Three “Rosetta Moments” for the Global Economy in 2015
by Christine Lagarde
Managing Director, International Monetary Fund
Washington D.C.—January 15, 2015
As prepared for delivery
Diana, thank you for the kind introduction, and thank you to Christopher Tuttle and the Council on Foreign Relations for the opportunity to speak today about the outlook for the global economy in this New Year 2015.
The Council and the IMF have much in common: they both take a global perspective; they were both founded after global conflicts – World War I and World War II; and they both joined the perennial quest for a more peaceful and more prosperous world. I am glad to say that we are still on the same team!
Good teamwork and strong leadership will be needed this year. The latest update of our World Economic Outlook – with all the specific numbers – will be formally presented next week. But I can already say this: despite the boost from cheaper oil and stronger U.S. growth, we see the global recovery continuing to face a very strong headwind.
But before I delve into the details of the challenges ahead, I would like to share with you a brief story that has resonated with me.
Late last year, on November 12, a little spacecraft operated by the European Space Agency made the first-ever landing on a comet after a 10-year journey covering half a billion miles. Like millions of others, I was mesmerized by the sheer audacity of this adventure.
The touchdown on the comet, called 67P, was part of the ongoing “Rosetta” mission, which is led by a multinational team of scientists. Together, these scientists have extended humanity’s reach into the cosmos and, by doing so, they have enhanced our understanding of our own planet. They embody the spirit of those 19th century scholars who used the original Rosetta Stone to decode the ancient Egyptian hieroglyphs.
Why is this story relevant right now? Because this year the global economy will face what we might call three “Rosetta moments”. These are major policy challenges that require decisions based on political courage, decisive action, and multilateral thinking—in short, true global leadership.
The first Rosetta moment is all about boosting growth and employment in the next 12 months – overcoming that “strong headwind” that I mentioned. The second Rosetta moment is about achieving more inclusive, shared growth; and the third is about attaining more sustainable, balanced growth.
These three moments are, of course, deeply interconnected and mutually dependent. All are important, all demand strong leadership, all require cooperation. But – surely – if we can catch a comet in space, can’t we address the policy challenges here on Earth?
1. Global outlook, risks, and policy actions – injecting new momentum
I will start with the immediate challenge of how to inject greater momentum into the recovery. As I said, we are still in the process of finalizing the hard numbers for our updated forecast. So I will focus on the main trends and policy recommendations.
The obvious question is this: should lower oil prices and a stronger recovery in the United States make us more upbeat about the prospects for the global economy? The answer is most likely “No,” since there are still powerful factors that weigh on the downside.
Certainly, the drop in oil prices is a welcome shot in the arm for the global economy. Cheaper oil increases consumers’ purchasing power and private demand in oil-importing countries.
Depending on how long oil prices will remain at low levels, this could provide a positive contribution to global growth for some time.
As for the U.S. economy, it performed well in 2014 and should strengthen further this year – largely due to more robust household spending. U.S. unemployment continues to decline; cheaper oil is boosting real incomes and consumer sentiment; and there is continued support from accommodative monetary policy.
So what is the catch? The oil price and U.S. growth are not a cure for deep-seated weaknesses elsewhere. Too many countries are still weighed down by the legacies of the financial crisis, including high debt and high unemployment. Too many companies and households keep cutting back on investment and consumption today because they are concerned about low growth in the future.
In fact, the United States is the only major economy that is likely to buck the trend this year, while others are being held back – mainly by lackluster investment. A promising recovery continues in the UK, but growth remains very low in the Euro Area and Japan. And emerging economies, led by China, are slowing down, relatively speaking.
Overall, we believe that global growth is still too low, too brittle, and too lopsided. Moreover, there are significant risks to the recovery. What are these?
- First, the asynchronous normalization of monetary policies in advanced economies. There has been a lot of talk about this, but this year we should expect it to actually begin. The U.S. could see its first rise in short-term interest rates since 2006 – an important moment. Even if this process is well-managed and well-communicated – and I believe that it has been and will be – there could be negative effects for emerging markets and global financial stability.
- Second, emerging and developing economies could face a triple hit of a strengthening U.S dollar, higher global interest rates, and more volatile capital flows. A stronger dollar will have a significant impact on financial systems in emerging markets, because many banks and companies have increased their borrowing in dollars over the past five years. The oil price drop – and weaker commodity prices more generally – have added to these risks, with some countries such as Nigeria, Russia, and Venezuela facing huge currency pressures. Given the size of these economies, the recent developments could also have significant regional effects.
