Confronting the Global Threat Posed by Ebola by Investing in Global Public Goods

Brookings Institute Blog - Fri, 10/10/2014 - 06:38

The first Ebola death in the United States makes clear that global health challenges in the 21st century can no longer be considered local problems. While the United States government just moved to require airport screening for fevers for passengers travelling from West Africa this is unlikely to be an effective strategy. Given the extended incubation period of the virus, even travelers who might have Ebola are likely to be asymptomatic. As the Director of the Centers for Disease Control and Prevention (CDC) Thomas Frieden explained, “The plain truth is we can’t make the risk zero until the outbreak is controlled in West Africa.”  The only effective strategy for the United States and other countries to defend against Ebola is to invest in the global public goods needed to defeat Ebola in Liberia, Sierra Leone, and Guinea.

The Ebola catastrophe did not have to happen but instead was a result of multiple failures when it comes to disease surveillance, vaccine innovation, and the emergency public health response. It reveals that we need different strategies to prevent the next outbreak and to deal with the exponential growth of the current pandemic.  As I have found in my research, effective global health responses require distinct approaches to solving collective action failures—the same type of failures that are at the root of the current crisis. Without these failures, the world would already have an Ebola vaccine, the initial outbreak would not have festered for three months without anyone figuring out what was happening, and a serious global response would not have been delayed by as much as nine months as the epidemic spun out of control.

The first failure that gave rise to the current Ebola crisis is the failure of adequate disease surveillance. It looks like the first victim of this outbreak was a 2-year-old boy in a remote Guinean village. His mysterious death in December 2013 was followed by similar deaths within that region and across the country before experts from Doctors Without Borders identified the culprit as Ebola. If Guinea’s extremely weak health system had a more robust system of surveillance this disease could have been stopped in its tracks before it ever reached Liberia or Sierra Leone. This weakest-link challenge resulting from limited disease surveillance capacity within Guinea reveals that without strengthening health systems in many of the poorest countries in the world, global health responses will continue to be behind the curve.

Even after Ebola was identified, another six months passed before any country with the resources to adequately respond to the pandemic stepped up to the plate in a major way. In September, President Obama committed the United States to building Ebola treatment units and training health care workers. Despite this important effort, the global response still faces a shortfall of over $300 million even as the cost of the epidemic continues to grow dramatically. Only three countries have committed more than $20 million and most countries have contributed nothing at all. This problem of aggregate effort is central to the challenge of financing a sufficient emergency public health response in the affected countries to contain the virus.

Perhaps the most dramatic failure is the fact that nearly 40 years after the discovery of the Ebola virus there is still no effective vaccine. Leading scientists suggest that the technical challenges to creating a vaccine are relatively modest and two potentially promising vaccine candidates already exist. Yet the lack of a sufficient financial incentive for drug manufacturers meant that neither vaccine candidate was pushed forward to human trials until very recently. In the face of this dramatic market failure, a “single-best effort” investment by the United States in vaccine innovation can make a dramatic difference for the entire world.

Despite the many failures which contributed to the current catastrophe, there are some important signs that Ebola can be defeated. The spread of Ebola to Nigeria was quickly contained in Africa’s most populous country thanks to a rapid response that included strict quarantines for suspected cases, the temporary closing of schools, and screening for thousands of others. The survival of courageous health workers from the United States and elsewhere suggests there may be promise in new treatments that the United States is now investing in bringing to human trials. The possibility of blood transfusions from those who have survived may be the most effective treatment at present. The development of a rapid diagnostic to detect Ebola, which is within reach, could dramatically simplify the process of identifying those suffering from the virus and implementing appropriate public health responses.

The reality remains, however, that none of this will be possible without a dramatically ramped up global response. Liberia alone needs hundreds of additional foreign medical staff just to treat those now infected. More than 8,000 people have been infected so far and without extraordinary efforts, the CDC estimates that this number could grow to as many as 1.4 million by January. Thousands of others are now dying from untreated malaria or other illnesses as a consequence of a pandemic that is devastating the economies of the region and causing significant food insecurity. In the short term, a global aggregate effort to finance an emergency response and provide trained health care workers is essential to prevent Ebola from reaching many more countries. In the long-term, only by strengthening the health care systems and disease surveillance capacity in West Africa and other low-income regions and by investing in innovation to catalyze effective vaccines for potentially devastating viruses such as Ebola can the United States and the rest of the world be protected.

Categories: Blog

The Poverty of Poverty Data

Brookings Institute Blog - Fri, 10/10/2014 - 06:33

Earlier this week, the World Bank published its latest estimate of global poverty, reporting that 1.01 billion people lived under $1.25 a day in 2011. Such estimates typically receive a good deal of attention and this time is likely to be no different. A goal to end extreme poverty is expected to feature as the cornerstone of a successor agenda to the Millennium Development Goals. In theory, the new poverty numbers should give a clear indication of how far we stand away from that mark, which is crucial to assessing the goal’s feasibility. Yet, in our view, the new poverty estimate fails to do this.

We are pleased to see global poverty numbers receiving greater attention. Ending extreme poverty is not the endgame of development, nor does the simple indicator of income poverty capture all aspects of well-being, but it remains a communicable and critical measure of human progress.

We also commend the World Bank for adopting its own institutional target to reduce the global poverty rate to 3 percent by 2030, and for thinking seriously about how poverty data can be improved. The World Bank, more than any other institution, understands the conceptual and empirical issues involved in monitoring poverty, as demonstrated in yesterday’s release of an impressive policy research report.

One change already in place is the bank’s commitment to report on progress against global poverty on an annual basis, where previously such updates only occurred around every 3 years. This commitment was made by President Jim Kim at his Georgetown speech in April 2013 when the bank’s “twin goals” were first unveiled. Updating global estimates every year means that new information can more rapidly inform and improve our understanding.

A good example of this is provided by India. Until Wednesday, the most recent global poverty estimates drew from India’s 2009-10 National Sample Survey, which was conducted at the height of a drought. That survey gave the impression that poverty reduction had been sluggish over the preceding 5 years, despite this being a period of record economic growth in the country. This week’s new estimates use data from India’s 2011-12 National Sample Survey, conducted when conditions were more representative. It reports about 100 million less people living under $1.25. One result is that the oft-repeated claim that the number of extreme poor living in India exceeds that in Africa can finally be put to rest. (As a counterexample, we are baffled by the bank’s decision to continue to use Nigeria’s 2010 Harmonized Living Standards Survey whose data are riddled with inconsistencies, when more recent estimates from the 2011 and 2013 General Household Survey Panel are available. Whereas the 2010 survey reports a poverty rate of over 60 percent, the more recent surveys suggest the rate is closer to 30 percent.)

At the same time, it is hard to come away from the new global estimates without feeling underwhelmed and frustrated by their limitations.

First, it is disappointing to see that the World Bank continues to generate poverty estimates based on 2005 Purchasing Power Parity (PPP) data rather than the new 2011 PPP data published earlier this year. As we pointed out in May, the new PPPs suggest that prices in developing countries are far lower than previously thought, which has a dramatic bearing on poverty numbers.

