IS THE GLOBAL RECOVERY FOR REAL? · the numbers. It’s a misunderstanding of what really drives...

CARNEGIE ENDOWMENT FOR INTERNATIONAL PEACE

IS THE GLOBAL RECOVERY FOR REAL?

MODERATOR:

PIETER BOTTELIER, VISITING SCHOLAR, CARNEGIE ENDOWMENT

SPEAKERS:

HANS TIMMER, LEAD ECONOMIST, DEVELOPMENT PROSPECTS,

THE WORLD BANK

JÖRG DECRESSIN, DIVISION CHIEF, EUROPEAN DEPARTMENT,

INTERNATIONAL MONETARY FUND

PHILIP SUTTLE, DIRECTOR, GLOBAL MACROECONOMIC ANALYSIS,

INSTITUTE OF INTERNATIONAL FINANCE

URI DADUSH, DIRECTOR, INTERNATIONAL ECONOMICS PROGRAM,

CARNEGIE ENDOWMENT FOR INTERNATIONAL PEACE

TUESDAY, SEPTEMBER 1, 2009

Transcript by Federal News Service Washington, D.C.

Transcript Not Checked Against Delivery

PIETER BOTTELIER: Good morning, all. I’d like to welcome you to this seminar of the Carnegie Endowment for International Peace on “Is the Global Recovery for Real?” My name is Pieter Bottelier. I am a professor at Johns Hopkins SAIS, and, as of today, a visiting scholar at the Carnegie Endowment. It’s my pleasure to introduce the subject and the speakers. The subject requires very little introduction; all of you have been following this monster recession, as I’m sure a few others in this town.

The four speakers we have on this subject are all very experienced professionals who follow this recession, write about it and make global projections for a living. On my far right we have Hans Timmer, who is responsible for long-term global projections in the World Bank. On my left, Mr. Jörg Decressin is doing something similar for the IMF, and both have extensive support staffs to help them in this enormous task. On my right is Mr. Philip Suttle, who is doing very similar work for the Institute of International Finance here in Washington – also responsible for global economic research at the institute. And on my far left, Uri Dadush, who is the head of the new global economics program that the Carnegie Endowment has started last year.

All four are long-term professionals who have been doing this kind of work for a very long

time. I will not spend a lot of time introducing them individually; you have the descriptions in front of you to save time. I would like to invite the first speaker, Mr. Hans Timmer, to make a presentation. And to emphasize – because of the large number of speakers we have – that the speaking time will be limited to 10 minutes.

HANS TIMMER: Good morning, everybody. Thank you very much for the invitation. It’s

always a pleasure to be able to discuss this subject with old friends. Since I have only 10 minutes, let me immediately start answering the question that is on the table: Is the recovery real? My answer is, that depends on how sustainable the rebound in the emerging countries is. Now, you might think, there we go again; ask an economist a question – any question – and the answer is, “it depends.” (Laughter.) But there might be a little bit more information in this answer than you think on first sight.

First of all, what I’m trying to say here is it doesn’t depend primarily, on my view, on the

rebound and the recovery in the high-income countries. It doesn’t rebound on what is happening in the United States. The world economy does not depend on the spending power of the U.S. consumer. And that might, by itself, be somewhat of a surprise because, of course, the crisis started in the United States; everybody is talking about the stimulus program and what is happening in the United States.

And even now in the popular press – I think recently in Newsweek, Fareed Zakaria had a

whole commentary that the only thing that matters is the U.S. consumer. I think that’s a misread of the numbers. It’s a misunderstanding of what really drives the dynamics of the world economy both in the downturn and in the upturn. So you really have to look at what’s happening in developing countries, in emerging economies, to understand the rebound.

And the second element is that, indeed, it depends. Although we do see now clear signs,

especially in emerging countries, especially in Asia, of a return to positive growth – sometimes surprisingly strong growth – it’s still not clear whether this signals a clear recovery. A lot of what you’re seeing now in the numbers is what you can call a “technical rebound,” as it has really nothing to do with the regaining of strength in the world economy. And also, it is not clear whether the


global financial system is strong enough to support a real, long-lasting recovery. So that is my answer. I will show, now, some graphs to illustrate the storyline behind this answer just until the 10 minutes is over, and then I’ll stop.

First of all, understanding where the dynamics in the downturns and the upturns are coming

from: On the left-hand side, you see what happened with trade in the first five months after the crisis erupted. And we are looking there at cumulative import growth for high-income countries over that five month period, and cumulative export growth. And what you’re seeing is that for the high-income countries, a decline in export was twice as large as a decline in import. And basically, for developing countries, you see the opposite mechanism.

So what happened after the crisis was not a slump in domestic demand in high-income

countries as a result of which the rest of the world was suffering; what really happened was that the decline in domestic demand in the developing countries was much stronger. As a result of that, the high-income countries are suffering with their exports, especially countries like Japan and Germany that were specialized in investment goods. What the crisis did was make the developing countries reconsider investment projects, would make the developing countries draw down on their inventories and stop importing. That is really what made the crisis so deep.

Then, if you look at the last five months, which you can say could be the start of a recovery

– and now we are looking from the perspective of emerging Asia – then you see that in emerging Asia, the picture has turned around – that the growth in imports is exceeding the growth in exports. So while the downturn primarily came from the developing countries, the upturn starts also coming from developing countries.

This is another way of illustrating that same point. We look here at export growth of Japan

– Japan, the country that was probably hit hardest by the crisis of all countries in the world. And we look, then, at contribution to that export growth of developing countries according to the country of destination. And we are looking at the impact of the United States, of Europe, and then, of the whole of Asia, including the emerging Asian economies – but a big part of that is China – and then the rest of the world.

And what you’re seeing is that before the crisis, really, Asia and China were the dominant

factors explaining the growth in export for Japan. But also in the downturn, it was Asia that flipped around much more. So what happened in Asia, again, with their investment process, was much more important than what happened in the United States during the downturn. And actually, the downturn in the United States started much before the financial crisis erupted and became a global financial crisis. The downturn in the United States started already at the end of 2006. In 2007, there was hardly any import growth anymore. The rest of the world was still growing very fast.

Now then, the question is, will there be a rebound in the developing countries, and is that

for real? If you look at a country like China, then really, something is happening over the last couple of months, illustrated here with their import demand. And again, in my view, that is a very important driver of the world economy. It will be a very important factor in the global recovery. This rebound is much stronger than what you’re seeing in the high-income countries. So there is, indeed, a sign that the world economy is turning.


Here, another illustration of the role of developing countries. What we are looking here at is three months over three months industrial production growth for the world as a whole; for the high-income country – Germany – and then for all developing countries, excluding China. We exclude China here because the data is pretty volatile. The interesting point made by this figure is that, if anything, the developing countries were indeed leading – leading in the downturn and also leading in the recovery.

Another illustration that you have to look at is what is happening in the developing world –

how sustainable is it – to understand whether we, indeed, will have a global recovery. Other indications that the situation, indeed, has changed for the better: If you look at the spreads that have skyrocketed in the developing world, the main cause – why the financial crisis was affecting the developing world – those spreads have come down significantly – not yet at the level before the crisis, but we are getting close to it. So an improvement there.

Also, if you look at commodity prices, that is consistent with the picture of the recovery in

the developing world. We are looking here at the oil price in dollar terms, in euros, and in real terms – and the latter that is the red line here is a real measure of what is happening in the commodity markets – a very similar picture, you see, for metal prices and, to some extent, for some of the agricultural prices. And, again, what you’re seeing is that over the last five months, the situation has turned for the better. It’s consistent with the recovery in the world economy.

Some people are even concerned that those prices are rising too fast, and that oil prices are

already at the level that might threaten the recovery. I’m not sure that that is true. Oil prices have been very volatile, but as this graph tries to illustrate, to a large extent, that was actually an exchange-rate story.

To a large extent, that was a story of first the weakening and then the strengthening of the

dollar. If you do it in relative terms or if you do it in a more neutral currency over the last period like the euro, then you see a better picture of what was the real price in the oil market. That real price was very consistent with what you’re seeing in the real economy. What you’re seeing is total production. You saw the increase until just before the crisis, then the sharp fall, and a moderate recovery. I would interpret this as another illustration that there might be a recovery on the way.

But – I have two “buts” to finish this presentation. First of all, when you look at the data

now in the developing world, most of the recovery is still what I could call of a technical nature. What you saw was that there was a sharp decline in investments, and there was an especially sharp decline in inventory build-up. That started in the fourth quarter; it was especially strong in the first quarter; and now in the second quarter, you see many countries returning to positive growth. But to a large extent, that is because investments have stopped falling, and, to a large extent, because the drawdown in inventories is no longer that large.

But inventory levels are still at a very low level; investment levels are still at a very low level;

and the positive growth is because consumption, which continues to grow at a positive rate, is still there. And you see it in a big turnaround. That is not yet a sign that the dynamics in the investment – which were so strong over the last six or 7 years, and one of the main drivers in the world economy – have gone back. It is just that they stopped falling. So in that sense, you can be comforted. There is a big potential for further growth, but whether that will be realized is not clear.


