View from the IMF: Building a Post-Crisis Global Economy

December 10, 2009

John Lipsky
, First Deputy Managing Director, International Monetary Fund

Mark Whitehouse
, Senior Economics Correspondent, The Wall Street Journal

John Lipsky of the International Monetary Fund spoke at Japan Society about the global economic outlook and the challenges of moving towards a more stable post-crisis world.

The global financial crisis could have led many nations to turn inward; instead, their collaboration intensified, "most strikingly through the innovative G-20 Leaders' Summits," which gave the IMF and other multilateral institutions new tools and resources, Mr. Lipsky said. "The result was a coherent and powerful policy response that helped to halt the global economy's downward spiral, and set the stage for the recovery that is now under way," though still fragile.

The IMF forecasts 2010 global growth at 3 percent, versus a 1 percent decline in 2009. For the advanced economies in particular, consumption is held back by unemployment and weakened household balance sheets while businesses have been exceptionally cautious about investing in equipment and inventories.

Japan's exports are up, "led by demand from China, but they remain far below last year's levels." The government's fiscal and monetary policies "have provided important support, but--as highlighted by the sharp downward revision of third-quarter growth figures in Japan--domestic demand, especially business investment, still remains weak."

"The most important implication of our outlook for global economic policy is that in these circumstances it's simply too early to begin a general withdrawal of macroeconomic policy support," said Mr. Lipsky. "The withdrawal of stimulus in the current circumstances should await a clear-cut and sustained recovery in private demand, as well as a return to more entrenched financial stability."

By 2014, the IMF projects advanced economies' government debt at nearly 120 percent of GDP, up from 70 percent in 2007, he said. "Just to bring the debt-to-GDP ratio back down to the level of 2007 would require a structural budget adjustment of as much as 8 percent of GDP on an annual basis. This is really a challenge of historic proportions."

To create a coherent exit strategy, countries must figure out how to bring back sustained global growth "while avoiding the policy mistakes that ignited the crisis," continued Mr. Lipsky. Among many complicating factors are the capital inflows into emerging market economies, as Asian markets "cycled from boom to bust and at least back to a partial boom" over a short period of time.

To deal with these issues, policymakers have several options, including exchange rate appreciation, fiscal tightening, sterilized intervention and reserve accumulation, use of prudential tools, and even temporary capital controls, though these last "should not be used to paper over real problems, or to avoid needed policy adjustment."

As recognized in the G-20's Framework for Strong, Sustainable, and Balanced Growth, adopted at the Pittsburgh summit in 2009, U.S. consumer demand won't reach pre-crisis growth levels any time soon, Mr. Lipsky observed. To make up for this, many countries will need structural and fiscal reforms to create strong, sustainable growth in their own economies' private demand. Moreover, global growth will need to be balanced. This "does not mean that current account deficits or surpluses are inherently dangerous, or that growth should be equalized across countries," but rather that policymakers must address the underlying policy problems, whether "outsized fiscal deficits, overly accommodative monetary stances, domestic market distortions, or inappropriate exchange rate policies."

Nor does it mean "that Asia should become inward looking and reduce trade and financial linkages," he said. Instead, "openness should remain at the heart of Asia's growth model" as countries in the region strive to promote public and private investment in infrastructure, transportation, energy, communications, education and "green growth" technology.

In the case of China, rebalancing "could encompass further developing the social safety net while deepening the financial system. At the same time, the unusually high share of corporate retained earnings suggests that enhanced corporate governance could make a real contribution." As for exchange rate policies, "it seems inevitable that increased currency flexibility in many Asian countries, including China, will form part of the rebalancing effort."

The U.S., like other deficit countries, will have to embrace both fiscal consolidation and financial sector reforms, Mr. Lipsky continued. There's "broad agreement" that these reforms should include broadening the scope of regulation to cover "all systemically important institutions" and creating a "robust resolution regime for large, complex financial institutions." More emphasis on "the macro-prudential dimension" of regulation will "almost certainly" entail "larger capital buffers and new limits on risk-taking." At the G-20's behest, the IMF is looking at options for financial sector taxation, either to help pay the costs of the current crisis or to mitigate risks and cover the costs of future crises. The Fund is due to report to the G-20 on this in June 2010.

At the Pittsburgh G-20 summit, the leaders pledged to develop a process by which member countries would examine, on a mutual basis, their proposed medium-term policies for growth--"quite a remarkable agreement" that hasn't received as much attention as it should have, he said.

In past years, and during the Asian crisis in 1997-98, "the IMF simply had no instruments available to it that had a chance of success in preventing crisis in a world of securitized finance. It's taken another decade and the mother of all crises to get the membership to finally agree on a preventative instrument that has a chance of success, and that's the Flexible Credit Line," Mr. Lipsky said. Meanwhile, official reserve assets have been increased by $283 billion in the IMF's Special Drawing Rights, and the IMF's New Arrangements to Borrow (NAB) are about to be expanded by up to $600 billion providing new resources to backstop the Fund's new facilities, if needed.

"We hope that by improving our crisis-prevention facilities, our members will opt for collective insurance in preference to self-insurance" against global capital market volatility, he commented. Piling up massive international reserves in an effort to self-insure is "a strategy that simply cannot be pursued successfully, simultaneously, by everyone."

