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International Economics

Speaker: John P. Lipsky, First Deputy Managing Director, International Monetary Fund
Presider: Richard Clarida, Professor of Economics and International Affairs, Columbia University, and Global Strategic Advisor, Pimco
December 17, 2008
Council on Foreign Relations


RICHARD CLARIDA:  Welcome.  I'm Richard Clarida, member of the council, professor of economics at Columbia University and global strategic advisor with PIMCO.

And welcome to this session.  This session, I should say, is part of the Peter McCullough series on international economics.

A couple of -- couple of reminders.  Please completely turn off -- not just on vibrate, but turn off your cell phones, BlackBerrys, all wireless devices, because they do interfere with the PA system.  And I include myself in that, so it's off.

I would also like to remind the members that this session is on the record, so please take that into account.  And we'll be organized as follows:  I'll introduce our speaker.  He will then have some time to give some opening remarks.  We'll then go to a question-answer session.  One of my -- the perks of doing this is I get to ask the first couple of questions and then we throw the floor open to you for the remainder of the time.  And we hope to be done by 9:00 A.M.

Well, we are really very lucky today and very pleased today to have someone who I think is known to most if not all of you, John Lipsky, who of course is the first deputy managing director of the International Monetary Fund, a position that he assumed in September of 2006.  Little did he know what was in store for him; little did we know.  But I certainly can say, from my own perspective, I could not think of a better individual to be in that crucial policy job than John Lipsky, who I've known for 15 years.

Before coming to the Fund, John was the vice chairman of the JPMorgan investment bank.  And in this position, he advised the firm's risk-takers, published independent -- and I can certainly say, from my perspective, very influential -- research on global financial markets, and was actively engaged in Morgan's -- with Morgan's key clients and represented the firm around the world.  Previously to that position, John served as the chief economist at JPMorgan and Chase Manhattan bank and also earlier in his career was with Salomon Brothers.

That obviously is an excellent background.  More importantly I think, vis-a-vis the IMF, John Lipsky chaired a financial sector review group at the International Monetary Fund, in 2000, a very important group, I think, from the perspective of reorienting the IMF's focus, into a world of financial globalization, and obviously one that prepared him very well for the current job.

Mr. Lipsky's current professional activities include serving on the board of directors of the National Bureau of Economic Research.  And prior to joining the IMF, he served as the director of several corporations and non-profit organizations.  He's a graduate of Wesleyan University and was awarded both an M.A. and Ph.D. from Stanford University.

So with that, John Lipsky.  (Applause.)

JOHN P. LIPSKY:  Thanks, Richard.  Thanks for those kind words.  Glad to be back.  Two points you left off of that biography.  I'm a member here.  But also for many years, looking around the room, one of the most fun things I did was the periodic -- these global economic -- what did they call them, global economic updates, with Dan Tarullo and Stephen Roach?

That was -- we had lots to talk about but nothing quite as dramatic as we have now.  But thank you very much for coming out so early on what is one of the shortest and hence the darkest days of the year.

Well, today's limited sunlight unfortunately provides an appropriate setting for discussing the current situation in financial markets and the global economy.  And certainly attempts to improve financial markets and the economy undoubtedly would benefit from both more light and more heat.  And hopefully the coming months will eventually begin to supply both.

Although I'm going to begin with a brief review of the near-term outlook, the principal theme of my remarks today is the current and prospective role of the International Monetary Fund.  And certainly in the question-and-answer session after, feel free to ask any questions you'd like, regardless of whether it's a topic I've covered in my talk.  But you will not be surprised that my primary thesis is that the IMF can contribute significantly and perhaps uniquely to dealing with both the current and likely future challenges.

In the broadest sense, the IMF's principal tasks are to help reduce the global economy's systemic instabilities and to promote effective countercyclical policy action.  In other words, the fund has been mandated by its members, who today total 185 countries, to play both a structural and a cyclical or, better put, a countercyclical role.

I also believe that this role fits neatly and inevitably into the emerging consensus about governance of the post-crisis global economy and the financial markets.  I'll discuss the fund's role and its governance implications in a bit more detail at the end of my remarks.

Regarding immediate prospects, my principal message is that additional and vigorous policy action will be needed, in order to avoid a serious global downturn.  Officials should concentrate their efforts on achieving such an outcome, as the emergence of substantial output gaps, in economies around the world, would leave a legacy of reduced output, lost opportunities and sacrificed well-being.

The measures needed, to avoid this, encompass both renewed efforts at stabilizing financial systems as well as monetary and budget measures to support final demand.  For now, global financial markets appear to have stepped back a bit from the brink in response to very aggressive policy support measures.  Nonetheless, the danger of renewed deterioration remains high in several markets, while funding and liquidity markets are still severely strained.

These negative developments reflect deep shocks that have undermined confidence in financial market counterparties, persistent concerns over future losses and funding needs, and large losses in bank and other institutions' capital.  Thus, financial market deleveraging is still under way, underpinning our base-case expectation of a substantial and sustained slowdown in credit growth through the coming year.

