Managing the Transition to a Healthier Global Economy
The following is an excerpt from an address by Christine Lagarde to the IMF.
Managing the Transition to a Healthier Global Economy
Address by Christine Lagarde, Managing Director, IMF
At “A Conversation with Christine Lagarde”
An event hosted by Council of the Americas
Washington, D.C., September 30, 2015
Before you read it, the stance of TNPP is that those in power, especially monetary power, should act in the best interests of everyone, not simply those with the most money. It stands to reason that those with money and power have a duty to act on behalf of those not capable of acting for themselves, especially if they do not hold any money or power.
State of the Global Economy
Our World Economic Outlook numbers will be released next week, but I can already tell you this: global growth will likely be weaker this year than last, with only a modest acceleration expected in 2016.
The good news is that we are seeing a modest pickup in advanced economies. The moderate recovery is strengthening in the Euro Area; Japan is returning to positive growth; and activity remains robust in the US and the UK as well.
The not-so-good news is that emerging economies are likely to see their fifth consecutive year of declining rates of growth.
India remains a bright spot. China is slowing down as it rebalances away from export-led growth. Countries such as Russia and Brazil are facing serious economic difficulties. Growth in Latin American countries, in general, continues to slow sharply. We are also seeing weaker activity in low-income countries – which will be increasingly affected by the worsening external environment.
At the global level, there is still a drag on the economy because financial stability is not yet assured. Despite progress in recent years, financial sector weaknesses remain in many countries, and financial risks are now elevated in emerging markets.
If we put all this together, we see global growth that is disappointing and uneven. In addition, medium-term growth prospects have become weaker. The “new mediocre” of which I warned exactly a year ago – the risk of low growth for a long time – looms closer.
Why? Because potential growth is being held back by low productivity, population aging, and the legacies of the global financial crisis. High debt, low investment, and weak banks continue to burden some advanced economies, especially in Europe; and many emerging economies continue to face adjustments after their post-crisis credit and investment boom.
Major economic transitions and spillovers
This outlook is heavily affected by some major economic transitions that are creating global ripple effects – what we call spillovers and spillbacks. Let me highlight two of these: China’s transition to a new growth model; and the normalization of U.S monetary policy.
To be clear: both of these shifts are necessary and healthy. They are good for China, good for the United States, and good for the world. The challenge is to manage them as efficiently and as smoothly as possible.
First, China, which is in the midst of a fundamental and welcome transformation. It has launched deep structural reforms to lift incomes and living standards. These reforms will, by design, lead to a “new normal” of slower, safer, and more sustainable growth. The new model relies more on consumption and less on commodity-intensive investment. More on services and less on manufacturing.
It also requires transitioning to a stable, more market-driven financial system. In other words, China’s policymakers are facing a delicate balancing act: they need to implement these difficult reforms while preserving demand and financial stability.
As I said, this kind of major transition can create spillover effects – through trade, exchange rates, asset markets, and capital flows.
We saw some of these spillovers in recent months: investors were worried about the speed at which China’s economy is slowing. These concerns put further pressure on commodity markets and triggered sizeable currency depreciations in a number of commodity exporters.
Those countries have, for many years, relied on China as an export destination. For example, China consumes 60 percent of the world’s iron ore. But as it invests less, China will reduce its appetite for commodities.
This will contribute to what could be a prolonged period of low commodity prices – a change that will need to be managed by policymakers, particularly in the large commodity exporters.
The second major transition concerns the normalization of U.S monetary policy. The Federal Reserve is poised to raise interest rates for the first time in nine years – although the Fed has also clearly indicated that rates are expected to remain low for some time. This transition reflects better economic conditions in the US, which is also good for the global economy.
Low interest rates contributed to a search for yield on the part of investors, which supported financial risk-taking and higher valuations of equities, sovereign bonds, and corporate credit. So the Fed also faces a delicate balancing act: to normalize interest rates while minimizing the risk of financial market disruption.
Again, there are potential spillovers. The prospect of rising U.S. rates has already contributed to higher financing costs for some borrowers, including emerging and developing economies.
This is part of a necessary adjustment in global financial conditions. The process, however, could be complicated by structural changes in fixed-income markets, which have become less liquid and more fragile – a recipe for market overreactions and disruptions.
Outside the advanced economies, countries are generally better prepared for higher interest rates than in the past. And yet I am concerned about their capacity to buffer shocks.
Why? Because many emerging and developing economies responded to the global financial crisis with bold counter-cyclical fiscal and monetary actions. By using these policy buffers, they were able to lead the global economy in its time of need. And over the past five years, they have accounted for almost 80 percent of global growth.
These policy actions generally went together with an increase in financial leverage in the private sector, and many countries have incurred more debt – a significant portion of which is in U.S dollars.
So rising U.S. interest rates and a stronger dollar could reveal currency mismatches, leading to corporate defaults – and a vicious cycle between corporates, banks, and sovereigns.
The bottom line is that proactive policy management by everyone – and especially the emerging economies – is now more important than ever.
2. What should we do?
So much for the diagnosis. What should be done? That is my second question.
While the transitions underway carry a downside risk, we know that this can be managed – by supporting demand, preserving financial stability, and implementing structural reforms.
Most economists would probably agree with this general recipe, but I would like to be very specific today. As I noted earlier, action is required now, and we need to intensify our policy efforts.
To be clear: I am calling on policymakers to make a policy upgrade to address the current challenges.
