Annex: Summing Up by the Chair

International Monetary Fund. Monetary and Capital Markets Department
Published Date:
April 2012
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The following remarks were made by the Chair at the conclusion of the Executive Board’s joint discussion of the Fiscal Monitor, Global Financial Stability Report, and World Economic Outlook on March 30, 2012

Executive Directors welcomed the gradual strengthening of global prospects after a major setback in 2011, noting that improved activity in the United States and policies in the euro area have reduced the threat of a sharp global slowdown. They underscored, however, that the recent improvements are very fragile, with risks firmly to the downside. Directors concurred that the present calm offers an opportunity for policymakers to finally get ahead of the crisis and to continue implementing the fundamental changes required to restore confidence, reduce debt, and achieve lasting stability, thereby facilitating healthy and sustained growth.

Directors considered that a weak recovery will likely continue in the major advanced economies, although job creation is expected to remain sluggish and the euro area is still projected to experience a mild recession in 2012. Nevertheless, growth prospects remain relatively solid in most emerging and developing economies in both 2012 and 2013.

Directors noted that recent policy steps, particularly the long-term refinancing operations by the European Central Bank, have been crucial in stabilizing euro area financial markets and easing the sovereign debt crisis. They stressed that sovereign risks are still elevated, and that pressures on European banks remain, including from sovereign risk, weak euro area growth, high rollover requirements, and the need to strengthen capital cushions. Together, these pressures have induced a broader drive to reduce balance sheet size. Directors considered that, while shrinkage of European banks’ balance sheets is needed, the potentially negative consequences of a synchronized large-scale deleveraging remain a concern if this were to lead to a reduced supply of credit to the real economy. In this context, they stressed the risk of adverse spillovers beyond the euro area, particularly to countries in emerging Europe, and noted that rapid shedding of bank assets could put pressure on global asset prices and transmit stresses to the U.S. financial system, notably through derivatives markets. Certain specialized lending segments in which European banks had traditionally played important roles, such as project finance, could be affected disproportionately.

Directors stressed that other downside risks continue to loom large. Heightened geopolitical tensions could trigger a sharp increase in oil prices, with detrimental effects on growth. Excessively tight macroeconomic policies could also push some major economies into a prolonged period of very low activity. Global bond and currency markets could be disrupted, with sudden increases in interest rates as a result of a lack of concrete actions and plans to put budget deficits and debt on a sustainable medium-term path in Japan, the United States, and other major advanced economies. Growth could also slow rapidly in some emerging economies. On the other hand, growth could be better than projected if policies improve further, financial conditions continue to ease, and geopolitical tensions recede.

Directors concurred that policymakers in Europe should build on recent progress and market improvements to push ahead with the agreed reforms and complete the policy agenda. They underscored that a robust firewall in Europe is instrumental to deterring contagion. Further progress on bank restructuring and resolution should complement the increases in bank capital and provisioning already underway. Just as important would be to continue the far-reaching institutional reforms that remedy design weaknesses in the economic and monetary union that contributed to the crisis, including policies for further integration that reinforce financial stability.

Regarding macroeconomic policies, most Directors agreed that the pace of near-term fiscal adjustment should be calibrated to avoid undue curtailment of demand, without undermining fiscal sustainability. With fiscal multipliers likely on the high side in the weak current environment, a gradual but steady pace of adjustment is preferable to heavy front-loading, and automatic stabilizers should operate freely if financing allows and where fiscal accounts are sufficiently robust. Given prospects for very low domestic inflation, most Directors agreed that policy rates should be cut where feasible as economic conditions require, and that unconventional support should be maintained or expanded further when some markets are impaired. A number of Directors were unconvinced about a slackening of the pace of fiscal consolidation to support short-run growth, emphasizing the need to reinforce policy credibility and honor policy commitments. A number of Directors also cautioned about the risks and spillover effects of prolonged monetary easing in advanced economies, including the impact on capital flows to emerging economies.

Directors stressed that putting public finances on a sounder footing over the medium term remains a key requirement for sustainable growth and debt reduction. Progress in the design and implementation of credible medium-term adjustment plans is taking place, but more efforts are needed, especially in the United States and Japan. The reform of entitlement programs and renewed efforts to strengthen fiscal frameworks are crucial, as they can greatly reduce future spending without significantly curtailing demand today, and help rebuild market confidence in the sustainability of public finances.

Directors underscored that growth-enhancing and financial stability-oriented structural reforms are needed to help tackle the challenges in advanced economies. In particular, financial sector reform must address the many weaknesses brought to light by the financial crisis, including household balance sheet repair where needed, problems related to institutions considered too big or too complex to fail, the shadow banking system, and cross-border collaboration between bank supervisors. Structural reforms to boost potential output, including in the product and labor markets, are also crucial. Furthermore, Directors observed that the environment of high uncertainty also puts a premium on broad and proactive communication strategies to bolster public confidence and credibility.

Directors considered that the key near-term challenge for emerging and developing economies is to appropriately calibrate macroeconomic policies to address the significant downside spillover risks from advanced economies, while containing overheating pressures and risks from elevated credit growth and higher energy prices. For economies that have largely normalized macroeconomic policies, the near-term focus should be on responding to adverse spillovers and lower external demand from advanced economies, and dealing with volatile capital flows. Other economies should continue to rebuild macroeconomic policy room and strengthen prudential policies and frameworks. The slower pace of fiscal adjustment envisaged in 2012 in emerging economies is generally appropriate in the context of weaker growth and relatively strong fiscal positions. Monetary authorities need to be vigilant that oil price hikes do not translate into broader inflation pressures, and fiscal policy must contain damage to public sector balance sheets by targeting subsidies only to the most vulnerable households. Directors welcomed the generally resilient growth performance of low-income economies and underscored that rebuilding policy buffers, particularly in the fiscal area, remains a priority in these economies.

Most Directors agreed that the latest developments suggest that global current account imbalances are no longer expected to widen, following their sharp reduction during the Great Recession. This is mainly because a slowdown of consumption growth in economies that ran large external deficits before the crisis has not been fully offset by higher consumption growth in surplus economies, leading to a decline in global demand. Nevertheless, some Directors underscored that global imbalances remain an issue that needs to be addressed through coordinated multilateral action. They noted that rebalancing activity in key surplus economies toward higher consumption, supported by more market-determined exchange rates, would help strengthen their prospects as well as those of the rest of the world. This would need to be matched by appropriate fiscal adjustment and structural reforms to increase competitiveness in deficit countries.

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