Transcript

Euro Zone Conference Call with Michael Deppler, Director, European I Department, IMF

September 16, 2003

MS. STANKOVA: Good morning everyone, and thank you for joining us today. I'm Olga Stankova with the External Relations Department at the IMF, and this is a briefing on this year's Article IV report on the Policies of the euro area. The briefing will be conducted by Mr. Michael Deppler, European I Department Director, together with Mr. Bankim Chadha, Chief of the EU Policies Division in the European I Department.

The briefing is on the record and under embargo until 15 minutes after conclusion of the conference call, and we will set the precise time when we conclude. A transcript of the briefing will be posted on the IMF website later today.

Now, let me turn the floor over to Mr. Deppler. Mr. Deppler, please.

MR. DEPPLER: Thank you. Good morning, everyone.

I just wanted to open with a few of the main points of the report. On the area's economic outlook, it's basically the one that's in the WEO. We are somewhat more cautious about the euro area than about the other main advanced countries. But because of an externally-led pickup we do see a recovery in the offing, but not a very robust one with inflation coming down fairly slowly.

The divergence in growth with the U.S. is reflects partly lower population growth, lower productivity growth, but also, in our view, the fact that adjustment to the bursting of the equity bubble has been slower than in the U.S., and also because of the appreciation of the euro.

In terms of the policy lines in the paper, there's basically an endorsement of monetary policy in the past. Looking forward, we see a need for monetary policy to give proper weight to downside risks on the inflation side, which we see as more problematic than upside risks to inflation. So we would see a need for monetary policy to maintain an accommodative bent until we are clear that a recovery is on track.

On the monetary strategy, there's a strong endorsement of the clarification of the ECB's two-pillar framework.

On fiscal policies, basically there's an endorsement of the Stability and Growth Pact as a broad long-run framework for the euro-area countries. This objective of balance in the medium term with a 3 percent deficit limit is an appropriate one in the longer term. The problem is how to get to that longer term given the shorter term.

Now, in this regard the report says that while the SGP is indeed about growth as well as stability, but growth is a matter of the quality of fiscal policies, the structural reform content, much more than the about the short-run demand management policies. So there's a strong emphasis in the report on improving the quality of fiscal adjustments in major countries.

In this regard we again go back to this business about trade-offs between the short term and the long term, and we see a half percentage of GDP fiscal adjustment per year as the standard that countries need to make. But for countries where there's significant improvement in the forward-looking content of the quality of fiscal policies—and we see some of that in parts of Europe—then we see some scope for trading off adjustment today for adjustment shortly down the road. In the report the precise way it's phrased is that we shouldn't be worried too much about it, the pace of adjustment in 2004, if we are sure that the quality and the pace of adjustment for the whole period 2004 to 2006 is going to be there.

This leads to the other major emphasis of the report which is the importance of structural policies in Europe. The report is quite striking in making the point that there is an abundant need for structural reforms. First of all, aging populations, meaning that the trend in growth rates in Europe is going to weaken pretty steadily over the next few years, and quite sharply, but there is scope and policies available to redress all of that, essentially by improving the utilization of labor, which is quite weak in Europe. I would say that some would also put the emphasis on the scope for improving productivity in Europe, but we view productivity as something which is less open to policy management than some of the issues in the labor market, and so labor market reforms are really viewed as key to strengthening growth prospects in Europe over the immediate term.

Let me close with a few words about some of the technical papers which we did for this report, because they have some interesting points, at least from a professional point of view. First there's a paper on inflation persistence in the euro area, and we've long thought that maybe persistence, the stickiness of prices, was greater in Europe than in the U.S. A somewhat surprising conclusion of that analysis is that while the process is a bit slower in Europe, in the end it's about the same as in the U.S. So that this has not been a source of difference between the us and the euro area.

There's a second paper on the role of demand versus supply shocks in explaining developments in Europe, which is at the root of the debates about what policies ought to be in Europe. There the paper doesn't really come to very clear conclusions. It's still unclear what the respective role of demand and supply are.

Then there is a paper on the pass-through of exchange rates to prices, where the finding is a fairly conventional one, that the pass-through of exchange rates is pretty slow, and basically the euro area, like the U.S., is a relatively closed economy.

There is also a paper on pension reforms in the context of the Stability Pact. Is the stability pact pension reform friendly? And the answer is yes, basically because you can deal with many of the problems of population aging through a cautious fiscal policy, but the other aspects that the paper underlines is that there really is a need to develop privately-funded pillars in Europe, partly so that people have a place to build up savings, which they're not going to be able to build up in the public sector. A final point is that there really is a need for more disinterested and informed information in Europe to make the populations aware of what the issues are in the longer term, and we find that the debate tends to be very polarized, and there's need for more objective information, and the paper presses the case for doing so.

I'll be glad to take your questions on any aspects of the report.

QUESTION: I was wondering if you think that currency appreciation in Asia would help or harm the euro Zone recovery?

MR. DEPPLER: The euro's appreciation that has taken place so far is viewed as an equilibriating adjustment, and as such is not problematic. It is slowing the growth of exports, and hence, is not helpful at this juncture, but in terms of the basic dynamics of the recovery, it's expected that recovery in the U.S. will help offset those negative effects. So I wouldn't see any difficulties with appreciation so far including the somewhat greater appreciation that we saw in the summer. If one went significantly beyond those kinds of euro-dollar rates, then the issue would become a bit more pointed, and there would be some implication for the pace of the recovery, as well as for policy, especially monetary policy.