Moreover, financial stresses have spread now to emerging markets, where equity-market downturns by now have equaled or outstripped those in advanced-economy markets and where outflows from debt markets threaten to reverse the structural progress that has been one of the most striking recent financial-market developments.

Now, against the background of weak financial markets, last month we revised lower our forecast for global growth.  Based on current policies, global economic growth is projected to decelerate to only 2-1/4 percent in 2009.  And that's down from 5 percent last year.  And we also scaled back our projection for recovery in 2010.

While we believe that efforts to stabilize financial conditions and strengthen demand-support measures could still enable a gradual recovery beginning in the second half of next year, it seems likely that we will be reducing again our growth forecast, notably in the upcoming January update of the World Economic Outlook.

Now, the Fund's extensive experience in dealing with crises in advanced emerging and developing economies has provided important lessons about which policies are more likely to be successful in reversing the economic downturn.  In particular, more effective policy measures are needed to restore financial markets and to support demand.  However, as has been evident from recent developments, achieving these goals is far from assured.

The Fund's extensive experience has underscored that a comprehensive and aggressive approach is required in order to reestablish financial-sector functionality.  In particular, three elements have proven to be necessary for success, comprising liquidity support of the kind that we've seen aggressively by the Fed's recent action, recapitalization of institutions, and the removal of damaged assets from balance sheets.

Measured by this triple standard, however, virtually all of the policy initiatives implemented thus far here and elsewhere have tended to -- have -- the measures taken to underpin financial-market functionality have tended to be partial rather than comprehensive.  Thus, it is not surprising that the sharp slowdown in credit growth here and abroad shows no sign of abating.  Redoubled efforts across the board will be required if the deleveraging is to be contained without creating substantial further damage to the financial system and to the global economy.

Let me underscore that again.  Liquidity provision alone is not going to reverse the deterioration in financial systems.  Recapitalization and the cleansing of balance sheets are necessary as well if there is going to be success.  And so far we have not seen the kind of comprehensive, across-the-board measures that will be necessary to produce the desired result.

With the global economy facing major challenges, there is no doubt about the need for both monetary and fiscal measures to support demand as well.  With inflation pressures currently in retreat, more aggressive monetary policy measures are justified in many key economies -- perhaps aggressive measures of the sort that we saw yesterday in Washington.  However, Fund experience has shown that fiscal action may become more important when impaired credit channels make monetary policy measures less effective and when there's a sharp rise in desired private savings.

In the current circumstances, our research suggests that the needed fiscal stimulus will be large.  Specifically, we've recommended that measures should total about 2 percent of global GDP.  We've also recommended that fiscal measures should be diversified, including both tax and spending measures, and that they should be sustained in their impact, given the seriousness of the downturn and its likely duration.

However, we also emphasize that individual countries' circumstances, including budget balance, debt position, and spare capacity availability, will dictate the degree to which fiscal -- which fiscal measures are appropriate, as well as the type of measures that are likely to be most useful in each individual case.

Now, the sustained turmoil in global financial markets over the past 16 months has revealed the degree to which our current economic and financial system contains powerful elements of procyclicality.  As I mentioned earlier, a key responsibility of the IMF, as mandated in its constitution, the Articles of Agreement, is to promote systemic improvements and to resist procyclical tendencies.

An essential way in which the IMF has been countering procyclicality is by promoting multilateral cooperation in setting policies.  Of course, this is directly in keeping with its original aim to avoid the disastrous Depression-era spiral of tariff protection, currency controls and competitive devaluations.

While this lesson is widely accepted, it turns out that "good neighbor" policymaking cannot be taken for granted, even in this age of globalization.  Indeed, when serious economic and financial strains appear, it is not surprising that pressures mount on national authorities to protect domestic interests.  These pressures can persist, even when they may appear to be detrimental to neighbors and other trading partners.

A recent case in point is deposit insurance.  Last September and October, the sudden emergence of heightened market volatility following the spectacular collapse of several well-known financial institutions produced a mushrooming of deposit guarantees around the world.  In part, this reflected underlying stress; but the authorities in many countries also feared that deposits and capital would flow out to neighbors that offered superior guarantees, forcing them to follow suit and match terms offered elsewhere.  The IMF spoke forcefully in favor of a coordinated approach, which, thankfully, did emerge within days following the mid-October IMF annual meetings.

More broadly, policy collaboration must remain a very high priority if we're to succeed in cushioning the cyclical downturn currently underway.  For example, the impact of fiscal stimulus is magnified when demand-boosting measures are implemented more or less simultaneously among key trading partners.  This doesn't mean that country authorities should try to do the same thing at the same time, but rather each should undertake the measures that are appropriate for the circumstances more or less at the same time.  Those kind of measures are mutually enforcing.

As I suspect you're aware, the Fund has recently stepped up financial support for its emerging economy members as well, just as capital flows to these economies are reversing.  In November alone, we approved loan commitments totaling $40 billion to Hungary, Iceland, Pakistan and Ukraine, and we're currently engaged in negotiations and discussions with several other member countries.  Moreover, Fund program lending in most of these cases catalyzes additional lending from other sources, magnifying the Fund's programs' positive impact.

