Ben S Bernanke: Rebalancing the global recovery
Keynote speech by Mr Ben S Bernanke, Chairman of the Board of Governors of the Federal
Reserve System, at the 6th ECB Central Banking Conference, Frankfurt am Main,
19 November 2010.
* * *
The global economy is now well into its second year of recovery from the deep recession
triggered by the most devastating financial crisis since the Great Depression. In the most
intense phase of the crisis, as a financial conflagration threatened to engulf the global
economy, policymakers in both advanced and emerging market economies found
themselves confronting common challenges. Amid this shared sense of urgency, national
policy responses were forceful, timely, and mutually reinforcing. This policy collaboration was
essential in averting a much deeper global economic contraction and providing a foundation
for renewed stability and growth.
In recent months, however, that sense of common purpose has waned. Tensions among
nations over economic policies have emerged and intensified, potentially threatening our
ability to find global solutions to global problems. One source of these tensions has been the
bifurcated nature of the global economic recovery: Some economies have fully recouped
their losses while others have lagged behind. But at a deeper level, the tensions arise from
the lack of an agreed-upon framework to ensure that national policies take appropriate
account of interdependencies across countries and the interests of the international system
as a whole. Accordingly, the essential challenge for policymakers around the world is to work
together to achieve a mutually beneficial outcome - namely, a robust global economic
expansion that is balanced, sustainable, and less prone to crises.
The two-speed global recovery
International policy cooperation is especially difficult now because of the two-speed nature of
the global recovery. Specifically, as shown in figure 1, since the recovery began, economic
growth in the emerging market economies (the dashed blue line) has far outstripped growth
in the advanced economies (the solid red line). These differences are partially attributable to
longer-term differences in growth potential between the two groups of countries, but to a
significant extent they also reflect the relatively weak pace of recovery thus far in the
advanced economies. This point is illustrated by figure 2, which shows the levels, as
opposed to the growth rates, of real gross domestic product (GDP) for the two groups of
countries. As you can see, generally speaking, output in the advanced economies has not
returned to the levels prevailing before the crisis, and real GDP in these economies remains
far below the levels implied by pre-crisis trends. In contrast, economic activity in the
emerging market economies has not only fully made up the losses induced by the global
recession, but is also rapidly approaching its pre-crisis trend. To cite some illustrative
numbers, if we were to extend forward from the end of 2007 the 10-year trends in output for
the two groups of countries, we would find that the level of output in the advanced economies
is currently about 8 percent below its longer-term trend, whereas economic activity in the
emerging markets is only about 1-1/2 percent below the corresponding (but much steeper)
trend line for that group of countries. Indeed, for some emerging market economies, the
crisis appears to have left little lasting imprint on growth. Notably, since the beginning of
2005, real output has risen more than 70 percent in China and about 55 percent in India.
In the United States, the recession officially ended in mid-2009, and - as shown in figure 3 -
real GDP growth was reasonably strong in the fourth quarter of 2009 and the first quarter of
this year. However, much of that growth appears to have stemmed from transitory factors,
including inventory adjustments and fiscal stimulus. Since the second quarter of this year,
GDP growth has moderated to around 2 percent at an annual rate, less than the Federal
Reserve's estimates of U.S. potential growth and insufficient to meaningfully reduce
unemployment. And indeed, as figure 4 shows, the U.S. unemployment rate (the solid black
line) has stagnated for about eighteen months near 10 percent of the labor force, up from
about 5 percent before the crisis; the increase of 5 percentage points in the U.S.
unemployment rate is roughly double that seen in the euro area, the United Kingdom, Japan,
or Canada. Of some 8.4 million U.S. jobs lost between the peak of the expansion and the
end of 2009, only about 900,000 have been restored thus far. Of course, the jobs gap is
presumably even larger if one takes into account the natural increase in the size of the
working age population over the past three years.
Of particular concern is the substantial increase in the share of unemployed workers who
have been without work for six months or more (the dashed red line in figure 4). Long-term
unemployment not only imposes extreme hardship on jobless people and their families, but,
by eroding these workers' skills and weakening their attachment to the labor force, it may
also convert what might otherwise be temporary cyclical unemployment into much more
intractable long-term structural unemployment. In addition, persistently high unemployment,
through its adverse effects on household income and confidence, could threaten the strength
and sustainability of the recovery.
