Coherent, Comprehensive, and Coordinated Approach to...

Coherent, Comprehensive, and Coordinated Approach to Economic

PolicyVitor Gaspar

Director, Fiscal Affairs DepartmentInternational Monetary Fund

DG ECFIN Annual Research Conference Brussels, November 23, 2015

Motivation

2003 ECB Evaluation of its Monetary Policy Strategy

“As regards the risk of deflation for the euro area as a whole, the risk that the monetary authority would have to lower interest rates to zero and then be effectively constrained by the zero lower bound does not seem to be substantial for inflation objectives below but close to 2% per annum.”

2

0.00

1.00

2.00

3.00

4.00

5.00

6.00

Jan-03 Dec-04 Nov-06 Oct-08 Sep-10 Aug-12 Jul-14

Monetary Policy Rates (percent)

United States

Euro Area

Japan

Note: Euro Area policy rate: Main Refinancing Operations Minimum Bid Rate. Japan policy rate: Uncollateralized Overnight Call Rate. United States policy rate: Fed Funds Target Rate.Source: Haver Analytics. Monthly data. Latest observation October 2015 for the Euro Area and United States, November 2015 for Japan.

Outline of the Presentation

1. Risks in the Macroeconomic Landscape

2. Shocks and Propagation at the Zero Lower Bound

3. Coherent, Comprehensive, and Coordinated Approach to Economic Policy

4. Japan

5. Conclusion

3

4

1. Risks in the Macroeconomic Landscape

Economic activity: Weak Recovery

5

Industrial production index

40

60

80

100

120

140

160

180

0 10 20 30 40 50 60 70 80Months

Japan

June 1929-November1936; June 1929 = 100

April 2008-September2015; April 2008 = 100

40

50

60

70

80

90

100

110

120

0 10 20 30 40 50 60 70 80Months

United States

Great depression

Global financial crisis

40

50

60

70

80

90

100

110

120

0 10 20 30 40 50 60 70 80Months

Euro Area

Note: For the Euro Area, the 1929 to 1936 series corresponds to the average across France, Germany, and Italy.Source: Eichengreen, B. and K.H. O’Rourke (2010) “What do the new data tell us?” VoxEU.org , 08 March; League of Nations Statistical Yearbooks 1934-38 made digitally available by Northw estern University Library at http://digital.library.northw estern.edu/league/stat.html ; Federal Reserve Bank of St. Louis; Haver Analytics and IMF staff estimates. Latest observation September 2015.

http://digital.library.northwestern.edu/league/stat.html

Economic activity:Low growth expectations

6Source: IMF World Economic Outlook October 2015.

Potential GDP Growth, 1995–2020(Percent)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

United States

Euro Area

Japan

Inflation dynamics:Low inflation for too long

7Source: Haver Analytics. Monthly data. Latest observation September 2015 for Japan, October 2015 for the United States and Euro Area.

Price Level Path, January 1999–October 2015 (Index, January 1999=100)

80

90

100

110

120

130

140

150

Jan-99 Jan-02 Jan-05 Jan-08 Jan-11 Jan-14

United States

Euro Area

Japan

Price level growing at2 percent

5y5y Inflation Linked Swap Rate, Daily rates, January 2013 to November 2015 (Percent)

Source: Bloomberg. Latest observation November 20, 2015.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

12/31/2012 12/31/2013 12/31/2014

Euro Area

Japan

5y5y

5y5y

30 day average

30 day average

United States

30 day average

5y5y

170

180

190

200

210

220

230

240

250

260

270

2005 2007 2009 2011 2013 2015 2017 2019

Spring 2007

8

Japan: Revisions to General Government Gross Debt, 2005-2020

(percent of GDP)

Sources: IMF, Fiscal Monitor October 2015 and World Economic Outlook October 2015

Low nominal growth is adversely affecting public finances

October 2015

2013 Spring

Spring 2011

Spring 2009

Italy: Revisions to General Government Gross Debt, 2005-2020

(percent of GDP)

90

100

110

120

130

140

150

2005 2007 2009 2011 2013 2015 2017 2019

Spring 2007

Spring 2009

Spring 2011

Spring 2013

October 2015

9

2. Shocks and Propagation at the Zero Lower Bound

Monetary policy: Zero Lower Bound

10

Inflation and Monetary Policy Rates(Percent)

Note: Euro Area policy rate: Main Refinancing Operations Minimum Bid Rate. Japan policy rate: Uncollateralized Overnight Call Rate. United States policy rate: Fed Funds Target Rate. Source: Haver Analytics and IMF Staff calculation. Latest observation September 2015 or October 2015.

