International Monetary Fund. Research Dept.
Published Date:
April 2002
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The following remarks by the Chairman were made at the conclusion of the Executive Board’s discussion of the World Economic Outlook. They were made on March 29, 2002.

Executive Directors noted that, since their discussion of the Interim World Economic Outlook in December, there have been increasing signs that the global slowdown has bottomed out, particularly in the United States and to a lesser extent in Europe, and in some countries in Asia. Financial markets have bounced back strongly since the September 11 shock; commodity prices have begun to pick up; and—with contagion effects from Argentina having so far been limited—emerging market financing conditions have also strengthened markedly. While different but serious concerns remain in a number of countries, notably Japan and Argentina, Directors believed that a global recovery is now under way.

Directors observed that the recovery is being underpinned by several factors, most importantly, the substantial easing of macroeconomic policies in advanced economies—particularly the United States—and also in a number of emerging economies, especially in Asia. They considered that the scope for such policy support owes much to earlier progress in lowering inflation, strengthening fiscal positions, and reducing other sources of vulnerability, which enabled countries across the membership to respond promptly and effectively to the difficult situation facing the world economy last year. Several Directors also noted that the adjustment in inventories appears to be well along in the United States and some other advanced economies, and that this will also help boost production in the period ahead. The recovery has also been supported by lower oil prices, although this is somewhat less of a factor following the strong pickup in prices since late February. Directors agreed that the impact of higher oil prices on the outlook will need to remain under careful assessment.

Overall, Directors agreed that the risks to the outlook have become more evenly balanced since the December 2001 Interim World Economic Outlook. Indeed, recent indicators of confidence, employment, and activity in the United States have been surprisingly positive, suggesting that the recovery may prove to be stronger than presently projected.

At the same time, Directors noted that a number of potential downside risks in the outlook require continued policy attention. First, in part because of the synchronous slowdown, relatively little progress has been made in reducing the persistent imbalances in the global economy—notably, the high U.S. current account deficit and surpluses elsewhere, the low U.S. personal saving rate, the apparent overvaluation of the dollar and undervaluation of the euro, and the relatively high household and corporate debts in a number of countries. With the United States leading the recovery, Directors considered that these imbalances could, at least in the short term, widen further.

In discussing the implications of this prospect for the global outlook, Directors observed that the risk of a disorderly unwinding of the current account imbalances might be reduced by the continued favorable outlook for U.S. productivity growth and capital inflows. Most Directors nevertheless agreed that policies, especially structural policies, should be formulated with a view to ensuring that the orderly reduction of the current imbalances enhances the sustainability of the global recovery.

As a second source of risk to the outlook, Directors noted that, following the strong rebound over recent months, global equity prices again appear richly valued and may be pricing in an excessively optimistic outlook for corporate earnings. Should earnings growth disappoint, there would be a risk of financial markets, confidence, and activity again weakening. In this context, Directors found revealing the analysis in Chapter II of the World Economic Outlook of the impact of asset prices on consumption, which indicates that asset prices, in particular equity prices, have become more important over time as a determinant of consumer spending. Given the aging of populations across the industrialized world, as well as continued financial market development, this trend is likely to continue, suggesting that developments in asset prices may become increasingly important in the formulation of macroeconomic policies.

Finally, Directors highlighted a number of specific risks, including the adverse effects that the continuing economic difficulties in Japan and Argentina—although of a different nature—could have on other countries in their respective regions. Regretting the recent decision by the U.S. authorities to raise tariffs on steel imports and the prospect of retaliation by other countries, Directors reiterated the critical importance for all countries to resist protectionist pressures and to ensure that substantive progress is made with multilateral trade negotiations under the Doha round.

Directors concurred that macroeconomic policies in most industrial countries should remain generally supportive of the emerging recovery. However, they noted that, with the exception of Japan, there appears little need at present for additional policy easing, and that in countries where the recovery is more advanced, attention should turn in due time toward reversing earlier monetary policy easing. Over the medium term, policy frameworks should be geared toward supporting sustainable growth, while aiming for an orderly reduction in global imbalances. This would require, in the euro area and in some Asian emerging markets, continued structural reforms to encourage growth; in Japan, decisive action to reinvigorate the economy; and in the United States, ensuring that medium-term fiscal targets are met. Directors also underscored the importance of using the recovery to make further progress in reducing vulnerabilities, including through accelerated efforts to address looming problems from aging populations in industrial countries; a sustained effort to achieve balanced budgets in the euro area; development of a medium-term fiscal consolidation plan in Japan; reform of the corporate and financial sectors in Asia; and medium-term efforts to strengthen fiscal positions in India, China, and many Latin American countries.