Low rates of resource utilization in the United States are creating disinflationary pressures.
As shown in figure 5, various measures of underlying inflation have been trending downward
and are currently around 1 percent, which is below the rate of 2 percent or a bit less that
most Federal Open Market Committee (FOMC) participants judge as being most consistent
with the Federal Reserve's policy objectives in the long run.1 With inflation expectations
stable, and with levels of resource slack expected to remain high, inflation trends are
expected to be quite subdued for some time.
Monetary policy in the United States
Because the genesis of the financial crisis was in the United States and other advanced
economies, the much weaker recovery in those economies compared with that in the
emerging markets may not be entirely unexpected (although, given their traditional
vulnerability to crises, the resilience of the emerging market economies over the past few
years is both notable and encouraging). What is clear is that the different cyclical positions of
the advanced and emerging market economies call for different policy settings. Although the
details of the outlook vary among jurisdictions, most advanced economies still need
accommodative policies to continue to lay the groundwork for a strong, durable recovery.
Insufficiently supportive policies in the advanced economies could undermine the recovery
not only in those economies, but for the world as a whole. In contrast, emerging market
economies increasingly face the challenge of maintaining robust growth while avoiding
overheating, which may in some cases involve the measured withdrawal of policy stimulus.
Let me address the case of the United States specifically. As I described, the U.S.
unemployment rate is high and, given the slow pace of economic growth, likely to remain so
for some time. Indeed, although I expect that growth will pick up and unemployment will
decline somewhat next year, we cannot rule out the possibility that unemployment might rise
further in the near term, creating added risks for the recovery. Inflation has declined
noticeably since the business cycle peak, and further disinflation could hinder the recovery.
In particular, with shorter-term nominal interest rates close to zero, declines in actual and
expected inflation imply both higher realized and expected real interest rates, creating further
drags on growth.2 In light of the significant risks to the economic recovery, to the health of
the labor market, and to price stability, the FOMC decided that additional policy support was
warranted.
The Federal Reserve's policy target for the federal funds rate has been near zero since
December 2008, so another means of providing monetary accommodation has been
necessary since that time. Accordingly, the FOMC purchased Treasury and agency-backed
securities on a large scale from December 2008 through March 2010, a policy that appears
to have been quite successful in helping to stabilize the economy and support the recovery
during that period. Following up on this earlier success, the Committee announced this
month that it would purchase additional Treasury securities. In taking that action, the
Committee seeks to support the economic recovery, promote a faster pace of job creation,
and reduce the risk of a further decline in inflation that would prove damaging to the
recovery.
Although securities purchases are a different tool for conducting monetary policy than the
more familiar approach of managing the overnight interest rate, the goals and transmission
mechanisms are very similar. In particular, securities purchases by the central bank affect
the economy primarily by lowering interest rates on securities of longer maturities, just as
conventional monetary policy, by affecting the expected path of short-term rates, also
influences longer-term rates. Lower longer-term rates in turn lead to more accommodative
financial conditions, which support household and business spending. As I noted, the
evidence suggests that asset purchases can be an effective tool; indeed, financial conditions
eased notably in anticipation of the Federal Reserve's policy announcement.
Incidentally, in my view, the use of the term "quantitative easing" to refer to the Federal
Reserve's policies is inappropriate. Quantitative easing typically refers to policies that seek to
have effects by changing the quantity of bank reserves, a channel which seems relatively
weak, at least in the U.S. context. In contrast, securities purchases work by affecting the
yields on the acquired securities and, via substitution effects in investors' portfolios, on a
wider range of assets.
This policy tool will be used in a manner that is measured and responsive to economic
conditions. In particular, the Committee stated that it would review its asset-purchase
program regularly in light of incoming information and would adjust the program as needed to
meet its objectives. Importantly, the Committee remains unwaveringly committed to price
stability and does not seek inflation above the level of 2 percent or a bit less that most FOMC
participants see as consistent with the Federal Reserve's mandate. In that regard, it bears
emphasizing that the Federal Reserve has worked hard to ensure that it will not have any
problems exiting from this program at the appropriate time. The Fed's power to pay interest
on banks' reserves held at the Federal Reserve will allow it to manage short-term interest
rates effectively and thus to tighten policy when needed, even if bank reserves remain high.