The bank has put off incorporating the new price data into its poverty calculations until it has had time to explore the changes and their causes more carefully. Such research is undoubtedly of value. Yet everything we know about the design and implementation of the 2011 International Comparison Program (the source of the new PPP data) suggests it is superior to the previous round. Choosing to delay the adoption of the new PPPs means consciously opting to employ inferior data. It also effectively puts in limbo the bank’s institutional poverty goal (including its interim 2020 target to reduce the global poverty rate to 9 percent) and more importantly, the forging of the post-2015 development agenda, which is actively being negotiated.

There is a second respect in which the World Bank’s new estimates have the feeling of immediately being old: we are furnished with global poverty estimates for 2011 as we near the end of 2014.

There is no reason why the bank could not generate provisional poverty estimates for the current year that can later be revised as and when additional data comes in. This is the approach taken with almost every other time-series of important economic data. World Bank country economists are well positioned to generate such estimates and in fact have done so in some bank regions for some time. Alongside its release of 2011 global poverty estimates, the bank has published projections of poverty for 2015 and other outer years. It is absurd that the bank is willing to provide estimates of poverty in the past and poverty in the future, while refusing to estimate poverty today. 

One of the innovations introduced by President Kim is the creation of a “Delivery Unit” specifically charged with generating real-time data on key performance indicators. Shouldn’t poverty data be held to the same standard?

Finally, it is disappointing that the World Bank chose to wait so long before updating PovcalNet: the online repository of survey data which serves as the source of global poverty estimates. This update includes the addition of data from several dozen national household surveys that the bank has obtained since the last revision 18 months ago.

In recent years, PovcalNet has become an indispensable resource for poverty researchers around the world; indeed it has played its part in a mini-revolution within development research, in which more open data and social media have reduced barriers and increased accountability. The delay in updating the public version of PovcalNet, while bank staff had access to an updated internal version, certainly goes against the bank’s claim to be a leader in the open data movement.

The World Bank is charged with promoting evidence for policymaking, not data for economic historians. Yet its institutional culture seems to steer it more towards the latter than the former. As the steward of global poverty data, this has to change.

Categories: Blog

The Hutchins Roundup: Big Impacts from Lower Mortgage Rates, Small Biz Loans Hurt Income Growth, and More

Brookings Institute Blog - Thu, 10/09/2014 - 11:04

What’s happening in fiscal and monetary policy right now? The Hutchins Roundup is a new feature to help keep you informed on the latest research, charts, and speeches. We hope you will find it useful.

Lower mortgage rates have big impacts

Benjamin Keys and Amit Seru of the University of Chicago, Tomasz Piskorski of Columbia University, and Vincent Yao of Fannie Mae argue that a reduction in mortgage interest rates has a significant beneficial effect on the economy. They find that when monthly payments are decreased by $150 per month, there is a substantial drop in mortgage defaults, a roughly 10% boost to sales of consumer durable goods, primarily autos, and an improvement in household credit standing.

Increased Small Business Administration loans hurt income growth

Using data for 3,035 counties for 1980 through 2009, Andrew Young and Donald Lacombe of West Virginia University and Matthew Higgins and Brianna Sell of the Georgia Institute of Technology suggest subsidizing small businesses may hurt a local economy by diverting resources  from more profitable or innovative firms. They find that a 10% increase in Small Business Administration loans per capita is associated with a 2 percentage point drop in per capita income growth rates.

World economic growth projections edge down

In an update to World Economic Outlook forecasts made in April, the International Monetary Fund downwardly revised year-over-year world output growth rates by 0.1 percentage points in 2014 to 3.3%, and by 0.2 percentage points in 2015 to 3.8%. The outlook for U.S. growth in 2015 was left unchanged, while the Euro Area, Japan, and Emerging Market outlooks each deteriorated slightly. The outlook for Brazil experienced the sharpest revision, down a combined 1.6 percentage points over 2014 and 2015.

Chart of the week: Inflation is expected to remain flat through 2015


European Central Bank to take a “more active and controlled” approach to balance sheet management

“And, with our asset purchase program – this is a pretty important point – we are transitioning from a monetary policy framework predominantly founded on passive provision of central bank credit to a more active and controlled management of our balance sheet. We expect our measures to have a sizeable impact on our balance sheet, and ultimately, through their impact on all channels of monetary transmission, on inflation.”
– Mario Draghi, President, European Central Bank

Categories: Blog

Brazil’s Presidential Election Surprise?

Brookings Institute Blog - Wed, 10/08/2014 - 11:31

The outcome of Brazil's first round election on October 5, in which President Dilma Rousseff (Partido dos Trabalhadores, or PT) and Senator Aécio Neves (Partido da Social Democracia Brasileira, or PSDB) move to a run-off, was a surprise for many, both for those inside the country and those observing from afar. Until the week immediately prior to the election, most media outlets focused on the possibility of a run-off between Rousseff and Marina Silva, candidate for the Partido Socialista Brasileiro. Silva’s explosive rise in public opinion polls followed the death of her running mate, Governor Eduardo Campos, in a plane crash on August 13. She captured the mood of many in the middle class who were looking for clean government and improved public services. During my visit to Brazil in August, even supporters of Aécio Neves were speculating about such an outcome and considering what role the PSDB might play in a future Marina Silva administration if they were to negotiate a coalition government. Though the prospects for a Silva-Rousseff second round dominated the electoral narrative in September, a Rousseff-Neves run-off was the expected outcome for Brazil’s presidential elections through most of 2013 and 2014.

President Rousseff’s run-off challenge

President Rousseff’s biggest advantage is incumbency, which is very powerful in the Latin American context. Since 1990, only two presidents in Latin America that chose to run for a consecutive term of office lost re-election. President Rousseff is able to run on 12 years of PT government that has greatly reduced poverty and expanded the middle class. The PT also has a powerful party electoral machine, and at least in the first round, Rousseff benefited from more airtime for television campaign advertising than any other candidate. In Brazil, candidates’ free airtime is allocated based on a formula that is heavily weighted according to their party’s congressional representation, and no further airtime can be purchased privately. The PT controlled the largest number of seats in the legislature going into these elections, and so it was able to use this advertising dominance to attack Marina Silva as being too conservative and framing her policies as a threat to recent socioeconomic gains. Rousseff has been able to convince many voters to take counsel of their fears for their economic future under a non-PT government.  

Yet President Rousseff faces some significant disadvantages. Brazil’s economy has entered a recession, and by her own admission, Rousseff does not have much room to maneuver on the economy. The PT’s state-led growth strategy designed to expand domestic consumption has reached its limits, the commodity export sector is unlikely to expand in a time of global macroeconomic weakness and she does not have a convincing strategy for promoting Brazil’s industrial exports or connecting Brazil to global value added chains. Tactically, her attacks on the opposition during the campaign that preceded the first round of voting mostly had the effect of shuffling voters between Marina and Aécio, not attracting them to her own ticket. In the second round run-off, Rousseff loses her advantage in television airtime over her opponent, so her ability to attack Neves will be more limited.  

