World Economic Update Dedicated to Martin Feldstein

Thursday, July 2, 2020

Global Chief Economist, Citi

Managing Director, Deputy Head, Official Institutions Group, BlackRock

Steven A. Tananbaum Senior Fellow for International Economics, Council on Foreign Relations; @Brad_Setser


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

Introductory Remarks

President, Council on Foreign Relations; Author, The World: A Brief Introduction; @RichardHaass

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 and is dedicated to the life and work of the distinguished economist Martin Feldstein.

HAASS: Well, thank you and good morning to one and all. I hope everyone is well and safe under the circumstances and is in a position to enjoy the Fourth of July. I want to welcome everyone to today’s Council on Foreign Relations meeting to, obviously, give us the World Economic Update. And what I hope you all know is that this series is now dedicated to the life and work of Marty Feldstein, who, as you know, passed away a year ago. And I want to thank all of those who have helped endow this series in his honor.

As I don’t think I need to explain to this audience, Marty was one of the great economists of this or any generation. He had his academic career at Harvard that spanned literally half a century. He chaired the Council of Economic Advisors under Ronald Reagan. And then he was president of the National Bureau of Economic Research, again for, I think, thirty or so—thirty or so years, really turning it into an extraordinary institution. He had all sorts of students that went on to accomplish one or two things. Some guy named Larry Summers, another Jeffrey Sachs, Raj Chetty. He was—did all sorts of things also with this institution.

He was a member for nearly forty years, was on our board for sixteen, then became director emeritus. He chaired the Foreign Affairs committee, our magazine, for fourteen years. And he also authored no less than thirteen articles for the same magazine. He was thoughtful in every sense of the world. Intellectually rigorously, intellectually curious, totally intellectually honest. And was also, I thought—what I liked so much about Marty, he wasn’t only a rigorous economist, but also drew connections between things, economics and beyond. As we used to say, or still do: Universities have departments, the world doesn’t. And Marty was able to get beyond a narrow economics department and, again, showed the broader linkages.

Given all that’s going on in the country and the world today, I think I’m not alone in saying I wish we had Marty’s help every once in a while, to navigate all that stands in front of us. But we don’t. But we have his legacy, and we also are fortunate today to have all sorts of other talented people with us to discuss the U.S. and global economic situation and outlook. And let me turn to one of those extraordinarily talented people, my colleague Sebastian Mallaby.

MALLABY: Well, thank you, Richard. I hope everyone can hear me fine. I certainly want to echo what you say about Marty. He as a tremendous friend. He came to China once on a trip that I organized where we talked about the international role of the renminbi. And what I remember is that mixture of sort of authority but also humility and open-mindedness. It was a very winning combination. He wrote me the most gracious and thoughtful letter possible after he read my biography of Alan Greenspan. And he’s someone I’ll always remember as a great friend and teacher.

So now to the conversation that I know he would appreciate. And we have more than 600 members registered for this call, showing that this is a time that we really should be focusing on the World Economic Outlook. It’s been an extraordinarily tough time. We’ve just been through the deepest, sharpest downturn since the 1930s. If you look back in the data that the IMF keeps back to 1980, you find only one time in which the global economy actually contracted for the year. And that was right after the fall Lehman Brothers, so 2009. And the contraction was so small that it barely counts—it was one-tenth of one percent.

Now, in contrast, the IMF is projecting a 4.9 percent contraction for the global economy in 2020. So even though you’ll all have seen the latest data has been a bit better, you’d have seen today’s U.S. jobs report coming in better than expectations. But we have to remember that this is a modest recovery from what has been an extraordinarily deep fall. And we don’t know if this recovery will be sustainable. So it is the time to focus on these tough questions.

And as always on these World Economic Updates, I’ve got a fantastic group of people: Catherine Mann, the global chief economist at Citigroup; Isabelle Mateos y Lago, the deputy head of the International Institutions Group at BlackRock; and my colleague Brad Setser, the Steven A. Tananbaum Senior Fellow for International Economics here at CFR.

So what I thought we would do is maybe start with Catherine, and just talk a bit about that IMF forecast. I mean, the IMF is the first, of course, to understand and to acknowledge that this, of all forecasts, is uncertain. It depends on basic things like when we might have a vaccine which, you know, is very tough to get a handle on. But, Catherine, form where you sit, do you think a sort of 5 percent shrinkage for 2020 as a base case, is that reasonable? And what do you see as the risks on either side of that projection?

MANN: Well, you know, the IMF has their numbers. Other institutions have numbers as well. And a lot of times it matters how you want to aggregate up the countries as to which number you have. But the basic contours are—as you said, it’s the deepest recession in living memory. It is only the second time since the 1960s that we’ve had a global contraction. The other time being the global financial crisis. So, you know, it’s not so much about the numbers per se, it’s about what are going to be the factors that are going to give us a profile of the recovery going forward? Is it going to be pretty flat, the U-shape that people are talking about? Is it the V-shape? Which of course the financial markets are pretty much V-shaped when we look at those. Do we have the W, which is the second round of infections affecting behavior and, perhaps, another set of lockdowns later on in the second half of the year?

