Christine Lagarde – Managing Director, International Monetary Fund
Council on Foreign Relations
C. Peter McColough Series on International Economics
I. The Rise in Interconnectedness
Good morning. I’m delighted to be back in New York, and especially with old friends at the Council on Foreign Relations.
Today, I’d like to talk about the challenges facing the world economy, and the role of the IMF. Since it’s only my 22nd day as Managing Director, I’m still in listening and learning mode. But it is already clear to me that for the IMF to be even more effective, it must understand even better the remarkable changes that are taking place in the global economy—and in particular, the dramatic rise in interconnectedness between countries. In other words, the IMF needs to bring an even more multilateral perspective to the advice it gives its member countries—especially the systemic economies, whose policies can have such a significant impact on the rest of the world. I will return to this point when I focus on the IMF.
II. Challenges Facing the Global Economy
But let me begin with three major challenges that I see facing the global economy today: sovereign debt, growth, and social instability. These challenges are intimately intertwined—and I will submit that it is only by solving all three that we can unlock strong, stable, and balanced global growth. Why is that? Because for sovereign debt to be sustainable, economic growth needs to be strong, but in a sustainable way. And for economic growth to be sustainable, it needs to deliver the stable social chemistry that holds societies together.
Let me turn to the first challenge—sovereign debt.
In Europe, fiscal problems in the periphery have revealed the risks posed by an incomplete economic and monetary union. As a result, the euro area as a whole is experiencing difficulties. Even the tough fiscal and structural measures adopted by the affected countries have not convinced markets that a lasting solution is in place.
Last week, eurozone leaders reached an important agreement to overcome these concerns. The package includes new financing for Greece, at much longer maturities and lower rates—terms that will also be available to the other crisis economies. The EFSF—Europe’s crisis financing tool—has been given greater flexibility in supporting member countries. The package also includes critical measures to strengthen economic governance in the eurozone.
The agreement shows that European leaders believe in the eurozone, and will do what it takes to secure its destiny. It has been welcomed by financial markets, as reflected in the stronger euro and lower peripheral bond spreads. But turbulence could easily resurface. For this reason, it is essential that the summit’s commitments should be implemented quickly.
I’m hopeful that the political courage shown by European leaders will soon be followed by bold fiscal action in the U.S. On the debt ceiling, the clock is ticking, and clearly the issue needs to be resolved immediately. Indeed, an adverse fiscal shock in the United States could have serious spillovers on the rest of the world. But more fundamentally, a credible fiscal adjustment plan is needed sooner rather than later. In Japan also, even though the situation is not as urgent, more ambitious measures are needed to deal with the very high level of public debt.
What will fiscal consolidation mean for growth? In the short-term, the impact is likely to be negative. Our research has found that a 1 percentage point cut in the deficit could lower growth by about ½ percentage point over two years. This is why measures that are legislated now—but only reduce deficits in the future, when the recovery is more robust—would be particularly helpful. But there is good news too: over the longer term, debt reduction can actually raise output by bringing down real interest rates and making room for tax cuts.
Another perspective on this issue comes from the IMF’s spillover analysis. Focusing on the United States, it finds that credible fiscal consolidation measures would likely have very modest contractionary effects on demand—and possibly even positive effects, as confidence improves.
This brings me to the second challenge—namely growth.
Overall, the IMF expects reasonable global growth in the near-term—about 4-4½ percent through 2012. But the recovery remains unbalanced, and risks are clearly to the downside.
Rapid growth in the emerging economies has been critical to sustain the global recovery—and reflects the pay-off from sound macroeconomic policies in recent years. But in some of these economies, signs of overheating are becoming more prominent. Staying ahead of the curve will be essential to avoid the possible hard landing if policy action comes too late.
Low-income countries have also been enjoying healthy growth. Here too, better macroeconomic policies have played a major role. But many of these countries are reeling from the surge in commodity prices. Earlier this year, the World Bank estimated that the rise in food prices had pushed an additional 44 million people into extreme poverty. And today, many countries in the Horn of Africa are facing potentially the worst food security crisis in decades. The IMF stands ready to help our low-income members deal with this crisis—and more broadly, as they seek strong, durable and inclusive growth.
Turning to the advanced economies, it is evident that the crisis has inflicted deep and long-lasting scars. To make up for the lost ground, a sea-change in policies is needed in many areas.
The United States could be facing another jobless recovery. Again, that’s why we’ve advised against fiscal consolidation that is unduly hasty—even as we stress the importance of getting a fiscal consolidation plan agreed soon. We’ve also recommended active labor market policies to stem the rise in structural unemployment, and measures to ease adjustment in the housing market (for example, mortgage relief).
In Europe, where job destruction has been much smaller, addressing competitiveness problems is a major issue. IMF analysis has found that the right reforms could lift annual growth by as much as ½ to 1¼ percentage points. Making labor and capital markets more productive will be essential. Deeper market integration will also play a key role.