Moreover, the Fed has invested considerable effort in developing tools that will allow it to
drain or immobilize bank reserves as needed to facilitate the smooth withdrawal of policy
accommodation when conditions warrant. If necessary, the Committee could also tighten
policy by redeeming or selling securities.
The foreign exchange value of the dollar has fluctuated considerably during the course of the
crisis, driven by a range of factors. A significant portion of these fluctuations has reflected
changes in investor risk aversion, with the dollar tending to appreciate when risk aversion is
high. In particular, much of the decline over the summer in the foreign exchange value of the
dollar reflected an unwinding of the increase in the dollar's value in the spring associated
with the European sovereign debt crisis. The dollar's role as a safe haven during periods of
market stress stems in no small part from the underlying strength and stability that the U.S.
economy has exhibited over the years. Fully aware of the important role that the dollar plays
in the international monetary and financial system, the Committee believes that the best way
to continue to deliver the strong economic fundamentals that underpin the value of the dollar,
as well as to support the global recovery, is through policies that lead to a resumption of
robust growth in a context of price stability in the United States.
In sum, on its current economic trajectory the United States runs the risk of seeing millions of
workers unemployed or underemployed for many years. As a society, we should find that
outcome unacceptable. Monetary policy is working in support of both economic recovery and
price stability, but there are limits to what can be achieved by the central bank alone. The
Federal Reserve is nonpartisan and does not make recommendations regarding specific tax
and spending programs. However, in general terms, a fiscal program that combines
nearterm measures to enhance growth with strong, confidence-inducing steps to reduce
longerterm structural deficits would be an important complement to the policies of the Federal
Reserve.
Global policy challenges and tensions
The two-speed nature of the global recovery implies that different policy stances are
appropriate for different groups of countries. As I have noted, advanced economies generally
need accommodative policies to sustain economic growth. In the emerging market
economies, by contrast, strong growth and incipient concerns about inflation have led to
somewhat tighter policies.
Unfortunately, the differences in the cyclical positions and policy stances of the advanced
and emerging market economies have intensified the challenges for policymakers around the
globe. Notably, in recent months, some officials in emerging market economies and
elsewhere have argued that accommodative monetary policies in the advanced economies,
especially the United States, have been producing negative spillover effects on their
economies. In particular, they are concerned that advanced economy policies are inducing
excessive capital inflows to the emerging market economies, inflows that in turn put
unwelcome upward pressure on emerging market currencies and threaten to create asset
price bubbles. As is evident in figure 6, net private capital flows to a selection of emerging
market economies (based on national balance of payments data) have rebounded from the
large outflows experienced during the worst of the crisis. Overall, by this broad measure,
such inflows through the second quarter of this year were not any larger than in the year
before the crisis, but they were nonetheless substantial. A narrower but timelier measure of
demand for emerging market assets - net inflows to equity and bond funds investing in
emerging markets, shown in figure 7 - suggests that inflows of capital to emerging market
economies have indeed picked up in recent months.
To a large degree, these capital flows have been driven by perceived return differentials that
favor emerging markets, resulting from factors such as stronger expected growth - both in
the short term and in the longer run - and higher interest rates, which reflect differences in
policy settings as well as other forces. As figures 6 and 7 show, even before the crisis,
fastgrowing emerging market economies were attractive destinations for cross-border
investment. However, beyond these fundamental factors, an important driver of the rapid
capital inflows to some emerging markets is incomplete adjustment of exchange rates in
those economies, which leads investors to anticipate additional returns arising from expected
exchange rate appreciation.
The exchange rate adjustment is incomplete, in part, because the authorities in some
emerging market economies have intervened in foreign exchange markets to prevent or slow
the appreciation of their currencies. The degree of intervention is illustrated for selected
emerging market economies in figure 8. The vertical axis of this graph shows the percent
change in the real effective exchange rate in the 12 months through September. The
horizontal axis shows the accumulation of foreign exchange reserves as a share of GDP
over the same period. The relationship evident in the graph suggests that the economies that
have most heavily intervened in foreign exchange markets have succeeded in limiting the
appreciation of their currencies. The graph also illustrates that some emerging market
economies have intervened at very high levels and others relatively little. Judging from the
changes in the real effective exchange rate, the emerging market economies that have
largely let market forces determine their exchange rates have seen their competitiveness
reduced relative to those emerging market economies that have intervened more
aggressively.
