Challenges and Opportunities for the World Economy and the IMF - Christine Lagarde

Christine Lagarde - Managing Director, International Monetary Fund Council on Foreign Relations C. Peter McColough Series on International Economics July 26, 2011 As prepared for delivery

Webcast of the speech I. The Rise in Interconnectedness Good morning. Im delighted to be back in New York, and especially with old friends at the Council on Foreign Relations. Today, Id like to talk about the challenges facing the world economy, and the role of the IMF. Since its only my 22nd day as Managing Director, Im 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 economyand 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 countriesespecially the systemic economies, whose policies can have such a signicant impact on the rest of the world. I will return to this point when I focus on the IMF.

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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 intertwinedand 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 rst challengesovereign debt. In Europe, scal 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 difculties. Even the tough scal 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 nancing for Greece, at much longer maturities and lower ratesterms that will also be available to the other crisis economies. The EFSFEuropes crisis nancing toolhas been given greater exibility 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 nancial markets, as reected in the stronger euro and lower peripheral bond spreads. But turbulence could easily resurface. For this reason, it is essential that the summits commitments should be implemented quickly. Im hopeful that the political courage shown by European leaders will soon be followed by bold scal 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 scal shock in the United States could have serious spillovers on the rest of the world. But more fundamentally, a credible scal 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 scal 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 decit could lower growth by about percentage point over two years. This is why measures that are legislated nowbut only reduce decits in the future, when the recovery is more robustwould 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.

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Another perspective on this issue comes from the IMFs spillover analysis. Focusing on the United States, it nds that credible scal consolidation measures would likely have very modest contractionary effects on demandand possibly even positive effects, as condence improves. This brings me to the second challengenamely growth. Overall, the IMF expects reasonable global growth in the near-termabout 4-4 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 recoveryand reects 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 crisisand more broadly, as they seek strong, durable and inclusive growth. Turning to the advanced economies, it is evident that the crisis has inicted 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, thats why weve advised against scal consolidation that is unduly hastyeven as we stress the importance of getting a scal consolidation plan agreed soon. Weve 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 to 1 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 cant simply be any growth we need the right kind of growth, that creates jobs and lifts people across the socio-economic spectrum.

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This is why we must deal with the third challengesocial 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 nding workwith potentially lifelong implications in terms of employability and income. At the same time, the older generations are ghting to protect their health and pension benets. 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 t into all this? Over the last few years, the IMFs role has grown tremendously. It was an intellectual leader during the crisis, with its early call for coordinated policy stimulus. It has been a exible nancial 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 relevantand 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 IMFs Articles of Agreement mandate us to preserve its stabilitywith 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, nancial support, and technical assistance. Some may see tensions between these two responsibilities. But in todays 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 nd 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 connectionsboth between and within countries.

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We are just completing a study of how policies in the worlds ve most systemically important economiesChina, the euro area, Japan, the United Kingdom, and the United Statesaffect 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 nancial system, and a stronger currencywould 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 betterespecially macronancial 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 nancial criteria to make sure that we dont miss other factorssuch as social concerns, or political economy issuesthat 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 credibleboth in how we work, and how were 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 IMFfair 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 IMFs voting structure reected the economic realities of bygone days. But this is changing. Last year, our members agreed to boost the voting power of the worlds 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 Id like to close today with some helpful advice from John Maynard Keynesincidentally, 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 IMFalong with the World Bankwould 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
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their sole allegiance is to the general good; - A box of vitamins, to encourage energy and a fearless spirit, that welcomes difcult 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 IMFand the worldtoday.

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