Decisive Action to Secure Durable Growth
Source : International Monetary Fund
Lecture by Christine Lagarde, Managing Director, IMF
Hosted by the Bundesbank and Goethe University
Frankfurt, Germany, April 5, 2016
As prepared for delivery
Good morning. President Weidmann and President Wolff, thank you for your kind introductions. Thanks also to the Bundesbank and Goethe University for your generous hospitality. And thank you, students, faculty and guests, for coming here this morning.
I am very pleased to be back in Frankfurt, Germany’s financial center and seat of the Bundesbank—the world’s first fully independent central bank with its history of notable Presidents such as Karl Otto Pöhl and Hans Tietmeyer. And of course, for over a century Goethe University has driven academic openness and excellence, inspiring some of the world’s leading thinkers.
Few reputations are as towering as that of Frankfurt’s most famous son, Johann Wolfgang von Goethe: writer, philosopher, scientist, musician and statesman. I also think of him as an internationalist. Not only were his major works widely translated and read abroad, but he also embarked on the first Italian “grand tour,” wrote Persian-style poetry, penned Sanskrit literature—and yet still found time to be a global diplomat! Goethe’s genius was to see the world as a whole, comprised of its many interconnected parts.
These two themes—interconnectedness and internationalism—have never been more important. In the face of destructive forces—some of which struck so recently and so painfully in Brussels and Lahore—the world must stand together. Solidarity is an imperative.
Likewise, if we are to overcome the risks and concerns that currently beset the global economy, we must work together. Cooperation is another key to the solution.
The IMF was founded on this spirit of cooperation. And the state of the global economy will be the focus of our 188 member countries when they meet next week in Washington for our Spring Meetings.
The good news is that the recovery continues; we have growth; we are not in a crisis. The not-so-good news is that the recovery remains too slow, too fragile, and risks to its durability are increasing.
Certainly, we have made much progress since the great financial crisis. But because growth has been too low for too long, too many people are simply not feeling it.
This persistent low growth can be self-reinforcing through negative effects on potential output that can be hard to reverse. The risk of becoming trapped in what I have called a “new mediocre” has increased.
This has consequences for the social and political fabric in many countries, even in Germany where the economy has been strong.
We can do better, we must do better—but to do so, policies must go further. And the policy mix must be more potent.
Let me be clear: we are on alert, not alarm. There has been a loss of growth momentum. However, if policymakers can confront the challenges, and act together, the positive effects on global confidence—and the global economy—will be substantial.
We can get back on track.
How to get there? I will answer that by discussing three topics:
- First, today’s global economic challenges
- Second, individual country actions that can add up at the global level; and
- Third, the international cooperation required to achieve our common goals—including the IMF’s role.
1. Today’s Global Challenges: A Time of Uncertainty
Let me turn first to the global challenges. Next week we will release our World Economic Outlook with our detailed forecast. Today, I will focus on broad trends.
Overall, the global outlook has weakened further over the last six months—exacerbated by China’s relative slowdown, lower commodity prices, and the prospect of financial tightening for many countries. Emerging markets had largely driven the recovery and the expectation was that the advanced economies would pick up the “growth baton.” That has not happened.
Indeed, for many advanced economies, the recovery is proving more moderate than anticipated. In the United States, growth is flat due partly to the strong dollar; in the Euro Area, low investment, high unemployment and weak balance sheets weigh on growth; in Japan, both growth and inflation are weaker than expected.
While emerging markets are a very diverse group, the story is broadly similar. China’s transition to a more sustainable economic model—which is good for China and the world—means that its growth rate, while still strong, is lower. Downturns in Brazil and Russia are larger than expected. The same is true for the Middle East—hit hard by the oil price decline. Many African and low-income nations also face diminished prospects.
India, by contrast, remains a bright spot—with strong growth and rising real incomes. The ASEAN-5 economies—Indonesia, Malaysia, Philippines, Thailand and Vietnam—are also performing well, while countries such as Mexico continue to grow.
Following turbulence at the beginning of this year, economic sentiment has improved—driven by further easing from the ECB, an apparent shift to a slower pace of rate increases by the U.S. Fed, a relative firming of oil prices, and lower capital outflows from China.
We should welcome this; but we should not be complacent. In the absence of decisive action to address lingering problems, downside risks remain and have probably increased.
What are those risks?
For advanced economies, they relate to longstanding crisis legacies—high debt, low inflation, low investment, low productivity, and, for some, high unemployment. In some countries, balance sheets of banks, and increasingly non-bank financial institutions, are strained by non-performing assets and low operating profit margins.
For emerging and developing economies, risks relate to rising vulnerabilities—lower commodity prices, higher corporate debt, volatile capital flows and—for some countries—de-risking and reduced bank lending.