So I mean, I want to focus—so there are a number of factors there. I would like to focus on the one that I think is most important and the most difficult to figure out, and that is consumer behavior. How—you know, if you ask—YouGov asks people: Are you afraid of getting COVID? A little bit, a lot, or whatever. In the U.S., for example, it’s 55 percent. In the Philippines, it’s much more. And, you know, in Finland it’s much less. So how does consumer behavior react in the face of a very—you know, a disease that at least you get very sick, maybe you’re going to die. First—that’s the first uncertainty.

The second uncertainty is how does business respond when they themselves have to consider the consumers might—you know, I’m going to be selling to the consumer one way or another. The consumer’s afraid. What are they going to do? I’m not really sure. How does that temper my investment strategy? How does that temper my employment strategy into the second half? And so we, writ large, already an uncertainty about consumption, an uncertainty about investment.

And then, let’s face it, the uncertainties about trade started a couple years ago. They’ve been intensifying over the course of the last year. We thought maybe they would be a little bit in pause when we were in January, but no. Trade tensions are continuing. And of course, they’ve metastasized now into this national security, economic security, medical security, technology security, food security. And how that is going to be impacting trade, which is another major component of, again, uncertainty for business investment.

So we’re looking at uncertainties across all of these macroeconomic—you know, the big macro factors. And let me add one more, of course. And that is given that the financial markets are current assuming a V, what happens when that isn’t what we see coming into the data in the second half? How does potential financial turbulence across different markets, you know, impact through business investment, consumer concerns, shocks on wealth, et cetera. How does that impact to future accentuate some of these—some of these uncertainties that we already see playing out in the macroeconomic domain? So a lot of uncertainties.

MALLABY: So we’ll come back to the financial instability question a bit later, but I wonder if you could just make one extra comment, which is to connect this uncertain outlook with the question of scarring, lasting effects to growth, even beyond a recovery. Even assuming you had a vaccine in a year’s time, people were back to work, everything is far. But there could still be the scar tissue that holds back output.

MANN: So in our—in our projections we have an outcome in the next—through the next three years or so where we have a loss of global GDP of, say, 4-7 percent. Now, to just put that into—relative to what had been expected as of January of this year, so only six months ago. We’re projecting forward a loss of global GDP of about 4-7 percent. So as I say, to put that into perspective, there was a loss of 5 percent of GDP after the GFC. So this is permanent losses. The consequences of permanent losses you can think about in a number of different ways.

Consequences of permanent losses means rising inequality. Smaller pie doesn’t get distributed any better. So you’ve got rising inequality within cohorts, within a generation. Of course, you have significant rising inequality across generations. Younger people—and this is true for all of the countries in the advanced world, particularly dramatic in the case of the U.S.—younger cohorts are not having the lifetime earning pattern that earlier cohorts, that their parents, did. And that has implications going forward for a whole range of issues.

Those are the demand side problems, the inequality side problems. But there are also the supply side problems. And that is when you have a deterioration in global trade, which of course has been going on for a decade now, you have a deterioration in productivity growth. When you have this collapse in business investment—and I’ve told a story about where it’s really hard to see businesses choosing to invest at all, because why would you bother if there’s this collapse in GDP, collapse in consumers? So we have a collapse in investment. That, of course, impacts capital—another major component of potential output.

And then you have this situation where no one in any of our countries that do our projections has a return to the pre-COVID level of unemployment. So you have labor market scarring. So right there, you have your three elements of potential output—capital, labor, and productivity—all significantly at risk. And so the picture going forward for this future potential output is really not very good. So we’re going to get into a discussion about policies and whether or not the set that are in place now are going to change this picture. But that’s the picture that we have right now, and it’s a pretty sober one.

MALLABY: Turning to you, Brad, next. There is a big split in the experience between the developing markets and the emerging ones. The developed markets are going to shrink less—3 percent in the IMF projection versus 8 percent for the developing markets. But the growth loss in emerging markets is roughly the same. In other words, because they have better demographic growth there is the inevitable momentum in catch-up economies. They started from a higher base, so falling to negative 3 (percent) is a big, big fall. I wonder if you could talk about, within the emerging world, Brad, are there particular regions where you think they’re going to escape that outcome? And which ones are you most worried about?

SETSER: Sure. It’s a very good question. Within the emerging world there’s actually enormous divergences in forecasts. So it’s almost inaccurate to speak of one forecast when the emerging world when in practice there are two very distinct forecasts that merge to produce an overall fall that is a little bit less in numeric terms than the fall in the advanced economies.

