. And what they found was that after a short period of disruption when they had to raise interest rates to get inflation down, they actually managed to get their interest rates down to exactly the same level as Europe generally and this means that actually the incentives for the hot money inflows went away. So instead of them struggling with kind of the tension that you get if you’re trying to run higher interest rates domestically and trying to control the capital flow, what they did is they took away the incentive in the first place, which meant that they obviated any needs to be controlling the capital flows.

But we also see that this happens in other countries and the process in for example, Chile and Malaysia, was a bit more staged and there we emphasize that the really important thing they did was they improved their prudential regulation. Because even if you have kind of good institutions, but poor prudential regulation, that can just encourage financial institutions to take unnecessary risks. This can lead to that credit boom and bust cycle that is all too familiar. And so one of the things we emphasize in terms of structural reform is prudential regulation really matters. Without that, we don’t see some of these countries getting it all right. So this is not a case of saying, there’s one magic bullet that you should float your exchange rates or should open up your capital account, we’re saying this is a package and in the countries we looked at we see that sometimes they had some of these elements, but not all of them, and that was not successful. So it is a case of you do need this package and we emphasize that getting the prudential right and the institutions right is the first step along that path. Thank you.

MR. DIENG: Thank you John. We’ll now open it to questions here in the room as well as online. So if you have a question, please identify yourself.

QUESTIONER: How difficult is it to measure -- I’m not sure if this -- I believe this falls in the scope of, or in the subject area of these papers. But when it comes to the normalization of monetary policy in the United States, the tapering as they call it, how difficult is it to measure the impact of that, the spillover on the global economy? And if you have any estimates on that impact, that would also be good. Thank you.

MR. PESCATORI: So Chapter 3 has estimated the impact of a shock to the U.S. Fed fund. So the question is how much this can apply to today. So what we have found is that, as I mentioned before, first of all there is a lot of heterogeneity in the response. You have to distinguish the countries that peg their own exchange rate to the U.S. dollars (). But their exchange rate is already stable to the U.S. dollar. And countries that instead let their exchange rate to float, vis a vis, the U.S. dollar. What we have seen first of all is that the effect is not necessarily homogenous -- probably not homogenous with the UMP (phonetic). Now in this case, what we are finding is that if the 100 basis point (phonetic) increase sudden unexpected increase in the U.S. tightening, is something like 20 basis point in the same month, increasing interest rates, even for countries that do not really peg the U.S. dollar, while countries that peg U.S. dollar has a bigger increase.

Now how much you can really rate this one and translate it today, it’s much more complicated because our sample stops in 2008 and it’s not by chance. It’s because it’s more complicated than to evaluate monetary policy shocks in the more recent times. And so regarding the normalization, the first thing probably you should ask yourself is whether the normalization would be faster than expected. Then somehow you have to translate in some points, but it’s definitely something that the chapter does not look at specifically; it’s beyond the scope of the chapter to see exactly the impact on the global economy.

MR. HELBLING: Let me just add that the expectation of the unwinding of the U.S. monetary policy stimulus and the implication for the global economy will be discussed in the press conference on the 8th of October in the prospect for the global economy. Just in terms of an impression, I think UMP as for other monetary policy, a lot of the impact on other economies first operates through interest rates and as Andrea said, the chapter analyzes that in-depth.

MR. DIENG: Thank you. Here in the back.

QUESTIONER: I noted that you used the maybe Chinese word yin and yang to describe the type to flow. So could you tell me why you chose these Chinese philosophical words in your analytical papers? I note here that you have no Chinese authors to prepare this Chapter 4. And is it your first time to use Chinese words, or will you keep doing these in the future?

MR. SIMON: So I don’t know about the future. For myself, it is the first time and attraction of this word is the emphasis on complementarity. So what we’re trying to emphasize here is not a hard response to capital flows, but a bending response. And this very much from my limited understanding of what’s involved are the concepts behind the yin and yang and the Taoist approach. And so we thought that this is kind of a good metaphor for what we were trying to suggest, which is take the soft approach to capital inflows rather than the hard. Instead of trying to oppose it directly, you bend and thereby you encourage capital outflows instead of trying to stop the inflows in the first place and that seemed to be very much in line with that. But to the extent that, yes, I am not Chinese and our co-authors are not Chinese, if we’ve got something wrong there, I apologize.

QUESTIONER: Am I allowed to do numbers? In Chapter 4, I was wondering, does what you recommend -- is it applicable to countries today like India and Indonesia which are already raising rates to fight inflation and are in a way acting countercyclical, which you know you say is not the right sort of things to prepare for the capital flight.

