Laurence Meyer April 14, 2004

MPIMeyer’s

The Global Outlook & Challenges for Monetary Policy

Global Issues and the U.S. OutlookGlobal Interdependence Center

April 14, 2004

Laurence H. MeyerSenior Adviser, Macroeconomic Advisers

mMacroeconomic Advisers, LLC www.meyersmpi.com 2

MPIMeyer’sOutline

• New and Old Challenges for Monetary Policy

• Global Outlook Themes

• Global Influences on the U.S. Outlook

• Country/Regional Developments

• Challenges to Monetary Policy


MPIMeyer’sGlobal Disinflation & the Great Moderation

0

2

4

6

8

10

12

14

16

84 86 88 90 92 94 96 98 00 02 04

H FPercent

Foreign

US

US Consumer Price Index andTrade-Weighted Foreign Consumer Price Index


MPIMeyer’sGlobal trend to Higher Interest Rates

2

4

6

8

10

12

14

84 86 88 90 92 94 96 98 00 02 04

Percent

10-year

Foreign

US 10-year Treasury YieldTrade-Weighted Foreign Government Bond Yield

H F


MPIMeyer’sU.S. and Foreign Real GDP Growth

-1

0

1

2

3

4

5

6

1999 2000 2001 2002 2003 2004 2005

United StatesWorld

4-quarter growth, percent

US GDP Growth and Trade-weighted Foreign GDP Growth

Foreign

H F


MPIMeyer’sGlobal Issues

• Synchronous global recovery• Initial conditions: low nominal, real rates and inflation• Little scope for monetary/fiscal stimulus• Diversity in challenges facing central banks• Adjustment of global imbalances/an asymmetry• Cyclical rebounds vs structural considerations• Common transitions: fiscal consolidation/global aging• China & India: threat or opportunity/managing success• Geopolitical uncertainty and terrorism


MPIMeyer’sThe U.S. Current Account Deficit

90

95

100

105

110

115

120

-560

-520

-480

-440

-400

-360

-320

2000 2001 2002 2003 2004 2005

Billions of US $1997=100Net Exports and Real Trade-Weighted Foreign Exchange Rate

Real Trade-Weighted35-Country

Foreign Exchange Rate

Net ExportsH F


MPIMeyer’sAdjustment of Global Imbalances

• U.S. current account deficit part of the global imbalance– More difficult for us or our counterparties?– Gradual or chaotic?– Sooner or later?– Narrowly or more broadly based?

• Implications of Asian accumulation of $s– Transition from private demand to official accumulation– Reduces breadth and overall amount of adjustment– Reduces immediate need for adjustment– Course of adjustment now depends on policy considerations

• Challenges– High U.S. import elasticity and initial conditions– Difficult to make adjustment unless ROW grows faster than U.S.– Japan, Euro area addicted to external demand– Difficult to be successful unless U.S. raises national saving


MPIMeyer’sDepreciation and U.S. Net Exports

105

110

115

120

125

130

135

-560

-520

-480

-440

-400

-360

-320

2000 2001 2002 2003 2004 2005

net exports

Trade-Weighted35-Country

Foreign Exchange Rate

Net Exports and Trade-Weighted Foreign Exchange RateBillions of US dollars1997=100

H F


MPIMeyer’sThe Global Rebound and Commodity Prices

-20

-10

0

10

20

30

1990 1992 1994 1996 1998 2000 2002

12-month percent change

Crude Core PPI


MPIMeyer’sHigher Oil Prices

16

20

24

28

32

36

40

2000 2001 2002 2003

West Texas IntermediateUS Dollars


MPIMeyer’sHow Much Pass-Through to Import Prices?

-12

-8

-4

0

4

8

2000 2001 2002 2003

Nonpetroleum Import Prices3-month percentage change, annualized


MPIMeyer’sCountry/regional Issues

• U.S.: productivity, employment and monetary policy

• Japan: finally a breakout and if so, why?

• Is China overheating and if so, hard or soft landing?

• Euro area: destined and content to under perform?


MPIMeyer’sProductivity Growth: How much will it slow?

1

2

3

4

5

6

96 97 98 99 00 01 02 03 04 05

H F

1-year

5-year

percentProductivity Growth


MPIMeyer’sAggregate Demand vs. Productivity Growth

-2

0

2

4

6

8

10

2000 2001 2002 2003 2004 2005

percent

GDPProductivity

GDP Growth and Productivity Growth


MPIMeyer’sWhat Drives Monetary Policy?