Senator Neves’s second wind?

Aécio Neves’s surprisingly strong showing in the first round of elections is likely to encourage his supporters, particularly since he captured nearly 10 percentage points greater support among voters than most polls had predicted in September. However, Neves is vulnerable to attacks by the PT on his advocacy of liberal economic policies. This strategy was effective against Marina, and it may work well against the more liberal Neves. Moreover, Neves needs to capture two-thirds of Marina’s first round voters to carry off the presidential election. Marina Silva will have to work hard to convince a large proportion of her voters to throw their weight behind Neves. At least a third of her supporters are on the left, and they may find it hard to vote for the liberal PSDB ticket. In the first round, 11 million people submitted blank or null ballots and 27.6 million did not vote. The total, 38.6 million, is well above the 34 million votes that Neves received. Between the need to capture Silva’s voters and the large number of non-voters from the first round still up for grabs, Neves faces a difficult path to victory in the second round.

Prospects for inter-American relations

This election may yet be significant for inter-American relations. The perennial friction between the United States and Brazil has become more acute since the Snowden surveillance revelations of summer 2013. Although commercial relations between the two countries are quite good, the U.S. and Brazil have been much less successful at finding common ground on other foreign policy fronts, including democracy and human rights, trade and security cooperation. Bilateral relations therefore remain distant. Brazil continues to work to limit U.S. influence in the Americas whenever possible and oppose the unilateral tendencies of the United States on global policy issues. Whether Rousseff or Neves win on October 26, there will be a great deal of continuity in Brazilian foreign policy. Brazil’s opposition to unilateralism and support for sovereignty and international law are common values held across the political spectrum. Nevetheless, Neves has made a point of emphasizing the importance of Brazil’s international trade, and under such an administration, there may be room for progress on bilateral trade, investment and taxation agreements. In addition, Neves’s party, the PSDB, has historically favored a more liberal approach to supporting democracy and human rights abroad, something that might prove significant in the Latin American context where there has been backsliding on both accounts.

However, win or lose, both Rousseff and Neves have reasons to pursue a reset in Brazil-U.S. relations, although the scope of such an opening would vary depending on who might be elected. This is good news for the United States and Brazil, neither of which benefit from the ongoing distance and friction between them given the many commonalities they share as large multi-ethnic, democratic and market oriented countries. There is a common agenda on education, science and technology, energy, democracy and global order that both countries can work together on. These elections provide an opportunity to draw a line under recent disagreements and start afresh.

Authors Image Source: © Reuters Staff / Reuters         
Categories: Blog

Smart Fiscal Policy Will Help Jobs

IMF blog - Wed, 10/08/2014 - 11:15

by Vitor Gaspar 

(version in EspañolFrançais中文Русский, and 日本語)

Unemployment remains unacceptably high in many countries. It increased dramatically during the Great Recession. Global unemployment currently exceeds 200 million people. An additional 13 million people are expected to be unemployed by 2018.

The most worrisome is youth unemployment. There are examples of advanced economies in Europe where youth unemployment surged above 50 percent. In several developing economies, job creation does not absorb the large number of young workers entering the labor force every year.

This puts unemployment at the top of the global policy agenda.

Working together: Fiscal and Structural

Faced with this immense challenge, we asked ourselves: “Can fiscal policy do more for jobs?” This is the theme of the October 2014 Fiscal Monitor, released today.

Support to employment and economic growth requires action on multiple fronts. In some countries, particularly in Europe, reform of labor markets may be necessary to remove persistent rigidities.

Fiscal policy cannot substitute for such reforms. But fiscal policy can work in tandem with broader structural reform efforts to support job creation.

The Fiscal Monitor highlights three possibilities.

First, fiscal policy can foster macroeconomic conditions that are supportive of economic activity and labor markets. For example, deficit reduction can be designed and timed to minimize negative effects on employment. Clearly, the adequate policy mix for each country needs to be tailored to its specific circumstances.

Second, fiscal policy can facilitate structural reforms in the labor market. How? Fiscal policy can offset the potential short term economic costs of reform. It can also help build political consensus on reform, for instance, by compensating groups that may be adversely affected by change. This allows me to make a point of general importance: going forward it is very important to improve the understanding of the political dimension of economic policy.

Effective fiscal policy in support of structural reform must meet certain conditions: it should not raise debt sustainability risks; the costs and benefits of the reform need to be well identified; the costs need to be constrained in size and duration; and there needs to be sufficient certainty that reforms will be carried fully to their end.

And third, fiscal policy can be part of the overall design of structural policy measures.

Let me give a couple of examples.

In advanced economies, we find that a carefully designed reduction in employer social security contributions on young workers can improve youth employment.

In emerging market and developing economies, we find that removing tax barriers, providing basic public services, and offering greater access to finance and training can help address challenges related to informality and low growth in labor productivity.

Current fiscal environment 

In the last six months, interest rates have been low and volatility in bond markets has been subdued. This has helped ease immediate pressures on public finances in most countries. However, we are at a difficult juncture. Underlying fiscal vulnerabilities and fiscal risks continue to accumulate.

In advanced economies, debt levels are stabilizing but remain elevated. In some cases, debt exceeds 100 percent of GDP. So it is important to bring government debt down to safer levels. But it is also important to be mindful of the uneven economic recovery and the risk of persistent low inflation in some countries, especially in the euro area.

In emerging economies, deficits and debt ratios are generally moderate, but still remain above pre-crisis levels. In some cases, there are risks to debt sustainability from off-budget transactions and government guarantees. Many of these economies share the need to raise potential growth while rebuilding the fiscal buffers used during the crisis.

In low-income developing countries, fiscal risks are generally modest. Here, efforts should focus on mobilizing revenue, better budget prioritization, and higher efficiency of public spending. Some countries also need to strengthen fiscal governance.

Smart fiscal policy 

Overall, the challenges I have pointed to throughout my presentation call for smart fiscal policy. This is no time for complacency.

Smart fiscal policy is imperative for countries facing the difficult juncture of an anemic recovery, weak potential growth, and very low inflation.

Smart fiscal policy is one that supports jobs and growth while bringing public debt to safer levels.

Smart fiscal policy is one that values efficient public investment and facilitates structural reform.

Categories: Blog

Five Charts to Explain Latin America’s Macroeconomic Outlook

Brookings Institute Blog - Wed, 10/08/2014 - 07:26

Editor’s Note: On October 2, 2014 the Brookings Global-CERES Economic and Social Policy in Latin America Initiative (ESPLA) launched the 2014 Latin America Macroeconomic Outlook  report: “Macroeconomic Vulnerabilities in an Uncertain World: One Region, Three Latin Americas.”  The five graphs below elucidate the major findings of the report.

After a decade of high growth and high expectations about the region’s future, the new and less complacent global context implies a return to lackluster growth rates of 3.3 percent over the next five years, from 2014 to 2018. Such a reduction in the cruising speed of the region comes as a result of the change in outlook for growth in advanced economies (mired in what has been called “secular stagnation”); the imminent end to China’s investment-led, credit-propelled growth model and further slowdown in its economy; softening commodity prices; and a gradual increase in the cost of international financing for emerging markets.