The other one is that the biggest rebound you see is in the countries that had the biggest fall. But in terms of level, also of production, you are still at very depressed levels. Here it is illustrated with industrial productions in Latin American countries. In Latin American countries, what you’re seeing is that a country like Chile had a relatively moderate decline, mainly driven by the decline in commodity prices, but mitigated by very solid policies at home.

Mexico very much depended on import demands of the United States; had a decline, but

relatively moderate in industrial production. The country that was really suddenly hit by the financial crisis was Brazil and, indeed, that is also the country that is rebounding fastest. But again, I would interpret that for the moment as a technical rebound.

The second “but” is that it is not clear that international credit supply will support the much

stronger rebound that is needed in the global economy. I think yesterday, Phil Suttle wrote in his daily observations that many people think that you need, first, a healthy banking sector before you can have a return of growth in the world economy. And he thinks it’s the other way around: Actually, you need a return to growth to make the banking sector healthy.

That might well be true, but I think it’s important to observe that the current rebound that

we’re seeing doesn’t really need an increase in credit supply. Perhaps China is a special case, but in most countries, the rebound that we’re seeing now is not really a rebound in investment; it is not a rebound to growth rates above potential. And only when you have that kind of a rebound, you need a lot of additional credit supply. And that is still a big question mark – whether we will get there.

My two minutes are up now, probably. I want to leave it here. My main message is if you

want to discuss that, let’s focus on what’s happening in the developing world. There are positive signs, but there are a lot of question marks still there. (Applause.)

MR. BOTTELIER: My next speaker is Jörg Decressin. JÖRG DECRESSIN: Good morning, ladies and gentlemen. I too will try to have an

answer of the question right away – and, as usual, with a “but.” We think the recovery is for real, but it is very heavily policy-dependent. Moreover, medium-run growth prospects – this is the second point I want to make in my short speech – are much less bright now than they were before the crisis. And this will interact with the recovery and make this a fairly subdued recovery by past standards.

So let’s go to the recovery. First, what you see here in the chart on the left is an index of

world trade. You can see that it has been covered. It basically makes a similar point that Pieter has made. The PMI index in the middle shows you what happened to manufacturing output in advancing and emerging economies. Emerging economies are in yellow; you see they have rebounded lately. The advanced economies are in red; they have also rebounded.

But note that the advanced economies are still below 50, if you move to the left, and that

suggests that manufacturing activity, at least as of July, was still contracting – but at a much reduced pace – in advanced economies when it was expanding in the emerging economies. And then way to the right, you see something which is very important. It’s consumer confidence in the advanced economies. And that, as you can see, has only recovered very modestly. And why is this important?


It’s important because consumption in advanced economies is a key driver of exports by many emerging economies.

So what has happened? Policies have been extremely forceful in addressing this downturn.

Fiscal policy has been very expansionary in many advanced and in many emerging economies, as well. Monetary policy has cut interest rates in advanced economies to between zero and 1 percent rates that we haven’t seen in a very, very long time, and moreover, has taken unconventional measures.

These actions, together with guarantees for the financial sector, have essentially taken the

fear of a great depression off the table. And this fear of a great depression had really caused a precipitous plunge in activity during the fourth quarter of 2008 and the first quarter of 2009. And what we are now seeing is a rebound from that. The question is, how far will this rebound go?

And this, in our minds, is really a function of several factors. And we’ll call one set of factor

revolving around rebalancing. What needs to happen for this recovery to become self-sustaining is that private demand needs to step in for public demand. Fiscal deficits have been racked up; they will need to be brought down. And therefore, private demand will have to step in for the recovery to become self-sustaining.

Central banks have taken exceptional measures. These will have to be very gradually

unwound as private demand gathers pace. And at the same time, there is, of course, only very limited room left for central banks to support the recovery further with interest rate cuts because most of them are, in advanced economies, between zero and 1 percent. So we need this rebalancing from public to private demand.

We also need the rebalancing at the global level. Many countries that have run current-

account deficits, and done so in the context of asset-price booms that have now burst and are now experiencing major pain in housing markets and also in other markets – these countries will see their domestic demand slowing down appreciatively. And so what has to happen for the global economy to keep growing is that domestic demand in other economies that have been running current-account surpluses needs to accelerate. This is our second facet of the rebalancing that needs to happen. And what I’ll argue is this is a complex – a complex process that will take quite some time. Aside from rebalancing, then, there is the other consideration, which is the banking crisis is typically associated with permanent output losses. And us coming out of this crisis will mean that it’ll take quite some time to rebuild activity and the recovery will definitely be quite sluggish. Let’s go over some of these points now. This here shows you a picture, on the top end, as to what is going to happen to countries that have current-account deficits, right? We have the United States on the left – top left – and other current-account deficit countries on the right. Now, these two groups account for probably the same overall current-account deficit. In these other countries, you find a range of countries from the U.K. to Spain, but then also many emerging economies – Turkey, Slovak Republic, Romania, Poland, Lithuania, Latvia, you mention it, a whole bunch. And their combined current-account deficit is about – is just a little bit smaller than that of the United States.


And what you see in this chart is that both for the United States and for these economies, many of which are in Eastern Europe, the current-account deficits are narrowing already quite a bit and will be narrowing further, right? So less domestic demand from these economies, and how does this happen? Just focus on the two charts below.

You can see the yellow line for the United States. It’s a change in investment and percent of GDP. Now, we know that GDP has been contracted for quite some time. And we know that it will grow very slowly but still, investment is going to be doing even worse. Okay? So that’s what’s going to detract from domestic demand in the U.S. And you have the same with the yellow line for the other current-account deficit economies. Private consumption, also, will be less dynamic over the medium run. It will not only, in the United States, fall as a share – fall in absolute – I mean, slow down appreciably in absolute terms because GDP slows down; it actually slows down more than GDP. So it’s going to be much less domestic demand in the United States and you have the same thing in the other current-account deficit economies, which comprise a few major advanced European countries and many emerging economies in Eastern Europe. So to address this – this rebalancing – what will have to happen is that demand and surplus economies will have to grow more rapidly and these surplus economies are the likes of China, but also Germany, Japan and quite a few others. And this is a complex process and in many cases, you know, people emphasize the role that China needs to play because countries like Germany and Japan have aging populations and therefore there is less dynamics to be expected from these economies.

But China accounts for – the consumption in China is equivalent to about 25 percent of the consumption in the United States and these other current-account deficit countries. So China alone cannot do it. There are Middle Eastern countries that you can put into the mix, but they too face special challenges that mean that this rebalancing will be a drawn-out process and therefore, this recovery will be a sluggish one.

It will also be sluggish because after banking crises, recoveries typically have been sluggish.

What you see on the left here is a result of the study of 88 banking crises that have happened and it plots what happens to output in the first 7 years after the banking crisis. And as you can see, it’s typically around, you know, 10 percent below where it was before. So there’s really appreciable permanent output losses following the banking crisis. And as you see on the right-hand side, these are driven by various factors. I mean first, you have a drop in the employment rate. You see that in yellow. People lose their jobs. It’s usually a pretty severe recession when it’s originating in the financial sector and it takes a long time for them to climb back to the labor market for various reasons. You also see in the green line that the capital labor ration declines and that’s because if you have a financial crisis, investment is hit particularly hard. A lot of capital becomes obsolete because economies need to reconfigure. And that means that you have low output from that account as well. And finally, you also have low output on account of productivity that slumps. So that’s why we, when you look at this picture here, are forecasting a much more subdued picture for the medium run than we have before the crisis. The yellow line shows you the projection for the current account surplus countries before the crisis in April 2007 and you can now see the red


line, which what we are projecting currently. We are roughly losing 10 percent of output as a result of this crisis for the current account surplus economies. For the deficit economies, things will be worse. The losses in output are larger and as you can see, the red line is also sloping less upwards, which suggests that growth rates, for quite some time, will be lower than they were before the crisis. So we are looking at a slow, sluggish recovery. And to put some numbers around this, here are our growth forecasts and our fan chart; you can see this on the right-hand side. For the world economy, after having contracted about 6.5 percent in the first quarter, we now see growth at around 1.5 percent for the second quarter of 2009. And in 2010, the growth rate will average right around – just below 3 percent is what our guess is at the moment, although our forecasts are still being tied down.