Latin America right now is tracking worse than the advanced economies. Mexico doing quite badly. The trade data just came out this morning. U.S. trade with Mexico is down 50 percent more than overall U.S. trade, which is unusual. Reflects the contraction in autos. And in places like Brazil, the failure to contain the spread of the coronavirus is likely to continue to weigh on activity. And in Brazil’s neighbors, the need to have strict shutdowns to limit the potential spread is producing very sharp falls in output.

So you go from Latin America, which is worse—amongst the worst forecasts, to places like Africa where in some sense the more agricultural your economy is the more naturally socially distanced you are and the smaller the fall in output. But South Africa is tracking close to the advanced economies. Then you can look at the commodity exporters who have to adjust to lower oil prices. Some can do that more successfully than others. And then you get to the really key element of the IMF forecast, which is China.

China stands out because China is forecast to have positive growth on a year over year basis. And year over year is basically a measure of where you are in the middle of the year, relative to where you are, you know, in the middle of the year the previous year. So it’s picking up the weakest part of the forecast for China. If you look at the forecasts from Q4 to Q4 in China for the IMF or many of the major investment banks, the expectation is 4-5 percent year over year growth, which implies a much closer to a V-shaped recovery in China.

I actually worry that that creates some substantial downside risk to the overall forecast, because the V in China hinges on sustained superior export growth. Chinese exports bounced back really strongly in the second quarter, driven by pent up demand. But it isn’t clear to me that that will be sustained. And it requires some shift in consumer behavior, as retail sales and the recovery in retail sales and services has lagged the recovery in industrial production. And I also worry that China hasn’t done enough to support consumer income and consumer spending. So there’s some risk that China’s recovery isn’t quite as strong as it is in that forecast.

Overall, I think I wouldn’t characterize the emerging world as doing substantially better than the advanced economies. I would say that right now there’s a hope that East Asia will do substantially better than the rest of the world.

MALLABY: Just to pick up a little bit on what you said about China, Brad. One of the things I think I understand is that the Chinese stimulus was slow, surprisingly small compared to what they did after the Lehman Brothers crisis, but it’s now feeding through the system. And in some sense, is a mirror opposite of the nature of how the stimulus might turn out in some advanced economies, where you had extremely quick direct transfers to workers through higher unemployment payments and so forth, which are now scheduled either to sunset or to taper, both in Europe and in the U.S. So you’ve got sort of the prospect that—you know, we’ll see how it plays out—but the prospect of fading stimulus in the advanced economies but accelerating stimulus in China. Is that how you see it?

SETSER: I guess I see a slightly more nuanced picture in China. I think that there will—there is stimulus through the traditional Chinese channels of infrastructure investment, support for local governments who want to embark on new projects—which is, you know, something the U.S. has yet to agree on. And that will, and already is, supporting some parts of the Chinese economy. I, though, worry that the almost complete absence of direct income support to workers will, in China, weigh on the recovery. If we pulled back on our stimulus, and I keep saying—see the same thing here—but, you know, not providing more direct support to workers, who I think have not completely found jobs—you know, particularly workers in the services sector, or migrant workers who have not returned—I think that could weigh on the strength of the consumer rebound over time and weigh on the Chinese recovery.

Now, the other factor that helps China is that consumption is a smaller share of the economy than investment. And so mechanically the stimulus through investment will probably have a slightly bigger impact than what I suspect is an ongoing weakness on the consumption side. So that helps. But I’m not quite as sanguine as your question would suggest.

MALLABY: And let me just sort of tax you with one more question, Brad. And that is, you’ve been critical in your writings on, on your blog, about the vigor of the IMF response. Pointing out that for those countries that do not have the fiscal space to deliver stimulus, why can’t they—you know, the fund has the resources, should it not be doing more? Do you still hold that view? And do you think it’s—just explain a bit about that.

SETSER: No, I mean, I absolutely still hold that view. If you had asked someone a year ago: How much of the IMF balance sheet should be used in the face of the, I guess, biggest downturn since World War II, in the face of a financial shock that at least at its peak in March and April was as intense as in the global financial crisis, I think you would sort of expect maybe 50 (percent), maybe 75 percent of the IMF’s resources to be committed and deployed, especially because there’s a financial dimension to this crisis. Social distancing reduces revenues, containing the virus requires increased spending on public health, fiscal deficits in some emerging economies are projected to be close to 15 percent of GDP, some comparable to some advanced economies. The need is there.

You might think that the IMF would be deploying the majority of its balance sheet. But if you look at what the IMF is projected to do—and the IMF has been pretty transparent about it—they’re projected to increase their lending from—and commitments—from 125 billion (dollars) to 250 billion (dollars), which is roughly using 25 percent of their balance sheet. Or, to put it differently, 70-75 percent of their balance sheet isn’t being used. Seven hundred and fifty billion (dollars) of lending capacity is sitting on the sidelines. I think we should be thinking about creative ways of using a portion of that unused capacity to help meet the fiscal financing need of a number of emerging economies.

