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Tuesday, October 04, 2005

The Bank of Canada's David Dodge on Solving Global Imbalances

David Dodge, Governor of the Bank of Canada, discusses global imbalances in The Financial Times and how their resolution is a shared worldwide responsibility, but I thought I'd go back to a more extended version of his remarks from a September 9 speech.  Among the issues cited as necessary to avoid a worldwide recession are the need for countries to adopt fiscal, labor market, financial market, and social safety net reform.  Fiscal reform will prepare countries for coming demographic challenges and also allow fiscal policy to be used, if necessary, to combat deficient aggregate demand.  The other reforms are intended to increase worldwide flexibility to respond quickly and efficiently to economic shocks and avoid prolonged recessions.  In addition, the reforms are intended to stimulate aggregate demand by reducing the need for saving.  His point that all countries have a role to play in the rebalancing effort is worth emphasizing since much of the debate on this issue has involved trying to identify a particular country or policy that explains the current situation when a combination of factors is at work:

The Evolution and Resolution of Global Imbalances, Remarks by David Dodge, Governor of the Bank of Canada: ...Today, I will talk about two types of global economic imbalances. The first relates to ... savings and investment ... being distributed across countries in an increasingly uneven way. The second is the possibility that, over the next couple of decades, the global economy might face a protracted period in which desired savings exceed planned investment, partly because of demographic trends. If economic policy-makers do not take appropriate measures quickly enough, there is even a risk—albeit a small one—that the world economy could end up with ... widespread demand deficiency and a persistent deflationary gap. ...Geographical imbalances are not necessarily a bad thing, nor are the large capital flows that they generate. Indeed, ... world financial markets ... allow savers in one country to lend to borrowers in another. Such a process leads to higher global growth ... If markets ... operate without interference, imbalances can resolve themselves in a reasonably smooth manner. But in the absence of appropriately functioning market mechanisms, there is a greater risk that the correction will be abrupt and disorderly. ... a disorderly correction might also lead governments to adopt wrong-headed protectionist measures... [R]egardless of how these imbalances are resolved, it is clear that the resolution will require greater net national savings in the United States. Investment in the U.S. economy will need more financing from domestic sources ... This implies an increase in net U.S. exports and a decrease in net exports elsewhere in the world, as well as an increase in domestic demand in other countries. Exchange rate movements have an important role to play in this regard, ... efforts by some countries to slow or prevent required adjustments by pegging exchange rates are ... counterproductive. ... such policies raise the risk of a much larger and more disorderly correction in the future, as well as an outbreak of protectionism... Within the United States, higher interest rates can be expected to lead to increased savings. Authorities could also encourage greater national savings with a tighter fiscal policy. And they could implement ... reforms to encourage national savings through taxation ... and other measures. But if the United States alone were to act to resolve its imbalance ... it would leave the global economy with much weaker aggregate demand. And so a number of other countries must focus on stimulating domestic demand. ... So, how can we stimulate domestic demand outside the United States? ... Structural reforms to remove market rigidities are important for most of us. Many need to improve or develop their financial system ... For some, the development of social safety nets would be helpful, so citizens don't feel the need to hold excessive precautionary savings. And for a few, more stimulative fiscal policy would be helpful.

...[T]he second type of imbalance ... will be posed by evolving economic and demographic realities. ... Let me ... expand on this risk by highlighting two trends that will be important over the next decade or two. First, ... Asia's share of the world economy will continue to grow. ... Asian nations have traditionally had a higher rate of savings ... so, all other things being equal, we can expect that global desired savings will rise. But all other things are not equal. The second trend that we can expect is higher desired savings in most OECD economies as the baby-boom generation prepares for retirement. Taken together, these two trends can certainly be expected to lead to a higher level of global desired savings. So it is critical for policy-makers to act now, so there can be an increase in demand and investment to compensate... To deal with this expected slower growth in domestic demand, ... what can policy-makers do to support  ... private consumption, government spending, and investment? In terms of investment, ...  First, one might look to governments to provide an expansionary fiscal policy. ... Certainly, the economies of emerging Asia have the scope to support demand with fiscal policy. But in North America, Europe, and Japan the scope for fiscal policy ... appears to be very limited ... But if there is one thing that all governments can do to stimulate demand, it is to have appropriate structural policies ... We all need to take steps to improve the flexibility of our labour markets ... We also need to recognize that well-functioning credit markets are extremely important ... The improvement of labour and financial market policies is particularly important in Europe. In emerging Asia, improving income-security policies is essential ...In closing, ... I'm not saying that a disorderly correction to global imbalances is certain to happen. Nor am I saying that the global economy is inevitably headed for a deflationary shortfall in demand. What I am saying is that, as prudent policy-makers, we must not rely on good fortune to help us muddle through...

    Posted by on Tuesday, October 4, 2005 at 01:17 AM in Budget Deficit, Economics, International Finance, Monetary Policy, Saving | Permalink  TrackBack (0)  Comments (3)

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