An outline based on Chapter One of the Fund’s Annual Report, 1980
During the period from the beginning of 1979 to the middle of 1980, the world economic situation was marked by three disturbing features. Rates of inflation in most countries remained very high and, indeed, accelerated; growth of real output in the industrial countries began to slow down markedly, threatening to halt the expansion of world trade and to turn into another international recession; and large surpluses and deficits re-emerged in the external balances on current account for major groups of countries, giving rise to widespread concern about the ability of some countries, particularly in the non-oil developing group, to sustain the financing of current account deficits on the scale projected. In varying degrees, the more than doubling of oil prices after the end of 1978 was a major factor in all three of these disturbing elements in the global economic picture.
However, not all aspects of the international economic situation at mid-1980 were disturbing. Rates of inflation in the industrial countries as measured by gross national product (GNP) deflators remained lower than those evidenced by consumer price indices or domestic expenditure deflators, signifying that secondary effects of higher import prices had not yet, at least, permeated the basic structures of domestic costs and incomes. The slowdown in economic activity, while in itself far from welcome, was undoubtedly tending to relieve some of the upward pressures on prices. Furthermore, the distribution of current account balances among the major industrial countries was less troublesome from the standpoint of international adjustment than in the previous sharp swing of the industrial group’s combined current account balance from surplus to deficit in 1974. At mid-1980, accordingly, the recycling of surplus funds from the oil exporting countries to the countries with large current account deficits appeared, by comparison with the earlier experience, to have proceeded with less intensive competition on the part of industrial countries for funds urgently needed by many non-oil developing countries. Also, exchange rate relationships among major currencies presented fewer difficulties in the past year or so than in the period 1974-75, even though changes in exchange rates for a few of the principal currencies were substantial.
Among the features of the world economic scene that have a disturbing character, the first and foremost is the prevailing rate of inflation in the industrial countries (see Chart 1). The general level of prices has been rising much faster in most of those countries since 1970-72 than during the previous decade, despite the recession in 1975 and the moderate character of the economic recovery since then. As measured by GNP deflators, the average annual increases of domestic prices in industrial countries since 1972 have all been in the 7-12 per cent range, compared with an average of only about 4 per cent in the preceding decade. Moreover, there has been a widespread acceleration of inflation among industrial countries during the past year. As already noted (and discussed more fully below), the acceleration was considerably more pronounced in terms of final product prices entering into domestic expenditures than in terms of overall GNP prices, which do not reflect direct effects of price increases for imported goods. Import prices paid by the industrial countries rose faster in 1979 and the first half of 1980, mainly because of the oil price rise, than did domestic prices in those countries.
Chart 1Major industrial countries: consumer prices, 1976-April 1980
Citation: 17, 3; 10.5089/9781616353421.022.A003
1 Three months ending in the months indicated over the preceding three months: seasonally adjusted, annual rates.
2Average for the seven major industrial countries.
3Excluded from the figures plotted is the estimated increase in U.K. consumer prices associated with the increase of approximately 3¾ per cent in value-added tax (VAT) rates in that country effective June 18, 1979.
The prevailing high rate of inflation in the industrial world, as distinguished from the recent acceleration of inflation, is attributable to a variety of factors operative over a period of many years. In retrospect, a principal factor was the application of unduly expansionary fiscal and monetary policies, whose effects were compounded by structural rigidities of an economic and social character, as well as by periodic external shocks, in an economic environment that was a very difficult one for policymakers. The present stress on demand management policies aimed at containment of inflation and inflationary expectations attests to a conviction that reduction of the present high inflation is a precondition for renewal of domestic growth and achievement of international equilibrium.
Even before the onset of the present slowdown, the average rate of expansion of economic activity in the industrial countries since 1976 had remained fairly moderate. After the 1975 recession, it did not exceed 4 per cent in any of the past three years. Indeed, it dropped appreciably below that figure in 1979, reflecting the initial weakening of the U.S., U.K., and Canadian economies (see Chart 2). Given the recent signs of a cyclical downturn of economic activity in the United States, it is now expected that the average increase in output of the industrial countries in 1980 may be only about 1 per cent, encompassing outright declines for the United States and the United Kingdom, along with generally lower rates of expansion in the other industrial countries.