Normally you want to make sure that the IMF doesn’t lend too liberally, that it doesn’t lend to countries that don’t really need the IMF, and that it lends on terms where it gets its money back pretty quickly. I think need to kind of reverse that right now. I think we need to think of ways to encourage more countries to use the funds’ resources to help anchor their debt sustainability with low-cost funding and take some of the pressure off local financial markets, which have to absorb all the debt associated with these necessary fiscal deficits. And correspondingly, rather than having the fund’s balance sheet necessarily resolve, I think a portion of the fund’s balance sheet could be committed to some relatively long-term exposures so that countries don’t have to worry about refinancing risk, that Isabelle’s friends in the markets can’t panic and pull back just when you need the money the most.

But it would be a substantial shift in how the world thinks about the IMF. But in my view, having the IMF’s firepower largely on the sidelines, you know, when the downturn is too sharp—so sharp, is a policy error.

MALLABY: So, Isabelle, I think you may not be the only person on the call to have friends in the markets, so don’t feel any need to defend yourself if that was the intent of Brad’s thing. (Laughs.) But you have spent fifteen years, I believe, at the IMF before going to BlackRock. So I would like to hear from you about whether you agree that the IMF could and should do a lot more to help emerging markets right now.

MATEOS Y LAGO: Sure. Well, first of all, I also have a lot of friends at the IMF, so it’s a balance act here. But, no, look I think—I think it’s a complicated question because, you know, one way of hearing what Brad just said, which of course is completely correct factually and is even worse if you look at the money actually disbursed. You know, the increase in money disbursed by the IMF since the end of February is $16 billion, or SDRs. This is—this is a tiny, silly amount when you think of the magnitude of the shock.

But it’s not for want of wanting to help. The IMF has been, frankly, on the front foot in drawing attention from global leaders to the problems faced by emerging and developing countries. They’ve received eighty-what program requests. And since people can’t travel they have to, you know, work at night to be in the time zone of the requesting countries. And to be fair, the commitments to the poorest countries have increased—sorry—the dispersions have increased by 60 percent in the space of—in the space of two months.

So the problem is not so much in channeling help to the poorest countries. Those have, in fact, absorbed a quarter of the disbursements in the last couple of months even though they represent only something like 3 percent of quota. So they’ve absorbed a very disproportionate share of the money disbursed by the IMF. But the issue is the emerging markets. And there, I think there’s—the tools that the IMF has, the policies it has, don’t really allow them to match their liquidity, their financing with the needs of the emerging markets. There’s a new facility that’s been created, short-term liquidity line, to kind of emulate the Fed swap line. Nobody has applied to it.

And nobody has applied to it because it just don’t fill a need, because those countries that are strong enough to qualify, frankly, have access to the flexible credit line or to the Fed swap line. And meanwhile, you have those that have, you know, substantial refinancing needs but fundamentals that are not the strongest. And those are afraid to go to the fund with the standard facilities. They’re afraid of all the conditionality burden. And they’re afraid, frankly, that capital markets will panic and say, oh no, a lot more senior debt is going to be piled on top of what is already there. This is looking a little scary. The fund now has these very demanding debt sustainability criteria. Maybe it’s not such a good idea to stay in. And so you’re at risk of having the opposite of the catalytic effect, of spooking financial markets.

So I think there’s a genuine problem there, that Brad has identified. But it’s not easy to solve. It’s certainly not for lack of will of the IMF of trying. I think the good news perhaps is that really after the massive capital outflows suffered by emerging markets in March, the situation has improved markedly. A number of them have been able to tap the markets again. And at least in countries where the epidemic seems somewhat under control, the situation is not as bad as perhaps was initially feared. But there is a systemic and sort of policy issue behind this, yeah.

MALLABY: Isabelle, let’s pivot to Europe. BlackRock has turned positive on Europe. And I guess the question is: Is that simply because there’s been such an extraordinary run in U.S. financial assets that, you know, the advice is you should rebalance? Or is it that you really think that Europe’s policy response, by which I mean both public health measures to contain the spread of the virus in addition to economic measures to counteract the shock to demand, do you think those policies have really gone surprisingly well by the sense of European policy crisis management?

MATEOS Y LAGO: Yeah, so I think, you know, it’s not just BlackRock that’s turned positive towards Europe. I think generally the market sentiment is more positive than it’s been since, you know, the second half of 2017. And you see this inequity flows that over the last few weeks have become net positive towards Europe, both from Europeans themselves but also from the—from the rest of the world. And that hadn’t been the case in a long time.

And I would say there’s broadly three schools of thought behind this change in sentiment. One school of thought, which is maybe a little over a third, is people thinking: That’s it. We’ve got a change in the nature of the eurozone. You know, we had banking union after the sovereign debt crisis. And now after COVID, we’re going to have a bit more of a fiscal/political union. And so there’s definitely a group of investors who think that we’re in a new ballgame in Europe. That everything’s going to be more sustainable, more cohesive, and more stable.

