Mussa: For the first time in two years, the World Economic Outlook is reporting an upgraded assessment of global economic performance and prospects. We now anticipate that real GDP growth in the world economy this year will be 3 percent—
The U.S. economy, of course, has continued to perform quite strongly, and we anticipate U.S. growth will hold up very well through the end of this year and slow down somewhat next year. One question is how much it will slow down and what may be needed if it does not slow naturally. In Japan, a recovery is now under way, but there are risks that it could be knocked off course if the yen appreciates substantially from recent levels. But the basis for recovery has been set, and the outcome next year could exceed our and others’ forecasts if policy remains appropriately supportive of recovery in the near term. In the euro area, we are seeing increasing signs that growth is beginning to pick up after the slowdown late last year and early this year.
In emerging markets, the Asian crisis economies—with the exception of Indonesia—are giving increased signs of strengthening growth performance, most spectacularly in Korea. Latin America clearly is suffering a difficult year, but we expect a bottoming-out by the end of the year and an upturn in growth next year. Emerging market economies more generally are still under tension from the sharply reduced flow of private capital. This tension, if anything, is picking up in light of Y2K concerns. But we expect these difficulties will be overcome. Larsen: I would like to highlight two issues in the World Economic Outlook: safeguarding macroeconomic stability at low rates of inflation and Y2K issues. The achievement of approximate price stability in much of the world in the 1990s is a major accomplishment. But in quite a few cases, price stability itself has not appeared sufficient to ensure strong, sustained growth. It is still a challenge to avoid macroeconomic and financial instability. The report particularly discusses the policy challenges when prices of currently produced goods and services are stable, but asset prices are rising strongly.
We take the Y2K issues very seriously at the IMF. The IMF has been studying closely the potential consequences for our member countries and for financial markets, and this work is described in an appendix to Chapter I. Even on relatively pessimistic assumptions, the results of our contingency scenarios suggest that the consequences of Y2K problems should be manageable in most cases. We do recognize, however, that there could be some pressures and problems because of the fear of possible problems developing. We have concluded that we need to be prepared to assist our member countries against this contingency (see Press Release No. 99/45, page 335).
Rising yen, falling dollar
Mussa: Normally, the exchange rate for a country like Japan is not a central concern of monetary policy, but when your short-term interest rates are at zero, the price level is stable or even declining, and your currency has already appreciated very substantially and threatens to appreciate more, the central bank needs to pay some explicit attention to the exchange rate. If the rest of the world indicates it wants to hold more Japanese yen, then the central bank can accommodate that demand by creating additional yen—sometimes described as nonsterilized intervention.
On the U.S. side, over the medium term the dollar does need to correct downward against virtually all other currencies to address the U.S. current account deficit. So far this year, the dollar has moved in the opposite direction against the euro; and over the medium term, that movement plausibly needs to be reversed and perhaps a little bit more than that. Since the spring of last year, there has been a very substantial upward correction of the yen. The yen today is about where it should be in terms of its medium-term adjustment path. A further significant appreciation of the yen would represent overshooting and might forestall the much needed recovery in the Japanese economy that is being very strongly supported by fiscal policy action of the Japanese government.
This is a situation in which it makes sense, provided credible means are available, to resist market developments that would undermine the preferred path of economic performance. But if intervention has no backing—or no perceived backing—from monetary policy, markets tend to believe its effect will not be large or enduring. So a key question is whether there is going to be some type of monetary policy backing of exchange market intervention. I would have little doubt that if there was a clear indication that intervention policy was to be backed in a meaningful way by monetary policy, it would be effective and persuasive in the market.
U.S. current account deficit
Mussa: Up to this point, the growth of the U.S. current account deficit has not only been benign, it has been beneficial. Over the past 18 months or so, the U. S. economy has supplied roughly half of the total demand growth in the global economy and somewhat less than that over the past three years. That has been a positive thing for the United States and the rest of the global economy. But it has left the heritage of a large and probably still rising U.S. current account deficit that over the medium term must be reduced.
There is an entirely plausible scenario in which gradually, over the medium term, the U.S. current account deficit can shrink, while the surpluses of Europe and Japan move in the opposite direction, and, with further recovery in Asia and other emerging markets, the large surpluses in the Asian emerging market economies contract somewhat along with their economic recoveries. For this to happen, domestic demand growth in the United States, which has been running a little bit below 5 percent for the past three years, needs to slow significantly—to something in the range of 2.5 percent—so that demand grows a little bit more slowly than output. There are good reasons to believe that because of the increase in nominal interest rates, the reversal of real terms of trade gains, and the end to the boost to consumption from mortgage refinancing, a natural slowing of demand growth can take place in the U.S. economy. The two interest rate increases earlier this year will contribute to that result.
My guess is that interest rates probably will need to become a little bit firmer next year to produce the requisite slowing in demand growth. That would forestall a rise on an enduring basis of inflationary pressures. My personal preference would be to take another step of tightening before year-end and then hold through the Y2K uncertainties and review the situation again in March or May of next year.
Larsen: What we are seeing in Asia is essentially a V-shaped recovery—a very deep, very severe recession, but a rapid rebound, as has of ten been the case in other countries after a financial crisis. In China, there has been concern about the ability to sustain the pace of structural reform when growth slows. In general, we are very encouraged by the continuing commitment of the authorities.
Mussa: In Latin America, we are going to be looking at a much happier ending of this decade than the lost decade of the 1980s. The recession in Brazil has turned out to be significantly less severe than was widely anticipated only a few months ago. And Brazil’s inflation has been much less aggressive than anticipated at the time the exchange rate was floated. But Argentina, Colombia, Venezuela, and Chile are experiencing tough times, and in many cases it is by no means clear that the bottom has yet been hit. However, as Mexico’s and Argentina’s experience after the tequila crisis indicates, once the bottom is hit, the turnaround can be quite rapid.
Mexico has been much better shielded from recent difficulties in emerging markets than have the other principal countries of Latin America. Growth in Mexico this year is around 3 percent, and somewhat better is expected next year. For Argentina, the numbers do not yet indicate a clear bottom to the recession. But we think the recovery will begin early next year, and once it does start, the growth rate of the economy moving forward will be significantly more substantial than is indicated by the year-over-year number.
Larsen:Europe was affected much less than Japan and many emerging markets by the recent turbulence in financial markets and the slowdown in world growth in general in 1998. At the beginning of 1999, growth did slow significantly in a number of cases, and this explains the weaker growth performance in 1999 on average. But there are clearly signs now that Europe has turned the corner, and indicators have been quite encouraging for a number of countries in recent months, suggesting that a pickup is under way and our previous projection is likely to materialize. I would not be surprised, in fact, to see slightly higher growth rates in the second half of 1999 and in 2000 than the ones we are projecting.
Mussa:Russia clearly had a very sharp recession last year, mainly after the devaluation and default, when the bottom fell out of industrial production in Russia. Then, associated with the default, Russia experienced a very sharp decline in the value of the Russian ruble and a large inflation reaction to the depreciation of the ruble. In real terms, the ruble has depreciated enormously, but this has made a lot of domestic-goods producers in Russia more price competitive. Russia’s fiscal policy has improved since last year. Total and cash revenues as shares of GDP are up, and the Russian government is now running a moderate-sized primary surplus, which means it is paying back creditors, not taking on net new credits.