What are the macroeconomic challenges that lie ahead for the region? To answer this question we have constructed a series of indicators that are comparable across countries. Every indicator is normalized so that whenever the value is below 1 it denotes a positive outlook and when the value is above 1 it denotes a negative outlook in each macroeconomic dimension.

What emerges is a not a narrative of one Latin America, but of three: one with sound macroeconomic fundamentals (Chile, Colombia, Mexico and Peru), one with weak fundamentals (Argentina and Venezuela), and one with mixed fundamentals (Brazil). Each cluster faces a different outlook and different policy challenges. 

Source: Own calculations based on the IMF Financial Soundness Indicators and national statistics for Venezuela. 

After a string of banking crises, debt restructurings and financial distress, the health of the financial system in the region has improved significantly. Clearly, the tightening of the regulation and supervision of the region’s banking systems during the last decade appears to have paid off.

In order to assess the banking outlook, we developed a Banking Vulnerability Ratio defined as the ratio of projected nonperforming loans under more adverse economic conditions—higher interest rates, lower growth and depreciating currencies—to maximum nonperforming loans (defined as the level of non-performing loans that would exhaust existing loan-loss provisions and bank capital). Surprisingly, the Banking Vulnerability Ratio is below 1 for each and every country in the region, meaning that if we rule out extreme events, banks in the region are in a strong position to endure a deterioration in economic conditions. From a macroeconomic perspective, this time around the weak link does not appear to be the banking system. 

Source: Own calculations based on national statistics, IMF, IADB, CAF and FLAR.

Since the beginning of the cooling-off period in mid-2011, there has been a sharp contrast in the behavior of international reserves between countries with full access and those with limited access to international financial markets. While they have continued to increase in the former (Brazil, Chile, Colombia, Mexico and Peru), they declined significantly in the latter (Argentina and Venezuela).

To assess the international liquidity position we developed the International Liquidity Ratio. The International Liquidity Ratio is defined as the ratio of short-term debt obligations of the public sector—both domestic and external and including the stock of central bank sterilization in­struments—and short-term external debt obligations of the corporate non-financial private sector due in the next 12 months to international reserves, plus the already agreed ex-ante contingent credit lines and potential credit lines that could be negotiated with multilat­eral or regional financial institutions.

We find that the countries in the first cluster—Chile, Colombia, Mexico and Peru—have a strong liquidity position which provides them with an effective cushion to weather episodes of financial turbulence in international capital markets, while Argentina and Venezuela have a very weak international liquidity position. Brazil is in an intermediate, borderline position.

Source: National statistics and private sector estimations for Argentina. Forecasts are obtained from FocusEconomics and Econviews for Argentina.

In order to assess the inflation outlook, we consider a country to have a positive (negative) outlook for inflation if it is expected to remain or fall below (rise above) 4 percent in the next three years. With this definition, we developed an Inflation Vulnerability Ratio, defined as the ratio of projected inflation at the end of 2016 to a 4 percent inflation threshold.

Once again, a heterogeneous picture arises in which some countries have a very negative inflation outlook (Argentina and Venezuela) and face the need to make substantial policy adjustments, while some others have an extraordinarily strong and sustained track record of very low and relatively stable inflation rates (Chile, Colombia, Mexico and Peru). Brazil misses the mark by a relatively small margin.

Source: Own calculations based on national statistics and IMF World Economic Outlook. 

To evaluate the strength of the fis­cal position we de­veloped a Fiscal Vulnerability Ratio. The Fiscal Vulnerability Ratio is defined as the ratio of projected debt to GDP over 15 years (assuming identical inflation tax revenues for every country) to a 50 percent debt to GDP thresh­old.

A very diverse picture emerges between countries with very vulnerable fiscal positions (Argentina and Venezuela) facing the need to make substantial policy adjustments to stabilize the dynamics of public debt, while others are safely below the critical level of 1 (Chile, Colombia, Mexico and Peru) displaying extraordinarily strong fiscal positions. Brazil starts out with relatively high levels of public debt and displays a non-convergent debt dynamics that will require timely adjustments to public finances to preserve its current credit standing.

Source: FocusEconomics.

When assessing overall macroeconomic vulnerability, the region clusters into 3 groups. One group is composed of Chile, Colombia, Peru and Mexico—countries with full access to international markets and multilateral financing and strong macroeconomic fundamentals. Another group is composed of Argentina and Venezuela—countries with limited access to international financial markets and multilateral financing and weak economic fundamentals. Finally, Brazil belongs to the final and intermediate group, with full access to international financial markets and multilateral financing, yet displaying vulnerabilities in some macroeconomic dimensions—especially on the fiscal front. Notably, the growth outlook for the five-year period 2014-2018 according to market consensus forecasts clusters these seven countries into the same three groups (see Figure 5).

The magnitude of macroeconomic challenges will depend on whether the countries be­long to a cluster with strong, mixed or weak macroeconomic fundamentals. For the countries with strong macroeconomic funda­mentals (Chile, Colombia, Mexico and Peru) the key challenge is to consolidate macroeconomic stability in more trying times. For the countries with weak macroeconomic fun­damentals, the need is to urgently restore confidence to stop capital outflows and the drain on international reserves, and to resuscitate their ailing economies. For Brazil, with mixed macroeconomic fun­damentals, the challenge is to react in a timely fashion on the fiscal front to avoid compromising its current credit standing.

From a development perspective, pro-growth reforms will be needed in every country in the region—those with strong and weak macroeconomic fundamentals—to revitalize what otherwise will be a lackluster growth performance in the years to come. More adverse conditions may provide the right incentives for precisely that, for those are the times when politically complex decisions are usually made. 

  • Ernesto Talvi
  • Santiago García da Rosa
  • Rafael Guntin
  • Rafael Xavier
  • Federico Ganz
  • Mercedes Cejas
  • Julia Ruiz Pozuelo
Categories: Blog

The New Global Imbalance: Too Much Financial Risk-Taking, Not Enough Economic-Risk Taking

IMF blog - Wed, 10/08/2014 - 06:17

 By José Viñals

(Versions in Español中文)

I have three key messages for you today:

1. Policymakers are facing a new global imbalance: not enough economic risk-taking in support of growth, but increasing excesses in financial risk-taking posing stability challenges.

2. Banks are safer but may not be strong enough to vigorously support the recovery. And risks are shifting to the shadow banking system in the form of rising market and liquidity risks. If left unaddressed, these risks could compromise global financial stability.

3. In order to address this new global imbalance, we must promote economic risk-taking by improving the transmission of monetary policy to the real economy. And we must address financial excesses through better micro- and macroprudential policies.

Now I’d like to develop these themes.

More than six years after the start of the financial crisis, the global recovery continues to rely heavily on accommodative monetary policies in advanced economies. This has helped economic risk-taking in the form of higher investment and employment by firms and higher consumption by households. But the impact has been too limited and uneven. Things look better in the United States and Japan, but less so in Europe and in emerging markets.