Moreover, as you can see by the confidence interval, it’s very wide. So things are still very uncertain and we see most of the risk on the downside. And the main risk I want to emphasize is that people mistake the recovery that we are seeing right now for a self-sustaining recovery and withdraw the policy support prematurely. Thank you very much. (Applause.) MR. BOTTELIER: Next speaker is Philip Suttle. PHILIP SUTTLE: Well, I do not have a slideshow so I’m going to speak from the desk, if that’s okay. And I’m a little embarrassed because, first of all, I don’t have a slideshow and my colleagues from the fund and the Bank do, so that obviously puts the IIF at a clear disadvantage. But also, I only had two points to make and Hans actually made both of them for me. (Laughter.) So – but seriously, I do have a little more than that. But coming third on top of two excellent, detailed – and I think – basically correct presentations, I guess what I’d like to do is just sort of, you know, take those a given, as I say, I agree with most of what was said and try and add some color around the edges where possible. And you know, one of the things I think it’s easy to do with the global economy is to get too grandiose and pretend you can talk all about the next two, three, 4 years with great confidence. I mean, anyone who’s lived through the last 2 years should know that our ability to forecast the next 18 months is not necessarily too good at the moment. None of us, I think it’s fair to say, saw the degree of the decline that we had over the fourth quarter of last year and the first quarter of this year. None of us really saw it coming. So I think it’s very important to track its development. I mean, I think to have any degree of confidence of where things are going, you’ve got to be on top of where we’re headed. And I think it is worth dwelling on where we just came from a little bit. And I think it is important to note that, you know, if you go back, especially to where we were in March, looking ahead to the second quarter, we’ve realistically had an unbelievable set of upside surprises. I mean, most importantly perhaps, in Europe and Japan, and I think it’s fair to say in China and other parts of emerging Asia as well, to a lesser extent, actually interestingly, the U.S. And I think a big part of that were the troubles in the U.S. auto industry, which lingered for longer than most people expected and gave U.S. industrial production much more downside than in most other countries. But I think it’s worth bearing in mind as one looks ahead that we’ve come out of a phase of consistent upside surprise. And I would actually say that that trend in the next six months or so should be, I think, with a reasonably high degree of confidence, should be extrapolated. And I just


want to run through a number of factors that I think are going to be quite important in giving us – what I would characterize – as probably surprising synchronized strength over the next six months or so globally.

And I take a little bit of issue with Han’s point that this is all a technical rebound because I mean, if you’re going to make that point, you probably should then say well, it was a technical recession. And it didn’t feel very technical to me. (Laughter.) It felt quite – it felt quite real. So I think one has to accept this will be a real rebound, you know, and there may be some sort of technical issues behind it, but it is going to be for real. Now, let me just tie that to six points very quickly. Number one is the stock cycle. I think we’ve all – you know, we were all on top of that point but I think it’s worth dwelling on the magnitudes. You know, in the second quarter, in the major economies, inventories were a pretty consistent drag on growth. And that meant that they were even more negative than they were in the first quarter in terms of the absolute change. So if we just go back – I mean, this is Hans’ technical point – if we just go back to zero in inventories, that’s a massive positive contribution to growth that, in my opinion, is likely to come through steadily rather than suddenly in coming quarters. Second point is your global financial conditions. Hans made that point very well. I think, wherever you look, you’ve got easier conditions kicking in. And the way I think about this is it’s really the benefit of easy money that we put in place last year really beginning to filter through. The transmission mechanism of easy money a year ago was not working. Now it is, much more. Third point is I think we’re seeing, credibly, some significant upward revisions to capital spending plans. I mean, again, one of the things that surprised us is that we expected CAPEX to remain low for long – you know, everything else might do a little better but no one was going to invest in this environment; turns out that capital spending has actually come back a lot quicker than we thought. There’s issues of sustainability, which I’ll come to in a moment. Fourth point: Housing collapses appear to be ending, maybe not everywhere, but certainly in the U.K. and the U.S. The worst on residential construction appears to be behind us. Fifth point, the benefits of easier fiscal policy probably are showing through. I mean, we can debate when the maximum thrust from fiscal policy shows up but my suspicion is it’s kind of happening almost as we speak. We certainly know that the U.S. fiscal program really kicks in, in earnest, between the middle of this year and the middle of next year. And then the final point I’d emphasize is I think there’s a very good chance that labor market conditions are going to begin to improve. I mean, one of the reasons we’ve all whipped ourselves up into a real round of negativity here is that we’re convinced that whatever happens, unemployment’s going to 10 percent in the U.S. and going to keep going up everywhere else. Well, actually, it stopped rising in the U.S. Whether it’ll happen or not is another matter – whether it’ll persist or not is another matter. It’s already stopped rising.

Germany, this morning, had its second straight decline in monthly unemployment. Now, you can say some of this is policy stimulus working and it’s therefore a transitory phenomena but I come back to my point that the long run is really a series of short runs that accumulate to provide a better environment. So my main point here is the recovery’s for real. That’s – I’ll give a definitive “yes.” And it certainly has a good six to nine months of legs to it.


I think the key question is we’ve got to ask is, are we going to double dip – or whatever that horrible phrase is? Is this going to be more like 1981 in the United States – those who’ve got long memories – we had a recession in 1980, we recovered in ’81 and by the end of the year, we were back into recession. Are we going to get that sort of scenario? Now, I would say, no, but I’m worried about three things. What could give us that scenario, I think, is a combination of – more likely combination of these three things. First, Hans’ point – the emerging markets don’t deliver. That’s possible, you know; who knows what can happen? But I suspect that’s probably the least likely phenomena. The second concern I would have is we just get another round of global financial turmoil. You know, Lehman Brothers or something comes out of the woodwork and causes real trouble.

There are two good bets to look at here for this – both of which appear to be not necessarily fully anticipated, but well thought about – one of which is collapses in Eastern Europe, especially in the Baltic states. And our friends at the IMF are doing their best to try and make sure that doesn’t happen. But clearly, there are issues of sustainability about some small, emerging economies and we know from sort of domino effects in the past that some small problems can accumulate into big ones.

A second one is the very obvious point about commercial construction and commercial real

estate and the financing side of that and the potential for that, especially in the United States, but I think more generally, to add another down leg to the banking sector’s difficulties. And I think that’s something – I think of that as just a slow train wreck. It’s almost unavoidable. We’re going to get big problems; it’s going to make the banking sector weak for a while. It goes back to Hans’ point about growth helping banks rather than banks helping growth. But commercial construction is something – I think its implications are definitely something to keep one’s mind on. And then the third and possibly the most decisive risk here is the IMF – my gentleman friend from the IMF’s point – policy gets tightened too early; we have premature withdrawal of stimulus, whatever. And I think the idea – the problem I have here is not so much that policymakers are idiots and they’ll do this stupidly. It’s that they may be forced into doing it by a combination of either market developments in the form of interest rates moves, which of course, you could say, well, that’ll be the markets doing it rather than the policymakers. But I think the biggest concern is inflation. We see inflation nowhere on the horizon, but our ability to forecast inflation consistently over the last 10 years has been dreadful. We’ve – our errors have typically been on the high side rather the low side. But I think, in the economics profession, to pretend we understand the inflation process fully, I think is a little naïve. And I think if we were to see an upside to inflation, possibly as the implication of this emerging market strength.

You know, if the emerging markets continue to boom in terms of domestic demand, it may have good surprise inflation implications that then feed through. So that would be my final – my departure point as it were, that on the risk side, my biggest concern to the risk of a double-dip is the risk of inflation. MR. BOTTELIER: Thank you, Philip. (Applause.) Uri Dadush shall be our final speaker. Uri.


URI DADUSH: Thank you very much. Well, fourth after three brilliant presentations; let me see if I can avoid repeating many of the points and add some commentary. The first is yes, we have a recovery. It is a nascent recovery and you see it here in the industrial production index for the world to the end of the second quarter.

I want to make two points about this chart. The first is that the rise that you have seen in recent months – and this is by and large confirmed by the July and August numbers that we have – is actually about as fast, if not faster, than the decline – very sharp decline phase that we saw back nine months ago. The second point to observe – that the recovery is, of course, from very low levels. And this is significant because one point I want to make is that the recovery may be slow as the IMF is predicting, but it cannot be too slow. The reason it cannot be too slow is that with levels of activity so far below previous levels, this is an indicator of huge strains in firms, in households and so on and so forth. So a recovery that is very slow from these low levels is almost bound to be a recovery that falters. And now the greatest reason for optimism that it will not falter, in my view, is the restoration of credit. It is my view that having restored credit and confidence that we’re not going into a great depression, that banks can lend to each other again, et cetera. We are hopefully unlikely to lose that asset. And the fact that credit has been restored means that the natural healing mechanisms and restoration mechanisms of economic actors can be relied upon to take the actions necessary to take us back to something like an even keel. The greatest reason to worry that we are not going to have a recovery we need to sustain recovery is that of course, at some point, these gigantic measures of stimulus are going to have to be withdrawn. Now, hopefully, that is not an issue for now, unless there’s a major policy mistake. This is an issue for six to 12 months from now. But in six to 12 months, very important questions will arise about the ability of the private sector to take over from the public. And therefore, I subscribe to Phil Suttle’s view that in the course of the next three to six months, at least, the recovery should persist. And it may be actually a somewhat faster recovery in the short term, at least and most are anticipating. Second point is that the sun rises in the East. It’s in Asia that the recovery is most evident. The sun is out. According to these numbers, to a large degree, and we are sort of at the dawn in Europe with industrial production and, you know, just beginning to rise. And we have heard this back in the United States. This is actually somewhat the opposite of what we expected.