We've also been monitoring closely the impact of the crisis on our low-income member countries, where we've provided additional financial assistance in many cases by augmenting preexisting arrangements in our Poverty Reduction and Growth Facility.  We also modified our Exogenous Shock Facility in order to make it a -- more responsive to our low-income members' needs.  Such Fund financing helps to ameliorate the cyclical forces bearing down on these economies, allowing a higher degree of consumption and income than would otherwise have been possible.  And in many of these cases, Fund-supported programs have also incorporated explicit provisions designed to protect low-income individuals and families.

Now, not every emerging market economy afflicted in the current crisis with restricted access to international capital markets is suffering from an underlying problem with its public finances or structural weaknesses in its banking system.  In other words, countries with essentially sound situations are also being hit by developments -- adverse developments in capital markets.  Rather, the immediate problem may simply be a temporary shortage of international liquidity, reflecting problems developed elsewhere.

So to meet the needs of such members, the Fund recently introduced a new lending instrument, the Short-Term Liquidity Facility, that provides high-speed access to large amounts of financing to members with strong fundamentals and track records of successful implementation.  In many cases, the Fund has also invoked its emergency financing procedures, that allows us to act quickly to aid those member countries that need financial support for their policy adjustment programs.  Moreover, the conditionality that accompanies recent programs and that is intended to both safeguard IMF resources but also to boost the credibility of the policy programs with both internal and external entities are focused narrowly and appropriately on those policies that are necessary for the programs to achieve their broad macro-economic goals.

One of the hallmarks of the current crisis has been that the financial resources that have been proven to be necessary to support damaged financial institutions and sectors in the advanced economies have dwarfed those of any previous experience.  Thus, it should not come as a surprise that the same is true in emerging and developing economies.  In general, the more open the economy and the more developed the financial system, the more financially demanding are stabilization efforts.

With this factor in mind and with the crisis still spreading through the global financial system, the issue has been raised whether the IMF's financial resources will prove to be adequate to the task.  It's important that they prove to be, since if this were not to be the case, the IMF's ability to play its key countercyclical role would be impaired.

Measured against the supersized scale of recent stabilization measures taken in advanced economies or against plausible scenarios of more virulent financial sector deleveraging yet to come or, indeed, against any measure of global capital flows, I'm afraid to say that the IMF's remaining lending capacity of some $200 billion is modest, indeed.

Although it is true that Fund lending previously has never crossed even half that figure, it's critical that the scale of Fund-supported stabilization programs are adequate to the task.  In our experience, under-funded stabilization programs are an invitation to rapid and even catastrophic failure.

For this reason, Japan's recent offer to lend the IMF a hundred billion dollars is a very welcome development.  In fact, the Fund's Articles of Agreement provide for substantial flexibility in financing sources.  And we are confident that our members will ensure that we will not fail in our mission because of inadequate resources.

Nonetheless, it's only common sense to review the Fund's capacity to mobilize new financial resources well in advance of any prospective need.  Moreover, other advanced-country governments, central banks and regional pools have the capacity to provide additional liquidity, in some cases have done so already.

It's also possible for these potential funding sources to act in concert with Fund financial-support programs.  So the message here is straightforward.  We need to ensure that adequate funding is available to deal with the problems that we face.

Although at this time the Fund's principal focus should remain that of overcoming the current crisis, it is not too early to look forward to a post-crisis global economy, with the goal of ridding the current system of those elements that have created a significant, and to a large degree unexpected, systemic fragility.  In this regard, I have advocated that the Fund should follow what I have called a three-gap approach to future crisis prevention, with the Fund endeavoring to act as a gap-filler.

The first gap is lack of information.  Call it a lack of market transparency.  As been demonstrated clearly -- if anything, far too clearly -- incomplete information can lead to poor decisions.

The second gap is that in regulation, supervision and in legal systems.  As we've witnessed all too clearly here as well, such gaps can lead directly to systemic weakness and potential crises.

The third gap is that of incomplete markets.  In this context, missing markets may make it impossible to buy insurance against specific market risks.  It's widely acknowledged that incomplete markets increase volatility and heighten risk.  And in seeking to help fill these gaps, the Fund naturally will work cooperatively with relevant national and multinational organizations.  But this task is crucial for an improved post-crisis world.

Well, the current crisis has also demonstrated the need for better early-warning capabilities.  I do not mean that the IMF should enter the crisis-prediction business, as this potential role is already filled with an army of prognosticators, but rather to undertake a more focused job of carefully identifying vulnerabilities and risks and proposing specific remedies.

Thus, it's not enough to warn that significant risk concentrations may be developing, as many financial-stability reports did well before the current crisis.  Rather, a name has to be put to the risks.  For example, the earlier proliferation of special investment vehicles, the now-notorious SIVs, should have been flagged and dealt with before they caused a crisis.

Well, moreover, proposals to deal with -- specific proposals to deal with these kind of problems should be proposed in such a case, either through redefining what we call the perimeter of regulation or through imposing higher capital charges on off-balance-sheet operations.  In general, this is a complex task that requires bringing together expertise and information that by nature tends to be scattered.  Coordinating the analysis and formulating response is key.