These risks should not be looked at in isolation—they have a macrofinancial dimension. This could, in adverse circumstances, create feedback loops to sovereign balance sheets—for example, through implicit guarantees of large and inefficient state-owned enterprises that take a hit from falling commodity revenues.
Moreover, each of these risks can be the cause of spillovers that cross borders with greater frequency and force than ever before. Indeed, our research indicates that spillovers from emerging economies have increased in recent years, including from trade, commodities, and financial markets.1
More broadly, global trade has slowed and financial stability risks have increased—with the recent market turmoil partly reflecting lower confidence in the effectiveness of policies. Given that these dynamics could become self-reinforcing, global financial stability is not yet assured.
These risks are also exacerbated by political and other risks that transcend borders—and which feed uncertainty and fear.
Here, I am thinking of terrorism and the repeated, appalling attacks on innocent lives; the silent threat of global epidemics; and conflict and persecution that force people to flee their homes. Many people wonder whether their way of life will have to change, whether their lives are still secure.
This extends all the way to countries that have received large numbers of refugees, like Jordan, Lebanon, Turkey, or some European countries since last year.
I would like to salute Chancellor Merkel and the German people for their leadership on this difficult—but hugely important—challenge. I have seen first-hand the respect that Germany has won around the world for its deeply humanistic approach to the refugee issue.
And then, on top of all this, there is the yawning gap in individual fortunes, manifest in persistent, excessive, and rising inequality. It is captured by Oxfam’s recent report which claims that the world’s richest 62 individuals own the same wealth as the poorest 3.6 billion.2
Even if inequality on a global, cross-country scale has been declining, it is no wonder that perceptions abound that the cards are stacked against the common man—and woman—in favor of elites.
These frustrations are leading people to question established institutions and international norms. To some, the answer is to look inward, to somehow unwind these linkages, to close borders and retreat into protectionism.
As history has told us—time and again—this would be a tragic course. The answer to the reality of our interconnected world is not fragmentation. It is cooperation.
But what are we to do, and how are we to cooperate?
From a macroeconomic perspective, the first priority must be to secure the recovery and lay the foundation for stronger and more equitable medium-term growth. Overcoming the voices of despair and exclusion requires an alternative path—one that leads to prospects for more employment, higher incomes, and more secure lives.
2. Key Actions at Country Level: A Three-Pronged Approach
Each country has to walk that path. We need different actions in different countries, of course, but I see a general “three-pronged” approach spanning structural, fiscal and monetary measures.
This may strike some as old hat. But if countries agree to take decisive action—going beyond the status quo—there is tremendous scope for making these policies mutually reinforcing. If each country plays its part, these policies can add up to a significant global package—the whole greater than the sum of its parts.
I. Structural Reforms: More Specificity
The first of the “three prongs” is structural reform. There have been commitments on this front by the G-20 nations to raise global GDP by an additional 2 percentage points by 2018. Rather than being implemented over several years, I have called to advance these commitments into 2016.
What kind of structural measures are needed? We know the usual suspects: deregulating product and services markets and reforming labor markets.
But now is time to get specific. Every country has something to do. Just a few examples:
- The United States can boost its labor supply by expanding the earned income tax credit, increasing the federal minimum wage, and strengthening family-friendly benefits.
- Euro Area countries can implement better training and employment-matching policies to help more people find jobs, especially young people.
- For commodity-exporters and for many low-income developing countries, increased diversification is the name of the game.
These supply-side measures should be taken now. To maximize their benefits, however, and to offset any dampening effect on demand in the short term, they must be complemented by supportive fiscal and monetary policies.
II. Fiscal Policy: More Growth-Friendly
Regarding fiscal policy, for most countries the issue is how to make policies more growth-friendly.
This can be done by shifting the composition of revenue and expenditure. India, for example, has reduced spending on costly energy subsidies so it can invest more in growth-enhancing social infrastructure. Japan is investing in childcare to help more women work, which will boost growth over the medium term. And Germany is implementing last year's plans to expand public investment by €17 billion in the years 2015-18 and will also provide labor tax relief in 2016.
Increasing the efficiency of public spending is also key. Research by IMF staff shows that the most efficient public investors get twice the growth “bang” for their investment “buck” than the least efficient.3
Investing in badly-needed—but well-designed—infrastructure is an obvious area of great potential. Investing in innovation is another.
Again, IMF staff have found that GDP in advanced economies could increase by 5 percent over the next two decades if private R&D investment was raised by 40 percent.4 This would entail a relatively small fiscal cost of around 0.4 percent of GDP per year—partly achieved through improved public spending and partly through better-targeted tax incentives.
In low-income and developing countries, strengthening domestic resource mobilization—including by reducing energy subsidies, the direct and indirect cost of which is estimated at about $5.3 trillion globally—can create room for social spending even while rebuilding fiscal buffers.5
Of course, countries with high and increasing debt, and elevated sovereign spreads need to pursue further fiscal consolidation. But others may have room for fiscal expansion—and even more so if they commit to credible, medium-term consolidation plans. With its recent budget, Canada stands out as one such country making the most of this space.