We expected – well, we certainly expected the United States to be among the first to come out. And the reason it hasn’t is, of course, that the center of the crisis and here, I disagree a little bit from Hans’ description. It clearly is in the United States – this is where the financial collapse happened and this is where the V-shaped recovery will have the toughest time because of the overextended consumers and the problems in the banking sector and of course, other countries in the same situation. U.K. and Ireland are ones that you could point to. A couple of points on this chart: Provided the exports no longer drag on Asia – and they’re not, according to the latest data over the last couple of months or so – then there really is very little


reason to think that Asia cannot continue growing and recovering. Asia did not suffer a banking crisis. They do not have a lot of structural and overextension problems that other regions do not.

But the second point I want to say is that it is also a mirage to think that Asia is going to pull the rest of the world out. And again, I differ somewhat from Hans’ interpretation, although I’m not sure that’s exactly what he said. He’ll have a chance to come back. But Asia is simply not big enough. China is not big enough, et cetera, et cetera. And the best way to think about the shape of the recovery is that the three main regions, Asia, U.S. and Europe each will have to rely on their own restructuring and their own domestic demand. I think the rebalancing issue across regions, et cetera, is an overplayed issue, in part because it is essentially happening; China, et cetera, the parts of the world that can are going faster. Their current-account surpluses are declining sharply. The current-account deficit in the United States is declining sharply.

More importantly, the oil exporters’ surplus is coming down hugely. And this is all assisting this general rebalancing story. Also, remember that rebalancing is not all about adding demand into the world. It is about redistributing demand to the world. So of course it’s worth doing that and there is a policy message that’s worthwhile there. But it isn’t by any stretch of the imagination, I think, a central question in the forecast at the moment. Let me see if I can – okay. Now, I do think that a central question in the forecast is how fast the financially impaired countries, I call them, are going to recover. And first and foremost, the United States has the largest economy. And here, I think that historical comparisons, while useful as reference points – and you know, you learn a lot from the historical analysis that’s been done by the IMF and others in this area – I don’t think they should force or straitjacket our interpretations. And that is because, in fact, situations are incredibly different.

So if I was to look at the United States today and I would say, well, the United States is a country that saw its exchange rate appreciate in the middle of a financial crisis. Capital went into the United States instead of going out. The United States is engaging in virtually unprecedented policy measures to deal with the problems. And, but most important, what I am really impressed by is the reaction of the private sector in the United States, which kind of stands in sharp contrast to what happened in Japan during their banking crisis as one of the reasons that I don’t want to pay too much attention to these historical numbers.

And here, you see one manifestation of how, in fact, industrial production in the United

States was cut back hugely relative to the personal consumption of goods. This is the other side of the big reduction in inventories that happened. It’s one way to illustrate it, but you could also look at the enormous changes in the housing market, the big reductions in housing and the big reductions in housing stock for sale, et cetera. Another chart that is really impressive is these big declines or very rapid declines in investment and inventories. I haven’t shown the big cuts in employment in the U.S. private sector. But then, remarkably, you have an improvement in profits – in corporate profits in the United States in the first and second quarter. Now, of course, this is the other side of picture to the enormous pain that has been caused to the U.S. consumer and the – and the lack of confidence, et cetera that


you’ve seen. But there is a positive side to this picture. And the positive side is that you have a large corporate sector in the United States that is in, actually, pretty good financial shape. And once the demand begins to stabilize, you are likely to get a very rapid response. And most notably – and here, I agree with Phil again – most notably, you will quickly see a rapid response in the employment picture and soon, the U.S. consumer may be looking at a situation where employment is rising again and as the prices are appreciating again. And the U.S. consumer is not shy, as you know, and will equal – also react quickly to this kind of situation. I am – I just want to say one word about policy – my two minutes are almost up, I think. And that is the big question, then, is the withdrawal of stimulus, six to 12 months down the road. If you actually look at the cost of the TARP program and the recovery program, the basic discussion of fiscal stimulus in the United States, it adds up to about something like – somewhere between 5 and 10 percent of GDP.

Of course, this is not actual outlays. Some of it is investment; quite a bit of it is investment. These are cash flow figures. So the numbers, really, are quite a bit smaller than that. Some of that may result in profits, and is, to a degree, for the U.S. government. This is actually a very small part of the story of the accumulation of debt due to the crisis, which is anticipated to be in the 30 percent range, something like that, if the IMF forecast is materialized. It’s a very small part of the story. The big part of the story is the – is the effect of the crisis on revenues and taxes, et cetera, et cetera. This – I’m saying all of this to underscore the point that withdrawing stimulus in these kind of circumstances may actually end up costing more to the U.S. taxpayer than keeping the stimulus, which is a relatively inexpensive part of this crisis going for another few quarters to make sure that we’re out of the woods. Thank you. (Applause.) MR. BOTTELIER: I’d like to thank all four speakers for extremely content-rich presentations and for staying within their time limits. Let me take advantage of the position I have as moderator and kick off the discussion for which we have about one hour with one initial question.

When the crisis began to break in the U.S. in late ’07, 2008, many commentators suggested that the developing world, the emerging markets would not be so much affected by it because there will have been a substantial amount of economic and financial decoupling. Reality turned out to be very different. After the collapse of the Lehman Brothers, I think the entire global financial system got sand in its wheels and triggered a global crisis, not only in the financial sphere but in the real economies just about everywhere. What we are seeing now is that the strongest recovery, as many of you emphasized, appears to be emerging in the developing countries, particularly in Asia. But at the same time, these countries are talking, all, about promoting South-South trade, South-South investment relationships as though they are intent on bringing about some degree of recovery in the next round.

What are your thoughts, if we can go around the table, on the prospect that perhaps in the next round, over the next five or 10 years, we will get a different global economy with a stronger bifurcated economic pattern on the one hand – the South-South emerging markets – on the other


hand, the old, rich industrialized economies in North America, Europe, and Japan? Would anybody care to comment on that? MR. TIMMER: First of all, I think that decoupling is a little bit of an awkward word because it suggests that there are groups of countries that are completely independent, not integrated into the world economy. The opposite is actually true. What has happened over the last 15 years is enormous integration into the global economy. If you look at the cyclical part of production all over the world, it has been more and more synchronized.

At the same time, I do think that trend growths in the developing world has decoupled from trend growths in the high-income countries for some time now, that for strong growth in the developing world, you don’t need strong domestic demand in the high-income countries. In that sense, the developing world is no longer dependent on what is happening with the U.S. consumer, what is happening with domestic demand.

What happened over the last 10 years is that as a result of very strong productivity growth,

which was partly due to an integration into the global economy, partly due to domestic reforms, as a result, a very strong productivity growth and strong growth in the developing world with a lot of investment that became even on the demand side, the driver of global growth. As a result, they could penetrate into the global market and into the markets of the high-income countries. That picture has not changed – not in the crisis, not in the recovery. And that was the background of my presentation, where I focused on a very narrow element. I don’t think that the slowdown in the developing countries was because of a slowdown in domestic demand in the high-income countries. If that were the case, it would have lasted – it would have taken much longer before it became apparent. If that would have been the case, then the slowdown should have reacted already to the slowdown in 2007 in the U.S. economy. That was not happening. What happened in the financial crisis is that the investment process that really supports a very strong growth in the developing world driven by productivity growth was interrupted. And the big question is how long does that interruption take and how strong is that recovery? Now, following up on that, it’s a bit scary that we agree all the time because every time we are surprised, but then in one moment in time, we all agree. (Laughter.) But I do want to say I agree with, strongly, with the point that Uri made that we are coming, now, from a very low level and it is almost inconsistent to talk about a slow recovery because if you have too long a slow recovery, then that recovery will indeed fail and you will have a double-dipping. You do need to return, now, to evolve trend growth to solve the labor market problems that have been created. You do need the private sector to take over. It is not possible for a substantial period of time to come now, with very slow growth. And that means that the element that supported growth before the crisis has to return quickly. And that element is confidence in the private sector. That element is productivity growth. And the policy should not continue to focus on just spending. I don’t think that the main danger is that the stimulus packages are stopped too soon. The main danger is that whatever can be done to further reform economies and to stimulate productivity growth is not being done. I think that was the main mistake during the 1990s in Japan. It was not that the government reacted too slowly. It was not that it didn’t spend enough. But it


didn’t use the opportunity for further productivity, especially in the service and domestic sector to boost growth again. But that is what needs to be done in the developing world and that’s where the big question is. MR. BOTTELIER: Thank you. (Inaudible, off mike) – the decoupling issue in particular, any other comments – (inaudible) – make on the presentations by other speakers? MR. DECRESSIN: Yes, a couple – I mean, three points on – let’s call it a bifurcation. The first is, emerging economies this time around have done better relative to the way they performed during previous financial crises in advanced economies. There is relatively little question in our minds about that.

