A woman walks past a sign displaying currency symbols in Seoul, South Korea. (photo: Jeon Hyeong-Jin/AFP)
Speech at Brookings
In a wide-ranging speech, "Perspectives on the Global Economic Landscape and the Role of the Dollar," Lipsky examined the tasks facing policymakers in advanced and developing economies, and said that rectifying many of the current difficulties was a shared global responsibility.
Speaking at the Brookings Institution in Washington, D.C. on July 22, Lipsky said that high oil prices were creating new imbalances in the global economy. While the depreciation of the dollar was helping reduce the U.S. current account deficit, it had not been sufficient to alleviate imbalances and risks. "Rather, new misalignments may be emerging and risks may be shifting," he stated.
Lipsky said policymakers around the world faced differing sets of challenges.
Advanced economies
In advanced economies, where growth is projected to fall below potential in 2008 and 2009 [see "IMF Gloomy on Growth"], supporting economic growth while stabilizing the financial system and managing inflation were key objectives. "The risk of second-round effects from the surge in commodities prices and continued stress in financial markets is complicating the response to the slowdown," Lipsky said. "That said, inflationary pressures must be monitored closely, as allowing the past decades' gains in lowering inflation and inflation expectations to be lost would seriously undermine future economic progress."
Emerging markets
In many key emerging market economies, combating rising inflation, resulting from both strong domestic demand growth and surging commodity prices, is the central challenge. Lipsky said that many central banks have raised policy interest rates in response to rising inflation, but interest rates generally remain negative in real terms, particularly in countries where exchange rate management has limited monetary policy flexibility. "There is a risk that many of these countries have "fallen behind the curve" in tightening policies," he said. "In several countries, particularly those whose growth above trend, monetary policy needs to be tightened further. Greater fiscal restraint and, in some cases, more flexible exchange rate management also may be needed." [see "Inflation Risks Have Reemerged."]
Financial markets
Lipsky said that financial market conditions remain difficult. "Forceful policy responses to the financial turbulence and encouraging progress toward bank recapitalization have represented important contributions. Nonetheless, indicators suggest that credit deterioration is widening and deepening as economic conditions weaken," he stated.
As banks in advanced economies—especially in North America and Europe—deleverage and rebuild capital, lending is beginning to be squeezed, further pressuring households and clouding the outlook for the real economy and the financial system. Moreover, increased inflation risks have raised economic uncertainty and reduced the flexibility for monetary policymakers to ease financial stress. "As we have emphasized previously, advanced economy policymakers may need to deploy decisive and innovative measures in order to safeguard financial stability and over time to put the global financial system on a firmer footing," Lipsky said.
Reducing global imbalances
Achieving better balance in demand growth across countries is needed to reduce global payments imbalances and boost confidence. Policy plans outlined in the IMF's Multilateral Consultation on Global Imbalances remain broadly appropriate for doing this, Lipsky said. Key components of these plans include a reduction in the current account deficit in the United States through a shift toward greater domestic saving and improved net export performance; in China, structural reforms, along with increased flexibility of the renminbi with respect to a basket of currencies in order to support a rebalancing of Chinese growth toward domestic consumption; an increase in infrastructure and social spending in Saudi Arabia to alleviate supply bottlenecks and reduce the current account surplus; further progress on growth-enhancing reforms in Europe; and continued structural reform, including fiscal consolidation, in Japan.
Oil markets
Appropriate structural policies in advanced, emerging, and developing economies alike have a role to play in restoring demand-supply balances in energy markets. On the demand side, increasing the pass through of international oil prices to domestic prices to allow a demand response to the reality of higher international prices is critical, particularly in emerging economies, Lipsky said. In advanced economies, improving conservation and energy efficiency will be important to help to moderate the growth in energy demand. On the supply side, oil producing countries should adopt policies to foster investment in the oil sector and in energy resources more generally. [see "Oil and Food Prices Expected to Ease Only Moderately."]
Exchange rates
The U.S. dollar has depreciated by about 25 percent in real effective terms since early 2002, in what has been one of the largest sustained episodes of dollar depreciation in the post-Bretton Woods era. The largest previous such episode—where the dollar depreciated by over 30 percent in real effective terms—took place between 1985 and 1991, also against the background of a large U.S. current account deficit.
Lipsky said that the U.S. dollar was now closest to its medium-term equilibrium value in a decade.
"At the same time, however, the currencies of many economies with flexible exchange rates have appreciated markedly. Indeed, in our view, the euro is now overvalued relative to medium-term fundamentals, while the currencies of many current account surplus countries, including China, remain substantially undervalued, despite a small appreciation in real effective terms," Lipsky said.
"The lack of adjustment in the currencies of several economies with inflexible exchange rate regimes and large external surpluses has not been supportive of an adjustment in global imbalances. Moreover, to the extent that real appreciation in these currencies has taken place more recently, it is largely due to accelerating inflation—hardly an ideal outcome," he added.
Prospects as a reserve currency
Lipsky said that despite pressures on the dollar, it retained a dominant role in both international transactions and as a reserve currency, accounting for nearly two-thirds of central bank international reserve holdings in early 2008. He saw a broader diversification of reserves over time, with a greater role of the euro. "But the dollar will continue to play the central role in international reserves for the foreseeable future."
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