What do I mean by “upgrade?”
On the demand side, most advanced economies, except the United States and possibly the UK, will continue to require accommodative monetary policies. All advanced economies, however, should fully incorporate spillover risks in their decision-making process and, in addition, ensure that their communications are very clear in this regard. This constitutes a crucial policy upgrade.
The Euro Area can upgrade by fully tackling nonperforming loans worth some €900 billion. This is one of the major unresolved legacies of the financial crisis. By removing the NPL buildup, banks would be able to increase the supply of credit to companies and households. It would enhance the potency of monetary accommodation, improve the outlook, and bolster market confidence.
Emerging economies would need to improve the monitoring of foreign currency exposures of major companies. They should also use macroprudential tools to ensure the resilience of banks vis-à-vis the buildup of corporate leverage and foreign debt. This would contribute to financial stability and reduce the risk of a vicious cycle between corporates, banks, and sovereigns.
At the global level, there is a pressing need to complete and implement the regulatory reform agenda – with a special focus on improving the transparency and oversight of non-banks, or shadow banks. And we still have another major upgrade ahead of us – the resolution framework for systemic, globally active financial institutions remains inadequate.
On the fiscal side, countries should use policies that are as flexible and growth-friendly as possible. The IMF continues to recommend that advanced economies with room for fiscal stimulus use it to boost public investment, especially in quality infrastructure. Credible medium-term fiscal plans also remain a priority, especially for the United States and Japan.
Commodity exporting countries that have policy room for maneuver should use it to smooth their adjustment to lower prices. Others should rely on growth-friendly fiscal rebalancing – including tax reforms, energy pricing reforms, and by reprioritizing spending, including to protect the most vulnerable.
What about the upgrade? Commodity exporters such as Colombia, Norway, and Botswana used the commodity boom to strengthen their fiscal frameworks against shocks. This has put them in a position where they can better determine the pace of necessary fiscal adjustment and thus preserve growth. There is a useful lesson here for others.
Finally, all countries need to upgrade their economic structures through reforms in labor and product markets, infrastructure, education, healthcare, and trade, to name just a few.
3. How do we make it happen?
Which brings me to my last, and perhaps most important question: How to make it happen?
It is, of course, easy to make policy recommendations. But implementation requires skillful and savvy policy making, especially in this phase of lower growth and higher uncertainty.
Moreover, it is important that these policies are implemented not only at the national level, but also that they contribute to a coherent global approach. Given the collective nature of many of the issues involved – like climate change, trade, migration, and the global financial safety net – increased international cooperation is more urgent and essential than ever before.
I was glad to see this spirit come through in the adoption of the Sustainable Development Goals last weekend in New York. I hope that it will also lead to a meaningful agreement at the Climate Change Summit in Paris in December.
Or take, for instance, the current refugee crisis in the Middle East and Europe. This is not just a humanitarian issue – it is an economic issue that affects everyone. Everyone has an obligation to help.
The IMF will play its part. We are analyzing the economic impact on our affected members, and we will provide specific policy recommendations. We are also providing more fiscal space in our program support – as we have done already in Jordan, Iraq, and Tunisia.
With our mandate to address growth and economic stability issues at the national and global level, we also continue to refine our core activities – surveillance, lending, and capacity building. And we are adapting to further strengthen our support for our membership as they face the ongoing transitions that I have outlined.
What do I mean by “adapting”? Our “AIM” is to improve along three dimensions: “A” as in “more agile,” “I” as in “more integrated,” and “M” as in “member-focused.”
- First, more agile – for example, focusing our policy advice much more on managing short and medium-term risks and spillovers. Analyzing the inter-linkages between economies and connecting the dots is becoming a hallmark of our work.
- Second, more integrated – macro-financial linkages, for instance, are becoming better integrated into our projections and risk assessments; so are macro-critical issues which have a bearing on growth sustainability – such as financial inclusion, inequality, climate change, and policies to support the post-2015 Sustainable Development Goals.
- Third, member-focused – enhancing our delivery of both country-specific assistance and cross-country experience. In my travels to our membership, I find that this sharing of best practices is now one of the Fund’s most highly valued contributions.
I will elaborate further on these “Aims” in my annual address to our 188 member countries next week in Lima. Let me add just one crucial point: the Fund can only be as effective as the support we receive from our members.
Therefore, the adoption of the 2010 Quota and Governance reforms is essential to reflect the dynamic changes taking place amongst our membership, and to ensure that the Fund has the resources that are needed to respond to our members’ needs – today and tomorrow. In fact, this is at the heart of the global financial safety net.
I continue to urge ratification by the U.S. Congress as quickly as possible.
It would be in line with the important role that the United States plays in the IMF – and it is, quite simply, indispensable if the world is to effectively manage the transitions that I have discussed with you here today.
Let me conclude by quoting from the IMF’s founding father, John Maynard Keynes. In the midst of the Great Depression, he wrote this:
“It is common to hear people say that the epoch of enormous economic progress is over. But I believe that is a wildly mistaken interpretation of what is happening to us.
We are suffering not from the rheumatics of old age, but from the growing pains of over-rapid changes, from the painfulness of readjustment between one economic period and another.”
Keynes’s note of realism – and optimism – proved to be right, of course. I believe it is a fitting note on which to end.
Yes, there is uncertainty. Yes, the challenges are great. And yes, with the right policies, leadership and cooperation, we can manage through to a brighter future for us all.