There’s a second school of thought who doesn’t quite buy this or doesn’t know. But they simply notice that Europe has done quite well in terms of coming to grips with the pandemic, has been able to reopen its economies without having a new surge, and that when you look at mobility data actually it’s now surpassed the United States in terms of return to normal, of a whole bunch of activities. On top of that, the policy response—which initially was perhaps seen as too timid of lagging behind the U.S.—the policy response from both the ECB and the fiscal authorities is now essentially on a par—definitely on par with the expected scale of the damage, but also on par with the U.S. And so on that basis, you know, that’s a case for being tactically warmer to Europe, even if you’re skeptical about the longer-term case.

And then you have a third bucket of investors who think: Well, I don’t believe in any of that. I’m not even sure the policy response makes a lot of sense. But guess what? Europe is cheap compared to the performance that we’re seeing from U.S. assets, in particular. And so just on that basis I’m going to warm up to that—to that zone and asset class for the time being. So I would say there’s a mix of views, but it adds up to a pretty bullish case, at least on the near-term basis.

MALLABY: Well, we’re getting towards the time when I’d like to ask members watching this webcast to ask questions. But I want to sneak one question for Catherine in, because we promised to come back to this question of financial stability. The IMF actually flagged this in the presentation that went with the last update to their forecast. And the point is simply that financial markets have been pretty calm, thanks to all the intervention. Therefore, if there’s a change in financial conditions it’s going to be in the direction of volatility and making it harder. So if it’s only got one way to move, that’s a negative for the outlook. And so I guess the question is, what sort of odds should one assign? On the one hand you’ve got the promise of open-ended monetary support for markets. On the other hand, you do see behaviors like the rise of the sports bettors who have moved to day trading and so forth. So, Catherine, how do you weigh the odds of financial instability becoming an exacerbating factor?

MANN: So we start—first, I have to just mention something on the emerging market story, and that is—and it feeds into this point. It’s the role of forward guidance. Forward guidance, saying that you will do something if you need to, can play a very important role. And I think that forward guidance by the IMF, along with the actual activities of other central banks, have created an environment where emerging markets have been able to go back to the market, add favorable spreads and long duration. So there’s some sense in which you don’t actually have to use your balance sheet in order to get the kinds of financial calm that you want.

Now, of course, this—we need to pivot to the European Central Bank, the Bank of Japan, and of course the Federal Reserve who are using their balance sheet in a very big way and have moved into a much more extensive set of interventions directly into the markets. I can say, and all of our colleagues agree, that in March it was crucial to have the actual—the programs in place, the programs announced, and the fiscal money spigots opened, and that this combination was absolutely crucial in providing financial—in calming the financial markets and preventing the type of cascade through, you know, investment grade, turns into high yield, turns into default, turns into, you know, fire sales.

That financial cascade on top of COVID clearly was something that absolutely had to be avoided. So it made perfect sense for the Federal Reserve to do what they did at that time. You know, so you prevent fire sales. But of course, the more you actually deploy your balance sheet, and deploy these programs, the more you are raising the specter of moral hazard. And we can see that in terms of the just incredible issuance by corporates in the current environment. You know, get while the gettin’s good is what all the clients are saying. They don’t know what—you know, there are some that need the liquidity. But an awful lot are sort of saying, you know, I don’t need any of this. I don’t need any additional debt on my balance sheet. But it is so cheap that I just—you know, I’m going to borrow now at incredibly low spreads, really long durations. And it will be a gift to the next CEO who comes after me.

So there’s this—the problem about the financial stability question is that if preventing fire sales, absolutely. Because this financial cascade on top of COVID, clear disaster. On the other hand, the more you actually deploy—which might even make sense in the short term, but short term, short term, short term—end up being the wrong direction in the longer-term. And that’s where the moral hazard issue comes up, because the more the moral hazard issue rises the less and less room to maneuver that the Fed has.

And even small changes in the purchases, much less rolling off of the balance sheet sometime way off in the future, just even small changes in the rate of purchase can be interpreted by the financial markets as an implied tightening, which they always think of as an implied tightening is a real tightening, even if you’re still loosening. You’re not loosening as much as you did before. And so that, of course, can create an environment where more and more of the Federal Reserve’s balance sheet has to be deployed. And that’s a problem.

MALLABY: OK. Let’s see if Carrie Bueche can help to moderate questions from viewers. Carrie?

STAFF: (Gives queuing instructions.)

We’ll take our first question from Dough Rediker.

Q: Hey, everyone. Great panel.

Particularly, I guess, for Brad and Isabelle, on the comments on the IMF and its thus-far underperforming in terms of how much it has lent to emerging markets in low-income countries, I was surprised that neither of you seemed to focus on the issue of China being the largest bilateral official creditor to many of those countries, and its thus-far unwillingness to actually provide meaningful debt relief or debt reduction. So you end up with a situation where not only is debt sustainability put into play, but where you have that odd and, let’s say, not terribly pleasant potential where IMF funds are used to repay Chinese lending to these countries, which is both politically and economically not an acceptable outcome. So I’m curious as to whether you see China’s role in enhancing the IMF’s ability to be more aggressive as one that is going to be overcomeable? Or if in fact that’s going to be a geopolitical question as much as an IMF governance one.

