World Economic Update

Tuesday, September 17, 2019
Brendan McDermid/Reuters
Lewis S. Alexander

Chief U.S. Economist and Head of Fixed Income Research in the Americas, Nomura Securities International, Inc.

Jan Hatzius

Chief Economist and Head of Global Economics and Markets Research, The Goldman Sachs Group, Inc.

Isabelle Mateos y Lago

Deputy Head, Official Institutions Group, BlackRock


Paul A. Volcker Senior Fellow for International Economics, Council on Foreign Relations; @scmallaby

The World Economic Update highlights the quarter’s most important and emerging trends. Discussions cover changes in the global marketplace with special emphasis on current economic events and their implications for U.S. policy. This series is presented by the Maurice R. Greenberg Center for Geoeconomic Studies.

MALLABY: Well, welcome, everybody, to today’s Council on Foreign Relations World Economic Update with, on my far right, Lewis Alexander from Nomura Securities; Jan Hatzius from Goldman Sachs; Isabelle Mateos y Lago from BlackRock. I’m Sebastian Mallaby from the Council, and I’ll be presiding over the discussion this morning.

So I think a fair summary of where we are with the world economy is that it’s growing moderately. The OECD reported fairly recently that growth in the G-20 is the lowest since 2013, but it’s still growing. We’ve got 2.2 percent forecast for 2019 in the U.S., 1.3 (percent) in the euro area, 1 percent in Japan, 6.1 percent or so in China. You’ve got pretty much full employment in the U.S., Japan, the U.K.—although not in Western Europe, where structural unemployment remains pretty high.

But you’ve still got stuff to talk about, to worry about. That’s our job here. That’s what we’ll be doing. You’ve got negative growth in the last quarter in Germany and Britain, disruption of the oil markets in the Middle East, full-scale disaster in Argentina. So there’s no shortage of things for these folks to comment on.

So let’s start with oil, since that is the most recent uncertainty. Maybe start with Jan. The first news kind of headlines after the drone attack on the Saudi infrastructure was that this was the biggest inter-day spike since 1990. And I’m wondering whether these headlines, in your view, exaggerate the impact on the world economy.

HATZIUS: Yeah, I mean, there was clearly a big inter-day spike, but I would say that they do exaggerate the impact from the perspective of the overall impulse from oil prices to growth and inflation. For that it’s not really the day-to-day moves that matter, but really more the moves over several quarters or a year or so. And on that basis, we’re still I think in reasonable shape. We had seen a negative impulse from oil prices to growth and a positive impulse to inflation a year ago, but with the decline that’s occurred since then even with the backup here these effects are gradually fading. And even at the current level, in our view they’re likely to turn into, you know, small positives on growth and, you know, somewhat less positive numbers on inflation, maybe slightly negative numbers. So I mean, these are all moves that are sort of at the margin, and I don’t think that anybody can really argue seriously that this significantly changes the economic outlook on its own.

The question, I think, is really more—and that’s probably more a question for security experts—what does this say about the vulnerability of oil infrastructure, and what does it say about, you know, future attacks or military conflict in the—in the Middle East? And you know, the oil market, obviously, tries to come up with some kind of judgment on that, and I think at the moment the judgment is that, you know, it’s probably not such a huge change in the—in the risk profile. But we’ll see.

MALLABY: Isabelle, do you think that the description—I mean, Jan’s given an overall description. I think you’re talking about the U.S. mainly when you give that answer?

HATZIUS: I’m talking, no, actually more about the global impact. I mean, the—since the oil price is basically global, the impulses from oil, you know, are likely to be relatively small. Obviously, the signs are different, the magnitudes are different for a given change in oil prices. But over the last year we just haven’t seen that much of a change. That’s really my main point.

MALLABY: Isabelle, would you agree that, you know, even if you think about a region like Europe where the balance of payments is a bit more exposed than in the U.S., it’s not a huge worry?

MATEOS Y LAGO: Well, so yes and no. I would say—I mean, at the macro level you just have to agree with Jan, and we don’t know where this is going. If it’s just, I mean, the oil price is still, you know, well within the range it’s been—it’s been trading over the last twelve months—in fact, you know, not even towards the higher end of that range—but we have to see where this goes. And to me the relevance of this shock is that, you know, even though most people don’t have a recession in their baseline forecasts for next year, this is a reminder that we are only, you know, a few shocks away from potentially sliding into that scenario, and I think that focuses the mind on what are the policy tools that are available to offset a serious shock if this is the direction we’re heading into.

I think also Europe is in a—as you pointed out, is in a different situation to the United States. It’s not—for most countries it’s not an oil producer, so it’s hard to get this offset between the corporate sector and the consumer sector that you would see in the United States.

And then the third point I would make is we are—we’ve been navigating a very complex geopolitical environment for the past twelve months at least, and this plays into this in terms of, you know, now is this going to change the dynamic of the U.S.-China trade negotiations because China needs to secure some other supply at a reasonable price? Is it going to be more willing to, you know, reconsider some of the tariffs that it’s put on U.S. oil prices? How is the U.S. and Europe going to respond to, you know, what seems to be a belief, certainly, in this country that Iran had anything to do with this action? So are we going to see an escalation and tensions in the region? All these are things we don’t know the answers yet—it’s too soon—but that could add to the uncertainty that has been plaguing corporate sentiment and investment, certainly, over the last quarters.

