José De Gregorio: IMF challenges and policies for the global economy
Statement by Mr José De Gregorio, Governor of the Central Bank of Chile, speaking on
behalf of the Southern Cone Countries of Latin America International Monetary and Financial
Committee Meeting, Washington DC, 24 September 2011.
* * *
In the past few months, the near-term prospects for the global economy have worsened
significantly and financial risks have increased. What some time ago was a modest, albeit
unbalanced recovery, risks turning into a new economic downturn, particularly in major
Advanced Economies (AEs). This new scenario poses urgent challenges to the IMF and to
the membership in terms of decisive political and policy responses to solve fundamental
weaknesses and mitigate the negative impact of this new downturn. Against this backdrop,
the Fund's surveillance capacities, and a well-functioning International Monetary System
(IMS), are being and will again be put to the test only a couple of years after the 2008-2009
Great Recession and financial crisis.
I. The immediate challenges ahead and the fund's policy advice
Two forces are influencing each other and weighing down on economic prospects in major
advanced economies. On the one hand, uncertainty and volatility have increased to their
highest levels since October 2008, constraining credit and leading to more cautious behavior
by households and financial institutions. On the other hand, fully credible medium-term fiscal
consolidation in those economies with high debt burdens is still lacking, prompting even
higher sovereign spreads and more calls for short-term fiscal retrenchment when private
demand has yet to recover to its pre-crisis levels. The policy debate surrounding the
appropriate fiscal and monetary policy mix, as well as the assessment of public debt
sustainability, have become muddled. It would be paradoxical that only a few years after
witnessing an example of successful global policy coordination and sound financial policies,
which staved off another Great Depression, the lessons learned were to be ignored. The
Fund can provide guidance and leadership on a number of issues, and the membership
should heed its advice. In particular, we would like to note that:

The political will to achieve meaningful short-term fiscal adjustment is more present
in those core AEs where public sector financing conditions are benefiting the most
from flight to quality, whereas in cases of more acute solvency concerns, and thus
higher spreads, adjustment fatigue is dangerously settling in.

The negative growth implications of further short-term fiscal retrenchment have not
been given proper regard by the global community. The bulk of the evidence, and
appropriate risk considerations in the weak economic environment of today, suggest
much caution should be exercised when implementing short-term fiscal
consolidation measures, especially in those cases where the long-term sustainability
of public finances is not threatened.

Structural reform fatigue is settling in, with electorates weary in both creditor and
debtor countries to pursue tough measures to ensure medium-term fiscal
consolidation and containment of the sovereign crisis in Europe. Moreover, financial
markets remain jittery as the final outcomes of agreed commitments are not a
foregone conclusion.

The risk of disorderly outcomes is high, and balance sheet repair, especially of
those banks most exposed to the European periphery, should be bolstered. Hoping
for the best is no substitute for preparing for the worst, and the markets are well
aware of that. More extreme measures on debt restructuring might be unavoidable if
fiscal transfers are ruled out and fatigue settles in debtor countries.
 In an environment of financial uncertainty and fiscal retrenchment, monetary policy
should remain supportive.
Emerging Market Economies (EMEs) and smaller, financially stable AEs, are threading
carefully in this uncertain environment, and as we saw a few years ago, it is unlikely that full
decoupling will occur under most scenarios. The Fund's advice should properly recognize
that the rebalancing challenges are not the same across this heterogeneous group of
economies; thus, an adequate level of differentiation in terms of policy advice is called for. In
this regard, we would like to note that:

If the external scenario should worsen significantly, many EMEs with flexible
exchange rates and inflation-targeting regimes would have scope to adjust monetary
policy, thanks to a timely process of raising interest rates to contain overheating
risks. Going forward, these economies will be able to react flexibly to changing
global circumstances in a context of anchored inflationary expectations.

Other EMEs have limited room for maneuver, as their economies have expanded
beyond their potential output, with widening fiscal and external deficits, and thus
today face the risk that external shocks might unhinge inflationary expectations and
force pro-cyclical monetary and fiscal policy adjustments.

A third group of EMEs has maintained structurally high national saving rates
throughout the expansion phase of the global cycle and might be subject to a natural
deceleration as the global economy cools down. In these cases, undertaking
reforms to boost domestic demand would help sustain both medium-term global
rebalancing and short-term policy accommodation.

Economies that are being affected by high commodity prices, particularly
LowIncome Countries (LICs), should strive to develop targeted policies to the most
vulnerable groups through efficient cash transfers, instead of across-the-board
subsidies. The international community should strive to support these efforts through
similar measures, as demand subsidies or export constraints in non-LIC economies
exacerbate commodity price pressures.
Policy advice by the Fund should be tailored to these different groups of economies. Policy
recommendations that are appropriate for some economies are not necessarily suitable for
other economies. One salient theme, however, is that fiscal policy space is more limited
across the spectrum than it was in the run up to the 2008-2009 financial crisis. Moving from
broad policy recommendations to concrete messages on policy implementation is required to
draw the policy-makers' attention and establish a constructive dialogue. The Consolidated
Multilateral Surveillance Report is a positive step in that direction.
II. The medium-term challenges and the fund's action plan
Under the current circumstances, the Fund should focus on its short-term policy challenges.
Indeed, one of the main issues that the Fund is tackling right now, namely the Triennial
Surveillance Review, will be shaped directly by the lessons that the practice and traction of
surveillance reveal in the current uncertain environment. Such surveillance practices will be
the basis on which to revamp the surveillance framework, for instance, through an integrated
surveillance decision that encompasses both its bilateral and multilateral aspects.
The Fund's resource adequacy is, in our view, directly linked to the functioning of Regional
Financial Arrangements (RFA) and the existence of bilateral central bank swap lines. It is
welcome that major central banks are currently cooperating in this area. A reasonable
question is whether current Fund resources, plus those available through RFAs and bilateral
swap lines, are sufficient to deal with a significant major financial dislocation.
Assessing these resource needs is critical to evaluate whether, for instance, the New
Arrangements to Borrow will have to remain active, even if the quota increase is fully
implemented by next year. Moreover, the discussion of resources would have to be linked to
a broader rethinking of the need for alternative lending instruments to bolster the global
safety net.
This topic should be given higher priority at the current juncture and not, as in our previous
IMFC meeting, simply as part of a broader agenda for IMS reform. The activation and
deactivation, and the criteria for conditionality, for the Flexible Credit Line or similar
instruments could be reviewed, towards making them closer substitutes to bilateral swap
lines that have been implemented by major central banks. This would help reduce the stigma
associated with the Fund's toolkit, and would contribute to ensure adequate liquidity
provision in times of market stress.