MALLABY: Maybe Brad first.

SETSER: Sure. I sort of differentiate pretty strongly between what I think the IMF should be doing in a subset of, like, the major emerging economies—the Brazils, the South Africas, India potentially—countries that aren’t really reliant on Chinese bilateral financing, that rely much more on their local markets and rely on the margin at external issuance. You know, I would—I agree that, you know, the external markets have opened to a degree.

But they’ve opened on relatively small scale relative to the massive fiscal financing need. And the IMF can help anchor debt sustainability with lower cost funding that the market can provide. Lower cost and, from the country’s point of view, lower risk. And at a time when I think we should be helping countries support the increase in debt associated with this pandemic, I’m much more willing to take risk with the IMF’s balance sheet that I would be in normal times. And I don’t think China’s a constraint there.

There’s a second set of issues associated with the low-income countries. And there, China is typically a very large share of the outstanding bilateral credit. And China absolutely should be agreeing to reschedule its loans on similar terms as the other creditors. And frankly, so should bond markets. I mean, if a bond is coming due this year or next, it also should be rescheduled. I hope China steps up.

There’s a complexity in that, you know, while the rest of the world views China as a monolithic actor, and says there’s no difference between Chinese development financing, loans from the China Development Bank, and loans from the Chinese state commercial banks, the Chinese tend to think that those distinctions are quite important and that, say, the China Development Bank lends on non-development terms and is not a forgivable loan. And the state commercial banks are much more akin to Citibank and BlackRock than they are to development financing. And they want different treatment for different buckets. To some degree that can be accommodated, but I think at the end of the day China needs to force its state institutions to step up.

Let me close with a final point: The numbers here are much smaller than what has typically been noted. I went through the World Bank’s data on low-income countries, the IDA set of countries, and looked at the expected gains from the debt service suspension initiative. The aggregate gain is about twelve billion, which is important but it’s not enormous. About half, five billion, though, comes from two countries—Angola, which is essentially China, and Pakistan, which is mostly China but not only China. For the rest of the IDA countries, full success will give you six billion in extra financing.

That strikes me as woefully inadequate. There’s been a lot of criticism by some of the idea of an SDR allocation, because it wouldn’t provide enough targeted support for low-income countries. But the SDR allocation would provide about twenty billion in financing to that set of countries. So while China’s important, and China’s role here is important, I don’t think we can let China and concerns about China drive the overall global response, particularly for countries other than Angola and Pakistan. The Debt Service Suspension Initiative won’t deliver enough financing to really make a meaningful difference to their output.

MALLABY: Isabelle, do you want to comment?

MATEOS Y LAGO: I mean, just—I mean, I agree with everything Brad said, including on the SDR allocation. But just in terms of the Debt Service Suspension Initiative, this is a G-20 initiative. China has fully signed up to it and is fully engaging alongside the Paris club in giving debt relief to the countries that ask for it. So I don’t really see an issue there. But of course, that’s just for the poorest countries.

MALLABY: OK. Next question.

STAFF: We will take our next question from Tara Hariharan.

Q: Thank you so much. Can you hear me?

MALLABY: Yes, we can.

Q: Thank you, again.

So my question pertains to the U.S. fiscal response, given that we have started to see the data rebound in the U.S., like the payroll numbers today. But of course, we face a second virus wave ahead. Where will the balance between the U.S. fiscal response and the monetary response fall? Because I appreciate all of Catherine’s excellent comments about forward guidance and central banking, but at this point it would appear that the fiscal response has to step up, particularly because we have a whole set of cliffs emerging in the next couple of months—whether it be in unemployment insurance or the payroll—Paycheck Protection Program, and such. Thank you.

MALLABY: Great question. Maybe, Catherine, do you want to comment on that?

MANN: You’re right. There are a variety of fiscal cliffs that are looming with regard to the, I call them, life preservers. At this point, everything that is being done by the U.S. fiscal programs are life preservers. They are keeping the, you know, businesses and workers in cash flow until the revenue—I mean, what is hoping—is that the revenue streams and the employment streams would be back on track by the deadlines that had been originally imposed in those—in those pieces of legislation.

Now, you know that the Payroll Protection Program has been extended to September, I believe. And the question on the unemployment compensation, the top-up of $600—top-up is under—there’s a number of issues on that on the discussion front—on that. But one thing that I would bring in on the fiscal issues in general, and this is a comparison between the fiscal in Europe and the fiscal in the U.S., and looking forward to, as I say, this backdrop of tremendous uncertainty that is being reflected in collapsing business investment, and it’s going to be, you know, slack employment as a result.

