Laurence Meyer April 14,2004

Meyer’s

The Global Outlook & Challenges for Monetary Policy

Global Issues and the U.S. OutlookGlobal Interdependence Center

April 14, 2004

Laurence H. MeyerSenior Adviser, Macroeconomic Advisers

m Macroeconomic Advisers, LLC www.meyersmpi.com 2

Meyer’s

Outline

• New and Old Challenges for Monetary Policy

• Global Outlook Themes

• Global Influences on the U.S. Outlook

• Country/Regional Developments

• Challenges to Monetary Policy


Meyer’s

0

2

4

6

8

10

12

14

16

84 86 88 90 92 94 96 98 00 02 04

H FPercent

Foreign

US

US Consumer Price Index andTrade-Weighted Foreign Consumer Price Index

Global Disinflation & the Great Moderation


Meyer’s

2

4

6

8

10

12

14

84 86 88 90 92 94 96 98 00 02 04

Percent

10-year

Foreign

US 10-year Treasury YieldTrade-Weighted Foreign Government Bond Yield

H F

Global trend to Higher Interest Rates


Meyer’s

U.S. and Foreign Real GDP Growth

-1

0

1

2

3

4

5

6

1999 2000 2001 2002 2003 2004 2005

United StatesWorld

4-quarter growth, percent

US GDP Growth and Trade-weighted Foreign GDP Growth

Foreign

H F


Meyer’s

Global Issues

• Synchronous global recovery• Initial conditions: low nominal, real rates and inflation• Little scope for monetary/fiscal stimulus• Diversity in challenges facing central banks• Adjustment of global imbalances/an asymmetry• Cyclical rebounds vs structural considerations• Common transitions: fiscal consolidation/global aging• China & India: threat or opportunity/managing success• Geopolitical uncertainty and terrorism


Meyer’s

The U.S. Current Account Deficit

90

95

100

105

110

115

120

-560

-520

-480

-440

-400

-360

-320

2000 2001 2002 2003 2004 2005

Billions of US $1997=100

Net Exports and Real Trade-Weighted Foreign Exchange Rate

Real Trade-Weighted35-Country

Foreign Exchange Rate

Net ExportsH F


Meyer’s

Adjustment of Global Imbalances

• U.S. current account deficit part of the global imbalance– More difficult for us or our counterparties?– Gradual or chaotic?– Sooner or later?– Narrowly or more broadly based?

• Implications of Asian accumulation of $s– Transition from private demand to official accumulation– Reduces breadth and overall amount of adjustment– Reduces immediate need for adjustment– Course of adjustment now depends on policy considerations

• Challenges– High U.S. import elasticity and initial conditions– Difficult to make adjustment unless ROW grows faster than U.S.– Japan, Euro area addicted to external demand– Difficult to be successful unless U.S. raises national saving


Meyer’s

105

110

115

120

125

130

135

-560

-520

-480

-440

-400

-360

-320

2000 2001 2002 2003 2004 2005

net exports

Trade-Weighted35-Country

Foreign Exchange Rate

Net Exports and Trade-Weighted Foreign Exchange RateBillions of US dollars1997=100

H F

Depreciation and U.S. Net Exports


Meyer’s

-20

-10

0

10

20

30

1990 1992 1994 1996 1998 2000 2002

12-month percent change

Crude Core PPI

The Global Rebound and Commodity Prices


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16

20

24

28

32

36

40

2000 2001 2002 2003

West Texas IntermediateUS Dollars

Higher Oil Prices


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-12

-8

-4

0

4

8

2000 2001 2002 2003

Nonpetroleum Import Prices3-month percentage change, annualized

How Much Pass-Through to Import Prices?


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Country/regional Issues

• U.S.: productivity, employment and monetary policy

• Japan: finally a breakout and if so, why?

• Is China overheating and if so, hard or soft landing?

• Euro area: destined and content to under perform?


Meyer’s

Productivity Growth: How much will it slow?

1

2

3

4

5

6

96 97 98 99 00 01 02 03 04 05

H F

1-year

5-year

percent

Productivity Growth


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Aggregate Demand vs. Productivity Growth

-2

0

2

4

6

8

10

2000 2001 2002 2003 2004 2005

percent

GDPProductivity

GDP Growth and Productivity Growth


Meyer’s

What Drives Monetary Policy?