The IMF has recently stepped up its work in this area, redoubling its analysis of financial markets, macro-financial linkages and spill-overs across countries.  The aim is to strengthen our early warning system.  And we are working in cooperation with the Financial Stability Forum, among other organizations.  Such exercises should encourage the early adoption of preventive or compensating policy responses, either in macroeconomic or regulatory areas.

Well, I'd also like to underscore that my specialist Fund colleagues and I have concluded that two key regulatory weaknesses helped to create the systemic fragility that is still playing out:  first, poorly drawn boundaries of regulatory oversight and, second, the lack of a macro-prudential aspect to financial regulation.  What we mean by the latter is that we have to go beyond the existing practice of focusing regulation on specific instruments and institutions and include considerations of economic circumstances in setting prudential standards.

Looking beyond regulatory issues, the difficult challenges the past year have underscored clearly the need for effective global cooperation in conducting countercyclical policy, in promoting macroeconomic stability and in advancing effective structural reforms.  Unfortunately, multilateral cooperation is not necessarily easier, even in good times.

For example, in an effort to reduce the risk to global economic growth and stability associated with the emergence of record global current account imbalances earlier in this decade which were the mirror image of capital inflows into risky financial assets, the IMF in 2006 and 2007 hosted a series of confidential discussions between China, the Euro area -- participating as a single entity -- Japan, Saudi Arabia and the United States in an innovative multilateral consultation on global imbalances.

That process, in fact, produced a set of voluntary policy programs that were deemed by the participants to be in their own individual interests while also supporting the overriding mutual goal of sustaining global growth while reducing the pressures associated with global payments and balances.  Unfortunately, in many cases, the proposed policy programs were not implemented with the requisite sense of urgency, no doubt contributing to the current strains.

Nonetheless, the example of the multilateral consultations demonstrated that the IMF could organize within its overall umbrella a discussion and negotiation among a limited group of relevant member countries to study and act on a topic of special importance.  This model was applied highly successfully earlier this year to form the International Working Group of Sovereign Wealth Funds and to help them negotiate the Santiago Principles of generally accepted practices for sovereign wealth funds.

Surely, the role of convener of a subgroup of members to address a specific -- a specific issue of particular importance to the group is a future role of potential importance and usefulness.

Well, ultimately, the working of the global economy would be strengthened by a mechanism that could help to effectively warn against impending risks and to organize countercyclical actions.  The IMF, in principle, has the institutional structure needed to provide such a mechanism.  It has a virtually universal membership and a system of constituencies that allow all of its members to be represented directly or indirectly at its executive board.  Thus it possesses a decision rule that allows it to act with legitimacy even if unanimous approval is absent.

Of course, the Fund's governance structure is not static.  Following a decision in 2006 to reform the relative quota weightings that govern voting power in the organization, the Fund has embarked on a process of adopting its voting shares over time to changes in relative weights of different countries in the world economy.  The Fund's governance structure today consists of a non-resident board of governors and an advisory International Monetary and Financial Committee -- both constituted at the ministerial level -- together with a resident executive board that consists of representatives of governors and is chaired by the managing director, who is also the head of the staff.

Although the Fund has shown that it can act swiftly and decisively when circumstances demand it, questions have been raised whether the current structure could be improved.  As you may be aware, there is a process under way to examine the basic issues of Fund governance, including through a working group of eminent persons chaired by South African Finance Minister Trevor Manuel.  This group is examining many proposals, including those for strengthening the Fund's governance structure by changing the relative role of the IMFC, the executive board and management.

One of the proposals under consideration is to convert the IMFC from its current advisory form into an executive body or council.  Creating such a council -- a ministerial-level group whose creation is authorized in the Fund's articles -- would increase the direct connection between ministerial authority and the Fund's day-to-day activities.  Like the Fund's board of governors and the executive board, the council would represent the entire Fund membership, and therefore would also have a decision rule via voting shares.

Now, it's intriguing to juxtapose the support among the Fund's membership for a review of the Fund's governance with the very positive reception that greeted the recent G-20 summit in Washington.  That summit represented a striking effort to boost the role of the G-20 group of countries in dealing with the current crisis.  The meeting, in fact, produced an action plan that includes some 50 specific policy deliverables, half of which are to be reported back to the leaders meeting planned for the next summit in April.

Of course, the G-20 summit meeting itself was viewed broadly as powerfully symbolic, denoting that the global community increasingly requires a cooperative and overarching ministerial-level body to deal with broad economic and financial issues that includes key emerging market economies as well as advanced economies -- kind of symbolized a changing of the guard.

There exists a clearly perceived need for a group that can help set a broad policy agenda for dealing with the current crisis and giving the global system a stronger foundation.  Well, it's still early in that process, but there's an obvious and striking similarity between the exact membership of the G-20 finance ministers and the Fund's International Monetary and Financial Committee, and thus with the potential council.

Inevitably, these two processes -- that initiated by the G-20 summit, and the Fund's work on governance reforms -- should and will converge.  And that convergence will represent a key event in defining the governance structure of the post-crisis global economy.  Watch for it.