It’s certainly true for the vast majority of emerging economies – there may be some emerging European – we can talk about that but that’s a separate issue. I’m talking about crises that originate in advanced economies and spill over to emerging economies and this time around, when that happened, they did much better than before. So there’s something like more autonomous forces taking root in these economies. Second point I want to make is still that – that their fate is still inextricably linked with that of advanced economies and vice versa at this stage. It is the fear of a great depression in the United States – in the advanced economies that brought the global economy to its knees in the final quarter of 2008 and first quarter of 2009. So we are all closely related.

The third point I want to make: Over the next eight to 10 years, it’s clear that consumption in all of these emerging economies – most of these emerging economies – is growing much faster than it is in the United States and in other advanced economies. So yes, they would become even more –their growth processes will become even more autonomously rooted than in the past. And so I would agree in that respect with Peter. Thank you. MR. SUTTLE: Just – you know, again, agreeing with most of what was said and just to add around the edges a couple of pieces of color. I mean, first, you know, I think there is a risk when we talk about emerging economies and mature economies and putting them into big lumps together.

You know, I think we are clearly in what I characterize as a world turned upside down where the balance of economic power is shifting from the mature economies to – on average – to the emerging economies led by, you know, what my colleagues at Goldman Sachs famously call the brick economies. And I think you have to credit them for their insight in seeing that it’s those large domestic demand-led economies that are doing well and continue to do well. But I think it’s important to recognize that a key aspect to this crisis , you know, as highlighted in the IMF presentation is the big imbalances that built up, you know, in a number of emerging economies as well as in a number of mature economies and most specifically, in Eastern Europe. And as I mentioned earlier, I think those problems are still ahead of us as much as behind us.

But I think, you know, when we discuss all this, I think it’s just very important not to lose sight of the fact that the reason emerging markets came through this so well is partly because they had their own financial crises so consistently for much of the last 15 years and learn from their


experiences so they position themselves, I think, a lot more diligently going into this downturn than might have been the case in the past. I mean, a good example is the virtuous part of Latin America, you know, Chile, Mexico, Brazil, Colombia – probably missed one or two out there – Peru, for example. I mean, you know, their ability to run autonomous monetary policy and independent monetary policy with a flexible exchange rate has been absolutely stunning in this environment. I mean, Uri mentioned how the dollar had appreciated in the financial crisis. Well, I mean, most of the Latin currencies actually appreciated. The Brazilian real actually appreciated quite – on the trend basis, quite appreciably over the last year or so, even as – as Hans’ picture showed very graphically, the Brazilian real economy was hit very dramatically. It meant that the Brazilian central bank and other central banks in Latin America could cut interest rates and cushion their economic systems. So I think, you know, this emerging market versus mature market relative performance is not – in my opinion – not a mystery, and not something that comes out of the fact they’re low-income guys and they’ve got some catching up to do. It comes out of macroeconomic policy reforms and policy frameworks that have been put in place in recent years and are shown to be very, very durable in the last few quarters. MR. DADUSH: Well, I kind of have to almost – the – I’m kind of with Hans on this. The – we have cyclical coupling in spades between the North and the South. And we have structural decoupling. And the two really are entirely separate phenomena. The structural decoupling is caused by rapid capital accumulation, high rates of investment in the South, rapid technological catch-up and more rapid labor force growth in the South than the North. So the rate of growth in the South is much faster in the long-term sense than in the North. But we have cyclical coupling in spades because these economies are linked through aggregate demand in the short term and, as we have seen dramatically, through international capital markets. And that’s how you reconcile the two phenomena – the implication of this combination of cyclical decoupling and structural coupling. So a structural decoupling and cyclical coupling is that over time, the developing countries are becoming cyclically very important in determining what’s happening in the industrial countries because their weight is increasing. And in the last few days, basically as near as I can tell, stock market behavior has essentially been driven by the big changes in China’s investor sentiment, which, again, is a relatively new phenomenon. By the way, just very quickly, the idea that we have a South-South and North-North world just doesn’t add up. I mean, anybody who has looked at trade flows knows that the big complementarities are generally between North and South for all sorts of reasons, rather than South-South.

And the possible exception to that is Asia, but again, it’s not a real exception; there’s a regional capacity within Asia because of the presence of both high-income countries in Asia and lower-income and middle-income countries in Asia to have more of an integration within Asia. But not in the rest of the developing world. MR. BOTTELIER: Thank you. I’m now opening the floor for debate and questions. The rules are very simple: Raise your hand, wait for the microphone, state your name and affiliation, and try to keep your question very short. Mr. Dahlman?


Q: Thank you. Carl Dahlman, Georgetown University. Well, this is great, and I’m very surprised about how positive all four of you are. One thing that you gave very light treatment to is the whole banking and money supply injections, especially in the U.S. And that has been a very important part of this recovery and stabilization. The real question, then, is how is that going to work out in terms of how the U.S. will be able to finance its very large and growing deficits, taking into account things beyond the crisis in terms of the pension? And, is the world going to be able to finance that, given that they’re losing confidence in the dollar? So that’s one question. The second is with respect to the interest rates. It would seem that we’re coming out of a period where interest rates were very low. And now that we’re going to be pricing risk higher, interest rates will be higher, and that will mean lower investment. And that’s another factor for having lower growth in most of the world, except, perhaps, China, where they have a lot of their own internal financing. So I’m wondering if you could address both those issues. Thank you.

MR. BOTTELIER: Is your question addressed to any of the panelists in particular? Who

would like to – (Off-side conversation.) MR. SUTTLE: Can I – I’ll be very brief on the banking budget deficit side in the U.S. I

mean, I think the so-called exit strategy on the monetary side, I think, has an element of automaticity about it. And then there’s obviously an element of pure policy decision-making. The automaticity part is already in action. You know, for those who follow the Fed’s balance sheet closely, the Fed’s liquidity injections have fallen by something like $800, $900 billion from the peak in the fourth quarter of last year.

What I really mean by that is especially all the international central bank swaps that the Fed

was doing to essentially provide financing to Europe and other parts of the world – most of those have been unwound, as have many of the emergency liquidity facilities. Now, the Fed’s balance sheet overall has remained broadly unchanged in that time. So what the Fed’s been doing is substituting a push of money into the system for, if you like, the drift of money coming back that the private sector is returning. And that really reflects, primarily – in fact, almost exclusively – an effort to get the mortgage market going again.

And I think one of the sad facts of the last year or so, in the last few months, is the U.S.

mortgage market remains very moribund. We’ve got a broken system here, and not much is being done to mend it, with the exception of the Fed really trying hard. My suspicion, however – my strong suspicion – is once the mortgage market does begin to improve – and unfortunately, it looks like it’s going to be last in line rather than first in line – it won’t be too difficult for the Fed to unwind that, as well.

So I don’t wish to sound too Panglossian here and “everything’s going to be fine,” but I

think we’ve got bigger problems that I’m going to leave my colleagues to talk about when it comes to exit strategies in some of the other areas, especially on the fiscal side. But I would say that the monetary exit strategy for the Fed is, I think, easy to see and relatively easy to manage.


MR. DECRESSIN: I’m going to take the question on fiscal deficits and interest rates. I mean, for the moment, you’re not really in an economy where private and public sector are competing very hard for funding. The demand for funding by the private sector has declined immensely because investment plans have been scrapped, and so forth. And basically, the public sector is stepping in to provide demand and is using the funds that are available.

So you don’t have a lot of upward pressure at this stage on interest rates from fiscal deficits.

Clearly, the interest rates would be lower if there hadn’t been any fiscal expansion, but investment would be lower still. The demand effect is much more investment than the industry effect. I think the question becomes quite pertinent when we go forward.

As the top-most demand starts growing, then the private sector will again compete with the

public sector for funds. There will be upward pressure on interest rates. And that’s also the time which fiscal deficits will have to be rolled back. And with the political economy pressures around, I expect that this will happen because the appetite for deficits actually is not big at all.

Q: Judd Harriet (sp), documentary film producer. My question may have been answered by

Philip, but I’d like to ask again: Given the huge increases in the monetary base as a result of Fed balance sheet activity – and again, addressing exit strategy – do all of the members of the panel feel optimistic that the Fed can orderly sop up this liquidity as the economy rebounds to avoid inflation?

MR. DECRESSIN: The answer is, I agree fully with Philip. Yes, I do feel confident that the

Fed can absorb this money. It can introduce, for example, timed-deposit accounts; it can repurchase instruments; it’s already paying interest on deposits. So the technical means to absorb this are effectively there, and so we are not concerned about this triggering inflation in the medium run.

MR. DADUSH: I agree that, technically, all the means exist. After all, technically, the

means existed to triple the balance sheet of the Fed very quickly. The means exist for cutting back the supply of money and the supply of credit relatively rapidly – technically. The problem in my view is not the technical issue. The problem is, number one, the timing question and, number two, the political question.

The timing question, I think, is going to be very, very difficult. For example, right now, little

Israel decided to raise interest rates – the first to raise interest rates. This has made major news, and suddenly people are very concerned. And now we get concerned about Australia raising interest rates. So there’s an issue about when this is done and how it is done in the United States, and whether confidence is sufficiently robust to withstand this major piece of news. So that’s one question.