None of the programs that the U.S. has right now has any forward-looking catalyst in it that would engage the private sector in renewed activity. As I say, it’s all kind of focused on life preservers, not how do we catalyze private sector activity going forward because, of course, ultimately we know that you don’t drive an economy forward based on, you know, fiscal spending. It’s the multipliers. And right now, the multipliers are not—they’re there, of course. But what we really need to have is a type of fiscal program going forward that delivers longer-term multipliers.

One of these, of course, the standard one, is infrastructure. We don’t think we’re going to have a lot of that. Maybe we’ll have enough to send a life preserver out to the state and local governments so that they can keep some of their infrastructure programs back on track, as opposed to in mothballs. But I contrast this lack of a strategy going forward, a vision for catalyzing private sector activity going forward in the post-COVID period with the glimmers—the glimmers in the European Recovery Fund of a focus on digital and climate.

And these are catalysts—maybe we don’t need digital in the U.S., I mean they need it in Europe—but the catalyst of climate policy to catalyze private-sector investment, private sector transition that’s associated with the climate transition. This is something that is part of the European Recovery Fund. It is something beyond the life preserver that is a target for businesses and the business environment to try to achieve. And that’s an important differentiator, I think, between what the fiscal program looks like in the U.S. right now and what it potentially—and as I say, there’s a glimmer of this, we’re not exactly sure quite how this is going to roll out for Europe. And Isabelle made a lot of comments that I agree with on that.

But I do think that these are important differentiators. So as much as I understand that fiscal cliffs right now are sort of a clear and present danger to supporting the recovery for the U.S., we also have to have some forward-looking policies that will have a longer-term impact on the capacity of the U.S. economy to repay all the obligations that it’s undertaken right now.

SETSER: Let me just chime in really quickly to reinforce the need for a life preserver for state and local governments. They’re facing a couple hundred billion loss of revenue over the next eighteen months, under an optimistic forecast. If they have to cut spending, whether it’s on infrastructure, or teachers, or police, or firefighters, or emergency responders, that’s a drag on the economy, of considerable proportion. We made that mistake of having the state and local governments pull back in our response to the global financial crisis. And I would hope we don’t make the same mistake now.

MALLABY: Another question.

STAFF: We will take our next question from Andrew Gundlach.

Q: Can you hear me?


Q: Hi. Good morning, everybody. It’s really interesting.

I’d like to also focus on the labor markets, where I’m having perhaps the greatest difficulty understanding everything that’s going on. The question ultimately goes to you, Catherine, but also Brad and Isabelle your input would be interesting, where you broke it down between capital, labor, and productivity. The question is really whether or not the case for structurally low inflation is something that you believe in a little bit longer-term. As I look at it, the government stepped in, to your point in the earlier question, and effectively changed the minimum wage to $25. Whether or not it continues it or not, what you—it almost reminds me of Y2K, where you had a recovering economy, you had essentially a labor market that had shifted permanently, and suddenly you had rising bond yields. And suddenly, the inflation surprise story was in play.

I personally don’t believe it’s a structural change in inflation, but it certainly can be a cyclical change in inflation. And I’m just curious how you’re thinking about labor markets and how you’re thinking about how the change in the price of labor is going to play out over the quarters ahead. If you could help me think about that, I’d be grateful. Thank you.

MALLABY: Catherine.

MANN: So what might happen with regard to, for example, the minimum wage and wages earned by the lower part of the income distribution—which, of course, that is the group that has a marginal propensity of consuming over one, and they have definitely been consuming the additional top-up on the unemployment compensation that they’ve gotten. We’ve seen it in the retail sales numbers, for example. And so depending on the election we could have a different outcome for a national minimum wage. I don’t think you’re going to be looking at twenty-five, but maybe something above seven and a quarter.

So but I want to—let me—you’re asking about inflation and you’re sort of linking labor markets wages and inflation. That’s an important ingredient, obviously. Cost push inflation coming from the labor markets might be something of concern. I doubt it, going forward, at least near term, because we’re looking at labor markets—if we didn’t have a—if we didn’t have a wage inflation problem at 3 ½ percent unemployment, we’re probably not going to have a wage inflation problem fundamentally at, you know, triple digits—triple times that, and double-digit unemployment, at least in the U.S.

And even so, the question might be even if you did get, say, a $15 minimum wage, rising over time, ultimately inflation has to do with the capacity of firms to pass on costs and raise their prices. And so that ultimately ends up forcing us to talk about competition and the degree to which firms think they have their pricing power. If the answer is costs are rising, and firms have no pricing power, well then we get to talk about equity markets, because we will not be looking at earnings quite as robust. If firms do have pricing power, then we can ask about the question of how do consumers punish firms who try to raise their prices?

So you have a—if you—if you get your cost increases up, and of course you can substitute for higher wage labor with a variety of cheaper capital. And we know that there’s potential—lots of potential to do that. But ultimately the question for a firm is going to be: Am I going to—if I can’t—you know, I’m either going to pass through my cost increases and worry about being punished on the consumer side, or I can’t pass on my cost increases and I have to worry about being punished on the market side.