It is striking that, amid all the concerns about renewed private capital inflows to the emerging
market economies, total capital, on net, is still flowing from relatively labor-abundant
emerging market economies to capital-abundant advanced economies. In particular, the
current account deficit of the United States implies that it experienced net capital inflows
exceeding 3 percent of GDP in the first half of this year. A key driver of this "uphill" flow of
capital is official reserve accumulation in the emerging market economies that exceeds
private capital inflows to these economies. The total holdings of foreign exchange reserves
by selected major emerging market economies, shown in figure 9, have risen sharply since
the crisis and now surpass $5 trillion - about six times their level a decade ago. China holds
about half of the total reserves of these selected economies, slightly more than $2.6 trillion.
It is instructive to contrast this situation with what would happen in an international system in
which exchange rates were allowed to fully reflect market fundamentals. In the current
context, advanced economies would pursue accommodative monetary policies as needed to
foster recovery and to guard against unwanted disinflation. At the same time, emerging
market economies would tighten their own monetary policies to the degree needed to
prevent overheating and inflation. The resulting increase in emerging market interest rates
relative to those in the advanced economies would naturally lead to increased capital flows
from advanced to emerging economies and, consequently, to currency appreciation in
emerging market economies. This currency appreciation would in turn tend to reduce net
exports and current account surpluses in the emerging markets, thus helping cool these
rapidly growing economies while adding to demand in the advanced economies. Moreover,
currency appreciation would help shift a greater proportion of domestic output toward
satisfying domestic needs in emerging markets. The net result would be more balanced and
sustainable global economic growth.
Given these advantages of a system of market-determined exchange rates, why have
officials in many emerging markets leaned against appreciation of their currencies toward
levels more consistent with market fundamentals? The principal answer is that currency
undervaluation on the part of some countries has been part of a long-term export-led strategy
for growth and development. This strategy, which allows a country's producers to operate at
a greater scale and to produce a more diverse set of products than domestic demand alone
might sustain, has been viewed as promoting economic growth and, more broadly, as
making an important contribution to the development of a number of countries. However,
increasingly over time, the strategy of currency undervaluation has demonstrated important
drawbacks, both for the world system and for the countries using that strategy.
First, as I have described, currency undervaluation inhibits necessary macroeconomic
adjustments and creates challenges for policymakers in both advanced and emerging market
economies. Globally, both growth and trade are unbalanced, as reflected in the two-speed
recovery and in persistent current account surpluses and deficits. Neither situation is
sustainable. Because a strong expansion in the emerging market economies will ultimately
depend on a recovery in the more advanced economies, this pattern of two-speed growth
might very well be resolved in favor of slow growth for everyone if the recovery in the
advanced economies falls short. Likewise, large and persistent imbalances in current
accounts represent a growing financial and economic risk.
Second, the current system leads to uneven burdens of adjustment among countries, with
those countries that allow substantial flexibility in their exchange rates bearing the greatest
burden (for example, in having to make potentially large and rapid adjustments in the scale of
export-oriented industries) and those that resist appreciation bearing the least.
Third, countries that maintain undervalued currencies may themselves face important costs
at the national level, including a reduced ability to use independent monetary policies to
stabilize their economies and the risks associated with excessive or volatile capital inflows.
The latter can be managed to some extent with a variety of tools, including various forms of
capital controls, but such approaches can be difficult to implement or lead to microeconomic
distortions. The high levels of reserves associated with currency undervaluation may also
imply significant fiscal costs if the liabilities issued to sterilize reserves bear interest rates that
exceed those on the reserve assets themselves. Perhaps most important, the ultimate
purpose of economic growth is to deliver higher living standards at home; thus, eventually,
the benefits of shifting productive resources to satisfying domestic needs must outweigh the
development benefits of continued reliance on export-led growth.
Improving the international system
The current international monetary system is not working as well as it should. Currency
undervaluation by surplus countries is inhibiting needed international adjustment and
creating spillover effects that would not exist if exchange rates better reflected market
fundamentals. In addition, differences in the degree of currency flexibility impose unequal
burdens of adjustment, penalizing countries with relatively flexible exchange rates. What
should be done?