September 2007


11



September 2011


12



September 2015

Central bank total assets (billion Euro)

0

500

1000

1500

2000

2500

3000

3500

4000

4500

Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14 Apr-15


13Note: Euro Area policy rate: Main Refinancing Operations Minimum Bid Rate. Japan policy rate: Uncollateralized Overnight Call Rate. United States policy rate: Fed Funds Target Rate. Source: Haver Analytics and IMF Staff calculation. Latest observation September 2015 or October 2015.

United States

Euro Area

Japan

US and Japan policy rate at 0.15

Euro Area policy rate at 0.15

In normal times, longer-term market interest rates and exchange rates act as shock absorbers

14

q: real exchange rate; e: nominal exchange rate; i: nominal interest rate; r: real interest rate; δ: risk premium

}{][0

*

0jt

k

jjt

k

jjt ieei tkt +

=+

=+ ++↑−=↓ ∑∑ + δ

}{][0

*

0jt

k

jjt

k

jjt rqqr tkt +

=+

=+ ++↑−=↓ ∑∑ + δ

At the ZLB, longer-term market interest rates and exchange rates act as shock amplifiers

15p: domestic price level; p*: foreign price level; q: real exchange rate; e: nominal exchange rate; i: nominal interest rate; r: real interest rate; δ: risk premium

}{][0

*

0jt

k

jjt

k

jjt ieei tkt +

=+

=+ ++↓−↓= ∑∑ + δ

}{][0

*

0jt

k

jjt

k

jjt rqqr tkt +

=+

=+ ++↓−=↑ ∑∑ + δ

*ktppeq ktktkt ++− +++ ↓↓=

ktppt +⇒ ↓↓

1+↓−=↑ tttt Eir π

16

Example of Exchange Rates as Shock Amplifiers: Japanese Yen Appreciates on Bad News (Decline in the Nikkei Index)

Note: Jan 2006=100; Domestic-oriented stock market index: average of real estate, w holesale trade, retail trade, banks, insurance and services.Source: Haver Analytics and IMF Staff Calculations. Latest observation October 2015.

0.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

0

20

40

60

80

100

120

140

Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15

Yen/US$St

ock

pric

e in

dex

Nikkei Stock Average: TSE 225 (left axis)

Domestic-oriented (left axis)

Yen/US$ (right axis)

Japan: Stock Market Indices and Exchange Rate

Germany France Italy Spain Ireland

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

7/31/14 9/30/14 11/30/14 1/31/15 3/31/15 5/31/15 7/31/15 9/30/15

Communication at the ZLB

17Source: Bloomberg and IMF Staff calculation. Latest observation November 20, 2015. Sovereign bond yield minus inflation swap rate at the corresponding maturity.

Selected Euro Area Countries: Real One-Year Sovereign Bond Yields (percent)

Sept. 4: QE announced (ABS, Covered bonds)

Dec. 4: Governing Council meeting

Jan. 22: Expansion of QE announced

Mar. 9: Public Sector Purchase Programme begins

Sept. 3: Pledge to extend QE beyond

Sept. 2016, if needed

18

3. Coherent, Comprehensive, and Coordinated Approach to Economic Policy

19

• Options to remove the ZLB• Cashless economy (Wicksell 1935, 1936; Woodford, 2003)

• Stamped currency (Keynes, 1936; Goodfriend, 2000)

• Electronic money (Buiter 2009; Agarwal and Kimball, 2015)

Can the ZLB be removed?

