The global economy remains very much in a holding pattern – stable, and getting better, but still highly vulnerable – IMF managing director Dominique Strauss-Kahn said in London on Friday.
Speaking at the annual conference of the Confederation of British Industry, Strauss-Kahn observed how major advanced country areas in particular remain fragile, still dependent on policy support. Financial conditions have improved, but are far from normal.
“Signs show confidence returning, but banking systems in many advanced economies remain undercapitalised and weighed down by leaden legacy assets and, increasingly, non-performing loans,” he told the conference of UK private sector employers. “On the household side, weak financial positions and high unemployment will dampen down consumption for some time. And large public deficits add to vulnerabilities.”
Strauss-Kahn said it is still too early for a general exit from accommodative fiscal, monetary, and financial sector policies. Instead, such an exit should await a sustained recovery in private demand, as well as entrenched financial stability.
“Exit too soon, and you kill the recovery. Exit too late, and you sow the seeds for the next crisis,” he said. “We recommend erring on the side of caution, as exiting too early is costlier than exiting too late.”
As the pace of recovery differs among countries, so must exit strategies differ, Strauss-Kahn stressed. Plans for fiscal consolidation should be the top priority, especially in advanced economies.
A related challenge to exit strategies is managing capital flows to emerging markets. “In many countries, appreciation should be the key policy response. Other tools include lower interest rates, reserves accumulation, tighter fiscal policy and financial sector prudential measures. Capital controls can be part of the package of measures,” he said. “But we should recognise that all tools have their limitations. We should be pragmatic,” he added.
Old growth model is dead
Turning to the sources of future growth, Strauss-Kahn said the old model under which households in the United States and elsewhere propelled the global economy with their voracious appetite for consumption, is dead – or at least on its last legs.
“If we are to have sustained global growth, somebody else needs to step into the breach. The leading candidates are the surplus countries,” Strauss-Kahn said, noting that China and other emerging Asian economies are shifting from exports toward domestic demand, aided by expansionary fiscal policy.
“But they have some way to go,” he stated. “This shift would be helped by stronger social security systems and higher spending on health and education, as well as reforms to boost access to credit. An appreciation in China’s exchange rate, along with some other Asian currencies, will also need to be part of the package.”
Noting that the financial sector in the advanced economies brought down the whole global economy, Strauss-Kahn called for progress on reforms to make the financial sector a safer, more stable place, without discouraging financial innovation.
Better application of rules
“In addition to better rules, we need a better application of rules – and that means beefing up supervision and supervisory capacity,” Strauss-Kahn said. “The new regulatory system must do a better job of avoiding capture and complacency. This is another lesson from the crisis.”
On addressing risk management in the financial sector, he added that it was essential to break the link between risky behaviour and compensation. “In this context, we have been asked by the G-20 to look into financial sector taxes. There are a number of ways to think about this, and we will look at it from various angles and consider all proposals,” he said.