2000 2001 2002 2003 2004 2005-2

0

2

4

6

8

10

2000 2001 2002 2003 2004 2005

unemployment rate

core CPI

1-quarter GDP growth

percent

The Unemployment Rate and Core Inflationin the Forecast

H F


MPIMeyer’sReal GDP Growth and Inflation in Japan

H F

-4

-3

-2

-1

0

1

2

3

4

5

95 96 97 98 99 00 01 02 03 04 05

Percent

JapanReal GDP and Consumer Prices

consumer prices

Real GDP

H F


MPIMeyer’sReal GDP Growth and Inflation in Euro Area

H F

0

1

2

3

4

5

95 96 97 98 99 00 01 02 03 04 05

Real GDP

Consumer Prices

Percent

EurozoneReal GDP and Consumer Prices

H F


MPIMeyer’sChina and India

2

4

6

8

10

12

95 96 97 98 99 00 01 02 03 04 05

China India

Percent

China and IndiaGrowth of Real GDP

H F


MPIMeyer’sReal GDP Growth and Inflation in China

H F

-5

0

5

10

15

20

25

95 96 97 98 99 00 01 02 03 04 05

Consumer prices

Real GDP

Percent

ChinaReal GDP and Consumer Prices

H F


MPIMeyer’sChange in Chinese Exchange Rate Regime?

• U.S., Euro, Asian, and Chinese perspectives

• Sequencing and the reluctance to float

• Consistency with domestic policy objectives

• Intermediate steps– Widening the band– Discrete revaluation– Moving to a market basket– Partial and gradual relaxation of capital controls


MPIMeyer’sThe Outsourcing Debate

• The magnitude of the problem?

• Bearing backlash to globalization, productivity

• Widening job insecurity related to globalization

• Winners and losers and the Pareto principle

• Reducing the gains from trade?

• The policy response


MPIMeyer’sMonetary Policy around the World

• Exit problems and return to neutrality

• Learning about nonconventional policy (Japan)

• Structural constraints (Euro area and Japan)

• Productivity and monetary policy (U.S.)

• Transparency and inflation targets

• Monetary policy and bubbles


MPIMeyer’sMonetary Policy in the U.S.: Sooner or Later

•Return to neutrality:– What is the neutral value of the funds rate?– What is the implicit inflation target and what is the NAIRU?– Timing of the start of tightening

• Preconditions and triggers• Higher hurdle for first move and never surprise the market• Should the Fed still “err on the side of ease?”• The two gaps story: how far from full employment & neutrality?• Accelerators: role of equity valuations, term and risk spreads• Patiently preemptive?• Does the election influence the timing of tightening?

– The pace of tightening and interaction with timing (via Greg Ip)• “Baby Steps”: Start early and move slowly• “Backloading”: Start later and then converge more quickly• “Late and Leisurely”: Start later and move slowly


MPIMeyer’sSooner or Later

• Later– Slow decline in unemployment rate, stable core inflation– Concern about inflection point/2nd half slowdown– Limited concerns with financial imbalances as accelerator– Maximin and comfort in still erring on side of ease

• Sooner– Faster decline in unemployment rate/upward rend in core inflation– Two gaps: not so far from potential/long way to neutrality– Reluctance to continue erring on side of ease– Preference for gradualism


MPIMeyer’sThe Taylor Rule and the MPI Call

0

2

4

6

8

10

88 90 92 94 96 98 00 02 04

Prescribed

Actual, MPI Forecast

H F

Taylor Rule Using Short-Run NAIRU

Actual, MA Forecast


MPIMeyer’sEvolution of Monetary Policy in Japan

• February 1999: zero rate policy

• April 1999: first statement re precommitment– “until deflationary concerns dispelled”

• August 2000: terminated ZRP/raised policy rate ¼ pp

• February 2001: returned to (near) zero policy rate

• March 2001: adopted “quantitative easing”– Targeting current account balance at BOJ– Clarified precommitment: until CPI inflation stable at zero or above


MPIMeyer’sEffectiveness of Nonconventional policy

• Limits to monetary policy: broken multiplier

• Quantitative easing

• Precommitment

• Improving the transmission mechanism


MPIMeyer’sECB

• Differences in objective conditions or strategy?

• Dismissive of “stabilization policy”

• Asymmetric re response to inflation

• Limits on monetary policy/structural constraints


MPIMeyer’sInflation Targets and Inflation Targeting

• Trend toward inflation targeting• U.S. and Japan: do not have explicit targets• Exit issue: what is the “implicit” inflation objective• Price stability vs. price stability + cushion• Transparency, accountability, and effectiveness• Hierarchical vs. dual mandates• Trade-off between inflation target & flexibility?• Explicit inflation objective within dual mandate


MPIMeyer’sMonetary Policy and Asset Bubbles

• Lessons from equity bubble: – Difficult to reach timely judgment about danger of bubble– Indirect vs. direct approaches – In close call, encourages tighter policy

• Today concerns with housing bubbles in UK, Australia – Contributed at margin to decisions to tighten

• U.S.– Some talk about bond market bubble– Reaching for yield across term and risk structure– Increases exit problem

Laurence Meyer April 14, 2004

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