Christine Lagarde's 4 Rs

A recent speech of IMF's Lagarde;

But before talking about solutions, we need to be clear about the problems. I would isolate three distinct, albeit related, issues—balance sheet pressures sapping growth, instability in the core of the global economic system, and social tensions.... I want to propose today four key policy dimensions needed to secure recovery and economic stability—repair, rebalance, reform, rebuild, the “4 R’s”.

First, repair. Before anything else, we must relieve some of the balance sheet pressures that risk smothering the recovery—on sovereigns, on households, on banks.

On sovereigns, advanced countries need credible medium-term plans to stabilize and lower public debt ratios. This must come first. But consolidating too quickly can hurt the recovery and worsen job prospects. So the challenge is to navigate between the twin perils of losing credibility and undermining growth. There is a way to do this. Credible measures that deliver and anchor savings in the medium term will help create space for accommodating growth today—by allowing a slower pace of consolidation.

Of course, the precise path is different for each country. Some have no choice but to cut deficits today, especially if they are under market pressure. Others should stick to their adjustment plans, but be ready to change course if growth falters further. Others still are probably pushing too hard today, and could slow down a bit.

One more point—it’s not just the what of the adjustment, it’s the how. In the short run, policymakers must focus on measures with the biggest bang-for-the-buck, that create jobs and kick-start growth, and that take distributional considerations into account. The how of adjustment is also important in the medium term, where fiscal plans should seek to support growth. I’m thinking of issues like tax reform, including by broadening bases. Equally, entitlement reforms will be essential in establishing long-term debt sustainability in virtually all advanced economies.

Policymakers must also deal with household and bank balance sheets.

In light of the jobs crisis in the United States, I welcome President Obama’s recent proposals to address growth and employment. At the same time, it remains critical for policymakers to clarify in parallel their medium term plans to put public debt on a sustainable path. In tandem with this crucial employment agenda, it is important to relieve overburdened households through actions like more aggressive principal reduction programs, or helping homeowners take advantage of low interest rates.

In Europe, the sovereigns must address firmly their financing problems through credible fiscal consolidation. In addition, to support growth, via private sector lending, all banks must have sufficient capital buffers.

The second “R” is reform. If repair was about getting the economy moving today, reform is about laying the foundations for a more stable economic future tomorrow.

A priority here is financial sector reform. On the plus side, we have broad agreement on higher quality capital and liquidity standards with appropriate phase-in arrangements. But substantial gaps remain in areas like supervision, cross-border resolution, too-important-to-fail, and shadow banking systems. We need international cooperation across all dimensions to avoid regulatory arbitrage. The fact that so many of these issues are still unresolved three years after Lehman should be of concern to us all.

We also need to develop and fine-tune macro-prudential tools to guard against financial risks. I’m thinking here of policies like having banks hold more capital when times are good or implementing maximum loan-to-value ratios to guard against housing price bubbles.

Under the reform banner, I would also include the social dimension. Employment must be central. It not only sustains demand, but supports human dignity. In the words of Dostoevsky, “deprived of meaningful work, men and women lose their reason for existence”. This is especially important among the young, who risk losing the race even before the starting gun has sounded. We should also seek growth that is inclusive, benefiting the whole of society.

The third “R” is rebalance. This has two meanings. First, it means shifting back demand from the public to the private sector, when the private sector is strong enough to carry the load. This hasn’t happened yet.

The second rebalancing involves a global demand switch from external deficit to external surplus counties. The idea here is straightforward—with lower spending and higher savings in the advanced economies, key emerging markets must take up the slack and start providing the demand needed to power the global recovery. But any rebalancing so far is largely due to lower growth. In some countries, rebalancing is being held back by policies that keep domestic demand growth too slow and currency appreciation too modest. Some other emerging markets are dealing with dangers from capital inflows that are too rapid.

This lack of sufficient rebalancing hurts everyone. In our inter-connected world, any thought of decoupling is a mirage. If the advanced economies succumb to recession, the emerging markets will not escape. Nobody will. Rebalancing is in the global interest, but it is also in the national interest.

Woodrow Wilson would have appreciated that, I'm sure.