And the second, which is related, is also the political question. And this is linked, also, to the

size of the budget deficit in the United States. It’s going to be a lot tougher for the Fed in a situation where you have very large budget deficits because, basically, very quickly, there is going to be confronted with either a crowding-out problem – you know, if it raises interest rates, et cetera, as private and public sector clash in the demand for credit – or with expectations about inflation.

So actually, the game that has to be played is not just a game for the Fed, and it’s not only an

international game that has to be played, but it is also the link between fiscal and monetary policy and the withdrawal of stimulus along both lines which is very complicated. And that’s why I didn’t


have time at the end of my presentation, but that’s why I agree with Jean-Claude Trichet, who said, we may be getting better, but it’s going to be a very bumpy road ahead.

MR. TIMMER: It might be my ignorance, and Phil and Jörg might know a lot more about

the Fed balance sheet, but this would be one of my main worries, actually – that we don’t have an orderly exit strategy, and that is especially for the reversal of the quantitative easing. And that’s for two reasons. First of all, we don’t have a lot of experience with that. There are not clear rules on how and when to do that. It was all done in emergency mode. And to reverse that is very different from reversing your standard loosening of monetary policy.

And the second one is the point, I think, that Uri also made – is that what, basically, the Fed

will do if they start selling the government securities and the corporate securities again is immediately interfere in the market. And that is at a time when the financing need of the government and the financing need of corporations is very high.

So I do see a problem there, and for me, the main risk is that for too long, we will have too

loose a monetary policy in the United States. I’m much more worried about that than about the fact that, at some point, the cost of capital will increase because the risk premium will go up – because I would see that much more as a return to normal and something that is needed for a recovery.

MR. SUTTLE: If I may, just to add a point addressing the gentleman’s concerns. I think

there’s a very helpful rule for addressing U.S. monetary policy: the famous Taylor rule. And there are two episodes where, clearly, the Fed, based on that rule, was too slow to raise interest rates, one of which was after the 1993-’94 episode when we had rates at 3 percent. The Fed was too slow. And the other one, most importantly, was in 2002-2003, when the deflation scale was in place. And, you know, I think that reminds us that the Fed has a pretty bad track record. It tends to move, in recent history, too slowly.

Now, based on the Taylor rule of the moment, interest rates, we estimate, should be

something like minus-2, minus-3 percent. They obviously can’t be at that level. So the Fed has to do this quantitative easing. But I think that rule is a very important thing to track. It’s based around inflation performance and the unemployment rate, essentially. As that rule brings rates back to zero or into positive territory, it will be very important to see the Fed responding to that, and not, as Uri would suggest, delaying based on politics and the concerns of market disruption.

The final point I’d throw out here is maybe what we should be most concerned about with

this U.S. monetary policy is not its implications for the U.S. and U.S. inflation, but its implications for possibly creating the next bubble elsewhere. And that’s not just true of the U.S.’s monetary policy; it’s true of Japan; it’s true of the euro area.

One of the things that really worries me at the current time: We’re all espousing this view of

emerging markets being the great new dawn. Well, average interest rates in most emerging market economies are probably 5 or 6 percent. They’re zero in the G-3. With that degree of interest rate differential, there’s tremendous potential for a lot of short-term capital to just consistently flow into emerging economies – much of it untracked by the data – creating the next problem that we have to deal with in five, six, seven, 8 years’ time.


MR. BOTTELIER: The gentleman introduced himself as a filmmaker; if by any chance you’re planning a movie – (laughter) – on monetary policy, and the unwinding of the Fed’s balance sheet, we would love you to show it here. (Laughter.) The next gentleman here in the front?

Q: Dev Kar, former senior economist at the IMF, now lead economist at Global Financial

Integrity. My question to the panel is that, how likely is there of a change in the international monetary system away from the dollar into an international basket of currency like the SDR? There was an article recently in the Washington Post by Professor Joseph Stiglitz, raising this kind of concern. And how likely is that to throw a monkey wrench into all these projections? My own take is that it’s not really likely in the medium term, but I would like to get the reaction of the panel. Thank you.

MR. DECRESSIN: I’m afraid I don’t have very original thoughts on that one. I mean,

reserve composition is something that changes very slowly. But it’s been changing, and, yes, what I would expect to happen over the next decade is that all central banks will increase the share of reserves they hold in emerging market currencies. But this will be a very, very gradual process – very slow process that will almost not be perceptible to the naked eye, just as it’s been over the past decades. So I don’t expect this to throw a monkey into our projections for the next 3 years.

MR. BOTTELIER: Any other views? MR. DADUSH: I’ll just – very quickly because it takes us off the main topic. I agree; I

don’t think it’s a major issue for the projections. The second, I don’t think that there is a valid alternative to the U.S. dollar as a reserve currency in the foreseeable future. And neither the euro nor the yen nor the yuan are likely challengers – the euro, at the margin, has been around – but likely challengers in the next 10 years or so.

And on the SDRs, I don’t know. Does the United States want to give the decision on how

much reserve currency to create to the International Monetary Fund, extraordinarily competent as they are? (Laughter.) And, I’m not sure, do the developing countries want this, or some developing countries? It just looks very far-fetched to me.

MR. TIMMER: Very quickly – I agree that it’s a slow process. It started already before the

crisis; it will take another 10 years. At the same time, I do think that 10 years from now when there is a much more multipolar world, when you have a lot deeper financial market in Asia, a lot more direct intermediation of the savings in Asia to investments in Asia, and the diminished role of the dollar, that people will say that that is one of the permanent impacts of the crisis that we are seeing now.

MR. BOTTELIER: I’m chairman, so I’m not a member of the panel, but on this subject, I

think one perspective is what is likely to happen – and I fully agree with the speakers that major change seems unlikely in the foreseeable future.

But another question is, what are the dynamics that have been put in motion by the opinions

expressed in China, but also in Brazil? In fact, almost all important emerging countries have publicly expressed support for the reform proposals that have emanated through China. I think that’s not to be ignored because these people will do what they can to try and bring about some reform, even though it is unlikely to materialize anytime soon. So next question, the gentleman in the back?


Q: Barry Wood, freelance correspondent. I wonder if the panel could give their views

about U.S. economic growth for 2010 and 2011. And for you, Jörg, I’m intrigued by what you said about current account deficits constraining demand in the United States and Eastern Europe.

I see the logic to that, but I wonder if you could speak further. Does that imply that you’re

thinking there would be a substantial devaluation of the dollar to accommodate a reversal in our current account deficit? Because it seems to me that past experience suggests that we’re really not impacted in our consumer demand by a large current account deficit.

MR. DECRESSIN: On the U.S. forecast for 2010, we will be coming out with new

projections in about a month’s time, and so I can’t give you an exact number now. I would refer you back to the U.S. staff report, which we issued about a month ago to look for numbers there. On the question on the current-account deficits, I mean, it’s clear that what has already happened is that household savings in the U.S. have risen and household savings will also rise in a number of other economies, such as the U.K., Spain, Ireland and many Eastern European economies, whose combined current-account deficit is almost as large as that of the United States.

And the savings are rising because people have lost assets, because people’s expectations

about income growth in the future have been scaled back as a result of this crisis. And that will hold back demand in these economies and that will slow down the global recovery. Inevitably, as you are switching from domestic demand-driven growth to somewhat more externally driven growth, right, this is typically accompanied by a change in the exchange rate in real effective terms. And that’s what we would expect to happen over the medium run.

Now, this can happen in various ways, right? It can happen in normal terms; it can happen

with the normal exchange rate; it can also happen with inflation differentials, right? And all of these will be operating over the next few years. That said, I should say that our assumptions or forecasts typically always – and many others are doing the same thing – assume that the real effective exchange rate stays, actually, unchanged.

Q: Yeah, my name’s Robert Lerman. I’m a professor of economics at American University.

And I find it a little bit strange that the emphasis is almost entirely, with some exceptions, on flows, as opposed to balance sheets, given the fact that the sectoral balance sheets – the corporate sectors, the banking sectors, government sectors – are all intertwined, and this intertwining of these balance sheet shocks played a big role in, quote, “the financial crisis,” and after all, we’ve been all referring to it as a financial crisis.

What do you see in terms of, let’s say, corporate and banking balance sheets, overall, in

terms of both the United States and, let’s say, other developing countries? We’ve already heard that the emerging countries are in better shapes, but maybe you could say something about that as well.

MR. SUTTLE: No, I know nothing about balance sheets. But I mean, the beauty of

balance sheets is, of course, they all balance and they all add up. In fact, there’s a wonderful – I’m sure, you’ve all heard this – but there’s a wonderful quote. I think Jacob Frenkel was using a lot last year when he said, well, you know, the great thing about the international banking system is, on the left hand side, there’s nothing right and on the right-hand side, there’s nothing left. (Laughter.) So we’re all balanced so we’re okay.