Well, thank you for your attention, and I very much look forward to your questions and comments.  Thank you.  (Applause.)

CLARIDA:  Well, John, that was very efficient.  And you covered a lot of ground there.  I'm going to open up with a couple of questions to spark the conversation.  And then we'll have plenty of time from the floor.

I think one thing --

LIPSKY:  I just want to reiterate.  I'm happy to take questions on, as I said at the outset, on issues that go beyond anything that I had in my remarks.  So feel free.

CLARIDA:  And I intend to do that.  I'll set a good, I'll set a good example.  (Laughter.)

We're in a period obviously of incredible dislocation.  And that's led to a range of policy responses, some innovative, others controversial.  You yourself discussed the short-term liquidity facility.

I'd like you to comment on the Federal Reserve's announcement of providing swap lines, pretty substantial, I think, in the range of 30 billion U.S., to a select group of countries; the IMF's view of that program, the way in which it could interact with existing programs, and anything that would come up in terms of coordinating those Fed swap lines with what your doing.

LIPSKY:  Right.

In spirit, there's a similarity between the IMF's new short-term liquidity facility and the Fed's swap line to some important emerging economies: specifically Brazil, Mexico, Singapore and South Korea.  That was an innovation, from the Fed's point of view, and also an innovation:  Our short-term liquidity facility is an innovation for us.

Our facility was designed to provide short-term liquidity for economies whose policies are sound, as opposed to our more traditional, so-called standby facilities, which are designed to provide financial support for countries whose policies need adjustment.  So in essence, not only the duration but the meaning of the two facilities is different.

Our facility in fact is open to all the members.  And initially it's been approved for a trial period of two years.  But we expect, fully expect it to be extended.  The Fed's swap lines, with the four emerging-market economies, so far is open only until next April, six months.  And when drawn down, generally the terms for such swaps is a three-month facility.

In our case, our swaps, or our short-term liquidity facility provides three months' financing rolled twice, rollable twice, so nine months.  The two facilities were actually announced on the same day.  And the Fed was very supportive of our facility.  And we're happy to see theirs.

I think in the long run, these are going to both provide a useful new tool for stabilizing global markets, in other words, a new source of short-term international liquidity to be a useful crisis prevention tool.  What remains to be seen is whether the Fed wants to stay in that business beyond the near-term emergency.

From our point of view, I think, the Fund wants to have such an instrument as part of its standard toolkit.  I'm not -- I think the Fed viewed its facilities as -- well, we'll see if it's a one-time-only, special, good deal.  But basically in response to these very -- these near-term strains.

CLARIDA:  And as I recall, the Fed invoked its -- as it has frequently in the last several months, the unusual and exigent circumstances language.  And so let us all hope that the circumstances don't remain unusual and exigent for another 10 or 20 years.  (Laughs.)

You mentioned a number of the programs, and I had forgotten that they were, indeed, all announced in November.  Probably the one that's attracted the most attention is Iceland, both the nature of the scale of the crisis relative to the size of the economy, the fact that there was a substantial amount of foreign currency, bank deposits, involved.  So if you could talk us through the considerations with regards to the Iceland program, and in particular sort of a best-case scenario for Iceland -- because the press has certainly discussed the worst-case scenarios -- and how the Fund's program could be part of that dynamic.

LIPSKY:  Well, thanks.  And let me take Iceland as an interesting case of which -- it's an extreme.  I mean, you're probably aware Iceland has 300,000 inhabitants.  It's a tiny place that became home to some banks that became very large multiples of the size of the host country, and therefore fell into a category that I guess has been labeled "too big to save."  (Laughter.)  The scale of the implied liabilities just far -- dramatically outstripped the possibility of the Icelandic government to respond.

CLARIDA:  And foreign-currency liabilities, I should remind the audience.

LIPSKY:  Yes.  Yes.

CLARIDA:  Entirely.

LIPSKY:  They -- let's call them -- they just were a case in point of how incomplete regulations can create problems.  These banks -- I don't want to spend too much time, but the essence of the problem, these banks raised -- operated substantially in England and in the Netherlands.  They raised many deposits over the Internet, and legally those deposits were, you know -- belonged -- were the responsibility, if you will, of the Icelandic authorities, even though they pertained to British and Dutch citizens.

So when the -- when those banks failed, who was in charge created terrific problems.  The result was we were able, with the cooperation of the other countries involved, to raise substantial funding.  But this is a -- going to be a difficult case for the Icelandic people.  Their national debt has gone -- their government debt has gone from 30 percent of GDP to 130 percent of GDP, even with substantial support.  We can't let these things happen in the future.

There are some other cases where we have potential problems -- not of that dramatic scale, where we were talking billions of dollars for a small country.  But there are other cases where there are the risks of too-big-to-save financial systems.  We have to address that in the future with more clarity.

CLARIDA:  I'm going to have -- invoke moderator privilege and ask one more question and then turn it over to the audience.