Chart 2Major industrial countries: growth of real GNP/GDP, 1977-first quarter 1980
For 1981 as a whole, a similarly low average rate of expansion would seem to be in prospect. Such factors as the absence of a boom in fixed investment preceding the current slowdown and an apparently satisfactory balance in the inventory positions of business enterprises should limit the degree and duration of the cyclical slowdown now under way, especially if rates of increase in consumer prices taper off as expected during the second half of 1980. However, it is extremely difficult to gauge the balance of expansionary and contractionary forces in the period ahead, and the possibility of international recession cannot be ruled out.
The most obvious aspect of the unbalanced pattern of external balances on current account that has emerged among major groups of countries is the rise in the current account surplus of the oil exporting countries. With the escalation of oil prices during 1979 and the first half of 1980, that surplus has again been building up rapidly, more or less as it did in 1974. As a group, the oil exporting countries are expected to have a current account surplus of some $115 billion in 1980, compared with $68 billion in 1979 and only $5 billion in 1978.
(These and other current account balances in this section are measured in terms of goods, services, and private transfers.)
Meanwhile, the combined current account balance of the industrial countries, having already shifted from a surplus of $33 billion in 1978 to a deficit of $10 billion in 1979, continues to move more deeply into deficit (see Table 1). For 1980, the deficit may well exceed $50 billion. Of the projected negative shift of more than $80 billion from 1978 to 1980, the bulk-more than $60 billion—will probably be concentrated in the accounts of the major industrial countries and, indeed, almost entirely in the three (the Federal Republic of Germany, Italy, and Japan) whose current account positions were strongest in 1978. However, the projected increase of the current account deficit of the smaller industrial countries to more than $20 billion may present more serious problems for some of them than are posed for the major countries by the larger swing in their accounts.
|Industrial countries 3||19.3||−11.6||17.9||−0.5||−4.1||33.4||−9.8||−50|
|Seven larger countries 4||14.1||−3.8||23.0||9.0||9.3||36.1||2.9||−29|
|Oil exporting countries 5||6.6||67.8||35.0||40.0||31.9||5.0||68.4||115|
|Non-oil developing countries 6||−11.5||−36.9||−45.9||−32.9||−28.6||−35.8||−52.9||−70|
|Current account deficit 1||11.5||36.9||45.9||32.9||28.6||35.8||52.9|
|Financing through transactions that do not affect net debt positions||9.8||13.2 2||11.7||12.1||14.4||16.2||19.4|
|Net unrequited transfers received by governments of non-oil developing countries||4.9||6.9 2||7.4||7.6||8.3||8.0||10.7|
|SDR allocations, gold monetization, and valuation adjustments||0.6||0.8||−1.0||−0.2||1.0||2.0||0.8|
|Direct investment flows, net||4.3||5.5||5.3||4.7||5.1||6.2||7.9|
|Net borrowing and use of reserves 3||1.7||23.7 2||34.2||20.8||14.2||19.6||33.5|
|Reduction of reserve assets (accumulation, -)||−9.3||−1.2||2.0||−12.7||−11.9||−18.2||−11.0|
|Net external borrowing 4||11.0||24.9 2||32.2||33.5||26.1||37.8||44.5|
|Long-term from official sources, net 5||5.5||9.6 2||11.4||10.2||12.4||13.3||15.9|
|Other long-term borrowing from nonresidents, net 6||6.6||10.2||14.7||17.6||15.8||25.1||23.4|
|Use of reserve-related credit facilities, net 7||0.3||1.6||2.4||4.3||0.4||0.7||0.2|
|Other short-term borrowing, net||—||5.1||6.5||3.9||−0.8||1.1||5.0|
|Residual errors and omissions 8||−1.4||−1.6||−2.8||−2.5||−1.7||−2.4|
The non-oil developing countries, whose capital-importing economic structure was reflected in a current account deficit of $36 billion in 1978, incurred a $53 billion deficit in 1979 and will probably have one approaching $70 billion in 1980 (see Table 1). Moreover, the deficit of this group will tend to rise considerably higher in 1981.