Progress toward an enduring reduction in poverty in the developing countries will require sustained broad-based growth, and, in this context, Directors noted that, despite encouraging progress in a number of countries, GDP growth in sub-Saharan Africa remains well below what would be needed to reduce poverty significantly. They agreed that national policies will need to play the lead role in improving economic performance, especially policies focused on improving the conditions for savings, investment, and private sector activity. Stronger international support of sound policies will also be essential. In this connection, Directors welcomed the progress made at the Monterrey Conference on Financing for Development, including the announcement of increased aid targets by European countries and the United States. They stressed, in particular, the vital importance of phasing out trade-distorting subsidies and giving greater access to exports from developing countries in world markets.

Major Currency Areas

Turning to the prospects for the major currency areas, Directors agreed that recent indicators increasingly point to recovery in the United States, with confidence and equity markets picking up, household spending remaining strong, and manufacturing output stabilizing. Some Directors considered that activity could pick up even more rapidly than currently projected, especially given the size of the policy stimulus in the pipeline and the continued resilience of productivity growth. Some other Directors, however, pointed to the possibility of a less sustained or less resilient upturn—for example, if low corporate profitability or excess capacity constrain investment growth, equity prices fail to sustain recent gains, or households rebuild savings. Given the balance of risks, Directors supported the Federal Reserve’s recent decision to keep interest rates on hold for the time being; while monetary policy should not be tightened prematurely, some tightening will be required in the coming months if economic activity continues to strengthen. Directors agreed that no further fiscal stimulus is warranted at this stage. While recognizing that the deterioration in the fiscal position over the past year is the result of a combination of factors, including tax cuts, the recent stimulus package, and the emergency and security spending measures taken in the aftermath of the September 11 events, Directors considered that the time has now come to turn attention to the efforts needed over the medium term to restore fiscal balance and address pressures stemming from the social security system.

Directors expressed serious concern about economic conditions and prospects in Japan, with the economy being in its third recession of the past decade, confidence and activity remaining very weak, and the banking sector experiencing severe strains. While welcoming recent initiatives and noting some signs of a possible bottoming out in the fall of activity, Directors urged the authorities to push ahead vigorously with measures directed at bank and corporate sector restructuring, which will remain the key to restoring confidence and prospects for solid growth. Although little scope remains for further macroeconomic stimulus, they also agreed that monetary policy needs to remain focused on ending deflation. Given the high public debt and rising long-term interest rates, Directors stressed the need for a clear and credible commitment to medium-term fiscal consolidation, backed up by reforms to the tax system, public enterprises, and the health sector. A few Directors considered that, within the context of such a medium-term commitment, a supplementary budget to mitigate the projected withdrawal of fiscal stimulus late in 2002 should not be ruled out.

Directors were encouraged that recent business confidence surveys and a pickup in industrial production point to an emerging recovery in the euro area. While the recovery is likely to be somewhat slower and come later than in the United States, a number of Directors pointed to the contribution that Europe’s strong fundamentals have made to global stability. Building on recent progress, further policy reforms to support a strong and sustained recovery should nevertheless continue to receive the highest priority. Directors emphasized the need for euro area economies to move ahead with structural reforms, in particular in the financial sector, labor markets, and pension systems, noting that the introduction of euro notes and coins in January has made such structural reforms all the more potentially beneficial. Directors supported the ECB’s current monetary policy stance, which is to keep interest rates on hold while being ready to move in either direction as macroeconomic developments unfold, with some Directors pointing to the scope that is available for further reducing interest rates in the event of continued weakness in demand. On the fiscal side, countries with sizable structural deficits will need to strengthen their fiscal position as growth picks up, both to provide scope for the automatic stabilizers to function during subsequent slowdowns, and to help tackle rising fiscal pressures from aging populations.

Emerging Markets

Directors noted that the prospective recovery in industrial countries should play a central role in supporting activity in emerging markets, along with continued efforts aimed at strengthening economic fundamentals to reduce vulnerability and enhance productivity growth. In Asia, which—with the exception of China and India—was particularly hard hit by the global slowdown, clear signs of a pickup in activity have begun to emerge, aided by a nascent strengthening in the electronics sector and easier macroeconomic policies in a number of countries. Directors underscored that the emerging recovery will need to be supported by ongoing reforms across the region, especially in financial and corporate sectors. In India, structural fiscal reforms need to back the substantial consolidation that is required; and China should move ahead with reforms to address the competitive challenges arising from WTO membership and, in particular, tackle difficulties in the state-owned enterprises, the banking sector, and the pension system.