At the same time, prolonged monetary ease has encouraged the buildup of excesses in financial risk-taking. This has resulted in elevated prices across a range of financial assets, credit spreads too narrow to compensate for default risks in some segments, and, until recently, record-low volatility, suggesting that investors are complacent. What is unprecedented is that these developments have occurred across a broad range of asset classes and across many countries at the same time. Finally, corporate leverage has continued to rise in emerging markets.

Addressing the policy challenges

Let me begin with banks. The good news is that banks are much safer now, having increased their capital levels and liquidity. However, this Global Financial Stability Report finds that many banks do not have the financial muscle to provide enough credit to vigorously support the recovery. It means that after stabilizing and repairing their balance sheets, banks now face a new challenge: They need to adapt their business models to the post-crisis market realities and new regulatory environment.

We analyzed 300 large banks in advanced economies—which comprise the bulk of their banking systems—and found that banks representing almost 40 percent of total assets are not strong enough to supply adequate credit in support of the recovery. In the euro area, this proportion rises to about 70 percent. These banks will need a more fundamental overhaul of their business models, including a combination of repricing existing business lines, reallocating capital across activities, consolidation, or retrenchment. In Europe, the comprehensive assessment of balance sheets by the European Central Bank provides a strong starting point for these much-needed changes in bank business models.

In other words, when banks are receiving a clean bill of health in terms of capital adequacy, it means that they are safe enough to lead a “normal life”. But in many countries, we need banks to be “athletes” who can vigorously support the recovery.

While banks grapple with these challenges, capital markets are now providing more significant sources of financing, which is a welcome development. Yet this is shifting the locus of risks to shadow banks. For example, credit-focused mutual funds have seen massive asset inflows, and have collectively become a very large owner of U.S. corporate and foreign bonds.

The problem is that these fund inflows have created an illusion of liquidity in fixed income markets. The liquidity promised to investors in good times is likely to exceed the available liquidity provided by markets in times of stress, especially as banks have less capacity to make markets.

At the same time, emerging markets have grown in importance as a destination for portfolio investors from advanced economies. These investors now allocate more than $4 trillion, or about 13 percent of their total investments, to emerging market equities and bonds—this share has doubled over the past decade. Because of these closer financial links, shocks emanating from advanced economies will propagate more quickly to emerging markets.

Together, these factors will amplify the impact of shocks on asset prices, resulting in sharper price falls and more market stress. Such an adverse scenario would hurt the global economy and, at the limit, could even compromise global financial stability. This chain reaction could be triggered by a wide variety of shocks, including geopolitical flare-ups, or a “bumpy” normalization of U.S. monetary policy.

So, what should be done to safeguard financial stability and strengthen the recovery? For this, policymakers need to address the new global imbalance between financial and economic risk-taking. They should use various means:

To be clear, accommodative monetary policies remain essential to support the recovery so long as demand stays weak. But monetary policy alone cannot accomplish everything. Other policies—including structural reforms, smart fiscal policies, and financial policies—need to play their role.

  • Let me focus on two key areas for financial policies. First, economic risk-taking would benefit from an improved flow of bank credit to the economy. But in order to unclog the credit channel, many banks must fundamentally adjust their business model. Supervisors need to facilitate this structural transformation, which would allow banks to improve their profitability—without taking excessive risks—and to support the economy through lending. This is particularly important in Europe where banks play a major role in financing the economy.
  • Second, policymakers need to design and implement a range of micro- and macroprudential policies to address financial excesses that can threaten stability. For example, in the asset management sector, greater oversight is needed to ensure redemption terms are better aligned with underlying liquidity conditions. More comprehensive monitoring and reporting of leverage in nonbank sectors and in the corporate sectors of emerging markets will help identify areas of potential vulnerabilities. To safeguard against global liquidity strains, bilateral and multilateral swap lines could be deepened to mitigate excessive volatility.Such policies will strengthen the global financial system by making financial institutions more resilient, while helping contain procyclical asset price and credit dynamics. This is highly relevant today to deal with the growing risks in shadow banking, particularly market and liquidity risks.

Policy makers need to be alert to these growing challenges to financial stability, and must take further actions now both to promote economic risk-taking in support of growth, and to address excesses in financial risk-taking to maintain stability.

Categories: Blog

Legacies, Clouds and Uncertainties

IMF blog - Tue, 10/07/2014 - 07:03

By Olivier Blanchard

(Versions in Françaisespañol, 中文Русский日本語)

The recovery continues, but it is weak and uneven.

You have now seen the basic numbers from our latest projections in the October 2014 World Economic Outlook released today.  We forecast world growth to be 3.3% in 2014, down 0.1% from our July forecast, and 3.8% in 2015, down 0.2% from our July forecast.

This number hides however very different evolutions.  Some countries have recovered or nearly recovered.  But others are still struggling.

Looking around the world, economies are subject to two main forces.  One from the past:  Countries have to deal with the legacies of the financial crisis, ranging from debt overhangs to high unemployment.  One from the future, or more accurately, the anticipated future:   Potential growth rates are being revised down, and these worse prospects are in turn affecting confidence, demand, and growth today.

Because these two forces play in different countries to different degrees, economic evolutions are becoming more differentiated.  With this in mind, let me take you on the usual quick tour of the world:

Growth prospects vary in advanced economies

Among advanced countries, the United States and the United Kingdom in particular are leaving the financial crisis behind and achieving decent growth.  Even for them however, potential growth is lower than it was in the early 2000s.

Japan is growing, but high public debt inherited from the past, together with very low potential growth going forward, raise major macroeconomic and fiscal challenges.

Growth in the euro area nearly stalled earlier this year, even in the core.  While this reflects in part temporary factors, both legacies, primarily in the south, and low potential growth, nearly everywhere, are playing a role in slowing down the recovery.

Emerging markets are adjusting to slower growth

In emerging market economies, lower potential growth is the dominating factor.  For emerging market economies as a whole, potential growth is now forecast to be 1.5% lower than it was in 2011.   But, there again, differentiation is the rule:

China is maintaining high growth, despite the end of a housing and a credit boom.  Looking forward, rebalancing is likely to imply slightly lower growth, but this must be seen as a healthy development.

India has recovered from its relative slump, and, thanks in part to policy and a renewal of confidence, growth is expected to exceed 5% again.

By contrast, uncertain investment prospects in Russia had already led to low growth before the Ukraine crisis, and the crisis has made it worse.  Uncertain prospects and low investment, are also weighing on Brazil.

Finally, low income developing countries continue to do remarkably well, and this despite a slowdown in commodity prices.  We forecast their growth rate to b 6.1% in 2014, 6.5 in 2015.

Downside risks are clearly present

The long period of low interest rates has led to some search for yield, and financial markets may be too complacent about the future.  One should not overplay these risks, but, clearly, policy makers should be on the lookout.  Macro prudential tools are the right instruments, but one has to worry that they may not be up to the task.