The ability of the non-oil developing countries to finance such deficits, while following appropriate adjustment policies, is one of the major issues confronting the Fund, as well as the countries themselves. In terms of magnitude, the surplus funds accruing to the oil exporting countries can be said to afford a source of sufficient financing, provided that the “recycling” process can be made to work smoothly enough. To do so, it will have to reconcile wide differences between the distribution of deficits among oil importing countries—especially the non-oil developing countries and the smaller industrial countries—and the distribution of initial placements of surplus funds by the oil exporters, mainly in financial institutions and capital markets of a relatively few industrial countries where such placements are feasible.
The debts and debt service obligations of many non-oil developing countries are already large, and the capacity and willingness of some countries to withstand the costs of still larger debts are widely questioned. At the same time, prudential considerations may inhibit continued expansion of lending to developing countries by some of the private financial institutions that comprise major outlets for funds placed abroad by the oil exporting countries. Such lending appears to be taking on a more selective character, and this tendency may become stronger in 1981. Unless satisfactory movements of loanable funds to the oil importing developing countries take place, curtailment of import growth by such countries is all too likely. Such curtailment would be a depressive influence on world trade, as well as a hindrance to domestic investment and growth in many of the developing countries.
For these reasons, the Fund has been giving active consideration to means that it might use to facilitate the movement of funds to countries that may not have sufficient access to funds from private sources. Many countries may require considerable time to carry out necessary structural adjustments, and may need both financial assistance from the Fund and the Fund’s help in devising realistic programs of structural adjustment. A considerable number of developing countries will also need larger concessional assistance of types provided by international institutions and national governments. Close cooperation among these various agencies is required at the present juncture in order to secure adequate coordination between the specialized assistance of development lending institutions or aid granting agencies and the general macroeconomic approach of the Fund’s operations.
The 1970s witnessed profound changes in commonly accepted views regarding the role that central authorities should play in the economy. Policymakers and economists alike have been obliged to re-examine postulates that they had come to take for granted during the 1950s and 1960s.
One basic postulate concerned the “fine-tuning” view of economic policy, the failure of which became obvious in the course of the 1970s. During the 1950s and 1960s, the relatively stable growth rates prevailing in most of the industrial world-coupled with good price performance—had led to a certain belief that national economies could be managed effectively through short-term adjustments of fiscal and monetary policies; and in many countries this belief, in turn, led to a short-term emphasis on growth and employment objectives.
In retrospect, it seems clear that it was not primarily management of the economy, but the existence of exceptionally favorable conditions for growth, that was responsible for the generally good economic record of the 1950s and 1960s. When these conditions changed during the 1970s, it was not possible to prevent the recurrence of major fluctuations in activity levels. Further, the general approach to national economic policy proved overly ambitious as it often had destabilizing effects because discretionary measures were put into effect too late, the measures were based on faulty economic forecasts, or consumers and enterprises had learned to anticipate policy changes. Recognition of the limits of anticyclical policies had become widespread by the time of initial recovery from the 1974-75 recession, and many national authorities were fully conscious of the need for reorienting economic policies toward the medium term.
Nevertheless, in the new and difficult setting of high inflation and high unemployment, attempts to bring about a gradual reduction in the rates of growth of nominal demand during the next few years were often tempered or reversed by strictly short-term considerations. Most recently, the top priority that has been accorded anti-inflation policy appears to signal a definitive change in this regard; a basic challenge is to sustain it.
The changes in economic conditions that developed during the 1970s, it should be emphasized, were of major significance. For one thing, it became clear that direction of fiscal and monetary policies toward the achievement and maintenance of unduly low unemployment rates can be very costly in terms of inflation. In the late 1960s and particularly during the 1970s, a number of economic, social, and political factors brought about an increase in unemployment and a decrease in productivity growth throughout the industrial world. The change in the real price of energy played a role in those broad developments, but other factors such as changes in the composition of the labor force and governmental regulations intended to achieve qualitative improvements in output or working conditions were probably even more important. In many cases, national authorities sought to offset the impact of these factors on productivity and unemployment by having recourse to expansionary monetary and fiscal measures. At least in part, such efforts reflected a lag in recognition that the slowing of growth in potential output had become a new limiting factor. Since increases in nominal demand could not change the effective labor supply or the rate of technical progress, their effects were ultimately felt on the price level. These repeated experiences were gradually, but firmly, translated into higher inflationary expectations on the part of the public, making the problem of inflation more intractable.