As the Fed made clear yesterday, and perhaps other central banks will make clear in coming months -- I characterized the Fed yesterday as, in the poker analogy of basically going all in, with quantitative easing, zero interest rates.  From the Fund's perspective, or John Lipsky's perspective -- I'd like either, if you can discuss those -- is it more likely in -- 2009 we'll take as a given; let's look to 2010.  Is it more likely in 2010 that if we were here talking about this, we would be talking about inflation on the rise or deflation on the fall?

LIPSKY:  Well, let's see.  (Laughter.)  That's an incisive answer.  (Laughter.)

Hopefully it will be, deflation averted is most likely.  The coming months are likely -- the coming few quarters are likely to be very difficult ones, because it's not just here; it's globally.

Our existing forecast, the one that I told you is going to be revised down, in January, already anticipates a contraction in the advanced economies as a group, in 2009, on an annual basis.

That is not business as usual.  It has not happened in the post-World War II era previously.  So this is -- this is not business as usual.  And that's why, we think, it's justified that -- the aggressive actions is called for and justified.

I hope and I'm going to repeat again because, I think, it's absolutely clear.  The Fed can't do this all by itself, even in the task of restoring credit growth.  It requires the three elements I said: liquidity provision, which the Fed is doing aggressively and appropriately, but also recapitalization of institutions and cleansing the balance sheets.

Until all three happen, it's not likely we're going to get a turnaround in the financial system, here or in other countries.  And two of those three are the responsibility of the fiscal authorities, of the government, not of the Federal Reserve.  So this requires a more comprehensive approach than has been taken so far.

CLARIDA:  Well, thank you for that.

Let's now open it up to the floor.  And looking on script, please, do stand.  State your name and affiliation.  A microphone will arrive.  And please do limit yourself to one question and try to be concise.

So who would like to lead off?  Right there in the front row, the gentleman in the orange tie.  (Laughter.)

QUESTIONER:  Mahesh Kotecha, Structured Credit International.  My question is about the --

CLARIDA:  Stand up.

QUESTIONER:  My question is regarding the comprehensive measures, in particular asset cleansing measures.  TARP was designed to do that.  It reversed course.  What do you think should be done?

LIPSKY:  Well, thank you for that.  Well, we can, and I assume you mean with the matter of cleansing balance sheets, of removing damaged assets.  The original TARP legislation was very broad in the powers it conveyed to the Treasury.  But one of course that was announced focused on the purchase of troubled assets and hasn't been used in that way.

The -- if we look abroad at other institutions, in other countries, and ask what is being done elsewhere, you'll find, there are actually a variety of ways to do this.  One has been used here before; the division, so-called good-bank, bad-bank techniques to separate out bad assets from existing institutions.  Second, you can take, look at the approach that the Swiss authorities have used, with regard to UBS, creating a separate asset management company that then was -- the government financed to acquired the assets.  That was similar to the -- in some ways to the techniques used here in Bear Stearns.

There's also a technique that we found interesting and attractive, and that is the so-called special liquidity scheme being used in the U.K. by the Bank of England, in which damaged assets are swapped with the Bank of England for government securities, for Gilts, on a one-year basis, rollable twice; in other words, for three years.  What that means is that the credit risk for these assets remains with the initial private institution.  But for three years they have the use of a highly liquid government security, with the idea that, given the long-enough scope for that swap, that hopefully the -- both economy and markets will be restored and the valuation of those assets will be restored.  But in the meantime, institutions have a liquid asset to use to fund operations.

So the point here is there are lots of options.  There are lots of ways to do it.  But we need to move forward if we expect to restore functionality -- financial system.  And I don't mean that just here.  I mean that generally.  When you look around, I would say in few places are there, if any, complete, comprehensive programs that have been adequate to restore functionality so far.

CLARIDA:  Mr. Garber?

QUESTIONER:  Peter Garber, Deutsche Bank.  As the fiscal expansions or interventions play themselves out the next year or two, one serious possibility at the end of that is -- if they don't work -- is the imposition of capital controls by various countries.  I know it's hard to project the Fund's views on that two years from now, but can you outline for us the current Fund attitude towards capital controls, both on inflows and outflows?

LIPSKY:  Yes.  And I can easily characterize.  We don't like them.  (Laughter.)  But sometimes you have to do things you don't want to do.

And in, for example, in the case of Iceland and elsewhere, once you're in a state of crisis and there's a need to work things out in an orderly way, you may have to resort to capital controls going both ways.  In this case we've had to acquiesce in the use of capital controls on outflows.  And it's something that we would like -- we'd like to avoid.  But when things get to the -- to an extreme, sometimes they're necessary to preserve an orderly adjustment.

CLARIDA:  Next question.  Right there.  Third row, in the front.

QUESTIONER:  Maurice Tempelsman.  Thanks, John.  It's a great overview.

Coming back to your use of the word "coordinating," if we look at the present crises, ironically there are two elements that work in favor of moving in that direction.  One is a sense that everybody's in the same boat and we all sink together.

LIPSKY:  Exactly.

QUESTIONER:  And the other one is a remarkable willingness to throw away dogma and improvise.  Looking at it from your perspective, not the IMF, John Lipsky's perspective, give us a critique of that coordination, both in terms of timing, which is critical, and substance.  And also, looking forward, where do you see the opportunities?  Where do you see the dangers of that what in essence is an ad hoc mechanism to get us from here to there?

