Christine Lagarde

Global Economic Challenges & Solutions - Sept. 12, 2011

Christine Lagarde
September 12, 2011— The Wilson Center, Washington, D.C.
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Thank you very much for having me and thank you very much for caring to listen to my remarks this morning. I would like to first of all thank the Wilson Center for their kind invitation and I would like to especially recognize and thank, and give my really deep appreciation to Jane Harman. In her long and distinguished career, Jane has worked in the executive branch, academia, law, we even share the privilege of having been -- both of us chairman of law firms-- which is, I can tell you a good training for managing egos. And of course congress where she has served nine terms in the House of Representatives where we know there are no egos. She has been and continues to be a devoted public servant. Thank you very much Jane for everything that you do, for having me this morning of course as well.

There shouldn't be, there couldn't be a more appropriate venue for my first speech in Washington as IMF managing director. More than anyone else, it was President Woodrow Wilson who championed the calls of multilateralism and global fraternity. The seeds that he planted took a little bit more time than he thought to actually bear fruit, but in the post war era he was able to actually steel this extraordinary belief that is still the objective of the IMF to make sure that corporation [inaudible] not only economic stability, but a better future for all. And this is at the very heart of what the IMF, one of these [inaudible] institution has to do and has to keep doing no matter what the circumstances are. And the idea has never been more important. This is what I have been advocating for the last few weeks.

Collective, bold, decisive, courageous action is needed and it will not only be in the interest of those that conduct such actions and for their countries, it will be for the good of the world. That's a very Wilsonian approach to economic stability. Now we're certainly living through very troubled time at the moment with great economic anxiety. Exactly three years ago after the collapse of Lehman Brothers, the economic skies today, they look troubled, they look turbulent as global activity slows and downside risks increase.

And we have entered into a dangerous phase of the crisis, and without this collective resolve that President Wilson was advocating, the confidence that the world so badly needs will not return. And as we all know, at the heart of economic development, at the heart of growth, lies confidence-- confidence in ourselves, confidence in what the others can do as well. Woodrow Wilson once cautioned that, and I will quote him, the thing to do is to supply light and not heat. I believe that the IMF's job is to see and show the light when the picture seems so dark and when there is light and shine the light on core economic problems, but now and again it doesn't hurt to turn on a little bit, the heat. Even though you take the hit back, whether it's heat or hit is to be debated. Now with that in mind, let me offer the following: despite the very gloomy picture that we have at the moment, I believe that there's a path to recovery. It's indeed a narrow one and it is certainly narrower than it was three years ago because the volume and the amount of ammunition is different, lower. But there is a path and it will require strong political will across the world, not just in one country but in many countries, and it will require decisive action on the part of some central banks which they seem to be showing to us including this morning. It will require leadership over [inaudible] corporation over competition, action over reaction. And all three components are difficult because they have to be demonstrated, implemented by political leaders who may have to put aside for a little while, not just their ego, we all have one, but also their partisan interests, and they will have to extend their agenda to beyond the next election.

Let's have a quick look at the global situation as it is and I'll really apologize for how brief that is going to be because I want to get into a quick analysis of what the problems are as we see them and more importantly what kind of solutions there are. If we look at the global economic outlook at the moment, and I'm not going to be specific on numbers because our revised outlook will be published next week when we have our annual shareholders meeting, so I will be general and not overly specific. But overall, growth is continuing to slow down. The advanced economies in particular are facing an anemic and bumpy recovery with unacceptably high levels of unemployment. The Euro area debt crisis has worsened. Financial strains are rising, and again, without collective bold action, there is a risk that the major economies slip back instead of moving forward. And while many advanced economies are facing those cold headwinds, many emerging markets are facing the risk of overheating with what comes with it -- that is, inflation, inflation pressure, strong credit growth, and rising unbalanced current accounts.

If we now turn to the low income countries, they have experienced in the [inaudible] more reasonable growth but they remain highly vulnerable to economic dislocation from elsewhere in the world because of their degree of dependency on flows of capital and support from other countries. They've suffered as well from the commodity price volatility which comes with heavy social costs, and that has an impact on their public finances as well because many of those countries have to put in place subsidies and grants program to support their most underprivileged population. Now, this is a bit of an aside, and yet it's a big problem. I would like to simply draw your attention to the human suffering that is taking place in the Horn of Africa as result of the drought. It's a devastating catastrophe. It's one where, again, aide is available. There are programs in place. For instance, the IMF stands ready to help as well as indeed other international institutions, and it's a matter yet again in that part of the world or political determination and ability to set aside political ambitions or drive to allow for the support to be sent to where it should be.