MALLABY: So, Lewis, you revealed two facts just before we came onstage. One was that you lived in Saudi Arabia in the ’70s and the other was that on a more recent basis you were staring at projections on what this oil thing does as recently as yesterday afternoon. (Laughs.) So you’ve got the history. You’ve got the contemporary. What’s your take on how much this matters?

ALEXANDER: I have to admit I’m surprised at—if you look out the oil curve, so you look out two years and look at how much oil futures have moved, it’s pretty small for something if you told me before that you were going to take out, even for a short period of time, half of Saudi capacity. The notion that that would—that’s all you’d see is a bit surprising. And so I very much agree with the previous two speakers in terms of a lot depends on what happens here, how those risks play out.

The other thing is, it—I think it is very important if you’re thinking about it from the U.S perspective to recognize how much things have changed, how much more we are producing, how sensitive that is. Not only are we producing more oil now so we’re essentially no longer a net—a net buyer of oil, we’re essentially balanced, but it’s also the investment intensity of the production is higher. The nature of fracking means that it takes a lot more investment activity to get the oil out of the ground. What that means is when oil prices go up and people want to do more of this, the impact of that on the economy is larger than it would have been in previous regions. So you can argue whether or not the impact on the U.S. is a small net negative or a small net positive. I’m not going to, like, pound the table on that. But it is quite different from the way we’ve thought about oil shocks in the past.

MALLABY: Well, since, as Isabelle pointed out, this is a reminder of, you know, the vulnerability of the system to shocks and the policy space there is to respond to those, let’s talk about monetary policy, and maybe start with Isabelle on Europe. Last week the European Central Bank tried to double down on stimulus. There’s some debate as to whether the efficacy is diminishing. But talk first about, you know, what was the central bank responding to when it announced a resumption of QE in November and a slightly bigger step towards negative rates? What’s the fear that it’s—that’s driving that?

MATEOS Y LAGO: So, I mean, look, very clearly—and Mario Draghi made that clear—the ECB is looking at a more pronounced and more protracted slowdown in the eurozone than they had expected, and as a result a more challenging inflation environment, meaning, you know, it’s going to take longer to reach the ECB’s inflation target. So they did feel a need to double down in terms of their stimulus efforts.

But, you know, to me the main takeaway from that—from that ECB meeting and from the press conference in particular was, you know, it’s time for fiscal policy to step in. And so I find it interesting that when you say let’s talk about policy space and let’s talk about monetary policy, I think increasingly there’s a—there’s a sense among monetary policymakers—and definitely that is the case in Europe—that monetary policy is not going to manage to do this all by itself, and that it’s time to look for fiscal space—well, to look for policy space in other places, and fiscal is a—is a good place to start.

And the debate is going to be difficult on this issue in Europe, but it is at least beginning to happen. And I wouldn’t expect a very rapid shift because there are some very entrenched conservative fiscal views in a number of member states, but nevertheless, that issue is now squarely on the table and that should be—that should be positive.

MALLABY: So Jan, I mean, what’s interesting though is that, you know, as Isabelle says, you know, Draghi, in his press conference, emphasized the importance of the fiscal response. But at the same time, he wasn’t saying he was going to do nothing to the country. He was doing as much as he possibly could. He was driving his committee to the brink; he drove at least seven members to vote against him. So he, obviously, thinks that it’s worth the central bank’s effort to push the boat out still as much as possible.

I’m tempted to read this by saying well, you know, Draghi arrived in the job in 2011 at a time that was basically the peak of Superman central bankdom. He’s now leaving the job at a time when the monetary tools have been used up, to some extent. And yet he can’t give up that Superman feeling that he had when he said, whatever it takes. So now he’s saying, however long it takes. Do you think this—am I being unfair?

HATZIUS: Well, I think a lot of people were saying back in 2011/2012 that central bankers were close to the, you know, close to the limits of what they—what they could achieve with— The interest rates were already low; they hadn’t, you know, started QE yet, but—in Europe. But there was that argument and, you know, at the time Draghi did prove that argument wrong. And I agree with you that now there’s less room for monetary policy than there was, but I still think there’s—there’s some room. You could do—you could do more. The European Central Bank, unlike the Fed, is authorized to buy pretty much any asset it chooses to buy.

So if things were to turn materially worse, I think we would see more aggressive moves from the—from the ECB. We think we’re still not at the effective lower bound on interest rates, even with a deposit rate of minus-fifty basis points. We think there’s still some room, especially if you can cushion the impact on the banks, which is the main negative impact, via tiering of reserves. So he can still do some more. He can still do some more on QE. They’re buying twenty billion a month. That’s not an enormous amount. That could be scaled up.

So, you know, I do agree with basically everything that was said, that fiscal policy would be the much more—the much more effective instrument. And there is a significant amount of fiscal space in the—in the euro area, especially in Germany. But monetary policy still has a role to play, I think. So what Draghi did here seems quite sensible to me.

MALLABY: And on the fiscal side, Jan, what’s your reading of the German politics around considering a fiscal expansion? Is it still off the table? I mean—

HATZIUS: No, I don’t think it’s off the table, but it’s just moving very slowly, for a couple of reasons. I mean, one is the sort of entrenched view in Germany that, you know, activist, Keynesian macro policy is something you should really only resort to in exceptional circumstances. There’s a sort of deep-seated skepticism of Keynesian macroeconomics which I don’t share, but it’s definitely there.