Now, that was a good line of the depth of the – oh, the left-hand side is the assets, the right-

hand side is the liabilities, for those who need some help. (Laughter.) You know, I think the danger with dealing with identities is trying to sort of strip out causality effects. And I mean, I think the right way to think about what we call the crisis is that there’s two episodes. I mean, in a sense, it’s the financial counterpart to this decoupling-synchronization story we’ve been talking about.

The first phase was – I guess you’d call it a crisis, but it was really a period of fairly

significant forced balance sheet adjustment on the part of the global banking system, but especially in the United States and Europe. And that began in the middle of ’07. You could say it began a little earlier, but it really kind of became evident in the middle of ’07 and went through to September-August or September ’08, when it stopped being that and it became a panic.

So we had a crisis phase and then – or an accelerated adjustment phase – then we had a

panic. And in that panic phase, not much net change occurred, to be honest, but everything just collapsed. Everyone wanted to go to ground, go to zero. You know, no one wanted exposure to anyone else. And that’s where the central banks became so important because they were the only people that anyone would be willing to take exposure to. So we actually had the bizarre situation that could have gone on for a long time – it didn’t – where the central banks effectively became the intermediaries in the financial system.

Now, that panic phase – my estimation – ended in, probably, January-February, but

certainly, by early March was over. So we had, sort of, about four or five months of genuine, good old-fashioned, 19th-century panic. And now we return to this phase – call it a crisis – but I think it’s best thought of as a phase of steady, accelerated balance sheet adjustments where certain key creditors have got too much exposure to certain sectors and they’re trying to work it down. Others, we would hope, are building up exposures elsewhere and can thus provide compensation in the form of overall global credit growth.

It goes back to Uri’s point that you want to keep overall global credit growth going, but you

want to sort of reallocate it away from the guys who had too much towards sectors – you know, for example, private creditors and private buyers in China who, maybe, wanted to gain more. So that’s, to me, the right way to get one’s mind around what I think you very correctly identified as balance sheet adjustment.

To me, it leaves the important, underlying message here that the worst thing to do would be

to try and push exposures in places where they need working down. In other words, we don’t want the U.S. consumer to take on more debt; we don’t want the U.S. banking system, to be brutally honest, to be adding leverage. We want, actually – you know, I would say a way of measuring success in the next few months is actually for us to be able to sustain growth whilst U.S. banks continue to rein in credit.

It sounds – no one else in the world is saying that; everyone’s saying the opposite. But that’s

the wrong way to think about it, in my opinion. We need to see a successful de-leveraging. The banks need to get smaller; they need to be recapitalized. And the only way to do that – who wants to buy bank equity here today? Who wants to buy a new issue of bank equity? No one. So the only way to recapitalize the banks effectively is for them to earn their way out of this and to de-leverage. And that will be the way we establish more normal medium-term growth conditions.


MR. TIMMER: Let me follow up on this very important description of, we had, already, a

period of adjustment starting at the end of 2006, beginning of 2007, and then suddenly, you had the complete collapse and the panic. Let me link that to the previous question on the current-account deficit and the imbalances. I would not be that confident in how easily we will see a further adjustment of the U.S. current account deficit. And we are in the process of unwinding the global imbalances.

I think in that first period that Phil described, there were actually fundamental forces in play

to unwind the global imbalances by reducing the spending and the credit in the U.S. economy. It didn’t show up immediately, because you have those processes that takes time and, at the same time, you had the dollar rising a lot, as a result of which the current-account deficit was not reduced as much as you would expect.

Now we see some reduction, but I would argue that the fundamental forces are, perhaps, not

that strong. And basically, what we are seeing is a big impact of the fall of the dollar, but at the same time, you don’t have that continuation of the orderly adjustment process that you have before, and you have the U.S. government that is spending a lot. Once you have a global recovery and the oil prices are going up again and you don’t have the access strategy on the fiscal policy, I’m not that sure that we see a quick unwinding of the rebalancing.

Q: Thank you. Xiong Ming (ph) from 21st Century Business Herald, a newspaper in China.

This is a good time to do assessment of the economy, because by later this month, we’re going to have the G-20 summit in Pittsburg. So after the panel’s assessment of the status of our world economy right now, what kind of policy actions should we expect from the G-20 summit?

And then a follow-up question to what Jörg just mentioned about China’s role in leading the

world economy out of this recession, you think China’s role is not – China cannot play a big enough role, and can you explain this to me in figures, why China is not big enough to lead the world out of this recession?

MR. DECRESSIN: First, China is playing a big role in sustaining world demand. They have

expanded the fiscal – I’m sorry, they’ve moved into a large fiscal deficit, they’ve stimulated the economy. And you’ve seen it, actually, in Hans’ figures, that imports in China are rising quite rapidly. So China is doing its part to help pull the world economy out of the recession. Can China do it alone?

No, I think everyone will have to do their part in order to get back to a healthy, sustainable

growth rate. And the figure that I mentioned was that if you take the consumption of China and you compare it to consumption of the U.S. and consumption of all these current-account deficit countries that I mentioned – it’s a long list, starting with the U.K., including Spain, Ireland, and then many emerging European countries – so you take the consumption of all these countries and then you compare China’s consumption with it, then China’s consumption is 25 percent. So China alone cannot do it.

Everyone has to play their part. For the advanced economies, it means more structural

reforms, especially more efforts to repair the banking systems. That’s absolutely critical. And then there are also tasks for the emerging economies, where more needs to be done to reform corporate


governance and also financial sectors to support consumption and improve the allocation of investment so that you can more sustainable growth.

There may also be a case for some emerging economies having to look at whether there are

distortions in place that foster investment in tradables rather than non-tradables. And that’s an issue that also would have to be taken into consideration. But you know, it’s really a broad set of tasks for a broad set of players that is called for.

MR. TIMMER: Just for clarification, to assess the importance of China or any other

country, you don’t look at shares, but you look at their contribution to growth. When you’re 25 percent but you’re growing twice as fast, you are as important as another country that is 50 percent. If you look at contribution to growth during the boom period, then developing countries were way more important than high-income countries.

I tried to argue that, also, in the downturn, the contribution to the downturn from the

developing world was larger than from the high-income countries, and I am convinced that’s true, also, in the recovery.

MR. DADUSH: You asked another part of the question about the G-20 and what they

should be doing. First of all, I think that, basically, the G-20 are, in terms of crisis mitigation policies, doing pretty much what they need to do. And actually, I think history will judge very kindly the crisis-response effort in this direction. And so the main job there is really to take stock and monitor, but also, in my view, to underscore the point which I think every one of us made today, I believe – maybe Phil, not – but the point that –

MR. DECRESSIN: You can’t blame him. (Laughter.) MR. DADUSH: Phil forgot. (Laughter.) But the point that policies have to persist – these

stimulus policies have to persist until we are certain that we are out of the woods. And it’s a lot more expensive to make a mistake withdrawing too early than withdrawing too late, in my view, in the current context – my view.

So I think to underscore that is very important, but second, to also underscore that people

need to have an exit strategy, et cetera, even though the exit strategy is not implemented now – that the articulation of exit strategy and coordination and discussion about the global repercussion of exit strategy be on the table. That’s as far as mitigation goes.

I think where the world is falling very seriously short, now, is on the next crisis, which is to –

how do we prevent the next crisis? And here, I think on the question of financial regulation, you know, I’m not an expert on financial regulation, but my sense is, from talking to people, from reading, et cetera, is that far not enough is happening in that direction. There are very good reasons. It’s complicated. Above all, the political resistances are enormous. These are very powerful players – you know, the players that Phil represents, for example. (Laughter.)

But these are very powerful players. So I don’t think enough is being done in that direction,

and the G-20 may be able – and I know that the Europeans intend to raise it, or some of the Europeans – may be able to do more than has been done. And I think, equally, although this is a subject that the G-20 studiously tend to avoid – I think there needs to be, as there was some


discussion of at the Jackson Hole symposium – discussion about the appropriate role of monetary policy in the stopping bubbles emerging.

I mean, I think the idea that monetary policy just concentrates on controlling inflation,

doesn’t worry about the broader, systemic risk issues, doesn’t worry about financial asset bubbles, doesn’t worry about housing price bubbles – I think that’s sort of completely punctured. That theory is very seriously punctured by the crisis that occurred. So there is a very serious set of issues that needs to be examined in that direction. The G-20 tends to stay away from it because monetary policy, remember, is supposed to be independent in a lot of places.

MR. TIMMER: Sorry to interrupt so often, but one other point on the G-20. The focus of

this G-20 will be on the low-income countries, and that focus is long overdue, because we are not talking about that they are not that important in the global economy, but there is a danger that the long-term impact will be largest for those low-income countries because they are most vulnerable.

They are vulnerable because they don’t have the domestic resources to react to the crisis, but

they are also vulnerable because in many of those countries, especially in Africa, the reforms that have produced an acceleration in growth were very recent, and in many of those countries, there is a backlash now, so they need a lot of support.

MR. BOTTELIER: You have a follow-up question? Can you wait for the mike? Normally,

we don’t allow follow-up questions – (laughter) – but we’ll make an exception. Q: Thank you for making this exception. I just wonder if Jörg from IMF and Philip from

IFS, I guess – IFC – agree with what are the priorities on the G-20, or if you had something else to say?