The answers differ depending on whether one is talking about the long term or the short
term. In the longer term, significantly greater flexibility in exchange rates to reflect market
forces would be desirable and achievable. That flexibility would help facilitate global
rebalancing and reduce the problems of policy spillovers that emerging market economies
are confronting today. The further liberalization of exchange rate and capital account regimes
would be most effective if it were accompanied by complementary financial and structural
policies to help achieve better global balance in trade and capital flows. For example, surplus
countries could speed adjustment with policies that boost domestic spending, such as
strengthening the social safety net, improving retail credit markets to encourage domestic
consumption, or other structural reforms. For their part, deficit countries need to do more
over time to narrow the gap between investment and national saving. In the United States,
putting fiscal policy on a sustainable path is a critical step toward increasing national saving
in the longer term. Higher private saving would also help. And resources will need to shift into
the production of export- and import-competing goods. Some of these shifts in spending and
production are already occurring; for example, China is taking steps to boost domestic
demand and the U.S. personal saving rate has risen sharply since 2007.
In the near term, a shift of the international regime toward one in which exchange rates
respond flexibly to market forces is, unfortunately, probably not practical for all economies.
Some emerging market economies do not have the infrastructure to support a fully
convertible, internationally traded currency and to allow unrestricted capital flows. Moreover,
the internal rebalancing associated with exchange rate appreciation - that is, the shifting of
resources and productive capacity from production for external markets to production for the
domestic market - takes time.
That said, in the short term, rebalancing economic growth between the advanced and
emerging market economies should remain a common objective, as a two-speed global
recovery may not be sustainable. Appropriately accommodative policies in the advanced
economies help rather hinder this process. But the rebalancing of growth would also be
facilitated if fast-growing countries, especially those with large current account surpluses,
would take action to reduce their surpluses, while slow-growing countries, especially those
with large current account deficits, take parallel actions to reduce those deficits. Some shift of
demand from surplus to deficit countries, which could be compensated for if necessary by
actions to strengthen domestic demand in the surplus countries, would accomplish two
objectives. First, it would be a down payment toward global rebalancing of trade and current
accounts, an essential outcome for long-run economic and financial stability. Second,
improving the trade balances of slow-growing countries would help them grow more quickly,
perhaps reducing the need for accommodative policies in those countries while enhancing
the sustainability of the global recovery. Unfortunately, so long as exchange rate adjustment
is incomplete and global growth prospects are markedly uneven, the problem of excessively
strong capital inflows to emerging markets may persist.
Conclusion
As currently constituted, the international monetary system has a structural flaw: It lacks a
mechanism, market based or otherwise, to induce needed adjustments by surplus countries,
which can result in persistent imbalances. This problem is not new. For example, in the
somewhat different context of the gold standard in the period prior to the Great Depression,
the United States and France ran large current account surpluses, accompanied by large
inflows of gold. However, in defiance of the so-called rules of the game of the international
gold standard, neither country allowed the higher gold reserves to feed through to their
domestic money supplies and price levels, with the result that the real exchange rate in each
country remained persistently undervalued. These policies created deflationary pressures in
deficit countries that were losing gold, which helped bring on the Great Depression.3 The
gold standard was meant to ensure economic and financial stability, but failures of
international coordination undermined these very goals. Although the parallels are certainly
far from perfect, and I am certainly not predicting a new Depression, some of the lessons
from that grim period are applicable today.4 In particular, for large, systemically important
countries with persistent current account surpluses, the pursuit of export-led growth cannot
ultimately succeed if the implications of that strategy for global growth and stability are not
taken into account.
Thus, it would be desirable for the global community, over time, to devise an international
monetary system that more consistently aligns the interests of individual countries with the
interests of the global economy as a whole. In particular, such a system would provide more
effective checks on the tendency for countries to run large and persistent external
imbalances, whether surpluses or deficits. Changes to accomplish these goals will take
considerable time, effort, and coordination to implement. In the meantime, without such a
system in place, the countries of the world must recognize their collective responsibility for
bringing about the rebalancing required to preserve global economic stability and prosperity.
I hope that policymakers in all countries can work together cooperatively to achieve a
stronger, more sustainable, and more balanced global economy.
BIS Review 155/2010
BIS Review 155/2010
BIS Review 155/2010
BIS Review 155/2010
BIS Review 155/2010
BIS Review 155/2010