And then number two, you have the debt break in the constitution which limits the structural deficit to 0.35 percent of GDP. So, you know, that gives you a very limited amount of room. There are probably ways of kind of getting around parts of that, especially for infrastructure spending. But it’s not as straightforward as it would be in the United States or other countries. So some of these shackles are obviously self-imposed, but nevertheless they’re there.

So I would expect some positive fiscal impulse, but certainly we’re not talking about percentage points of GDP. We’re talking about, you know, probably more tenths of a percentage point.

MALLABY: So Lewis, how do you think the incoming ECB president, Christine Lagarde, plays this? I mean, she arrives, you know, seven members or whatever it is of the committee have voted against her predecessor. Her predecessor nonetheless seems to have forwardly committed her to a policy, even though this authority to buy wider categories of bonds was not approved by the committee—right, Jan?—in the meeting last week. I mean, in theory they have the ability to expand the category of bonds that they’re going to buy, but they didn’t go there.

So what do you think Christine Lagarde does about all this? Does she—does she accept the mandate that her predecessor seems to have given her, or does she wiggle and—

ALEXANDER: My guess, and I’m no expert on Christine Lagarde—(laughter)—but my guess is yes. And the point I would make to the way you sort of framed this earlier is even if—even if the tools are limited, even if the effectiveness is questionable, I don’t think any central banker is ever going to come out and say there’s nothing we can do. They are always, in some sense, going to sort of say, Of course there are things we’re going to do and it’s our job to use the tools available to achieve the objectives that have been set for us. And in that sense, I don’t get the sense from what I know about Christine Lagarde and her views on the world that in some sense Draghi has put her in a place that is uncomfortable.

How far she can bring the ECB is an open question that we will find out over time. As you’ve laid out, there are disagreements, and we’ll see how compelling she can be in all of that. But I don’t think he has put her in a position that she doesn’t want to be in. My guess is the way she sees the situation in Europe is very similar to the way Draghi did.

MALLABY: So Isabelle, I can’t resist asking you two quick questions on Brexit. The first is that the government in Britain has been projecting an air that at last it is grappling with the mechanics of what leaving would mean and that no-deal wouldn’t be so catastrophic, because they’re really thinking about it hard. In your personal experience as a French citizen living in London, what’s your perception? (Laughter.)

MATEOS Y LAGO: I—well, maybe—I mean, first I would say probably living in London probably doesn’t give a fair reflection of the mood of the country or the degree of preparedness of the country. So that’s number one. I mean, look, number two, what I’ve observed, I mean, certainly the government has been trying its utmost to stress that everything’s going to be fine and maybe—save for a few bumps in the road.

What I’ve observed is that as the risk of an abrupt no-deal exit at the end of October has risen, or rose for a while and then before—before maybe falling again, we saw many more businesses going out in public and saying, Actually we’re very worried that there’s going to be very significant disruptions, which hadn’t been the case very much so far, because I guess, you know, nobody wanted to be seen to wade into a highly politicized issue. So the reality is there’s been a number of assessments put out by professional associations, really, throughout the economy and the medical sectors, saying there’s going to be a lot of disruption. Even if we do everything we can to be prepared, this is not going to be a smooth process.

So look, this debate is ongoing. It now seems we’re in a phase again where the risk of a no-deal exit at the end of October has receded, both for political reasons and because the prime minister seems keen now to really work hard at getting a deal. So we’ll see where—we’ll see where that goes, but that risk is absolutely not off the table. If we end up having a general election, then the outcome of that could well be that the country after all is quite keen to leave without a deal.

The problem is people’s views have pretty much not changed since the—since the referendum. And you know, the Remain campaign had promised all sorts of really adverse consequences if the referendum was—turned out in favor of leaving. And these consequences, for the most part, haven’t happened, and only now we’re seeing a material slowing-down in the U.K. economy, but the labor market is still doing really well.

And so a lot of people who believe in leaving actually do not—do not buy all the warnings from various parts of the country that there’s going to be problems. They just—they just do not believe it. And so unfortunately, the argument remains very based on views of, you know, what’s good for the future and yes, a few bumps in the road are probably a price worth paying.

MALLABY: Because I have total faith in the government, I assume that, you know, all these preparations, so that high-value foreign citizens living in Britain can stay and continue to contribute to the economy, that this is all being worked out. So if you want, for example, yourself to have permanent residency, you just whip out your iPhone and with a few clicks you can sort that out, right?

MATEOS Y LAGO: Yeah—no, so we spoke about this earlier. (Laughter.) No, actually, you need an Android device, but the—

MALLABY: You need an Android?

MATEOS Y LAGO: You need an Android device, which is a complication.

MALLABY: So with an Apple you’re out of luck?

MATEOS Y LAGO: For now, you’re out of luck entirely, yes.

MALLABY: Well, then I have still total confidence in the government. (Laughter.)

Let’s move to the U.S. economy. So a Wall Street Journal poll of economists recently found that the sort of expected probability of recession in the next twelve months has gone up to one in three, so that’s about twice as high as the same poll said a year ago.