Countries should also prepare fiscally smart contingency measures that can be implemented promptly should downside risks materialize.
In sum, if each country plays its part, the global economy will be better for all.
III. Monetary Policy: More Help from Fiscal and Structural
Monetary policy is the third “prong” to help deliver more durable growth.
Accommodative measures have played an invaluable role in supporting the global recovery. Across several major economies, this was achieved through successive rounds of quantitative easing, combined with the successive lowering of interest rates. Here I would like to commend President Draghi and the ECB for the steps it has taken to improve confidence and financial conditions in the Euro Area, which will further support the recovery.
In this context, we see the recent introduction of negative interest rates by the ECB and Bank of Japan—though not without side effects that warrant vigilance—as net positives in current circumstances. While moving in a different direction, the U.S. Fed’s December decision—alongside its continued commitment to data-dependent actions—also remains appropriate.
While accommodation should continue in most advanced economies, it is clear that monetary policy can no longer be the alpha and omega to recovery. Indeed, it will be much more effective with support from structural and fiscal elements along the lines that I just mentioned.
It also needs to be supported by efficient transmission channels. High levels of non-performing loans—ranging across countries from the EU to China—impede the positive effects of lower interest rates. That is why it is important to strengthen bank balance sheets by enhancing prudential oversight, debt enforcement regimes, and insolvency frameworks.
These measures are also vital for strengthening the financial sector as a whole—crucial to support a growing economy.
In emerging and developing economies—many grappling with the impact of weaker currencies on inflation and private sector balance sheets—monetary policy should continue to adapt to circumstances. This includes exchange rate flexibility where feasible, and especially to help cushion against terms of trade shocks.
Political Will and Leadership
As I said at the outset, implementing this “three-prong approach”—structural, fiscal, monetary—will involve going beyond the status quo—and possibly crossing political red lines.
Now, many policy makers will be tempted to quote Faust on this issue:
“Die Botschaft hör ich wohl, allein mir fehlt der Glaube”
[“The message well I hear, my faith alone is weak”]
Well, there is always a good reason not to act. But that would be precisely the wrong move. The growth momentum is weak, risks are probably on the rise, and confidence is sorely lacking. Now is the time for leadership. And now is the time for cooperation.
3. International Action: Time for Greater Global Cooperation
Indeed, cooperation is essential for addressing shared priorities that countries cannot tackle by themselves. These include shoring up global trade, pressing ahead with financial regulatory reform, and tackling a range of “global public goods” challenges—from climate change to corruption. It is also essential for maintaining a strong global financial safety net that protects countries from sudden liquidity shortages or external shocks.
During the crisis, the global community came together to address weaknesses in the international monetary system: creating the Financial Stability Board and European Stability Mechanism, strengthening central bank swap lines, and carving out a more prominent role for the G-20.
The IMF was a central part of this effort, overhauling our surveillance and lending toolkits and boosting our resources. Part of this, the doubling of quotas, finally came into effect earlier this year with the long-awaited passage of the 2010 Governance Reforms—it not only put our financial resources on stronger footing, it also greatly enhanced the representation of dynamic emerging markets in the Fund.
While these measures were welcome, there is a need to re-visit the global safety net:
- To reflect on its size, given the rapid acceleration in financial globalization, and to take account of the scale and speed of spillovers;
- To consider ways to improve access, given that most emerging and developing countries are unable to use key elements of the current safety net—advanced-economy swap lines, for example;
- And to increase its responsiveness to new challenges facing the international monetary system—from digital currencies, to block chain technology, to cyber-hacking.
In the coming months, various options will be discussed by the IMF’s membership. A well-resourced Fund is fundamental to it. We, in turn, will be looking at how we can strengthen our approach to helping members manage risk, volatility, and uncertainty—including a financial backstop as needed.
We will also be working to help countries identify policy space, craft measures, and build capacity. For example, we are deepening our work on issues such as structural reforms, capital flows, and de-risking.
In addition, we are striving to be more agile in responding to other emerging issues: from the impact of migration on growth, to women’s role in labor markets, to inequality and climate change. These may not seem traditional areas for the IMF. But our members tell us these are urgent macro-critical problems.
They are asking for our help, and so we follow our raison d’être, which is to serve our membership.
To conclude: the global economy faces a time of increased risk and uncertainty. Now is the time to show leadership. Or to say it with Goethe himself:
“It is not enough to know, we must also apply;
it is not enough to will, we must also do.“6
1Global Financial Stability Report, April 2016, Chapter 2.
2Oxfam Briefing Paper, January 2016
4 IMF Fiscal Monitor, April 2016
5IMF Working Paper: How Large Are Global Energy Subsidies?
6 Translation of The Maxims and Reflections of Goethe
Source: International Monetary Fund