Geopolitical risks have become more relevant.   So far, there is little evidence that Ukraine crisis has had measurable effects beyond the affected countries and their immediate neighbors.  Nor has turmoil in the Middle East affected either the level or the volatility of energy prices very much.   But, clearly, the risk that they do so in the future is there, and could affect the world economy in a major way.

The third risk is a stalling of the recovery in the euro area, the risk that demand weakens further, and that low inflation turns into deflation.  This is not our baseline, as we believe fundamentals are slowly improving, but, were it to happen, it would clearly be the major issue confronting the world economy.

And this takes me to policy implications

In advanced economies, policies must both deal with the legacies of the crisis and address low potential growth.  With respect to legacies, while a major focus has been on improving bank balance sheets, debt overhang of firms and households remains an issue in a number of countries.   So long as demand remains weak, monetary accommodation and low interest rates remain of the essence.

The weak recovery in the euro area has triggered a new debate about the stance of fiscal policy.  The low spreads on sovereign bonds suggest that the fiscal consolidation of the past few years has led financial investors to believe that current fiscal paths are sustainable.  This credibility, which was acquired at a high price, should not be threatened.  This does not mean however that there is no scope for fiscal policy to sustain the recovery.  As we argue in one of the analytical chapters, infrastructure investment, even if debt financed, may well be justified and can help demand in the short run and supply in the medium run.  And, were the risk of stalling to materialize, being ready to do more is also important.

Finally, one obviously wishes that potential growth were higher.  This would not only be good for itself, but it would also make fiscal and financial challenges much less daunting.  Increasing potential output, let alone potential growth, is however a tall order, and expectations should remain realistic.  Yet, in most countries, specific structural reforms can help.  The challenge, for both advanced and emerging market countries, is to go beyond the general mantra of “structural reforms,” to identify which reforms are most needed, which reforms are politically feasible.

Perhaps more generally, the challenge for policy makers is to reestablish confidence, through a clear plan to deal with both the legacies of the crisis and the challenge of low potential growth.

Categories: Blog

Peña Nieto Confronts Renewed Violence in Mexico

Brookings Institute Blog - Fri, 10/03/2014 - 14:00

The government of Peña Nieto changed the national discourse on organized crime and violence in Mexico. It requested that the media banish homicides from its front pages in order to calm citizens' anxieties and assure foreign investors that the government held control over insecurity. The means to assert this control transferred greater autonomy to the armed forces, as well as to state and municipal police, institutions lacking appropriate training for law enforcement. In September 2014, both the armed forces and the municipal police are alleged to have killed and caused the disappearance of groups of citizens. These violent acts, as well as the murder of prominent politicians, have raised the specter that a new level of violence has returned to Mexico – this time carried out by official bodies as well as organized crime.

Allegations Against the Armed Forces and Local Police 

On July 29, Secretary of the Interior Osorio Chong announced that “violence has been reduced to its minimum expression.”[1] He chose to ignore the fact that one month earlier members of the armed forces had killed 22 people. In late September, the secretary of defense admitted that military elements in Tlatlaya (located in the State of Mexico), had carried out the homicides. Photographs of 19 of those bodies show that they were shot while kneeling in the dirt from a range of 30 to 50 centimeters.

In the state of Veracruz, students marched in late September to protest the military and the police’s use of excessive force against, so-called organized criminals. On September 29, in the town of Iguala, the attorney general for the state of Guerrero, Iñaky Blanco Cabrera, announced that he had begun investigations into police slaying of three students, two passengers and a passerby in an incident concerning the football team, Los Avispones, as it was bussed to its game. Ballistic tests showed that members of the municipal police had shot into the bus. Separately, Iñaky Blanco also admitted that municipal police had shot at students from the radical teacher training school, Ayotzinapa Normal, who were also moving out of Iguala in three busses. Forty-three of those students disappeared on September 26, 20 to 30 of whom are believed to have been arrested and taken to an unknown location. Since that time, they have not been found. On Sunday, September 28, the state leader of the conservative party, PAN (National Action Party), was murdered. The purported massacres and disappearances, allegedly at the hands of the military and local police have raised alarm bells in Mexico.

Past and Present PRI Policies

The distinction between the six years of violence against drug cartels under President Felipe Calderón and now is that Mexico’s armed forces as well as municipal and state police are accused and, in several cases, found guilty of carrying out the crimes. The state has assumed the role as guardian of public order and in so doing has carried out widespread abuses of citizens' human rights. Students, struggling to find jobs commensurate with their professional studies, are demonstrating throughout the country in support of the 43 missing and presumed dead Ayotzinapa students. Today, students throwing bricks at glass buildings make up front page stories.

In citizens' minds, the coincidence of timing reminds them of October 2, 1968, when thousands of students gathered in protest in the plaza of Tlatelolco, as well as within the Escuela Normal, the most prestigious high school in Mexico City. Approximately 300 died or disappeared. At that time, the students were accused of Marxist Leninist tendencies and President Echeverría’s minister of interior ordered their suppression. The vivid memory of that period lives on among a generation who now qualify for a pension. The PRI (Institutional Revolutionary Party) government of 46 years ago was authoritarian, centralized and abhorred protest that might destabilize the country.

Today, a new PRI government has returned to power after 12 years in opposition. With pride, party leaders assert that strong governance to protect citizen security has returned. Journalists are threatened by drug cartels. State and local officials pressure them into publishing bland reports, usually based on police statements. As a result, self-censorship is becoming the norm. A reading of newspaper articles regarding the Tlatlaya and Iguala killings requires the reader to rely upon the statements of state prosecutors, the mayor’s office and the press officer for Mexico’s armed forces. Searches for stories from victims' families and witnesses are not to be found in the mainstream press. Fortunately, opinion makers are free to publish and continue to provide effective freedom of expression, but otherwise Mexico’s media is seriously restrained in what it publishes.

The Human Rights Commission has become a puppet of Mexico's Ministry of Interior. It took weeks before it decided to investigate the Tlatlaya killings at the hands of the military and its report is still not finished. A vocal defender of human rights was asked to leave the commission, her term of office terminated prematurely.

An Increasingly Skeptical Public

The government of Peña Nieto is determined to rebuild confidence in the state’s capacity to keep people safe and to assure foreign investors that Mexico is open for business. The government’s much respected statistical office, INEGI (National Institute of Statistics and Geography), was required to publish intentional homicide numbers without waiting for the customary review period. As a result, Osorio Chong’s announcement on July 29 that homicides related to organized crime had fallen by close to 30 percent year on year was received with askance by citizens who suffer the widespread extortion and consequential brutality on a regular basis. Disappearances are now common and investigations rare. This has led the Catholic Church and religious leaders to join the demands of family members for information into the whereabouts of their loved ones.

In a world of social media, it is foolish to believe that the government can clamp down on news that it finds unacceptable. The old-time leaders of the PRI may remember how they used to limit the diffusion of unsavory stories, but their grandchildren can share with them narratives and images of daily occurrences gathered through the internet. The Mexican government may be unusually skilled in propaganda, but it cannot hide incidents of insecurity from its citizens.