And so I guess the question I’ve got, maybe for Lewis first, is, you know, if inflation is subdued, financial markets are not about to crash, the Fed has a bit of space, what’s—what’s going to trigger this expected—I mean, it’s only a one-in-three expectation, but if there were to be a recession, what’s the trigger?

ALEXANDER: First of all, I don’t know. Second of all, one of the obvious uncertainties at this moment is the degree to which the policy uncertainty that starts with trade but is more—broader than that is going to be a constraint on business spending. Seems like the most obvious problem.

MALLABY: Mmm hmm.

ALEXANDER: And we all spend our time trying to assess it. I must admit my own—my own and other modeling work I’ve read on the trade effects, they all seem remarkably small, when you kind of run them through conventional models. And I suspect it may well be that we’re underestimating some of those effects. So the biggest risk that I see sort of centers there.

The consumer has been very strong. Fundamentals in terms of income growth, confidence, have held up pretty well. Savings rate is actually pretty high, given how strong the balance sheets have been. That raises an obvious question as to whether or not consumers are just more cautious than they’ve been in the past in the wake of the Great Recession. And so you wonder if consumers were going to crack because of their concerns about this outlook. That could be another issue.

I think you look—financially, I—in the wake of the Great Recession and all of the financial disruptions, I think the policy response has been pretty robust, which means I don’t think the financial sector itself is going to be the source of the problem in the way it was in the last recession.

Corporate debt is obviously a particular problem, and if you saw a series of unexpected defaults, that could be the financial, sort of, accelerant. None of those things seem like, you know, preeminent, imminent issues, which is why I would broadly agree with the notion that that probability is about a third. But these things are almost inevitably things you don’t see coming.

MALLABY: Jan, what do you think?

HATZIUS: I’m in a similar place. I mean, I’d probably put the number at less than that, in terms of probabilities. Obviously it’s not something you can—you can rule out, especially given the potential for significant shocks from trade policy from geopolitical issues, you know, just political shocks in general.

MALLABY: But just on the—so on the trade policy, I mean, we’ve had shocks. What’s the extra shock that you’re thinking of?

HATZIUS: Well, if we were to see further increases in the—in the tariff rates beyond what’s been announced. You know, we’re building in as effectively what the White House has already announced, so the increases scheduled for October and December we think are mostly going to go through. That’s incorporated. Then the expectation that we’re building in is that as the 2020 election approaches, trade policy and tariff escalation gets put onto the back burner to some degree. So we’re not expecting a deal, but we do think that the escalation basically stops there. If that were to be wrong and the escalation continued and you continued to see maybe more of an escalation even beyond tariffs in—you know, making life more difficult for basically each other’s multinationals, you could see a shock that—that is large enough to result in a further slowdown in growth.

Right now, the U.S. economy’s probably growing at—roughly at trend pace, you know, a little below 2 percent. And by our—by our estimates, if you were to push that down significantly further, then you’d have to again worry about the, you know, sustainability of below-trend growth. But that’s—that’s not our best guess. Our best guess is that things actually stabilize and growth maybe picks up a little bit as we go into 2020.

And I would say, underscoring what Lewis has said, that if I look at the private sector and the vulnerability of the private sector to adverse shocks, I’m actually fairly sanguine. I mean, the private sector, households and businesses taken together, runs a large financial surplus of more than 4 percent of GDP. That’s a very, very different place relative to where we were in the—you know, equivalent periods in the past couple of cycles. You know, 2000, 2006, 2007 private sector was running very large financial deficits, and therefore very vulnerable to shocks. We’re not seeing that. You know, the shocks could get large enough, but I think the private sector is in pretty solid shape.

MALLABY: So I want to invite questions from members in a minute. I’ve got time for one more. So I’m going to jump over China and Japan, where you can come back by prompting questions. But I want to get in a question for Isabelle about Argentina, if that’s OK.

I mean, this is obviously a tragic mess. You’ve got a country that had—you know, went to the IMF for an absolutely massive loan, 10 percent of GDP. Now it wants more loans to pay back that loan already. It wants to restructure its private debts, but the private sector is not very keen to negotiate with a lame duck government that looks likely to lose power to the Peronists in the election coming up.

So the question I ask, I mean, clearly, you know, Macri and his government made a mistake in moving too slowly to stabilize the fiscal position and to stabilize inflation. He—in some ways I think reflected, it’s fair to say, the IMF fashion at the moment, which has been less shock therapy, more gradualistic, you know, do what the political circumstances can absorb. So that kind of go-slowly-don’t-worry-too-much-about-that, which maybe reflects a bit, you know, on the debate on whether debt matters, whether fiscal debt matters in the rich world.

When transported to Argentina, which obviously has a history of crises and therefore much less space afforded to it in terms of the confidence of the markets, it didn’t—it was a disaster. I mean, going too slowly was a big mistake. They should have worried more about fiscal debt, not less. And so I guess, with the shift of power at the IMF, and you worked at the IMF, which is why I’m pointing this to you. Does the IMF move back towards a more, you know, get-your-house-in-order-quickly kind of stance, or how does this—how does it absorb this lesson and avoid it in future?

MATEOS Y LAGO: Yeah. No, that’s a very good question. I mean, look, Argentina is obviously in a very difficult place right now, and everybody is looking around for—for culprits, and I don’t think there are any easy answers.