LIPSKY:  Thank you.  That's a very good question, very perceptive.  First of all, it's been remarkable to see how this has evolved.  And I would say it took a while before there was recognition of the scope of the problems.  And there is a natural tendency on the part of national authorities to say, "Well, they may be having trouble, but we're going to be okay.  It's not coming here."

Then gradually there was a growing recognition on the part of the advanced economy authorities that, "Well, we may be having trouble, but thankfully the emerging markets are going to be okay and they're going to pull us out of this."

It was very cathartic to see the annual meetings in October, where, for the first time, senior authorities -- ministerial-level authorities -- came together from both emerging market and advanced economies and there was a kind of mutual recognition that the -- you had the advanced economy ministers saying, "Well, you guys are going to help pull us out of this," and the emerging economy authorities said, "Your trouble's coming to our house, and it's coming double because it's coming through the financial markets and through external demand."

This mutual recognition, I think, led directly to the quite remarkable G-20 summit.  Again, it's easy to look by -- look past that.  There were 21 heads of government or heads of state with their finance ministers assembled at the White House on four weeks' notice.  I asked at the White House, when had there been a similar number of heads of state gathered at once?  The answer is, as far as I can tell, never.  In four weeks.

So, they -- and out of that came a declaration that the -- if you're -- if you haven't looked at it and you're inclined, take a look.  An action plan -- I mentioned it in my remarks.  Fifty deliverables have to be delivered by the next summit in April and the second half by the -- by the annual meetings next year.  Will they all get done?  No, no.  They're very complicated.  Some of them are very difficult issues of regulatory reform, et cetera.  But I would say there is a new spirit and a recognition that we've got to -- we've got to do this together and we've got to arrive in a mutual and a cooperative and collaborative way at systemic reforms.  This is going to take a while.

And also, I think, what comes clear through these meetings is that we need a structure, not just a spirit, of collaboration, but to look in much more specific terms about how we get that done.  And you probably -- that was the final point I made in my -- in my prepared remarks, that this inevitably is going to lead to a broad reconsideration of let's call it international institutional architecture.  It's not just -- not just the rules of the game, but how we go about deciding what the rules of the game are.  So it's going to be a very profound period, and either we're going to succeed at this or we're going to have troubles.

And the other point I was making -- hope it came through clearly -- we can't take success for granted.  I am sure that the authorities in the 1930s did not think they were causing the Great Depression.  I'm sure they thought they were doing the right thing at the right time, and it proved disastrous.  So it's a -- again, it's going to take some clarity of thought and some strength of vision to make sure we do this right.

CLARIDA:  Back there, in the -- yes, in the -- on the -- yeah.

QUESTIONER:  John, you said that --

CLARIDA:  Introduce yourself, please.

QUESTIONER:  Charles Frank.  I'm with Central European Media Enterprises, among other things.  You said that both recapitalization is still needed, that we haven't finished the job there yet, and also taking assets -- bad assets off the balance sheet is needed.  If you spend enough effort on recapitalization, doesn't that reduce or mitigate the problem of bad assets?  And does it make sense to focus more on the capitalization, as the U.S. has done, or to do both?  What -- how would you make a judgment between the two?

LIPSKY:  First, thanks, Charles.  Thanks for that.  The -- I would guess, in terms of fast action, capitalization is necessary.  And so it -- that's a -- that's a necessary condition and should be done as quickly as possible.

Your question was, well, if there's enough capital, why would you worry about balance sheets?  And I would say, yes, that's true.  But the current circumstances have shown the difficulties in overcoming the uncertainties in counterparties when there's doubts about what is the value -- when there's lack of clarity, lack of transparency about what's on their balance sheet.  And so, yes, you could put in enough capital, but our guess is that that -- ultimately it's possible, but not efficient.  Better to get -- better to act directly on the bad assets and try to get to a situation where the doubts about counterparties are down to a manageable level without resort to huge -- needing to have huge capital injections.

CLARIDA:  Right there, yeah.

QUESTIONER:  Byron Wien, Pequot Capital.  I guess all of us in the room are wondering when this turnaround in the world economy is going to occur.  I sort of gathered from your remarks that the problems were monumental, but there's a possibility that we would see positive real GDP in the second half of 2009.  If that's right, how can that be, in the face of all the challenges that we're facing?  And if it's wrong, when do you think the developed markets will have positive GDP?  And how bad do you think growth in India and China will be?

LIPSKY:  Whew.  (Laughter.)  Thanks, Byron.  A set of easy questions.

The -- what I was hoping I made clear -- to have a -- to think realistically about a turnaround before the end of next year is going to require some very broad-based, very comprehensive and very aggressive policy action.  And I guess, once again, the message I was trying to give is that so far we haven't seen that on the table.

So what we hope is going to happen is that we're going to be marking down our growth forecasts in the coming month, but we're going to be marking up our estimates of the policy response.  And without that, I don't think we can think realistically about a quick turnaround.