The events of September 2014 are a wakeup call to both Mexican citizens and their government. Members of the armed forces can no longer impose vigilante justice against 22 men and women, even if they are suspected of membership in La Familia’s drug cartel. Municipal police can no longer cause 43 students to disappear despite the suspicion of vandalism. An increasingly skeptical nation, as well as outside observers, watches the repression of Mexican citizens with growing concern.

If the Mexican state is to be trusted, its officers must carry out their functions with respect for the law. If the state abuses its authority, organized criminal gangs which trade in illicit drugs and people, will emerge the winners because their criminal acts can be attributed easily to public officials. Despite government assurances, Mexican citizens do not know whom to fear more: criminals or state protected officers. This is a sad condition for Mexico, but one that can be corrected. Peña Nieto and his government have announced that they will prosecute and punish identified military and police personnel, but the legal process must be transparent and the sanction must comply fully with the pertinent laws.

[1] SEGOB, Secretario Osorio Chong, Conferencia de Prensa, 29 de Julio, 2014.

Authors Image Source: © Jorge Lopez / Reuters         
Categories: Blog

Turkey’s ISIL Dilemma: To Fight or Not to Fight

Brookings Institute Blog - Fri, 10/03/2014 - 13:52

The Turkish Parliament has just granted the government the authority to send the Turkish military into Iraq and Syria, should the government decide to take such actions. This authorization also includes the possibility of receiving foreign military personnel in Turkey. The decision comes at a critical time when the military coalition led by the United States is actively engaging the Islamic State in Iraq and the Levant (ISIL, or ISIS). It also coincides with increasing Western pressure on Turkey to become more actively involved in U.S. efforts to “degrade and defeat” ISIL. Will the Turkish parliament’s decision pave Turkey’s way to joining the military wing of the coalition and actually fight ISIL? Will Turkey allow the United States to use the Incirlik NATO base 60 miles from the Syrian-Turkish border? Will Turkey finally lend support to the Kurds who are desperately trying to defend the city of Kobane against ISIL’s relentless onslaught on the Syrian border with Turkey?

While there are a number of factors present that are likely to prevent affirmative answers to these questions, the Turkish Parliament’s decision, coupled with mounting criticism of ISIL by the Turkish President Recep Tayyip Erdoğan and Prime Minister Ahmet Davutoğlu, opens the door for much deeper cooperation between Turkey and the U.S.-led coalition fighting ISIL.

What’s Holding Turkey Back?

An important factor that will continue to prevent the Turkish government from becoming militarily involved is a difference in priorities between the United States and Turkey. Although both sides agree that ISIL’s rise is directly linked to a failure to replace the Assad regime in Syria, the United States gives priority to defeating ISIL as the removal of Assad takes a back seat. This explains Erdoğan’s repeated calls to create a no-fly zone along the Syrian-Turkish border. He believes such a zone would not only help alleviate the enormous pressure 1.5 million refugees are putting on Turkey, but also provide an operational base for the moderate Syrian opposition. It is very unlikely that the United States will pursue the establishment of such a zone, given the inevitable objections that would come from both the Iranians and the Russians. This in turn, discourages Turkey from becoming militarily involved in any significant manner.

There is also a realization that in Iraq, ISIL has the support of Sunni tribes and elements of the former Baath Party, which became deeply disenchanted by the discriminatory and repressive policies of former Iraqi Prime Minister Nouri al-Maliki. Turkey’s declared policy towards the future of Iraq and Syria is very much in line with that of the United States as it seeks the reconstitution of Iraq and Syria within their existing borders with regimes more representative of their diverse populations. Yet, there is also recognition that the region is undergoing tremendous instability and transformation that may lead to unforeseen future territorial and political configurations. The Turkish government is consciously aware that Turkey is a neighbor to this geography and hence likely to continue to err on the side of caution and avoid direct military involvement with ISIL. This sense of vigilance is also fueled by the complicated situation that the Kurds are under attack by ISIL in Rojava (the Kurdish belt of north and northeast Syria where the city of Kobane is situated) creates for Turkey.

Since 2012, the Turkish government has been involved in negotiations with the imprisoned leader of the Kurdistan Workers’ Party (PKK), Abdullah Öcalan, in an effort to reach a political solution to the Kurdish question in Turkey. At the same time, Turkey considers the PKK a terrorist organization, which is closely associated with its Syrian wing, the Democratic Union Party (PYD), the main Kurdish force, currently under attack by ISIL. It is not clear whether the Turkish military would extend military assistance to the PYD (and, by extension, the PKK) in Rojava, organizations it has traditionally fought against.

To Fight or Not to Fight ISIL?

Turkey’s dilemma to “fight or not to fight” ISIL is also directly linked to national security and economic considerations. The Turkish economy has long been sensitive to external developments and security related issues. An economy once hailed as a success story, is increasingly experiencing problems, particularly with respect to an incurable current accounts deficit. Two important sectors helping to balance this deficit are tourism and commerce. In 2013 alone, close to 35 million foreign nationals visited Turkey. In the past, Turkey’s commerce and tourism revenues were adversely affected by wars in its neighborhood, even when it managed to stay out of them. The danger in provoking ISIL into mounting a terrorist attack is a major concern for decision makers and will continue to put the brakes on military involvement against ISIL.

As much as these factors may force the Turkish government to put the parliamentary authorization on the back burner and decide not to fight ISIL, it does not mean there would not be room for much closer and effective cooperation with the United States. Public opinion in Turkey is deeply disturbed by ISIL’s actions as well as the growing number of Turkish youth joining its ranks. After considerable nudging by the United States and European Union (EU), the Turkish government has begun to take action against preventing foreign fighters and arms from transiting through Turkey into Syria. Measures have also been introduced to control the smuggling of ISIL oil into Turkey. The parliament’s recent decision and mounting public opinion against ISIL should help expand and make cooperation with the United States more effective. However, Western expectations of Turkey completely sealing its more than 500 mile long, porous border with Syria are extremely unrealistic. Even deploying a mere 10 soldiers to guard every mile of the border would require 30,000 soldiers, assuming four hourly guard shifts in a day is logistically and humanly possible. Instead, the focus should be on hard-core intelligence sharing and counterterrorism efforts.

A U.S.-Turkey Dialogue

Another area of cooperation should focus on nurturing better coordination and dialogue between the United States and Turkey with respect to the grand strategy on Syria and the region’s future. Two questions regarding the future that matter most for Turkish decision makers are: will the United States stay around for the long haul if things get worse, and will the United States remain committed to regime change in Damascus? These are two challenging issues at the very crux of Turkey’s dilemma and have come at a time when Turkey’s relations with the West have not been particularly good and mutual trust is at an all-time low. Yet, the challenges constituted by ISIL, the deep instability in the Middle East and Russian aggression are all nudging Turkey slowly but surely back into the ranks of the West.