Certainly the key lesson that the IMF had learned, both from the Asian crisis at the end of the ‘90s and from its prior experience with Argentina was that, you know, too much austerity is not helpful in the long run. And that is not just the lesson that the IMF, you know, staff or—had learned. This was the general worldview. IMF has been too keen to impose austerity on a bunch of countries, including, by the way, in the—in Europe.

And so it was politically very courageous for President Macri to resume a relationship with the IMF, and he knew and the IMF knew this is only going to work. The problems Argentina has are deep-rooted. They’re not going to be sorted out in one mandate. We need—we need time to address this. And so both—on both sides there was a sense that we need this program to work so that Macri can get re-elected and we can get two mandates to deal with these deep-rooted problems.

And so at the time, I think it made sense to say, Well, let’s not be too austerian in this program so that the population can find it, you know, acceptable. Now, this was not necessarily a stupid strategy, but it was a strategy that was predicated on Argentina continuing to receive large amounts of financing from capital markets. And frankly, this is where things fell apart, that the global environment ended up being significantly less conducive to capital inflows to Argentina. But again, Argentina was kind of—was not alone in this situation. The capital markets did—sentiment towards emerging markets soured last year. Argentina had larger vulnerabilities than most, and so was hit most. And from that point on, you know, markets began doubting that Macri could be reelected. And this is where we are now. This has intensified after the unusual primary election that Argentina had in August. And now there’s been almost a fast forward to everybody assuming Macri’s not going to be reelected, and therefore making him face all the disruption that in reality would more likely be brought about by the next president.

So it’s extremely tricky. Now the IMF has to decide whether to put more money before the next president comes in. The next president comes from a party that is extremely anti-IMF, may or may not be willing to repay its obligation to the IMF. So it’s an extremely difficult issue, and a difficult one for any new managing director to inherit. But this is where we are. The IMF ultimately has a responsibility to help countries in trouble. Where do you place the balance between financing and adjustment is the perennial question. Did everybody get it right in this case? Ex post, obviously not. But you know, should they have made a different decision back at the start of the program? Very hard to say, because for the—for the Argentine president to go back and ask financing from the IMF was a very difficult step.

MALLABY: It does remind me a bit of Russia in ’98, where you have the leader who the West really, really, really wants to succeed politically. And so you give him quite a lot of backing. And ultimately when it doesn’t work, it’s a big shock.

OK. I’d like to invite members to join the conversation. Remember that this is on the record. So if you have a question—yes, let’s start right here. Just wait for the microphone.

Q: Hi. Bob Hormats.

I’d like to follow up with a question on monetary policy. There seems to be consensus that there’s more room for central banks to operate. My question really relates the efficacy of what they do. And that is, what would be the impact of their moving particularly to more QE kinds of tactics or more unconventional kinds of things, like the ECB? And what’s the transition—what’s the most effective transition device? In the U.S. the consumer’s doing quite well. To what degree would that have an impact on capital investment, because it does seem to me that that transmission device toward more investment would provide a lift, both for the economy and for productivity. How effective would these unconventional or repetition of QE policies be in the transmission device from those policies to a higher degree of capital investment?

MALLABY: Bob, are you talking about the U.S. or about Europe, Japan?

Q: I’m talking, first, about the U.S., but also Europe. Europe’s—the techniques are somewhat different. We would—we would probably not do some of the things the Europeans are doing. We would do more QE if there were more room, if we needed to. So my question is, what’s the transition device? How effective would it be? And would you get more capital investment through this kind of unconventional or somewhat different central bank approach?

MALLABY: Maybe Lewis and then Jan?

HATZIUS: Oh, I would say in the U.S., of course, initially you would use up the remaining room to cut the funds rate to somewhere close to zero. Probably the next step would be a return to QE, if that, you know, were to be necessary, if 200 basis points also of easing wasn’t sufficient. And you try to basically restart the QE program within certain parameters. The Fed can only buy government-guaranteed instruments. So you’d be talking primarily Treasurys again. And you know, I think the transmission in the first instance is always going to be housing and consumer durables. I mean, those are the most interest rate-sensitive sectors. They’re obviously already getting a lift from the significant declines in rates that have already occurred with the, you know, ten-year Treasury yield at 1.8 percent, down from 3.2. So, you know, we’re getting a decent lift already. But that’s—that would be the main impulse.

And then I think the impact on business investment would probably be a bit more indirect. Typically it’s really more the expectation of stronger future demand that has an impact on business investment, more than, you know, changes in riskless interest rates. So I think there would be a positive impact on business investment as well, but it would be more indirect. You know, I think there still is a significant amount of room. Two hundred basis points is still substantial. It’s obviously a lot less than the cuts that we’ve seen in the average post-war recession, which was about five hundred basis points. But I do think that that probably understates the available room to some degree for two reasons.

One, historically the cuts in the funds rate were not accompanied by significant forward guidance about the future path of the funds rate. So markets basically built in pretty quick reversal of sizable rate cuts, and that to some degree limited the effectiveness of the cuts. That would very likely be different in an environment where the Fed had to cut more aggressively. And then the other one, of course, is QE. QE is now an established instrument of monetary policy and would be—would be used again. I mean, there are challenges in terms of policy room. I’m not denying that there are challenges. But I think sometimes they’re overstated by this comparison of, you know, two hundred basis points of conventional policy room versus five hundred basis points of cuts in the average post-war recession.