The IMF membership has agreed "to shift quota shares toward dynamic, under-represented emerging markets and developing countries," Mr. Lipsky said. This change, which is to take effect by January 2011, "will represent a landmark achievement in the shift to a post-crisis global economy. You can be sure that the role played by Asian economies in a new Fund will be enhanced."

"Notably, Japan was the first country to provide extra resources to the IMF in 2009. In a sense, Japan's provision of $100 billion in liquid resources was a catalyst of the agreement at the London Leaders' Summit to provide around $1 trillion in anti-crisis funding." As the IMF deepens its relations with APEC, ASEAN and other regional organizations, it's "actively exploring ways to strengthen ties with the Chiang Mai initiative, Asia's regional reserve pool, which already provides an important complement to IMF financing."

Mr. Lipsky concluded, "Asia has an important leadership role to play in helping to guide the global economy toward a new, revitalized, global growth model. The challenges are daunting but the opportunities to create a new period of progress are exhilarating, and they are real."


Presider Mark Whitehouse of The Wall Street Journal got the Q&A ball rolling:

For collective insurance to be credible, countries would have to be pretty sure that the IMF would step in and bail them out if they got into trouble. But if they had that insurance, wouldn't that encourage them to pursue irresponsible policies?

"That's a good question, although I object to the term bailout--but I'll pass on that detail," Mr. Lipsky replied. "Does insurance create moral hazard? Yes, of course it does. Does that mean it's bad? No. Does having fire insurance mean that you're more likely to set fire to your house? Yes. Does that mean fire insurance is bad? I don't think so."

"The issues of consequence are the ones you pointed out: is the insurance likely to be effective, and is it reliable?"

How would you assess the effectiveness of government policies linked to the ongoing economic crisis?

"Many observers claim that this crisis was a result of regulatory failure. Instead, I would say, that from the financial side, the principal failure was that of financial institutions risk management that regulation failed to prevent," Mr. Lipsky answered.

"Can the policies be put in place that are needed to support the goals of the [G-20] Framework? Well, I'm starting out optimistically but not overlooking the really significant challenges," including the fiscal challenges, facing the advanced economies that "will be with us for the next few decades."

How did the IMF look at the Dubai request for a debt moratorium, and what is the impact on Asia and everywhere else?

"My guess is if any of you had visited Dubai over the last couple of years you probably won't be shocked at the notion that perhaps building there became over exuberant, and that there was a lot of activity occurring all at once. If you were thinking there could be a problem somewhere in the commercial real estate sector, Dubai would have been a prime candidate," Mr. Lipsky replied.

"If investors think that this is an isolated case, that in general policymakers are doing the right thing, and that economies are adjusting the way they need to, then this case will stay isolated. But we can't take that for granted, and have to think clearly and in a penetrating way about the challenges."

Japan stayed out of a lot of the stuff that blew up in this current financial crisis, yet Japan's economy has performed much worse than any other major economy during this crisis. Is there a connection?

"There's an obvious tradeoff between the restrictiveness of regulation and the potential for risks," responded Mr. Lipsky.

"Japan had benefited from living in a pretty good neighborhood, with a lot of strong growth around them for awhile, and then it went away," he continued. "I don't think anybody would have imagined" that Japanese exports would fall 50 percent between the fourth quarter of 2008 and the first quarter of 2009," yet "that is exactly what happened."

"The financial sector is not the main cause, nor going to be the main cure. So, in the big picture, the lack of financial disturbance in Japan has been good. Even bigger picture, we're going to have to think about what is the right way to modulate the amount of risks that we should allow in the financial sector, and then think about whether we should mitigate that risk by a charge on the sector."

What policies can be enacted to get the potential growth rate in Japan back to 2 to 3 percent, and avoid Japan's becoming the next financial disaster out there in five to 10 years?

"Domestic service sector reform and other reforms still seem to be promising in terms of improving productivity in the Japanese economy," Mr. Lipsky said. "Potential growth comes from investment plus population growth," both of which are challenges for Japan. "I don't have easy outsider's answers to prescribe. But these are going to have to be addressed."

What are your views on the U.S. dollar as a reserve currency?

"I don't think there's any serious risk that the dollar is going to lose its preeminent role as an international reserve currency any time in the foreseeable future. That being said, the dollar represents about 65 percent or so of international reserve currency holdings today. So already it's not a unipolar world," Mr. Lipsky replied.

The IMF looks at currencies "in the medium-term, multilateral equilibrium sense. And by that sense, what stands out in the world is not the current weakness of the dollar but the undervaluation of some other important currencies, particularly in Asia. And of course that includes the Chinese currency that we find to be substantially undervalued."

Bear in mind that "over time, over a long period," as per capita income equalizes, "the relative share of the advanced economies in general, the U.S. in particular, is going to shrink relative to the faster growing emerging markets," he added. "Undoubtedly that will have some long-term monetary implications. To anticipate them now is very difficult."

Are Chinese recovery and growth sustainable? What's happening in the financial sector--are there bad loans or similar problems?

Both China and the U.S. are currently undergoing their very first FSAPs, financial sector assessment programs, which are detailed reviews carried out jointly by the IMF and the World Bank, Mr. Lipsky responded. "We do know that the Chinese authorities themselves have expressed a great concern over the pace of credit expansion earlier this year in the Chinese economy, and have acted to slow it down, for exactly the reasons you suggest: a worry that it was running the risk of distorting asset values and creating potential strains."

--Katherine Hyde
Topics:  Business, Policy

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