- Third, there is a risk that the Euro Area and Japan could remain stuck in a world of low growth and low inflation for a prolonged period. This “low-low environment” would make it even harder for many Euro Area countries to reduce unemployment and excessive public and private debt, and so would raise the risk of recession and deflation.
- Fourth, there are increased geopolitical risks. In Ukraine, for example, increased international support to complement IMF support is crucial. At the same time, there is a palpable sense that the forces of intolerance and fragmentation are gaining strength. The recent atrocities in France – my home country – in Nigeria, or in Pakistan are only the latest actions of forces that are fundamentally opposed to what we here in this room believe in.
Broadly speaking, accommodative monetary policies remain essential. Fiscal adjustment must be as growth and job-friendly as possible. And above all, policymakers need to finally step up structural reforms. This economic mantra – support demand, growth, and structural reforms – is not new, but now takes on increased urgency. And it places increased emphasis on political leadership.
For example, the impact of lower oil prices will prove to be an immediate test for many policy makers. Not so much for oil importers, for whom the windfall provides an opportunity to strengthen their macroeconomic frameworks and may help in alleviating inflation pressures.
But oil exporters need to cushion the shock on their economies. Some are using their rainy day funds and fiscal deficits to adjust public spending more gradually. Others resort to allowing substantial exchange rate depreciation, which poses the risk of inflation and may require tighter monetary policies.
In the Euro Area, cheaper oil is contributing to a further decline in inflation expectations, which increases the risk of deflation. This bolsters the case for additional monetary stimulus, which the European Central Bank has indicated it stands ready to support as needed.
Most importantly, however, the drop in oil prices provides a golden opportunity to cut energy subsidies and use the savings for more targeted transfers to protect the poor – for which the IMF has been pushing hard. We have recently seen a successful decrease in fossil fuel subsidies in countries such as Cameroon, Côte d’Ivoire, Egypt, Haiti, India, Indonesia, and Malaysia. In some advanced countries, policymakers should also seize the moment to increase energy taxes to build fiscal buffers or reduce other taxes, especially on labor.
This, of course, requires political courage – which it has in common with the 2nd Rosetta moment: how to achieve more inclusive, more shared growth over the medium term.
2. Structural reforms, infrastructure, and trade – generating more inclusive growth
Let me be blunt: more than six years after the start of the Great Recession, too many people still do not feel the recovery. In too many countries, unemployment remains high and inequality has increased. This is why we need a decisive push for structural reforms to boost current and potential growth over the medium term.
2015 must be the year of action. This means removing deep-seated distortions in labor and product markets; it means revamping creaking infrastructures and building new ones; it means trade liberalization and pressing ahead with reforms in education, health, and social safety nets. It also means unleashing the economic power of women.
I would like to expand on two potential game changers.
One is infrastructure investment – where it is carefully chosen and efficient. Let me be clear: I am not referring to the proverbial “bridges to nowhere”. IMF research shows that increased public infrastructure investment raises output in the short term by boosting demand; and in the long term by raising the economy’s productive capacity. Indeed, lifting quality infrastructure investment is a major part of the G-20 growth agenda, which is estimated to add more than US$2 trillion to the global economy over the next four years.
The scope for such investments varies across countries, depending on their fiscal space and infrastructure gaps. India and Brazil, for example, would need to focus on removing bottlenecks – in transportation and energy – that constrain their growth. In the U.S. and Germany, it is more about fixing up existing infrastructure after decades of under-investment.
Whatever the need, now is the time to show determination – for example, by following through on the European Commission’s ambitious €315bn investment plan, which holds out the promise of stronger growth and job creation.
Another potential game changer is to unleash the economic power of millions of women who are currently locked out of the labor market. Excluding these women is not just morally wrong, it is bad economics. Gender gaps in labor force participation exist all over the world, ranging from 12 percent in the OECD economies to 50 percent in the Middle East and North Africa.
Countries like Chile and the Netherlands, for example, have shown that you can sharply increase female labor force participation through smart policies that emphasize affordable childcare, maternity leave, and workplace flexibility. Again, one of the key goals of the G-20 growth strategy is to close the gender gap by 25 per cent over the next decade. This would bring more than 100 million women into the labor force, thus increasing global growth and reducing poverty and inequality.