QUESTION: My question was about Asian currency, if Asian currency's appreciated?

MR. DEPPLER: I would say that the broad context is one of global imbalances in current accounts. And this is sort of something that is hanging over the global economy over the medium term and needs to be resolved. I don't think there is an issue about how exactly these bilateral flows get solved, but there is a need particularly for the U.S. current account to rebalance. In this context, there's a need for the U.S. to rebalance not only vis-a-vis the euro area, but also vis-a-vis other currencies in the world. And from that point of view there is a need for a more balanced adjustments of the structure of exchange rates around the world.

QUESTION: It's a question about fiscal policy. Your paper suggests that perhaps next year, 2004, consolidation could be put on hold in some of the budget offenders in the EU and then they could perhaps do more over 2004 to 2006. Do you think that this is a policy that might be taken up by the Europeans? And are there not problems with this from a political point of view in that it does mean that the pact is, in effect—the stability pact has been broken by the two biggest economies in the euro zone? It doesn't seem to get around that problem.

MR. DEPPLER: First of all, as you say, the report does point to possibilities to sort of backload the pace of adjustment over the period 2004 to 2006. But it doesn't do so in an unconditional way. It does so in the context of policies that, sort of make credible commitments about adjusting not only in 2004 but also in 2005 and '06. And this is in the context of governments who basically have not been very forward-looking in terms of their fiscal policies. The basic stance of the paper is that for the SGP to work, these countries need to be more forward-looking in terms of—and think in terms of higher quality and sustainable adjustment in sort of correcting their situations.

So in that context, there is a willingness to trade—and this is a view, I should say, that's shared by Executive Board. There is a willingness to trade the timing of adjustment for the quality and the durability of the adjustment. That's the basic idea.

Now, is this in violation of the SGP? Well, in strict terms, the answer would have to be yes. But, frankly, in these kinds of situations, you have to—the economies are weak while these countries are in the situation they are in essentially because they didn't adjust in the past when they should have. Nonetheless, you are in a position of having to decide how to go forward. And in terms of the economics, we see the kind of posture set out in the paper as a reasonable one, and that gets all these countries back into a workable framework within the SGP over the medium term.

QUESTION: What could be the consequences of the Swedish referendum and of the failure of Cancun?

MR. DEPPLER: Clearly this is a disappointment from the point of view of the attractiveness of the euro area, and in the other case for multilateral free trade.

The euro area is going through a difficult patch right now and clearly is in the process of needing to work out key policies and basic modus operandi. I wouldn't take sort of longer-term views on these things, but I would certainly take it as a wake-up call for these countries to become more diligent in making the euro area sort of a growth area in the future, which is clearly what we call for in all respects. It's basically a question of growth. My reading would be that this is in the pipeline.

On Cancun, I would only say that the Fund and the Fund's Executive Board has pressed the EU, but also other advanced economies, to sort of be more prepared to make concessions towards achievement of the Doha Round. And, you know, this has clearly not happened given the events of this weekend. But we would hope that this would come back on the agenda in the months and years to come.

QUESTION: Yes, a question about the European central bank. Two questions. Your report says that the bank should maintain an accommodative stance for sometime to come. If growth continues on the path that you've laid out or that you've forecast sort of rising to 2 percent next year, do you think there might be a case for the ECB changing bias perhaps late this year, late next year? And a sort of follow-up question. The ECB recently announced reforms to its Governing Council to prepare for enlargement. What's the IMF's view on those changes? Do you think that perhaps the bank might become a bit unwieldy with so many new entrants coming up in the next couple of years?

MR. DEPPLER: On the first question, the phrase we used is accommodative bent, and basically our view is there should be an accodmodative bent until we see this recovery in hand, we are concerned about the downside risks not only to growth, but also when we move to inflation. And we see the risks of inflation undershooting the ECB's inflation target, below but close to 2 percent, as significant. And these are things that need to be guarded against. So until we see sort of an investment-propelled recovery in the euro area, we think the ECB should maintain an accommodative bent.

Now, when we see this pick-up in investment in particular, then I think, the situation needs to be reassessed. But, frankly, as of now, while the expectations indices have improved, there's little sort of hard evidence in terms of actual economic statistic, or, rather, mixed evidence in any case of a recovery. And from our point of view, it's too early to even be thinking about changing the stance.

QUESTION: And the follow-up on the enlargement of the ECB Governing Council?

MR. DEPPLER: The EU institutions involve a large number of people, and, frankly, it's not always very clear that this is the best way to do business. But by the same token, there is a need to accommodate sort of the multinational character of these policies. And so, these compromises are made, and the one they have made seems to us on a par and as workable as the other arrangements they've made in constructing the euro zone.

OPERATOR: We have no further questions in queue at this time. Please continue.

MS. STANKOVA: Thank you, everyone. If you would like to have a copy of Mr. Deppler's introductory remarks or if you have any follow-up questions, please send me an e-mail or give a call, and we will send you the remarks or try to arrange responses to your follow-up questions.

Mr. Deppler's remarks and responses will be embargoed until 8:40 a.m. Washington time, which is 1240 GMT. And we also would like to announce that we lift the embargo on the IMF's report on the euro area policies at this time, at 8:40 a.m. Washington time, which is 1240 GMT.

Thank you for being with us today and good-bye.