MALLABY: Do you have a question? Yes.

Q: Niso Abuaf of Pace University.

At what point of interest rates do the costs of low interest rates offset the benefits, especially when we look at negative interest rates in Europe? And how much of that have central bankers realized that?

MALLABY: Maybe Lewis could take that, and perhaps link it to the Japanese meeting this week.

ALEXANDER: Sure. So first of all, I think the Japanese and the Europeans are actually having exactly that debate right now. I think in the case of both the BOJ and the ECB they think they have some room to go further, that there are ways that you can minimize the negative consequences on the financial system, primarily banks, that come from pushing rates further into negative territory in ways that mean that you can still generate some stimulus. In the Japanese case, a lot of it has to do with the exchange rate. I think their hope would be that they could push short rates down, that would weaken the yen in an environment where they could provide some insulation to the profitability of the banking system and therefore get some monetary stimulus from that. But I think they are clearly very concerned about it and don’t feel all that confident about how strong it will be.

In the context of the BOJ meeting this week, we don’t think they’re going to do anything, in spite of the fact that the slowdown in China, the slowdown in global trade obviously affects them, in part because they don’t feel they’re kind of at a critical point where they need to. My impression is the ECB debate is very much going into the same territory. The decision to adopt tiering I think is clearly related to trying to find some room to use lower—even lower rates in a way that will still provide some stimulus. So I think my answer would be I think in both the BOJ and the ECB’s case they feel they have—they can go a bit further, but they’re pushing on the limits.

MALLABY: Yes, right here.

Q: Nancy Truitt, Truitt Enterprises.

I’d like to raise a question about Argentina, because Argentina—if you look at it, and go back to the time of Peron, they have an economic crisis about ever eight—seven to ten years. It’s a rollercoaster. And it seems to me that you’ve got to look at the underlying causes, and not just the ones that affect this recent crisis if you’re going to do anything about Argentina, or it’s going to keep being every seven to ten years you can count on a crisis.

MALLABY: Here we are, cultural determinism. Maybe Lewis can—(laughter)—

ALEXANDER: So I’m—let me take a shot at that one. I spent a bunch of my career doing emerging markets. I did my dissertation on the Latin debt crisis in the ’80s. And around the time of the Argentine crisis in 2001, I was head of emerging markets at Citi. So I lived that particular one very closely. I was convinced in the wake of the utter disaster of 2001 in Argentina that surely this was the economic crisis that was big enough that it would transform the politics of Argentina. And I would argue for about a year after that it kind of looked like that’s how it was going to play out.

I have to admit, that obviously did not happen. I honestly don’t know what it would take to get them out of this cycle. But frankly, if the economic crisis in 2001 and 2002 wasn’t enough to do it, I’m not sure what you do. The challenge for the Fund, and I’m totally sympathetic to the problems they face there, I am struck by the notion that the other alternative that you faced is some much larger reduction in debt, some version of sovereign bankruptcy. And there is—to some extent, if you were going to go back and rethink that I wonder if the thing you wouldn’t rethink is whether or not you should have just done that more dramatically. But I don’t think there’s any easy answer to the politics in Argentina, which is, I think, the question you’re asking.

MALLABY: Let’s go, yes, over here.

Q: My name is Richard Erb, and I have a very simple question.

And that is, why are interest rates still negative in Japan and in Europe? What fundamental change has taken place that would lead us into a world of negative interest rates? If twenty years ago you had forecast negative interest rates in 2020 you would have been sent to, well, someplace—would have been thought of as crazy. But here we are, negative interest rates. Why? What are the—I’m looking for the longer-term structural issues here, not a short-run macro response to, well, maybe we’ll have a recession, and what we need to do to stop that recession.

MALLABY: So is Larry Summers right?

ALEXANDER: I think Jan has a different view on this, but I’ll say yes and Jan can say no. (Laughter.) Look, I think there are a bunch of things that have affected by savings and investment that have pushed down interest rates. Just to throw out two of them, if you look at the percentage of time that people spent in retirement in industrial countries, that has gone up by something like 60 percent over the last twenty years. If you think about what that implies for the demand for private savings, it’s pretty profound. That’s simply one argument you can make on the savings side of the equation.

On the investment side of the equation I would make the argument that the nature of innovation today simply requires less capital spending. Think about the differences between Uber and railroads. We simply—the way—the nature of innovation today does not require the level of capital spending it has in the past. So I think there are—there are a set of things on the basically savings and investment side that have gotten us here. I would stress the fact that this is global. This is not something that you see in just one or two countries. It is a global phenomenon.

The other thing I think that is underappreciated is the degree to which we now live in a world where stock prices and bond prices move in opposite directions. The correlation between stock prices and bond prices is negative. In the ’90s, and in the ’80s, and in the ’70s, that correlation was positive. If you think about what that means for how investors should price risk, it’s pretty profound. If you’re saying your two primary asset classes are negatively correlated, it is just simply a much better place to invest. And I think that means risk premium generally are lower. That’s certainly, I would argue, part of why interest rates are generally so low. I also think, frankly, it’s why equity valuations seem surprisingly high.