Now this is all very dark and gloomy and I would like to simply just, you know, indicate that there is always hope and I have to say that when I was Saturday in Marseille in the South of France for that Deauville Partnership meeting that brought together the finance ministers of the G8 countries plus the head of international institutions, and the finance ministers of countries is like Tunisia, Egypt, Libya, but also Jordan and Morocco, there was hope in the room. There was warmth. There was determination to actually move ahead with the development and put in place a strategy and reach out to those populations and those governments that have the courage to take their destiny in their hands. There again, there is a time for developing a strategy. There is a time for implementing a strategy, and my hope is that we will be able to continue to work together and to support those countries. It's not just a political issue that I'm not dealing with, it's an economic issue, it's a matter of development and it's a matter of organizing, on a regional basis, exchanges and demonstrating that market access can actually help the development of countries that decide to move on and to develop economically for the good of their population.

Now turning to the, the roots of the problems or some of the roots as we analyze them because I'm supposed to deal with global challenges and global solutions, I see three distinct roots for the problems that we're facing at the moment. Number one, the balance sheet pressures that sap growth at the moment. Number two, the instability in the core of the global economic system. And number three, social tensions that are a little bit below the radar screen in corners of the world, but in others that are really popping up. First of all, a key short-term issue in advanced economy is that balance sheet pressures are knocking the wind out of the recovery. There is still too much debt in the system.

Uncertainty weighs over sovereign across advanced economies, banks in Europe, households in the United States. Weak growth and weak balance sheets of government, financial institutions, households, are feeding negatively on each other fueling a crisis of confidence and holding back demand, holding back investments and job creation. This vicious cycle is gaining momentum and frankly it has been exacerbated by policy uncertainty and political lack of resolve and collective determination. That's for the first part. The second one, which is more of a long-term issue, has to do with the risk of core instability.

What we find in our economic studies at the fund is that the world is totally interconnected with major conduit of connections generally in the financial system. This is clearly the result of what we've done at the fund which are the spillover analysis and the combination of analysis of economies and the connections between them. There will be a lot more said next week at the time of our annual meeting. But in this interconnected world, economic tremors in one country can reverberate swiftly and powerfully across the globe especially if they originate, number one is the systemic economies, and number two are channeled and exacerbated by the financial circuits. Those linkages are key and they have to be addressed.

The third issue relates to what I call the social tensions which is bubbling below the surface that we don't necessarily see very well in some advanced economies. Although if you look carefully at what's happening in Chile for instance, or in less advanced economies, there is clearly social tensions under the surface. And that is caused by a number of intertwined strands: entrenched high unemployment. This is the case in this country but it is the case in many, many countries, particularly the advanced economies. And that affects in particular the younger generation.

There have been discussions of the lost generation. Well certainly we need to do our best to avoid that because with a lost decade of growth, we run the risk of a lost generation when it comes to job. Fiscal austerity that chips away social protections and what we call the automatic stabilizers. Perception of the unfairness where Wall Street is treated a little bit better than Main Street. And the legacies of growth in many countries that predominantly benefitted from a period of time to the higher echelon societies and that was particularly true in countries that have decided to take their destiny in their hands and for the future to actually operate and develop for the better of the entire community and not just the top 10%. Now in the face of all these problems, what are the solutions and are there solutions? I contend that there are solutions, and as I said, implementing those solutions will be a matter of collective drive and of political determination and willingness to address candidly the problems and their analysis.

Because I'm a simple mind I like to start with being able to remember what I preach, and to me those solutions are my four R's. The first R is repair; there's quite a lot of work that needs to be done when it comes to repair the shop, and then maintain it.

What do I mean by that? Before anything else we must relieve some of the balance sheet's pressures that risk smothering the recovery, on sovereign, on the households, and on banks. On sovereigns, advanced countries need credible medium term plans to stabilize and then lower their public debt ratios to GDP. That must come first and foremost. This is a pre-condition to anything else. The degree at which it is done is something that will vary on a country per country analysis, but it is a first condition. It is a first condition and yet, consolidating too quickly, too heavily exposes to the risk of reducing the little growth that there is currently in our economies. So the challenge really is to navigate between the two imperials 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 create space in the very short term for accommodating growth. In other words we want to get out of the vicious circle that I was describing earlier on by entering into a virtuous path. And that goes through a slow pace of consolidation in the immediate short term for some countries—not necessarily all-- and a much downloaded program that in the medium and long-term delivers the saving that will be needed to slow the debt, stabilize it, and then reduce it.