My fourth—and final—“R” is rebuild. Here I am thinking mainly of the low-income countries that need to rebuild their economic policy buffers—including fiscal positions—that served them so well during the crisis, to protect themselves against future storms. This will also help provide the space for growth-enhancing public investment and social safety nets—for example, allowing countries to deploy well-targeted subsidies to protect the poor from commodity price swings with minimal damage to fiscal sustainability.

Target what you can hit

The analytical chapters of the WEO is out. The 3rd chapter address the following questions;

-What are the effects of international commodity price swings on inflation across a variety of economies? What economic factors influence these effects?

-What is the appropriate monetary policy response to commodity price shocks? In particular, how does the approach of targeting underlying inflation rather than headline inflation perform in terms of delivering macroeconomic stability in different types of economies? Should central banks respond to persistent commodity price shocks any differently than to one-time shocks?

-Finally, what are the implications for monetary policy in today’s environment, with excess demand pressures in some emerging and developing economies and economic slack in advanced economies?

These are the main findings of the chapter:

-Food price shocks tend to have larger effects on headline inflation in emerging and developing economies than in advanced economies. On a related note, because medium-term inflation expectations are weakly anchored in many emerging and developing economies, food price shocks have larger effects on inflation expectations in these economies.

-The measure of inflation used to define a central bank’s target matters because of its effect on the central bank’s credibility. In economies with low initial monetary policy credibility and high food shares in the consumption basket, focusing on underlying inflation—that is, a measure that reflects the changes in inflation that are likely to be sustained over the medium term—rather than on headline inflation, makes it easier to build credibility. The reason is that it is harder to hit headline inflation targets when commodity prices are volatile. Higher credibility, in turn, leads to better-anchored inflation expectations and lower volatility of both output and headline inflation.

-The desirability of setting and communicating monetary policy based on a measure of underlying inflation depends on the relative importance of headline inflation and output to a country’s welfare. A headline framework can lower the volatility of headline inflation, but at the cost of significantly higher volatility in output (and hence in household income).

-Finally, in economies where central bank credibility is still limited and the share of food in consumption is high (as in a number of emerging and developing economies), a food price shock is likely to have even larger second-round effects and require a more aggressive policy response when excess demand pressures are high and inflation is running above target. This assumes that the economic costs rise as the gap increases between actual inflation and the target. In contrast, in economies where the central bank’s credibility is strong, where food accounts for a low share in consumption baskets, and where there is substantial economic slack (as in major advanced economies today), the monetary policy tightening required to stabilize inflation is more gradual.

Mongolia - the Economy in Pictures

Mongolia Quarterly Economic Update, August 2011

Mongolia’s economic outlook depends heavily on global macroeconomic factors: the current uncertainty and poor growth prospects for the global economy are cause for concern. If there is another global recession, Mongolia’s small, open economy will be affected. In that case, China’s policy reaction will be crucial for Mongolia. If China reacts as fast and as strongly as it did in 2008/9 then the effects of a global recession on Mongolia will be mitigated, largely owing to Chinese demand for minerals from Mongolia. Beyond this, it is up to Mongolia to capitalize on its excellent long term prospects by continuing the reform agenda it embarked on during the 2008/9 crisis.

East Asia Economic Update- Eas Asia Saves the World

East Asia & Pacific Update - Battling the forces of global recession;

-Prospects for recovery among the developed countries are uncertain.
-Over the medium term, the countries of developing East Asia can achieve high rates of economic expansion in a slowly growing world economy to the extent they are able to extract more growth from domestic demand, boost competitiveness, penetrate new markets, and further improve the attractiveness of the region as a key destination for foreign investment.

Related;

comparing the 1997-98 Asian financial crisis and the current crisis

Deep Impact across the World

Kenyan coastal city of Malindi, which has a population of 70,757 and depends entirely on tourism


The town of Huaxi, China


The town of Danville, Virginia


The town of Luton, near London

More on Financial Crisis

Origins of and Responses to the Ongoing Financial Market Crisis

Speaker: Klaus Regling, EU Fellow, Lee Kuan Yew School of Public Policy, Senior Advisor, European Commission

Mr Paul Volcker, Chairman, Board of Trustees, The Group of Thirty

Report of the Day

Global Risks 2009