So I do think there are set of fundamental factors that can get you there. Now, I—you know, the hard question is, how long does this last? I think, as somebody who—part of my job is to forecast interest rates—one of the things I’m spending a lot of time trying to think about is how durable are those trends? And I wish I had a better answer on that.

HATZIUS: I would say—I mean, I agree with a lot of this, certainly the point about, you know, much lower term premium at the long end of the curve because of changes in the correlation between stock and bond returns. I think that’s important. I would add also on the term premium side, you know, which affects obviously the longer end of the curve, the—basically getting use to the low inflation environment that’s now been in place for twenty to twenty-five years. If you look at inflation over that period, since the late 1990s, it’s been very stable and low. We’re talking a lot more about the death of inflation now than we did perhaps in the, you know, 2000 period or the subsequent cycle. But actually, if you look at the U.S. and—or Europe, although in Europe you would sort of start that comparison in the early 2000s—we’ve really been in a very low inflation environment for a long period of time. And that has kind of gradually filtered through into the premium that investors think they require in order to hold long-term bonds.

I think as far as short-term rates are concerned, you know, the equilibrium short-term interest rate also, you know, certainly seems lower for some of the reasons that Lewis outlined on the savings said and investment side. That said, I don’t think that short-term rates are going to stay, you know, as low as they are now. There are some important cyclical factors. The fear of recession, I think, is an important factor. And you know, at least in Europe and many other places—less so maybe in the U.S.—still to some degree a hangover from the crisis. I mean, in the U.S. the crisis occurred, you know, eleven years ago, but the crisis didn’t really peak in Europe until 2011/2012. And Europe is still recovering from that. Right now very slowly, but if and when this recovery gets back on track, I think that will also have consequences for short-term interest rate expectations.

Certainly don’t expect any hikes from the European Central Bank for several years. But I also don’t think that we’ll be at minus fifty basis points on the—on the policy rate forever.

MALLABY: Do you want to weigh in, or?

LAGO: No, just on—I mean, certainly an additional consideration in Europe—I mean, ultimately it is a demand and supply story. And I think part of the story in Europe has been the lack of supply in the form of the very conservative fiscal policies of German, in particular. Sort of lack of public investment and the broader debate around at least a perception of insufficient supply of safe assets in the eurozone that leads to extreme compression of interest rates on German debt and other core eurozone debt in general. And these are—these are largely structural issues as well, that hopefully will be addressed at some point, but I think it will persist beyond the current cyclical phase.

MALLABY: Another question. Yes. Just the microphone.

Q: Nick Bratt with Lazard.

Putting aside the official statistics, could you give us a sense of what’s going on in the Chinese economy?

MALLABY: I’m glad you asked that. We need to talk about China. Six-point-one percent is the official growth rate this year.

HATZIUS: Is it reasonable to ask around that, you know, what the—you know, the true growth pace is? There are a number of different trackers out there. We’re towards the lower end probably. We’re in the kind of 5-5 ½ percent range at the moment, based on higher frequency indicators that we think are more reliable. So, you know, we do think that the trade war, the tariff escalation, and maybe to some degree still the slowdown in debt growth that we saw from late 2017 to early 2019—that that is having a negative impact on China. It hasn’t been a dramatic negative impact. It’s not looking as serious as what you saw back in 2015-2016. Certainly on the financial side we haven’t seen the capital outflows that were a major worry back there, with reserve losses of up to $100 billion a month. But there has been an impact and that, I think, still points towards increases in the stimulus provided by the—by the authorities to monetary policy and fiscal policy. And so, you know, we think we can get back to 6 percent, but right now I don’t think we’re there.

MALLABY: Anybody else want to weigh in on China? Nope? OK, there’s one right here.

Q: Is this on?


Q: Could we talk about U.S. fiscal deficits? If you would look back five, ten years ago, would you have expected ten years into a recovery they’d be this high? And do you think they’re sustainable?

ALEXANDER: So, short answer, depends on the horizon you’re looking at. In the near term, there’s very little evidence that it’s a problem. I mentioned this correlation issue between stocks and bonds. And there’s some interesting—there’s been some interesting research that basically shows the sensitivity of interest rates to supply of Treasurys is partly a function of that correlation. In this world where the correlation is negative, it seems like we can put a lot more in and not have an effect. So my answer in the short run is I see no evidence that it’s not sustainable. Obviously in the long run, we are—you know, we’re on a trajectory that can’t work. The trick, and obviously in that scenario, is obviously what gets you from one place to the other.

I have to say in terms of what’s coming in terms of the election, it’s hard to see us—the politics of this sort of getting us back on track anytime soon. We are now at the point where the Baby Boom generation is in the process of retiring. And just the near-term dynamics on entitlements are extremely demanding, even forgetting the discretionary side of the budget which is what we sort of all focus on. So, you know, my long-term answer is of course it’s not sustainable. But I don’t see the process in the—kind of the forecasting horizon that is going to force us back onto that. So I don’t see it say, for example, being a significant upward pressure on U.S. interest rates in the near term. I think it would take a different macroeconomic environment to get that.