Boosting growth in these economies is no small task. And the goal can’t simply be any growth—we need the right kind of growth, that creates jobs and lifts people across the socio-economic spectrum.
This is why we must deal with the third challenge—social instability.
In the Middle East and North Africa, we have seen how socially imbalanced growth contributed to the political upheaval. And in many emerging and developing economies, rising commodity prices are exacerbating social problems associated with high joblessness. In these countries, strong social safety nets can help protect the most vulnerable, while better education can improve job prospects.
Social problems are of major concern to advanced economies too. The young in particular are having a hard time finding work—with potentially lifelong implications in terms of employability and income. At the same time, the older generations are fighting to protect their health and pension benefits. Combine the two, and we may face a “clash of generations”, to borrow a term coined by the scholar David Rothkopf. This is why focusing on the right kind of growth is so important.
III. The Role of the IMF
So how does the IMF fit into all this? Over the last few years, the IMF’s role has grown tremendously. It was an intellectual leader during the crisis, with its early call for coordinated policy stimulus. It has been a flexible financial partner, reforming its lending instruments and making available a record amount of support, totaling about $330 billion. And it is helping build a stronger global economy, through its policy advice and technical assistance efforts.
But as the needs of our members change, we too must we adapt. I see four organizing principles for an IMF that remains relevant—and they all, rather conveniently, begin with C.
First, the IMF must be client-focused. Who are our clients? Arguably, our most important client is the international monetary system. The IMF’s Articles of Agreement mandate us to preserve its stability—with the ultimate goal of fostering a healthy global economy and increasing human welfare. But clearly, our member countries are also our clients. And we service them by providing policy advice, financial support, and technical assistance.
Some may see tensions between these two responsibilities. But in today’s highly interconnected global economy, domestic policies have in a way become external policies. And so by focusing on the policies needed to stabilize the system as a whole, the IMF can help its members find the policies best suited to deliver strong and stable growth over the long run.
Second, as I said at the outset, the IMF must understand better the connections—both between and within countries.
We are just completing a study of how policies in the world’s five most systemically important economies—China, the euro area, Japan, the United Kingdom, and the United States—affect stability in others. We found, for example, that a successful rebalancing of the Chinese economy—including a stronger social safety net, a liberalization of the financial system, and a stronger currency—would generate positive spillovers for the global economy. We also found that the adoption of a suitably ambitious regulatory and supervisory regime in the United Kingdom would strengthen the stability of the system as a whole.
There are also connections within countries that we must understand better—especially macrofinancial linkages. Here too, the IMF has stepped up its analytical work, and is contributing to efforts to build a macroprudential framework.
Third, the IMF must be comprehensive. When evaluating the strength of an economy, we need to look beyond the standard economic and financial criteria to make sure that we don’t miss other factors—such as social concerns, or political economy issues—that may threaten macroeconomic stability.
Now, does this mean that I intend to turn the IMF into the International Multi-Disciplinary Fund? Not at all. But we do need new thinking on the interplay between macroeconomics and these other dimensions, and we should draw more on outside expertise in this area.
Fourth, the IMF must be credible—both in how we work, and how we’re governed.
Candor and evenhandedness is essential for the IMF to be credible in its monitoring of economic policies. This means that all countries should get fair treatment from the IMF—fair in listening to their views, fair in evaluating their policies, and fair in reporting them to the world.
Credibility of our governance is also essential for the IMF to be effective. For too long, the IMF’s voting structure reflected the economic realities of bygone days. But this is changing. Last year, our members agreed to boost the voting power of the world’s fastest growing economies, such that the BRICs will be amongst our top ten shareholders. Getting these reforms implemented as soon as possible is one of my top priorities.
IV. Conclusion: The Spirit of Wisdom
I’d like to close today with some helpful advice from John Maynard Keynes—incidentally, a great fan of New York, who lobbied very hard for the IMF to be established here.
Speaking at the Savannah conference in 1946, Keynes expressed his hope that the IMF—along with the World Bank—would be blessed with three gifts from their fairy godmothers:
– A many-colored coat, as a perpetual reminder that they belong to the whole world and that their sole allegiance is to the general good;
– A box of vitamins, to encourage energy and a fearless spirit, that welcomes difficult issues and is determined to solve them; and
– A spirit of wisdom, patience, and grave discretion, so that their approach to every problem is absolutely objective.
These three gifts remain as essential for the Fund today as they were at its establishment.
So – I have bought a colorful new coat and have stocked up on vitamins. Now all I need is a spirit of wisdom! Thankfully, I can rely on the tremendous collective wisdom of the members of the IMF, of its Executive Board, and of its dedicated and talented staff. I also look to you, our friends at the Council on Foreign Relations, to share your wise counsel on the critical challenges facing the IMF—and the world—today.