And how that plays out is fundamental for whether or not we see goods—you know, the CPI-type inflation. You know, we used to call it goods price inflation, but it’s, you know, goods and services price inflation in the real economy, versus the asset price inflation. And I think that differentiation between what happens in the real economy side, CPI/PCE, and what happens on asset prices is fundamentally about firm pricing power.

MALLABY: OK. Next question.

STAFF: We’ll take our next question from Steve Kaplan.

Q: Good morning. Can you hear me?


Q: Thank you. My question gets back to China. The IMF report and Brad’s discussion referred to China and the numbers that were issued and underlay the overall numbers. But my question is, how much can we trust the Chinese numbers? Not in general, but in reference to this issue? And if the answer is some degree of uncertainty, or doubt, or et cetera, then what does that mean for the overall—the large projections? Thank you.

MALLABY: Brad, do you want to start?

SETSER: Sure. I mean, I think, you know, in general the number that should be trusted the least is the one that gets the most attention, which is the headline growth number, which traditionally has always had to hit the official target. This year there’s not an official target, but there’s kind of an unofficial target. And it would be extremely surprising, no matter what the real outcome is, if China didn’t report a positive year over year number. It may not be as big as it has been in the past, but I think there will be, if necessary, massaging of the data.

That said, a lot of the big data changes to the world have also come to China. So there’s big data measures on mobility, on consumption. And there are data series that traditionally have been relatively reliable. The Chinese trade data usually maps, with an adjustment for Hong Kong, the import data and export data for the rest of the world. So I think we know with a reasonably high level of confidence that Chinese industrial production actually has bounced back in the second quarter. Certainly, Chinese exports have bounced back in the second quarter. And we know, with a relatively high degree of confidence because it’s matched to a lot of big data sets, that the recovery on the retail side and on the services side, has lagged the recovery in exports and industrial production.

So those are pretty solid data points. The difficult part, I think, is the forward-looking forecast. What fraction of the rebound in China’s exports so far was pent-up demand created by the fall in the first quarter? And can that be sustained? How directly will China’s infrastructure investment increase spillover to the rest of the world economy? Typically you see it in INR prices. And INR prices have done sort of OK-ish. So that seems like it is real.

But then, you know, as I mentioned, at some point the absence of a stronger rebound on the retail and consumption side in China will likely weigh on the sustainability of the recovery and industrial production. So on a dynamic, forward-looking basis I do worry about whether the Chinese recovery will be as strong as forecast. But I worry about it in large part because I fear that the real basis for that recovery isn’t yet in place.

MALLABY: We’re almost out of time, so I’m going to try to have some fun, if that’s possible on Zoom, by asking each of you—all three of you—to just give me the sense on the following question. It’s clear that, picking up on these Chinese discussion, both sides, the U.S. and China, will try to draw out of the COVID episode some kind of propaganda advantage. And there’ll be a question: You know, which system weather this economic shock better? If I propose that, looking back five years from now, China will be seen to have managed the crisis better, you can either say strongly agree, agree—so, five, four, three, et cetera. And strongly agree is five. Let’s start with Isabelle. Do you believe that China will come out looking stronger than the U.S.?

MATEOS Y LAGO: I agree that China will come out looking stronger than a lot of others. But I think the point that Brad just made now is critical. China will only do as well as the rest of the world does. And it will struggle if the rest of the world does. So we need to keep that in mind. But China needs to be, yeah, I think something everybody needs to be exposed to going forward. China is a growing global power. That’s inescapable. And certainly they haven’t failed that test under COVID.

MALLABY: OK. Catherine, will the Chinese be seen to have outperformed the U.S. through COVID?

MANN: I think by the measures that are often deployed, which is GDP growth, it might look better. But I think that there are vulnerabilities and rigidities that may well set it up for problems going forward. We know, prior to COVID, we had talked about these vulnerabilities on the financial side. They have not gone away. And so I do think that what looks to be a stable and strong environment may have termites—may have some serious termites.

MALLABY: Brad, what’s the termite factor? Will China emerge—you’re lucky here. I gave you the last word. You have the longest to think about it. That’s because you’re my colleague. I’ve got to face you next week. But tell us, is China in five years going to be seen to have come through COVID better than the U.S.?

SETSER: Yes, but largely because of the failures of the U.S., not because of the success of China’s response. The U.S. public health response has lagged that of China, lagged that of Korea, of Taiwan, and now lags that of the EU. It’s much more a reflection of what we’ve done to ourselves. But there is an irony in the fact that the virus emerged out of China, and China is now forecast to have the strongest economic growth of any major region of the world in this year. I think that just highlights how unpredictable a pandemic can be, and how unprepared the world was for this kind of shock.

MALLABY: OK. Well, that wraps up the World Economic Update, in honor and in memory of Marty Feldstein. Thank you to all of you for participating. Bye-bye.


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