Now of course the precise path is going to be different on a per country, per country basis. Some have no choice but to cut deficit now and they simply do not have the luxury of creating this path which begins low and finishes high. They just have to cut because they are under such market pressure that there is no option but to do that. Others should stick to their adjustment plans and many advanced economies have put together those, those plans so they have to stick to the plan but they have to be very, very attentive to the pace of growth at the moment and be prepared to relax a little bit and certainly to let the economic stabilizers work. And some countries, not many but some big ones, have the space to actually allow for those growth conducive measures and space in the forefront provided-- and that's critically important-- provided that there is an anchored way of actually reducing those deficits and stabilizing the debt to reduce it in the long run. It is not, by the way, what kind of adjustment there is, it is also how this adjustment is being produced, and I think that both in relation to the short-term measures that would allow that growth space and in relation to the medium and long-term measures that anchor this more virtuous approach to public finance, finances, the how is critically important and certainly now mind it goes through entitlement reform, it goes through the kind of tax reforms that broadens the base and that needs to happen in all advanced economies. It is happening in some. There are many countries for instance in in Europe that have taken the decision to completely revise their pension system so that the entitlement is is is stabilized in the medium and longterm.

This is the kind of reform that we have in mind in terms of entitlement. Now policymakers should also deal not just with sovereigns, they should also deal with households and and bank balance sheets.

Incidentally, in light of the job crisis in the United States, I certainly welcome President Obama's recent proposal to address growth unemployment, but at the same time it remains critical that this be associated with a parallel track that actually indicates and anchors those medium terms actions and decisions that are so needed to stabilize the debt and to redress for the better the the debt trajectory. Equally, in this country in particular, it will certainly be important to consider relieving overburdened households through actions like more aggressive principle reduction programs or helping homeowners that take advantage, or should be able to take advantage of lower interest rates. Now turning to Europe, the sovereigns must address firmly their financing problems through credible cons- fiscal consolidation; goes without saying.

And to support growth with the risks that are lurking in the background, it is also critical in my view that banks be able to strengthen their capital by way of capital buffers for instance, with a view to avoiding the deleveraging that is the other natural tendency to actually strengthen the institutions. That is you know so much for repair having looked at sovereign, households, banks and always with a sort of balance sheet perspective. If we look now at the second R, reform. Reform is about the longer term. The repair was the fix, you know the fix immediate action that need to be taken followed by proper maintenance. It's not, you know it's one thing to repair but you have to keep maintaining what the repair has produced. The reform is about much longer term and it's about lying the foundations for a more stable economic future tomorrow.

And in that particular section of reform, I see two critical areas that need attention, and the first one is the financial sector reform. There are some good news in that category. On the plus side, there have been, some will find long discussions about capital ratios, liquidity ratios, the stability of financial institutions.

Well I would, I would just call your attention to the fact that although it has lasted a little over two years, it's been a lot faster that, than what had taken place in the previous discussions in Basel. Basel 2 took about eight years, Basel 3 which is the set of rules and regulations applying to the capital ratios, liquidity ratios and overall supervisory environment of banks, that has taken a lot less in in this Basel 3 phase and it is, and it is good. But, substantial gaps remain in areas like supervision and particularly cross border supervision in regards to international banking institutions. Cross border resolution which is still, you know, to be tackled on a global basis and with proper national and regional ramifications when it comes to the legal system. The too important to fail issue and the development of the shadow banking systems.

The fact that in the last three years, some progress has been made but not enough to actually be able to say in the face of the depositors, the people who put their saving in those institutions, we've done the job I think is a question that needs to be addressed urgently. We also need in that regard to develop and finetune macro prudential tools to guard against financial risks. I'm thinking here of policies like having banks hold more capital in good times so that they do have those capital buffers, those counter cyclical policies that will actually help them in the tough time, or implementing maximum loan to value ratios to guard against housing prices bubbles for instance. Progress has been made, there's no doubt about it, but it needs to be reinforced and it needs to be leveled because we need, institutions need, and more importantly the general interests need that level playing field where there is as little regulatory arbitrage as possible. Now under the reform banner I would also include the social dimension. Employment must be central; it's at the core. The economy grows, but if jobs are not created, it's not a waste, but it's a massive human waste. And it is especially important amongst the young people who risk, you know, this lost generation syndrome that we should by all means try to avoid. The third R is rebalance, rebalancing.

Now one might argue that, you know, this is really a a general principle and it's not an immediate concern.