20

• With interest rate policy constrained, unconventional monetary policy is followed to achieve price stability

• But the impact of UMP is more uncertain than conventional policy (regarding its effects on broader financial conditions, economic activity, and inflation)

• Structural reforms can improve long-run prospects for employment and output

• But in some cases these have short-term costs (October 2014 Fiscal Monitor)

• They are slow to implement, or slow to gain traction• May be deflationary (Eggertsson, 2013)

Challenges associated with UMP and structural reforms

21

In some circumstances, support from fiscal policy is needed, and can be especially effective at the ZLB

1. Fiscal policy can serve as a backup to monetary policy• Makes demand management policies credible and effective

• Larger automatic stabilizers can reduce the likelihood of becoming constrained by the zero lower bound

2. Structural fiscal reforms can make tax and expenditure policies more growth-friendly

3. Fiscal policy can encourage structural reform• Offsetting potential short term economic costs of reform

• Mitigating the distributive effects of structural reform• Supporting demand to avoid deflationary pressures

Fiscal policy can support monetary and structural policy

22

Coherent, Comprehensive, and Coordinated Approach to Economic Policy

Sustained and inclusive economic growthCPI inflation at 2% over the medium term

Jobs creation

+ +Fiscal

Infrastructure investment;

targeted transfers

Structural

Labor market; product market;

tax system

Monetary

Unconventional monetary

policy

23

4. Japan

24

Japan: 3-C Approach based on 4 Legs

Challenges: Weak growth prospects, vulnerable to deflationary shocks, high public debt, declining population

Need for a Coherent, Comprehensive, and Coordinated policy package based on 4 legs:1: Monetary policy framework to improve policy effectiveness and support more consistent policy communications

2: Fiscal policy framework that provides demand support while managing public sector balance sheet risks

3: Incomes policy to support the monetary policy framework and guard against deflation

4: Structural reforms to raise potential output.

VAT hike in 2017 from 8% to 10%

Japan: Simulations for a 3-C Policy Package

Illustrative simulations based on the Flexible System of Global Models (FSGM) described in IMF Working Paper No. 15/64. 25

26

5. Conclusion

Monetary policy is overburdenedSingle vs National Policies in the Euro Area

27

EA Single policies

National policies

Monetary

Financial

Fiscal

Economic

Social

Monetary policy is taking on most of the burden to support demand.

What fiscal policies can be put in place to support demand and long-run prospects?

What are the minimum fiscal requirements for sustainability of the euro area?

What should be the priorities?

Monetary policy is overburdened

28

Fiscal

Social

Economic

Monetary

Financial

• Macroeconomic stabilization policies need to be accompanied with structural policies to improve competitiveness and increase potential growth.

• Demand management policies can support the implementation of structural reform policies, by offsetting their potential short term economic costs or mitigating their distributive effects.

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Conclusion

30

Thank You!

• Agarwal, R. and M. Kimball, 2015, “Breaking Through the Zero Lower Bound”, IMF Working Paper No. 15/224.

• Andrle, M., P. Blagrave, P. Espaillat, K. Honjo, B. Hunt, M. Kortelainen, R. Lalonde, D. Laxton, E. Mavroeidi, D. Muir, S. Mursula, and S. Snudden, 2015, “The Flexible System of Global Models –FSGM”, IMF Working Paper No. 15/64.

• Buiter, W. H., 2009, “Negative Nominal Interest Rates: Three Ways to Overcome the Zero Lower Bound”, NBER Working Paper No. 15118.

• Eggertsson, G., A. Ferrero, A. Raffo, 2013, “Can Structural Reforms Help Europe?” International Finance Discussion Papers Number 1092.

• Keynes, J. M. (1936): General Theory of Employment, Interest, and Money, London: Macmillan and Co. Limited.

• Goodfriend, Marvin, 2000, “Overcoming the Zero Bound on Interest Rate Policy,” Journal of Money, Credit, and Banking, Vol. 32(4)/2000, S. 1007–1035.

• International Monetary Fund, October 2014, Fiscal Monitor: Back to work: How Fiscal Policy Can Help.

• Wicksell, K., 1935, Lectures on Political Economy, London: Routledge & Kegan Paul Ltd.

• Wicksell, K., 1936, Interest and Prices: A Study of Causes Regulating the Value of Money, London: Macmillan and Co. Limited.

• Woodford, M., 2003, Interest and Prices; Foundations of a Theory of Monetary Policy, Princeton University Press, Princeton and Oxford. 31

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