Directors considered the diverse prospects facing Latin America. They noted with concern that the situation in Argentina remains very difficult, with a significant contraction in output and acceleration of inflation in 2002 appearing unavoidable. They urged the authorities to move quickly to put a sustainable economic plan in place, including measures to rein in the fiscal deficit and strengthen the banking system. To date, spillovers from Argentina on other regional economies appear to have been generally limited (with the possible exception of Uruguay), although they remain a source of potential risk. Directors noted that the recovery is likely to be strongest in Mexico and Central America, which are closely linked to the United States, as well as some Andean countries, while in other countries the pace of recovery is likely to be more subdued. Directors welcomed the analysis in the World Economic Outlook of debt crises in Latin America and the extent to which the region’s relative closure to external trade, higher macroeconomic volatility, relatively underdeveloped domestic financial markets, and low saving rates may help to explain their relatively high incidence in this region. While cautioning against generalizations across countries and across different stages of their reform processes, and noting the important progress that many have made in recent years in reducing vulnerability, including by adopting more flexible exchange rate regimes, Directors considered that this analysis nevertheless contains useful guidance for future policies. They underscored the benefits that countries in the region would reap from further progress in strengthening fiscal positions to avoid the need for a procyclical response to shocks, as well as from continuing reforms of their trade and financial systems.

Directors noted that growth among most of the European Union candidates in central and eastern Europe has been generally well sustained during the global slowdown, with robust domestic demand offsetting weaker export performance, and is expected to pick up further as the global recovery takes hold. While the high current account deficits in many of these countries have so far been readily financed by direct investment and other capital inflows, they nevertheless represent a source of vulnerability that, Directors agreed, underscores the importance of ongoing fiscal discipline and structural reforms to help ensure that the climate for investment and growth remains positive. Directors welcomed the recent improvements in economic indicators in Turkey, and expected that strengthening confidence and exports should underpin a sustained recovery in 2002, provided the strong implementation of sound macroeconomic and structural policies continue.

Growth in the CIS countries has also remained remarkably resilient to the global slowdown, although the pace of activity in 2002 may weaken somewhat—mainly as a result of slowing demand in the region’s oil exporting countries. Directors welcomed the acceleration of structural reforms in Russia, while noting that efforts to improve the investment climate remain a key priority. For the region as a whole, the central challenge continues to be to accelerate progress in structural reforms, notably institutional building and governance, enterprise and financial sector restructuring, and transforming the role of the state. Directors also stressed that the high level of external debt in a number of the poorest CIS countries continues to be a serious concern, requiring ongoing close monitoring.

Directors were encouraged that growth in Africa has also held up relatively well in 2001 and is expected to remain quite robust in 2002. The outlook for much of the region continues to depend heavily on commodity market developments, and on further progress in eradicating armed conflict and other sources of civil tension. Directors highlighted the central role that sound economic policies have played in raising significantly per capita income growth in strongly performing countries in recent years. They stressed that sustained economic growth and diversification will require faster structural reforms, in particular in the area of governance, including strengthened regulatory institutions, and more insecure and stable property rights. Directors welcomed the New Partnership for African Development, which emphasizes African ownership, leadership, and accountability in improving the foundations for growth and eradicating poverty. They stressed that these efforts will need to be supported by appropriate external assistance, including the further reduction of trade barriers, increased development aid, especially for HIV/AIDS, and support to capacity-building efforts.

Directors observed that growth in the Middle East is projected to weaken in 2002, although much will depend on oil market developments and the impact on activity of the regional security situation. They noted that the adverse impact of lower oil prices in 2001 on oil exporting countries has been limited by the prudent macroeconomic policies of recent years. Over the medium term, a key policy priority in many countries is to continue efforts to diversify production into nonenergy sectors and hence to reduce dependence on oil revenues.

Recessions and Recoveries

Directors welcomed the analysis of previous recessions and recoveries in industrial countries in Chapter III of the World Economic Outlook. They noted that the synchronicity of the recent global slowdown had much in common with past downturns and was indeed in line with the historical norm, whereas the relatively unsynchronized recessions of the early 1990s were an exception reflecting different shocks in different countries. In the recent downturn, the collapse in investment spending associated with the bursting of the tech bubble was also consistent with the regularity of the sharp drops in business fixed investment that occurred typically in the lead-up to recessions in recent decades.

Directors also observed that the mildness of the recent global slowdown was in line with the historical trend toward shallower recessions. However, the short duration and mildness of the recent downturn does not imply that the recovery will be slow or weak. Directors observed that the increases in interest rates prior to the recent downturns were smaller than before, reflecting relatively low inflation during the previous expansion. This helps explain why the subsequent downturns have been relatively mild.

Monetary Policy in a Low Inflation Era

Turning to the essay on monetary policies in a low inflation environment, Directors agreed that a major reason for the remarkable decline in inflation among industrial countries over recent decades has been the widespread change in emphasis of central banks toward price stability and associated beneficial changes in private sector behavior. In discussing some of the policy challenges for central banks in this new environment, some Directors considered that, given the existence of the zero nominal interest rate bound, monetary policy may need to respond relatively rapidly to significant downward shocks to activity in order to minimize the possibility of a deflationary spiral. Many Directors, however, cautioned against premature policy conclusions, noting that in several countries the low inflation environment has not significantly hampered the effectiveness of monetary policy. More generally, the credibility of anti-inflationary monetary policy is an important asset that should be preserved.

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