2000 2001 2002 2003 2004 2005-2

0

2

4

6

8

10

2000 2001 2002 2003 2004 2005

unemployment rate

core CPI

1-quarter GDP growth

percent

The Unemployment Rate and Core Inflationin the Forecast

H F


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H F

-4

-3

-2

-1

0

1

2

3

4

5

95 96 97 98 99 00 01 02 03 04 05

Percent

JapanReal GDP and Consumer Prices

consumer prices

Real GDP

H F

Real GDP Growth and Inflation in Japan


Meyer’s

H F

0

1

2

3

4

5

95 96 97 98 99 00 01 02 03 04 05

Real GDP

Consumer Prices

Percent

EurozoneReal GDP and Consumer Prices

H F

Real GDP Growth and Inflation in Euro Area


Meyer’s

China and India

2

4

6

8

10

12

95 96 97 98 99 00 01 02 03 04 05

China India

Percent

China and IndiaGrowth of Real GDP

H F


Meyer’s

H F

-5

0

5

10

15

20

25

95 96 97 98 99 00 01 02 03 04 05

Consumer prices

Real GDP

Percent

ChinaReal GDP and Consumer Prices

H F

Real GDP Growth and Inflation in China


Meyer’s

Change in Chinese Exchange Rate Regime?

• U.S., Euro, Asian, and Chinese perspectives

• Sequencing and the reluctance to float

• Consistency with domestic policy objectives

• Intermediate steps– Widening the band– Discrete revaluation– Moving to a market basket– Partial and gradual relaxation of capital controls


Meyer’s

The Outsourcing Debate

• The magnitude of the problem?

• Bearing backlash to globalization, productivity

• Widening job insecurity related to globalization

• Winners and losers and the Pareto principle

• Reducing the gains from trade?

• The policy response


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Monetary Policy around the World

• Exit problems and return to neutrality

• Learning about nonconventional policy (Japan)

• Structural constraints (Euro area and Japan)

• Productivity and monetary policy (U.S.)

• Transparency and inflation targets

• Monetary policy and bubbles


Meyer’s

Monetary Policy in the U.S.: Sooner or Later

•Return to neutrality:– What is the neutral value of the funds rate?– What is the implicit inflation target and what is the NAIRU?– Timing of the start of tightening

• Preconditions and triggers• Higher hurdle for first move and never surprise the market• Should the Fed still “err on the side of ease?”• The two gaps story: how far from full employment & neutrality?• Accelerators: role of equity valuations, term and risk spreads• Patiently preemptive?• Does the election influence the timing of tightening?

– The pace of tightening and interaction with timing (via Greg Ip)• “Baby Steps”: Start early and move slowly• “Backloading”: Start later and then converge more quickly• “Late and Leisurely”: Start later and move slowly


Meyer’s

Sooner or Later• Later

– Slow decline in unemployment rate, stable core inflation– Concern about inflection point/2nd half slowdown– Limited concerns with financial imbalances as accelerator– Maximin and comfort in still erring on side of ease

• Sooner– Faster decline in unemployment rate/upward rend in core inflation– Two gaps: not so far from potential/long way to neutrality– Reluctance to continue erring on side of ease– Preference for gradualism


Meyer’s

The Taylor Rule and the MPI Call

0

2

4

6

8

10

88 90 92 94 96 98 00 02 04

Prescribed

Actual, MPI Forecast

H F

Taylor Rule Using Short-Run NAIRU

Actual, MA Forecast


Meyer’s

Evolution of Monetary Policy in Japan

• February 1999: zero rate policy

• April 1999: first statement re precommitment– “until deflationary concerns dispelled”

• August 2000: terminated ZRP/raised policy rate ¼ pp

• February 2001: returned to (near) zero policy rate

• March 2001: adopted “quantitative easing”– Targeting current account balance at BOJ– Clarified precommitment: until CPI inflation stable at zero or above


Meyer’s

Effectiveness of Nonconventional policy

• Limits to monetary policy: broken multiplier

• Quantitative easing

• Precommitment

• Improving the transmission mechanism


Meyer’s

ECB

• Differences in objective conditions or strategy?

• Dismissive of “stabilization policy”

• Asymmetric re response to inflation

• Limits on monetary policy/structural constraints


Meyer’s

Inflation Targets and Inflation Targeting

• Trend toward inflation targeting• U.S. and Japan: do not have explicit targets• Exit issue: what is the “implicit” inflation objective• Price stability vs. price stability + cushion• Transparency, accountability, and effectiveness• Hierarchical vs. dual mandates• Trade-off between inflation target & flexibility?• Explicit inflation objective within dual mandate


Meyer’s

Monetary Policy and Asset Bubbles

• Lessons from equity bubble: – Difficult to reach timely judgment about danger of bubble– Indirect vs. direct approaches – In close call, encourages tighter policy

• Today concerns with housing bubbles in UK, Australia – Contributed at margin to decisions to tighten

• U.S.– Some talk about bond market bubble– Reaching for yield across term and risk structure– Increases exit problem

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Laurence Meyer April 14,2004

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