I would argue that it is a critical point and when I, what I mean by rebalancing is it's this dual rebalancing that needs to take place where we move from public support to private investment and that hasn't really yet taken place. The second rebalancing that is equally important is this rebalancing where the deficit economies operate differently and the surplus economies operate differently, and that goes through various measures because in some countries the rebalancing is just held back by excessively protective regulations or by the lack of appreciation of exchange rate. So that rebalancing is very important. Put it very simply, it's a question for those countries that have a massive deficit to actually be able to operate differently to save more and for those countries that have a massive surplus, to actually consume a bit more domestically and not just by way of investment or massive infrastructure projects, but by domestic consumption. And to that end clearly letting appreciation happen when it comes to currency is very important. And this lack of rebalancing hurts everyone. In our interconnected world that I referred to, the thought that one country or a set of countries, because they're emerging for instance, could be decoupled by the rest of the world, is an illusion-- total illusion. In the advanced economy, if the advanced economies were to succumb to recession, the emerging market economies will not escape. When you're a big supplier of goods, you need clients around the planet and it's as simple and as basic as that. So rebalancing is in the global interest and it's also in the interest of each and every economy of each and every country. I think Woodrow Wilson would have appreciated that, Jane. That would be in his mantra.

Now my fourth and final R is rebuild and here I'm mainly thinking of the low income countries that need to rebuild their economic policy buffers including their fiscal positions. They had such buffers for many of them but they had to use them at the time of the financial crisis and in the last three years. There has to be some rebuilding so that they can protect themselves against future storms. And 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.

Now having gone through my four R's, I can't resist mentioning a fifth one and I did say that was my last one but I will indulge, if you will allow me, and that is the Role of the IMF. What's the IMF in it-- what's the role of the IMF in all of this? Well it is a critical role.

It's a critical role because number one, we can help country with appropriate national, regional, and global [inaudible]. I've been a minister of finance, I've been a minister of trade. There are things that you simply don't see for yourself because you're right in the middle of it and you're trying to row this boat but you don't necessarily have the distance and the impartiality to actually analyze exactly the strength and the weaknesses of your economy. So that work of surveying how things work, how they interconnect, what is the spillover effects of some of the decisions that are made in one country and that will affect the others with the degree of impartiality and academic skills and talent that is required and that I was very lucky to find when I joined the fund. That's number one. Number two, we have the ability to provide the level of technical assistance that will actually help countries, and I'm thinking for instance of the country in the Middle East and north Africa, to build their public finance sectors, to build a proper fiscal system, to develop their tax system, to organize the collection of tax, to build their monetary institutions. We can do that. In many corners of the world we do, and certainly those countries will be, will continue to be the recipient of technical assistance support. And finally the third arm of the fund is our lending capacity and ability to actually respond to moment of crisis, to current account end balances, and to situations where there is nobody else but the fund that can actually come to support by way of lending, not by way of subsidies, not just dumping money without consideration, but under programs that are well established with appropriate conditionalities. And let me say-- because everybody has a pitch--I have my pitch, and I'd like to share it with you. Let me say that the International Monetary Fund is actually critical for the world, but it's also critical for the United States of America. I know in hard times there is a tendency to trim around the edges and to think oh well, that's not really critical. Mission critical is something else.

Three points: first of all, the International Monetary Fund is a disciplined, organized, I hope well managed, but that will have to be demonstrated and I will do my best for that institution. It was one of the Bretton Woods Institution and when I was asked whether I would be intimidated as a lawyer by background to operate with economists essentially, 2,500 or them more or less, I was a little bit. Until I came to the fund, and I realized how disciplined, organized, rule-based it is, and how the principles actually matter over the arbitrary decisions and the discretion of doing as we please. It's an institution where my main shareholder is the United States of America with 17% of the quota rights and de facto veto right on all the key decisions. That's reason number one. Number two, because I've heard that, why should we invest our money? Might be a waste. Well any dollar, any Euro that is invested in the fund, goes back to the member. 187 members, they all get their money back, principle and interest. We're not in the business of subsidies, we're not in the business of giving grants, we lend. And we lend under very strict terms that are called the conditionalities of our programs. We lend with terms and we come to the country-- those are the missions that are sent on the ground-- and they check that the conditionalities are actually respected, that the reforms are taking place, that there is consideration for the special support that is being given.

And if it is not the case, money is not paid on the next [inaudible] until there is completion of the commitments that were made. And third reason why the International Monetary Fund actually matters is that for the largest economic power in the world, the United States of America, it's actually very important that there is stability around the world, that there is stability in all corners, and that the international monetary system is without excessive volatility. Certainty is a key to fuel confidence. Confidence is a key to develop growth. Growth is key to create jobs. That's the reason why the International Monetary Fund I think is perfectly legitimate in being accountable to all its members for the money it receives, for the money that it lends and for the money that it pays back to its members.

Thank you very much, Jane, for giving me also the chance to pitch.