MR. DECRESSIN: I think Hans has stated what the priorities of this G-20 are. The focus

will be on low-income economies, and I do agree that these economies are facing major challenges and that years of work in terms of poverty reduction are being put in peril by this crisis. And therefore, you know, this focus is appropriate.

MR. BOTTELIER: If I may put in two cents on the China question that you raised, I’ve

been looking at it a bit. It’s my impression that China’s stimulus program, which is largely monetary but also fiscal, is probably the largest and most comprehensive in the world, certainly in relative terms, and also one of the most effective. It kicked in pretty early. China didn’t have an over-leveraging problem, so the banking system was relatively strong. And it is remarkable that most of this emerging market growth that we are talking about is accounted for by China.

China, in fact, accounts for most of global growth in the first half of this year. It’s

extraordinary, the importance. But that doesn’t mean that China is going to remain a principal motor of recovery. Ultimately, the U.S. and the rich countries have to come back, as Uri, I think, stressed. If you look at the composition of China’s growth in the first half of this year, it’s all investment. It’s all government-driven, credit-financed investment.

I mean, the investment rate in China was already high in recent years – over 40 percent. You

know how much it was in the first half of this year? Eighty-seven percent – a totally unsustainable picture, of course. China investment demand – government finance compensated for the drop-off


in external demand, and compensated for more than that. But it is obviously not a growth pattern that can continue for long. Next question? Bert?

Q: Thank you. Bert Keidel – I’m an independent development economist. I used to

manage the East Asia office at the U.S. Treasury Department. There’s a theme underlying a lot of your positions that I would like to ask about and Philip Suttle teed it up when he talked about the de-leveraging process. And I was surprised at Hans Timmer’s statement that the crisis was not only going to be solved by emerging markets, but actually was, in a sense, caused by their early downturn.

And for you, I would ask, didn’t that, if I’m mistaken, your analysis rely on trade flows, when

there are a lot of indirect trade flows that, if you look at Asia – trade dropping – it was in anticipation of U.S. decline or dropping U.S. orders, which were still being filled in China, and then those trade flows kept going to the U.S. But the trade flows to China actually dropped precipitously because of the anticipation that the U.S. demand and European demand were clearly collapsing.

And so there’s the issue of causality here. We’re not talking about balance sheets, but we’re

talking about ex post trade patterns or ex post growth patterns, where the liquidity growth in the United States, due to deregulation, which brings us back to Uri’s point about going forward – that, that liquidity in the U.S. was a major driver of the current-account imbalances and the imbalances globally. And many researchers have pointed that out – that you don’t get the global pattern of surpluses if the imbalances are due to one country or another.

But could you again go over why you think that the emerging markets were so important in

this crisis – in causing it – and also, why, then, they could have the gravitas to pull us out of it? And related to this issue – this demand factor from the United States, that I’m not sure has been played enough, not due to monetary or fiscal policy but due to deregulation and the leveraging that, that caused – is the treatment of productivity growth as if it’s an exogenous – sort of an independent – factor that we can work on, when ex post, a lot of productivity growth is also driven by what had been demand patterns in the world, when you get labor productivity growth and even what looks like TFP growth.

So I’m – I wonder if you all could comment on the role of the U.S. demand from the

liquidity growth, both in consumer and non-consumers, from deregulation, and how that, as a driving, causal force, would look like a lot of the other things that you’re using as causes of the crisis and potential solutions.

MR. TIMMER: There is indeed an issue of causality here. I never meant to say that the

crisis was caused by developing countries. This is clearly as U.S. financial crisis that, through the financial markets, spread to the rest of the world. What I tried to say is that, if you try to understand the patterns of production and trade, then it is good to realize that, everywhere in the world, domestic demand fell, but it fell strongest in the developing world. It especially fell strong in those countries where investments are very important – important because they are a big share of the economy; important because they used to grow fast because of the crisis.

And that is what you saw – that decline in investment in the developing world and the

drawdown on the inventories in the developing world was a major force to understand the slowdown in production and trade, as a result of which import demands fell much more in


developing countries than export demands. As a result of that, it was especially countries like Japan and Germany that took a big hit through their export channel.

Even then, of course, there is the question of causality. Did people in developing countries

stop investing because there was a credit squeeze, because there was suddenly the panic in all financial markets, or did they stop investing because they anticipated a further fall in domestic demand in the U.S. and high-income countries? Irrespective of that answer, I think you can at least conclude that you won’t have a global recovery if not that investment process that had been so important is restored in the developing world.

And what you can also see is that developing countries – and especially Asian economies –

have been able to keep up their growth and to keep up their investment in 2007 and the early part of 2008, when the domestic demand in the United States already sloped sharply and when there was no growth in import demand in the United States. So it is possible to have that process going even without a lot of demand stimulus in the U.S. economy. And that’s, I think, by itself an important observation.

MR. BOTTELIER: (Off mike.) MR. SUTTLE: Can I – I’m not sure it’s answering your question, but it’s a point I’d like to

make, which gets to this whole issue of potential growth and, by implication, there’s a productivity point in there somewhere. I mean, I actually think we’re kind of fools as economists, because we keep going on about this term – potential growth – with a great degree of confidence. We even use it to measure something called the output gap, which we then use to forecast inflation. Given that it’s all completely unobservable, I’m bewildered, at times, at how much reliance we put on it.

But I think one thing we’re often suckered into is a recognition or a belief – essentially,

potential growth is a purely extrapolative phenomenon in my opinion. What growth has been in the last X years tends to be what we think potential is. And when growth gets pumped up by good things, maybe that’s okay, but when it gets pumped up by excessive credit growth, as it was in Japan in the 1980s and as, I believe, it was in the U.S. in the years 2002 through 2007, we tend to assume that, that can be sustained forever. And we’re actually remarkable slow in waking up to the reality that not only has the so-called crisis caused a lowering of potential growth, but in fact, that’s a completely wrong way of reading it.

What actually happened was potential growth was much slower all along than we realized,

and the only way we could keep this growth going at these high rates was by throwing more credit at the problem. And once that credit began to go away, you know, we’re left with a much tougher reality. And that’s just my way of saying that, I think, just as in Japan in the ’90s, we had to get used to a much lower rate of growth on trend basis than anyone conceived of in the early part of that decade – and it actually took a remarkable long amount of time for people to adjust their expectations down. You know, you look at the OECD’s estimates for potential growth for Japan in as late as 1994, ’95, they were still up there at 4 percent, in line with the ’80s experience.

And my strong suspicion is, we’re going to rerun through that in the U.S – that there’s going

to be this expectation that the U.S. can grow at 3, 3.5 percent on a trend basis. And that’s not going to be possible, I don’t think, especially given some of the demographic factors, which are also kicking in, that add to a more legitimate downgrading of potential growth. So I think the whole


linkage between credit and productivity and credit and potential output, I think, it probably one of the least understood but most important things to get one’s mind on.

MR. BOTTELIER: We have room for one, possibly two, questions. This gentleman here. Q: Hi. Thank you. Juan Martinez, economic counselor of the Embassy of Spain. I just

wanted to ask the opinion of the panel on a thing that I think that you didn’t mention – that is, do you think that the development of the Asian financial markets since the 1990s up to now, and/or the exchange rate policy in many of these countries regarding the accumulation of reserves, has something to do with this quicker rebound of the economies, or maybe it’s just a coincidence? Yes, thank you.

MR. SUTTLE: I’ll just make the point I made earlier, which is, the emerging markets in

aggregate, but especially those countries, put themselves in a much more sound financial position – obviously, in the most extreme case, in China and some of the other large, Asian economies – giving themselves a buffer that then boosted their credibility in the financial markets. So I think the point is well taken that the response to the last crisis helped them this time around, and it will be a point taken looking ahead.

You should expect emerging economies to want to build more, not fewer, foreign exchange

reserves. And it almost gets back to the discussion about the international reserve currency issue, because certainly, the demand for international reserves, in whatever currency, is going to go up, not down, in my opinion, over the next five to 7 years.

MR. DECRESSIN: We’ve looked at this issue and tried to distinguish to what extent was it

reserves or stronger fiscal policies and lower inflation and, therefore, more policy room for maneuver that helped these economies to weather this crisis better. As with all economic studies, it comes with large confidence intervals and huge amounts of uncertainty, but we found somewhat stronger evidence for policy room for maneuver having played a bigger role than reserves. And you can see, I mean, there’s a whole range of emerging economies that have come through this crisis better than during earlier crises. And some of them have piled up a huge amount of reserves – others, much less so. But that is not to dismiss the importance of having some reserves.

MR. BOTTELIER: I think we are approaching the end of the session. And I think the

audience would join me in thanking the presenters for what I think is an extremely rich set of issues and commentaries on a subject that is as difficult and as complex as it is important for all of us. So I’d like to ask you to join me in thanking the presenters, and – (inaudible, applause).

(END)

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