This past week we've been provided a snapshot of what topics may be discussed at the May 17-18 Group of 8 summit, which in a surprise move was relocated from Chicago to Camp David. The move itself was said to be, “more closely approximate the remote settings in which the G8 leaders prefer to gather,” as meetings in larger, urban areas tend to attract clamorous protests.
The snapshot that we've been provided though comes by way of two speeches, one delivered at The Brookings institution by Managing Director of the International Monetary Fund, Christine Lagarde. The other at New York University by Vice Chair of the Board of Governors of the Federal Reserve System, Janet L. Yellen. Both speakers discussed the state of global and U.S. economies with proposals on moving forward from our current situation.
“Only a few months ago, we seemed to be staring into the abyss. More recently, some data have [sic] indicated that the United States may be beginning to turn the corner,” said Lagarde who spoke inspirationally of the economic situation and quoted Nelson Mandela when she suggested that there is still much work to come beginning with that countries must limit their exposure to the financial vulnerabilities of their trading partners as has been occurring in the European Union where financial strains remain high. “A stronger global firewall will help complete the circle of protection for every country.”
On the day of Lagarde's speech, the International Monetary Fund posted that it had concluded its 2012 Article IV Consultation with Iceland. “Iceland is gradually emerging from its post-crisis recession. The economy expanded by 3 percent in 2011 driven by a broad-based rebound in consumption and a gradual pick-up in investment. Unemployment declined steadily and now stands at around 7 percent.” This comes just three years after Iceland allowed its banks to fail. On that same day Iceland announced that it would be forgiving much of the mortgage debt held by its citizens and indicting key members of the government and financial sectors for their roles in the economic collapse.
In her speech, Yellin referenced this stage of recovery with, “In addition, it's conceivable that the European situation could deteriorate and prompt a significant increase in global financial market stress. Such developments would likely have substantial adverse effects on U.S. economic activity and inflation.” Although inflation didn't appear to be the primary concern as she said, “significant headwinds are likely to continue to restrain aggregate spending, and progress in closing the remaining employment gap is likely to be quite gradual. Apart from sizable increases in gasoline prices, inflation has been subdued in recent months.” She added that she expects inflation to stay at or below the 2 percent projected by the Federal Open Market Committee (FOMC).
On the day of Yellen's speech, the Bank of France posted that there was no growth in the first quarter of 2012 and that there are no signs of a strong recovery in activity in the coming months. The Euro zone's second largest economy barely avoided a recession after it grew by 0.2% in the fourth quarter 2011.
Lagarde suggested that this moment is one of global redistribution. “Clearly, the rebalancing of the global economy—a shift in demand from external deficit to surplus countries—is key and something that the IMF has been advocating for some time.” She furthered this in citing global successes by referencing, “new forms of collaboration coming into play,” as seen in the BRICS—Brazil, Russia, India, China, and South Africa—that have established a development bank to aid burgeoning economies. “The IMF recognizes it too,” she said. “We are at the very intersection of an increasingly global world.” From this she surmised that Western economies have something to learn in the way these markets work and that we would do well to look towards emulating some of these as a path to recovery.
“One, we need financial systems that support—not destabilize—the economy. This means repairing financial systems so they can deliver credit, growth and jobs.” Lagarde added, “This means better regulation and supervision, and coordination across countries, to prevent the recurrence of reckless risk-taking.”
“Two, we must improve competitiveness and have better functioning labor markets so that we can generate more jobs.” Lagarde's rational on this was that workers across the board, skilled and unskilled would need to accept that industry wage standards would have to be lowered to remain competitive in the global economy. “The focus should be on getting people back to work.”
“Three, as countries undertake the sometimes wrenching reforms that are needed, the social fabric is in danger of being stretched.” Lagarde cautioned, “So they must protect and reinforce appropriate safety nets.”
Recommendations from Lagarde did somewhat match those of Yellen in that to move from our current situation, our economy must begin to capitalize on its labor resources. “The level of private payrolls remains nearly 5 million below its pre-recession peak, and the unemployment rate stands well above levels that I, and most analysts, judge as normal over the longer run,” Yellen said on citing a ¾ point fall in unemployment in the first three months of the year to 8.25 percent. “FOMC participants' projections indicate that unemployment will decline gradually from current levels. Included in the figure as well is the central tendency of FOMC participants' estimates of the longer-run normal unemployment rate, which ranges from 5.2 percent to 6 percent. The unemployment rate is expected to remain well above its longer-run normal value over the next several years.”
Without plotting the same course, Yellen cited the same reasons given in Legarde's speech.“Putting all the evidence together, I see no good reason to doubt that our nation's high unemployment rate indicates a substantial degree of slack in the labor market,” Yellen said. “Moreover, while I recognize the significant uncertainty surrounding such forecasts, I anticipate that growth in real gross domestic product will be sufficient to lower unemployment only gradually from this point forward, in part because substantial headwinds continue to restrain the recovery.”
In her discussing the near term economic outlook, Yellen cited three factors that prevent the U.S. Economy from returning to pre-recession levels where she first pointed to the housing market as a reason for an anemic recovery. “One headwind comes from the housing sector, which has typically been a driver of business cycle recoveries. We have seen some improvement recently, but demand for housing is likely to pick up only gradually given still-elevated unemployment, uncertainties over the direction of house prices, and mortgage credit availability that seems likely to remain very restricted for all but the most creditworthy buyers.”
On the financial markets, Yellen took her speech away from the conclusions of Lagarde's call for financial reform and instead offered tax revenue as a resource by stating, “A second headwind comes from fiscal policy. State and local governments continue to face extremely tight budget situations in light of the weak economy, depressed home prices, and the phasing out of federal stimulus grants, though overall tax revenues have been improving and that should continue as the economy expands further.”
Finally citing the global market as a reason, Yellen offered, “A third factor weighing on the outlook is the sluggish pace of economic growth abroad. Strains in global financial markets have eased somewhat since late last year, an improvement that reflects in part policy actions taken by European authorities. Nonetheless, risk premiums on sovereign debt and other securities are still elevated in many European countries, while European banks continue to face pressure to shrink their balance sheets, and concerns about the outlook for the region remain. A further slowdown in economic activity in Europe and in other foreign economies would inhibit U.S. export growth.”
Overall there is the divergence, Largarde asks a radical shift in monetary policy that would include slashing wages and other austerity measures, while Yellen recommends staying with existing policy set forth when the FOMC issued statements following its January and March meetings indicating that it “currently anticipates that economic conditions—including low rates of resource utilization and a subdued outlook for inflation over the medium run—are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.”