You said what -- if that doesn't work, how bad can it get?  Well, I look forward to reading your pieces about that.  But the --

QUESTIONER:  (Off mike.)

LIPSKY:  On more specifically India and China, we've seen, of course, the new news that has shown in spades that a country like China has not been immune to these -- to the problems.  In both those cases -- in both India and in China, we think that not only are policy measures that would tend to boost domestic demand possible -- available, but also appropriate.

For example, when we think about the adjustment in the global economy, think back to those multilateral consultations that I talked about.  The goal of Chinese policy in that context was to shift policy to help -- or to adopt policy that would help shift the economy towards domestic demand growth as the primary source of expansion.

Now, as you know, the Chinese authorities have announced policies that would work in that direction.  There's uncertainty about how thorough or effective they will be.  But my guess is, from our contacts with the Chinese authorities, that that is the direction that they will be going in.  Our view:  They have ample room for action and, we hope, success.

CLARIDA:  Right there.

QUESTIONER:  Robert Fallon, Columbia Business School.  John, the Basel Committee on Banking Supervision is looking at trying to plug some of the obvious gaps or shortcomings in Basel II.  Is the IMF working closely with the Basel Committee in this regard?

And with respect to a new financial architecture globally, what is your view in terms of the IMF taking a role in terms of capital supervision for all or non-bank financial institutions?

LIPSKY:  Thanks.  Well, those are very good questions.  The Fund works closely with the Basel Committee, and we are a member of the Financial Stability Forum and the Financial Stability Forum's working group, so we're actively involved with what we call the standard-setting institutions.

The Fund is not, will not -- no, never say never.  The Fund is not and does not aspire to be a regulator or a supervisor.  What we do think we can do is provide expertise and support of regulators and supervisors to collaborate with the standard-setting bodies.  But also, we, in collaboration and cooperation with the World Bank, undertake what are called financial stability assessment programs, or FSAPs, and -- in other words, our role is to -- "oversee" is probably the wrong word -- to study and evaluate -- that's probably a better word -- to evaluate the implementation of the agreed reforms.  So we help provide support to the standard setters who agree the actual standards, and then we evaluate on a global basis how they are being implemented.

And in fact, there was a debate at the G-20, an explicit debate about whether FSAPs, the so-called FSAPs, should become mandatory.  Right now they're voluntary.  But the Fund will be working actively in collaboration with these standard-setting bodies.  And again, take a look at the action plan of the G-20, and you'll see it's very deeply and detailed -- in a detailed way involved in the challenges of regulatory reform.

None of this is going to be quick, but it's going to be followed with a lot of attention and a lot of energy.

CLARIDA:  I think we have time for one more.  Right there.  You get the prize, since you were up first.

QUESTIONER:  Nick -- (name and affiliation off mike).  You emphasized -- (off mike) -- international policy coordination.  I get the impression that it's left to the Europeans, particularly some Central Europeans -- (off mike) ---- and the U.S. government, and indeed some have commented that the U.S. has not been particularly helpful, either.  I wonder if you could comment whether those impressions are indeed correct.

LIPSKY:  Well, I don't think I'd want to respond quite directly to that question.  (Laughter.)  But the -- inevitably, there will be differences of views about appropriate policies.  But at this -- from our point of view, as I said before, sometimes around here, especially around Washington, policy coordination tends to make hair stand up on the back of necks, because it sounds like everybody's supposed to do the same thing at the same time.

And my response is, we're not talking about synchronized swimming here.  We're talking about economic policymaking.  And the idea is, everyone should do what's appropriate but, as I said, at the same time, with a thought of the internal -- the consistency of the policies being adopted.

In the European context, that always produces a certain amount of tension inevitably, as you have fiscal authorities at the national level still responding to national imperatives and still, yet at the same time, trying to reach some kind of a consistent policy within the European Union.

So much can always be made of the differences of view.  But it's my impression that there is a consensus about the -- about the need for action, about the need also to create the impression, the reality but also the impression of consistency and coherence of purpose.

And hopefully that will become clear because again for the Nth time, we think, more is needed.  More aggressive policy action is needed basically pretty much everywhere.  And we hope that will be forthcoming.

But let me make one, if I could, just one little factoid that I didn't really have a chance to discuss.

CLARIDA:  Please.

LIPSKY:  One of the elements that's overlooked, in the current environment, that is going to play an important role, of international adjustment, is the role of the oil exporters.

They are suffering a tremendous loss of revenues.  And yet they are maintaining their level of spending.  And from, but this is absolutely helpful and appropriate, from a global point of view.

They're going from huge current-account surpluses to a dramatic drop in those surpluses in the coming year.  And that is going to be a positive element for growth elsewhere in the world.

Think of the counterfactual.  If the oil exporters were to make a massive cutback in their current spending, in response to a decline in their revenues, this would have -- the reverberations worldwide would be -- are obvious.

So I think the positive role that is likely, that we expect to be played, in the coming year, to help maintain growth, is easy to overlook.  But it's going to be quite dramatic.

CLARIDA:  Well, on that note, please join me in thanking John Lipsky for a very outstanding discussion.  (Applause.)







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