MALLABY: Lewis, it’s quite striking that the Democratic debates, as far as I paid attention, you know, people talk about the Democrats moving to the left. It’s not left as expressed through protectionism, which it would have been twenty years ago, right. When people talked about the economic left of the Democrats, they would talk about Gephardt’s view on Japan, or whatever. Now, you know, Trump’s got that covered. If you want protectionism it’s in the debate, it’s in the policy. And so Democratic left now means Medicare for All. It means more progressivity on taxes. Does this strike you as a shift that is going to have economic consequences?

ALEXANDER: This is a very different debate on the Democratic side. I would push back on you on a little bit on the notion that protectionism isn’t there. It’s not an issue in the campaign because it’s not a—it’s not a way for Democrats to distinguish themselves from Trump. The remarkable thing to me is this incredibly important thing that the current government is doing is essentially not being commented on by the other party, which is basically telling you I think that the politics of trade within the Democratic Party have moved in a direction where they’ll pursue it in a different way, but we are not going back to the Obama and Clinton policies on trade.

I do think there are a bunch of fiscal commitments that are—you can tick them off. There is some form of guaranteed income. There’s some sort of form of significant expansion of health care coverage. There’s probably something on student debt. And then there’s some version of climate change, all of which are going to be significant fiscal demands that any Democratic candidate for president is going to support.

The other thing which I think is important for people to recognize is, just sort of moving away from the fiscal side, is I think you’re going to see income distribution as a kind of overarching framework for a next Democratic administration. And that means things like the labor share is going to go up. So think about things like what California just did vis-à-vis Uber. And you had a sort of set of economic policies under Bill Clinton and under Obama that were, in some sense, business friendly. You can also add to that sort of what Elizabeth Warren is talking about in terms of the big tech firms. And you’re going to see, I think, potentially a very different attitude about that, that is relevant for things like if the labor share is going to go up, the capital share is going to go down. And some point in the election, and I think that is something that people are going to focus on.

Now, if you’ll indulge me, there’s one other thing I want to talk about in terms of the election. We haven’t talked about Trump and the Fed. Trump has very little direct impact on the Fed, except through appointments. There are two vacant seats on the board. He’s put out two names. They haven’t been formally nominated. Even if those two people get on the board, it won’t make a big difference. But if he’s reelected he gets to reappoint the two vice chairs and the chair. And if those two vacant seats are not filled, which frankly I think is the more likely outcome, a reelected president Trump will have the potential to essentially remake the Fed. So I don’t think Fed independence is a near term issue, but I do think it is very much an issue if Trump is reelected. And I think if you’re looking for something that markets at some point are going to focus on in the run-up to the election, I think you’ve got to put that on your list too.

MALLABY: Either of you want to comment on that, or good? OK. Another question. Yes, right here.

Q: Hi. Great conversation. Jay Koh from The Lightsmith Group.

I’m glad the word “climate change” was mentioned at least once. Mark Carney and the Network for Greening the Financial System—which is a substantial number, at least thirty-six-plus central bankers, not including the United States or some other major OECD countries—have said that climate risk is now an important consideration. There’s a major conference here next week that the secretary-general’s holding. Is climate risk of any kind being factored into your forward economic analysis and upside or downside surprise? And if there’s more volatility going forward, do you think it plays into investor sentiment at all? Or is this just an irrelevancy? Because we’re pretty far into this conversation without it actually rearing its head at all.

MALLABY: Anybody want to?

ALEXANDER: Let me just say a couple things. I mean, the honest short answer is no. In part, that reflects the fact that I don’t see the financial sector as being vulnerable. And the obvious short-term issue is some set of climate events that creates losses that filter back on the financial system. One of the things people don’t talk about in terms of the crisis of 1907 is the role that the 1906 earthquake played in setting up the circumstances for that. And so there are—there are some serious questions about how you view those vulnerabilities. I don’t think those are kind of massive, near-term issues.

There’s a set of longer-term issues about the fiscal outlook, which I do think are important. It’s obviously part of the debate of the United States. It’s my impression that it’s part of the debate in Europe as well, that if you’re actually looking for a scenario for how you could get a significant fiscal expansion out of Germany, one way is the Greens win, right? So I do think there are ways in which it filters in, but it’s not a kind of an immediate issue.

LAGO: If I could add just on this, it is a more immediate issue in investment decisions that the financial sector is making, and everybody. So it’s a learning process that is an accelerating phase. But anybody who invests or already holds long-dated assets is essentially going through a crash course in figuring out what is going to be the impact on—of climate change on the return and the capital integrity of these assets. But it’s true that in the link to the macro forecasts are absolutely in terms of the spending commitments that are going to have to be made. And I think in Europe, it’s not just in Germany, it’s literally been one of the priorities of the new president of the European Commission. There are very specific commitments there that are going to—that are going to require significant spending. So that would be, for me, the most relevant macro angle.

MALLABY: In Europe, I guess it might also be the case that—and this is a bit what you’re saying—that it contributes to the fragmentation politically. That, you know, the Extinction Rebellion has a lot of energy behind it, Green parties can mobilize that. And in an environment where we’re already talking about the sort center-right, center-left having lost to the populist wings, a resurgent Green movement further complicates European politics and makes it tougher to sort of come up with cohesive governments, because of the coalitions being difficult.

We’ve run out of time. Thank you all for coming, for participating. Thank you to the three panelists. (Applause.)


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