Press Release - Managing Spillovers—Striking the Right Balance of Domestic Objectives and External Stability - By Christine Lagarde - Norges Bank 200th Anniversary Symposium on “The Interaction Between Monetary Policy and Financial Stability—Going Forward”, Oslo, Norway June 16, 2016
Ladies and gentlemen – good morning. God morgen!
Deputy Governor Matsen – thank you for your generous introduction and for the opportunity to speak to such a distinguished audience.
I would like to start by congratulating Norway and the Norges Bank on its 200th Anniversary this year! Norway boasts economic institutions that are as solid, sturdy, and well-tested as the Fram– which I had the privilege of visiting yesterday.1
And the Norges Bank, whose age now spans two centuries, is “Exhibit A” on this list! Thank you for the invitation, and I am honored to be here for your birthday party!
I would also like to congratulate Governor Olsen on his reappointment—a testament to his stewardship of this historic institution. It takes a wise man to lead this institution, and this brings me to a Norwegian proverb:
“Wise men learn by other men’s mistakes – fool’s by their own.”
So let us use the opportunity of this round birthday to think about what we have learned from the past, and from the mistakes that were made—whether from us or from others. How can we do better in the future?
This is a big topic and we could spend days on this. I believe you have a TV show that is called “Slow TV.” If I followed that format, I could have entitled my remarks “Norges Bank: 200 years in 200 minutes”!
So let me rather stick to something I know better—one lesson that we at the IMF have drawn from our 70 years’ worth of analyzing global economic developments. (We are still a young institution, mind you!)
The way economic and financial shocks have unfolded since the 2008 crisis made it clear to us that the world is interconnected like never before, in multiple and complex ways. The lesson for us was also clear. We need to better understand how developments in one country can have spillovers – economic, financial, even political – on other countries that can be thousands of miles away.
It used to be that advanced economies were the sources of spillovers. For example, monetary policy in the United States, Europe, and Japan has always had an impact on capital flows to emerging markets. This certainly continues, except that now we also have emerging economies as emitters of spillovers, both regionally and globally. Think of China, Russia or Brazil.
1. Current spillovers
There are currently two such shocks causing spillovers at the global stage, whose implications for the world economy we try to understand.
First, China is in the midst of a welcome transition to a slower but more sustainable growth path. This transition partly explains the cooling of global growth, and especially trade. Our estimates suggest that a 1 percentage point decline in China’s growth could reduce global GDP by about 0.2 percentage points.
This is not trivial, and it contributes to what our Chief Economist Maurice Obstfeld recently said: “the Holy Grail of robust and synchronized global expansion remains elusive” – and that is despite massive monetary stimulus in recent years.
The second spillover comes from the oil market. A slow global recovery, a downward shift in expected demand from China, and ample supply have all contributed to a drop in oil prices by some 70 percent from their peak. And as you know very well, despite a small rebound since late 2015, futures markets suggest that prices are likely to stay low for longer.
How do these spillovers play out in the world economy?
At the global level, the fall in oil prices led to a redistribution of income across countries – from heavy exporters such as Saudi Arabia, Russia and Norway to net importers such as the United States, Germany, Japan, China and India.
Faced with such a drastic fall in prices and rising financial pressures, many of the commodity exporters had to adjust.
Most countries cut government spending sharply and reduced investment, in the energy sector and elsewhere. Exchange rates were allowed to depreciate. Think of the 25 percent real effective depreciation in Brazil or the 15 percent depreciation in Russia.
A few countries had to go further and abandon fixed exchange rates, such as Kazakhstan – a country I just visited – and others should also do so, such as Nigeria. These changes helped reduce the need for excessive fiscal adjustment – by limiting the domestic currency loss of commodity revenues.
At the same time, countries with large financial and policy buffers were in a better position to smooth the adjustment. This is the case in Norway, where the sovereign wealth fund, the Government Pension Fund Global, helped buffer the impact of the oil price downturn on the economy. However, even countries with ample buffers such as Saudi Arabia and Russia required significant adjustment and a rethinking of their fiscal and growth plans.
So clearly the impact on oil exporters was severe—perhaps more than anticipated. But oil exporters represent a much smaller share of global GDP than oil importers, less than 15 percent.
One could therefore have thought that the oil price decline would be “a shot in the arm” for the global economy.2 After all, oil importers would enjoy a “windfall income” and a boost to growth from lower prices. Additional spending by importers would exceed the contraction by exporters, and growth would rebound.
Well, that oil “windfall” turned out to be more like a breeze! It was perhaps most noticeable in the United States, where private consumption has been strong, and to some extent in the Euro area where demand also picked up. But in Japan, consumption remained virtually flat.
So compared with past cycles, lower oil prices have not helped overcome the drag from other factors causing slow growth and asymmetric recoveries in oil importers – such as public and private sector debt overhang, slow credit growth, weak employment and low wage growth, and rising inequality, to name a few.
Moreover, we are seeing a slight widening of global current account imbalances, which had narrowed substantially after 2008. While China’s transformation has been a key contributor to the reduction in imbalances in recent years, other countries went in the opposite direction. In 2015, the external deficit in the U.S. increased while the surpluses in the euro area and Japan have widened.3
These changes reflect the asymmetric recoveries and associated large exchange rate movements across major currencies. If continued, this trend would lead to a further widening of stock imbalances, or growing disparities between creditor and debtor countries, which could raise global risks.
This points to the need for better balancing global demand to reinvigorate global growth and contain external imbalances through active use of policy space.
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