The next question is: how can we better leverage the gains from various structural reforms? Trade liberalization may well provide the right answer!
After years of slowing growth in global trade, 2015 could be a make-or-break year for negotiations on an ambitious Transpacific trade deal – the Trans-Pacific Partnership (or TPP). Policymakers also need to press ahead with negotiations on a Transatlantic deal, known as TTIP, which is less advanced but could provide just as many benefits as its Pacific cousin.
In the United States, these important trade deals are areas of potential cooperation between the new Congress and the President. For the European Union, progress on trade would be immensely helpful in lifting growth and confidence. The Japanese government is keen to use the TPP to inject greater competition into its low-growth economy. And emerging and developing economies would benefit from better integration into the global economy. So what’s there not to like?
On all sides, there are incentives to cut deals. Political will is now needed to get to the finish line.
Here we arrive at the 3rd Rosetta moment: how to achieve more sustainable, balanced growth over the long term? Financial regulation, international development, and environmental policy are key.
3. Financial regulation, international development, and climate change – engendering more sustainable growth
If there is one lesson from the Great Recession, it is that you cannot have sustainable economic growth without a sustainable financial sector. So we must complete the agenda on financial sector reform.
There has been progress, especially on banking regulation and – to a lesser extent – on addressing too-important-to-fail financial institutions. The global banking system is now less leveraged and therefore less vulnerable to contagion. But shadow banking has yet to be transformed into a resilient source of finance for the economy.
The big challenge now is to implement reforms and improve the quality of supervision. For example, the two most important financial markets – the United States and the European Union – have diverged in their implementation of the Basel III framework. These differences will need to be carefully monitored. We also need to make progress in setting rules for complex derivatives transactions that stretch across borders.
Above all, we have yet to see a sea change in the culture of the financial sector. Some important actions are being taken: for example, the first jury trials related to the LIBOR trading scandal will be held this year. But fully restoring trust needs an all-out effort to promote and enforce ethical behavior throughout the industry.
Sustainable Development and Climate Change
Another example of how to engender more sustainable growth is through international development. Later this year, in September, the United Nations will host a major conference that will seek to replace the Millennium Development Goals, adopted in 2000, with a new set of Sustainable Development Goals. We, the IMF, will play a significant role in helping countries meet the new development goals, building on our long-standing work in developing countries.
2015 will also be make-or-break for efforts to strike an international agreement on climate change, which is on a collision course with the global economy. Average temperatures are rising – 2014 was the warmest year on record – and so is the risk of more frequent natural disasters and of more food and water insecurity.
Again, we need greater political courage to reach a comprehensive deal to cut carbon emissions at the Paris summit in December. A successful agreement could usher in a new energy era that could help save the planet.
This brings me back to the beginning. While I was speaking, the Rosetta spacecraft has continued to circle the dark, icy object that is comet 67P. As the comet proceeds closer to the sun, we may yet learn more of its secrets. Given the diversity of its staff and backers, the Rosetta mission is a true testament to global cooperation.
Policymakers should take inspiration from that. There are no secrets about what can engender growth. But if they are to deliver on the three Rosetta moments, they need to enhance global cooperation. They need to embrace what I have called the “new multilateralism”. This is the year when it should be put into practice.
The new multilateralism also requires institutions that are efficient, credible, and representative of a changing global economy. This is why the international community agreed to reform the IMF to increase the representation of emerging market countries. The 2010 quota and governance reforms would also help sustain the Fund’s financial firepower to meet the challenges ahead.
The IMF’s membership had called on the United States to ratify the 2010 reforms by the end of last year, which did not happen. As I have spoken much about leadership today, I cannot but express my profound disappointment in the political powers who have so far failed to grasp the benefits of the reform both for their own country and for the world at large. We have seen better from the United States over the last 70 years.
We will now be working on interim solutions to address some of the concerns of our other 187 member countries. But let me be clear: given the challenges that 2015 and the following years will bring, there is no alternative to completing the 2010 reforms – and we continue to call on Congress to approve them without delay.
I would like to end with a quote that encapsulates my call for greater leadership and cooperation in service of the global public good.
It is attributed to Pericles, the Athenian statesman and orator:
“What you leave behind is not what is engraved in stone monuments, but what is woven into the lives of others.”
There is a lot of weaving to be done this year. Thank you.