The importance of an efficient system of economic incentives to the process of economic growth was also highlighted by economic developments of the 1970s. Countries with such a system of incentives were able to achieve relatively high growth rates despite a lack of comparative advantage in natural resources, while others better endowed with resources were stagnating, or even regressing, under the weight of price and trade restrictions and of unrealistic exchange rates….
Further, the 1970s showed a continued increase in the degree of interdependence among countries and demonstrated the importance of international cooperation. In the field of exchange rate policies, a clear message from the latter 1960s and early 1970s was that balance of payments disequilibria should not be allowed to persist for too long; once disequilibria are embedded in the economic structure, adjustment becomes a difficult and costly process even with exchange rate flexibility. Developments since 1973, on the other hand, have also shown that an exchange rate that is allowed to be freely determined by market forces can at times become excessively variable or go too far in one direction. These developments have led to renewed attempts by the authorities to exercise some degree of influence over their exchange rates through market intervention or other instruments, notably monetary policy.
In the prevailing mixed system, however, possibilities for inconsistencies or conflicts among nations in the conduct of their economic policies are abundant, and international surveillance over exchange rate policies is of clear-cut importance. A further lesson of the 1970s was that no international monetary system can function well when underlying domestic economic and financial conditions are unstable in a number of the major industrial countries. Surveillance must, therefore, focus to a large extent on the achievement of more stable domestic conditions.
The issue of interdependence involves more than the question of the exchange rate system…. Several examples of policy requirements arising from the interdependence of countries may be cited. First, there is urgent need for a strong flow of grants and concessional loans from the industrial and oil exporting countries to the non-oil developing countries, particularly those in the low-income category. Second, because of their heavy weight in the world economy, the major industrial countries have an international responsibility extending beyond the provision of official development assistance. This includes maintenance of open markets and avoidance of protectionism; it also includes, more broadly, both coordinated efforts in exchange market intervention and appropriate conduct of national economic policies in accordance with the principles of the international adjustment process established in the Fund (as summarized in the 1977 Annual Report, page 12). Adherence to such principles would (1) ensure provision of all feasible support to the general level of economic activity and (2) counter forces making for disequilibrium in the distribution of current account balances—a disequilibrium that, as experience of the past few years has shown, can have very disturbing effects on foreign exchange markets.
Another example of the importance of international cooperation concerns the energy problem. Clearly, there is need for cooperation among energy importing and exporting countries for the purpose of developing a basis for more stable conditions in the world oil market. Such cooperation calls for the group of oil exporting countries—given their importance on the supply side of the world oil market—to pay due regard to international considerations in the pursuit of their oil policies, consistent with their own national interests. Among the other countries, those that produce substantial amounts of oil have an international responsibility similar to that of the oil exporting group. All the oil importing countries, including the ones that also produce oil, have the particular responsibility of strengthening present efforts to use energy more efficiently, to constrain the demand for oil, and to increase the supply of alternative sources of energy in order to contribute to the achievement of orderly oil market conditions. More reliance on the price system and on direct governmental measures to reduce the ratio of energy consumption to GNP and to help in the development of new energy sources is required. Without such efforts, the economic impact of energy problems could intensify during the 1980s, and place a severe constraint on economic growth in both industrial and developing countries.
In sum, the various developments that have been touched on tend to show that—with full awareness of the interdependence of countries and the importance of international cooperation—the proper central focus of national economic policy is the establishment and maintenance of an environment conducive to economic growth with price stability. A basic element of such an environment is a price and incomes system that is not distorted by misguided controls. Another element is a level of public expenditure that does not put undue constraint on the conduct of monetary policy or limit work and investment incentives in the private sector. A third element is the avoidance of frequent discretionary changes in policies that tend to decrease the credibility of the authorities.