MR. SIMON: So the important emphasis about ours is, ours is more of a medium term focus. When you are in the midst, the fund has got advice, which we refer to in the chapter and you can read, it’s kind of the institutional view. What we’re trying to emphasize is here’s a way that many countries have managed to avoid that in the first place. So countries have managed to change their institutions in a way that instead of having to deal with capital flight, they’ve already got for example built up reserves overseas in the form of either official reserves or we emphasize the private reserve that can then be repatriated and balance this all out. If you happen to find yourself in a situation where that’s not the case and that’s not happened, obviously there are other techniques you need to take. But this is very much kind of a complimentary approach such that if one doesn’t help you or you use a bit of both, once again this is something that other countries for example have found themselves forced into and it’s been quite successful. But for example, you can look at the experience in Malaysia where they took a very staged process of it, 10 years after the Asian crisis to get to the situation that we’re looking at today where they’ve got the flows opened up and the private sector balancing the inflows. So it’s something that can take some time, but it’s also complimentary to the existing, yes.

QUESTIONER: If I can just follow up. Does it mean that for the coming up tapering, it can happen any time and we know how sensitive it’s been, is it almost too late for countries to adopt these packages now?

MR. SIMON: No. In the sense that certainly in the history -- well, without speaking specifically to countries, we know in history you can actually adopt these packages relatively quickly. Also the situations today are somewhat more different in that a number of countries have built up higher levels of reserves, which as we mentioned in the chapter, are one other way of doing buffering. And so you can kind of buffer these flows with the reserves or you can buffer it with the private sector. But one of the fundamental things is if there is a required current account adjustment, that needs to be done and it’s a question of how smoothly you can make that transition. In the past unfortunately, this has had to be done very quickly and that’s been traumatic, but if you’ve got buffers to make a fundamental adjustment to the level of a current account, if it has become too large because of a credit boom domestically, then this is one of the ways you can smooth that transition. It doesn’t mean that there may not be some fundamental changes that need to be made, structural reforms to improve your economy and adjustment that need to be done. It’s just a question of can you do those in a staged, slow and steady manner, rather than in a rapid crisis-like manner.

QUESTIONER: Okay. Thank you. I have another follow-up question on Chinese economy. So what is your evaluation on the overall status of Chinese economy in terms of its financial market and the capital flow status and in terms of reforms, what do you think are the measures that are urgently needed? Or do you know China is not a kind of country that will be heavily impacted by monetary measures by the United States or other developed countries? Thank you.

MR. HELBLING: In terms of the analysis of Chapter 4, I think China has still a relatively close capital account and then for Chinese policies in the current conjuncture that will also be discussed on October 8th, when the conjunctural chapter of the World Economic Outlook will be discussed.

MR. SIMON: I mean perhaps for the longer term, we set out a path that countries have successfully followed in terms of reforming their economies, improving prudential regulation, improving the structural features of their economy as kind of a transition path. Perhaps you can look at Malaysia as that and to the extent that I understand this is the direction China is moving, this might provide them with some guideposts of countries that have traveled that path before, but it’s not something for the here and now. It’s kind of what the plan for the future looks like.

MR. DIENG: John, I have a question online you from Center Bank and Publication: Is resident investment overseas better for financial stability than a central bank accumulation of reserves?

MR. SIMON: So we don’t comment on that, or we remain agnostic on that question in the chapter. What we observe is in practice, in countries even like Malaysia where there have been large reserves built up, more recently the private sector is actually doing a lot more of the adjustment. So it’s a case of not saying that one is better than the other, and indeed there is some research we refer to that suggests maybe they’re complimentary, but as a practical matter we observe the private sector does seem to do a lot more of this in countries that are further along this path.

MR. DIENG: Thank you. I don’t have any questions online. Do you have more questions in the room? I have a question on Mexico. Is Mexico in a dangerous situation because of capital flows?

MR. HELBLING: Again, country specific situations will be discussed on October 8th.

QUESTIONER: I just wanted to follow up something (inaudible) because you don’t want to discuss specific situations, but you have three country cases and I’m interested in Malaysia because the country has been feeling the tapering or talk of tapering impact.

Do you think it’s well prepared with what you describe for another capital flight?

MR. SIMON: I think it is much better prepared than it was during the Asian crisis they had a very deliberate process of building up their institutions, their reserves and indeed they’ve been improving of the ability of their financial institutions and their companies generally to go out and interact with the world economy. And so they are much better prepared. But making predictions about that would require you know an analysis of exactly what’s going on there. They have certainly taken a bunch of steps that mean that I think they are much more resilient than they were in the past.

MR. DIENG: I see that we don’t have any more questions line. So this will bring an end to our press conference today and I just wanted to remind you of the launch of the main chapters of the WEO on Tuesday, October 8th. Thank you for your presence.