Because of inadequate policy management and the external shocks of the 1970s, national authorities are now faced with the major problems of high inflation, low productivity growth, unemployment, rising energy costs, and international payments imbalances inherited from that period. To deal with these problems will require firmness and steadfastness—indeed, courage—on the part of the authorities. Policy prescriptions will of course differ among countries, but they must nevertheless be built on certain general principles.
Reducing inflation has to be the first priority, if only because the achievement of targets concerning growth and employment, as well as viability of the external position, is dependent on it. On the basis of harsh experience, it is now generally agreed that restoration of adequate saving and investment incentives, renewal of satisfactory productivity gains, and efficient allocation of resources require a marked lowering of inflation rates and of inflationary expectations. For that purpose, the central authorities should design their monetary and fiscal policies so as to obtain a gradual decrease in the rate of growth of nominal domestic demand—aiming at a rate consistent with the growth of potential output and a feasible adjustment path for inflation….
While gradualism is the only feasible course from the standpoint of economic, social, and political considerations, adjustment measures should be decisive so as to bring about a reduction of inflationary expectations. Further, such a policy of adjustment should not be interrupted as soon as the level of economic activity tends to weaken. Any attempt to offset that development through fiscal or monetary expansion would only impair the credibility of the anti-inflation policy stance of the authorities and ratchet the economy to an even higher rate of inflation that would ultimately call for a still more costly process of adjustment. While restoration of satisfactory and sustained economic growth is the target, it is a target that in most countries can be reached only through a reduction in inflation brought about by a difficult period of adjustment—with the extent and duration of the difficulty dependent primarily on the speed with which inflationary expectations can be curtailed.
An actively “stimulative” monetary policy should be avoided because, in addition to the impairment of credibility, its practical effect would be to provide liquidity to banks or corporations that are already highly liquid. The record of the 1960s and 1970s seems to show that aggressive monetary expansion during recession periods contributes very little to revival of real demand and output at the time when such revival is most needed, but leaves a legacy of bank liquidity that will tend to frustrate efforts to moderate credit expansion at a later stage.
However, the kind of restraint being suggested does not imply passivity of monetary or credit policy from a countercyclical point of view. With the slackening of demands for credit by business enterprises that is typical of a cyclical easing, interest rates are bound to fall (as has been demonstrated again in the past few months), and the availability of credit to nonbusiness borrowers is bound to rise—in an automatically stabilizing way, even without accelerated provision of reserves to the banking system by the central bank. Likewise with respect to fiscal policy, reliance in countering recessionary tendencies should be placed—with due regard for differences in national fiscal systems—on the well-known stabilizing effects that automatically emerge with the decline in tax revenues and the rise in certain categories of expenditure.
The policy of reducing the rate of growth of nominal domestic demand over the medium term should be accompanied by a policy that aims at achieving a consistent reduction in the growth of nominal incomes…. Measures that would exclude oil prices from the mechanism of wage indexation, and thus serve to limit self-defeating wage-price spirals, are of particular importance in this regard….
The fight against inflation should be accompanied by further measures that aim at establishing an economic environment more conducive to economic growth. A more stable overall price level is a major part of that environment, but only a part. A change in the fiscal system of many countries to remove existing disincentives against saving and investment seems to be called for, and selective tax adjustments could make a positive contribution to the supply side of the economy through the provision of actual incentives for productive investment. A reconsideration of the overall levels of public taxation and expenditure may be needed in a number of cases. More attention should also be given to the mass of controls and restrictions of various kinds that have accumulated over the years in developing as well as industrial countries. While some may be needed on social or other grounds, many are likely to be found detrimental to the interests of the community at large.
One special factor that will have a predominant influence on the environment for economic growth during the 1980s is the supply and cost of energy. The seriousness of the situation in that area is now widely recognized.
A further factor that will condition the growth environment is the external payments constraint faced by many non-oil developing countries. Structural adjustments are needed in these countries, where (as in the industrial countries) policy decisions made under the pressure of harsh developments have often led to harmful restrictions and controls and an excessive level of public expenditure. Correcting this situation and adjusting to higher energy prices are bound to take time, and means will have to be found to finance large payments imbalances during the adjustment period. Failure to do so not only would seriously impair the long-term economic development of non-oil developing countries but also could have a significant impact on growth in the industrial countries.