This is starkly reflected in the recent Transatlantic Trends survey that recorded a surprisingly significant jump in the Turkish public’s support for both the EU and NATO compared to last year. This has been accompanied by the decision to revamp EU-Turkish relations, very recently taken by the Turkish government, and efforts to deepen economic relations with the United States. Furthermore, trade statistics for the first seven months of this year when compared to 2013, show a significant increase in Turkey’s exports to the EU and United States, compared to a drop in exports to neighboring countries such as Russia, Iran, Iraq, Egypt and the Gulf. Thus, the moment is ripe to engage Turkey in deeper and more strategic cooperation in a manner that reinforces its place in the transatlantic alliance, rather than allowing tactical differences in fighting ISIL aggravate relations between Turkey and the West further. In return, it is important that Turkey urgently engages with its NATO partners to enable a more effective use of the Incirlik air base against ISIL. The parliament’s decision clearly provides for this possibility.

Authors Image Source: © Murad Sezer / Reuters         
Categories: Blog

The Growth of Shadow Banking

IMF blog - Fri, 10/03/2014 - 10:39

By Gaston Gelos and Nico Valckx

Shadow banking has grown by leaps and bounds around the world in the last decade.  It is now worth over $70 trillion. We take a closer look at what has driven this growth to help countries figure out what policies to use to minimize the risks involved.

In our analysis, we’ve found that shadow banks are both a boon and a bane for countries. Many people are worried about institutions that provide credit intermediation, borrow and lend money like banks, but are not regulated like them and lack a formal safety net. The largest shadow banking markets are in the United States and Europe, but in emerging markets, they have also expanded very rapidly, albeit from a low base.

In our latest Global Financial Stability Report we discuss three ways of measuring the size of shadow banking:

  • The Financial Stability Board offers a broad definition of shadow banks as nonbank financial intermediaries engaged in credit intermediation (including investment funds), and a more narrow one which excludes entities which do not directly undertake credit intermediation or which are consolidated into banking groups.
  • We compute another measure, derived from flow of funds accounts, for a smaller set of countries. It focuses on “other financial intermediaries” and excludes non-money market investment funds, since the latter mainly manage assets on behalf of clients and thus do not engage directly in credit intermediation.
  • Lastly, we propose a new, alternative definition of shadow banking as financial activities using nontraditional funding, independently of the financial institution involved. The focus on activities is one advantage of this approach. For example, securitization is classified as shadow banking, whether it is conducted on-balance sheet by banks, or off-balance sheet through special purpose vehicles.

These measures show some notable differences for the United States and the euro area. They all share a similar growth trend until 2007, after which their paths diverge markedly (Figure 1). After a mild drop around 2008, the Financial Stability Board’s measures now surpass their pre-crisis levels. Positive valuation effects are one of the reasons behind the pickup in the Financial Stability Board’s measures, given the growth in the investment fund industry.

In contrast, our measures remain broadly constant or have fallen, which reflects two opposing forces: the decline in the role of certain activities after the crisis, such as securitization and securities and repo lending, and a concomitant rise in other activities, includ­ing those of country-specific entities, such as special financial institutions in the Netherlands and U.S. holding corporations.

For broad monitoring purposes, it may be good to keep an eye on various measures, as they may capture different developments across the shadow banking spectrum.

The driver’s seat

What drives shadow banking? Our analysis shows that shadow banking growth is associated with GDP growth, low interest rates and low term spreads (inducing search for yield), bank capital stringency (capturing regulatory circumvention), and with growth of institutional investors (Figure 2.A). Controlling for these factors, there also appears to be some complementarity with the size of the banking sector.

Looking forward, the current financial environment remains conducive to further growth in shadow banking. Many indications point to the migration of some activities—such as lending to firms—from traditional banks to the nonbank sector. Especially in the euro area, the growth of lending by shadow banks seems to gather force, while its share of total lending remains high in the United States (Figure 2.B).

The analysis in our report shows that in the euro area and the United States, investment funds, traditionally considered less risky (think PIMCO or Blackrock) have been growing the fastest since 2009—but taking on more risk. Some of these funds have been venturing into less liquid assets, including loans to companies.

More data needed

We recommend policymakers should keep an eye on how different shadow banking activities and entities grow and may contribute to systemic risk.

We need more data on balance sheets of shadow banking entities to improve our understanding of the risks that shadow banks (and their growth) may pose—that is, whether they engage in excessive maturity or liquidity transformation, how much leverage is involved, how risky their credit positions are, and how interconnected they are with the rest of the financial system. So far, such analysis can only be undertaken in very broad terms for some broad shadow banking sectors.

Hence, a definitive assessment of whether the growth of shadow banking is good or bad for financial stability cannot yet be given – but there are indications of risk build up, at least in some sectors.

Categories: Blog

Talking Trade with Congressmen Jim Costa and Erik Paulsen: Why TPP and TTIP Advance U.S. Economic and Strategic Interests

Brookings Institute Blog - Fri, 10/03/2014 - 10:14

Recently I sat down with Democratic Congressman Jim Costa of California and Republican Congressman Erik Paulsen of Minnesota to discuss one of the few issues that remain bipartisan on Capitol Hill—trade.

Increased exports from the U.S. over the past five years have been responsible for one-third of the country’s economic growth. Last year, exports of goods and services reached a record high of $2.3 trillion. America's exports to its 20 free trade agreement partners have risen by 57 percent in the past five years, whereas they rose just 44 percent for the rest of the world.

U.S. negotiators are continuing to hash out details of two significant and new trade agreements: the Trans-Pacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TTIP). Taken together, the countries participating in TPP and TTIP account for two-thirds of global GDP and half of global trade, and have a combined market of 1.3 billion consumers. Nearly 70 percent of U.S. exports already go to TPP or TTIP partners, and 84 percent of foreign direct investment comes from them. By 2018, TPP and TTIP markets are estimated to grow by $6.7 trillion. At the conclusion of both negotiations, the United States would enjoy liberalized trade with almost two-thirds of the global economy.

While Democrats and Republicans have historically coalesced around trade agreements that hold great promise for increasing U.S. exports and jobs, there is a limited window of opportunity to see the Obama administration and Congress, as well as the United States and its trading partners in Asia and Europe, land on the same page.

Categories: Blog

Backing out of Hong Kong's Crisis

Brookings Institute Blog - Fri, 10/03/2014 - 10:08

In my October 1st blogpost, I suggested that good crisis management and crisis termination requires each side to preserve for its adversary a way out. Putting one’s adversary in a corner raises the prospects for escalation. And for the adversary to take the way out, it itself (not the party creating the exit) must believe that it is a reasonable, or even honorable, course of action. (I understand that it is easy for me to state this but very difficult for those who are trapped in the crisis to do it, particularly as the number of sleep-deprived days increases.)

In the current Hong Kong crisis, we see a couple examples of an unwillingness to create a way out:

  • For the authorities in Beijing to suggest that the Hong Kong protesters are lawbreakers who are mounting a “to challenge the supreme state's power organ,” as it did today in an authoritative People’s Daily commentary, is probably not a good way to get them to climb down. Nor is the threat of heavy-handed police tactics. Among other things, such threats only stimulate average citizens to rally to the side of the protesters, as they have done repeatedly over the last week.
  • For the protesters to demand the resignation of Chief Executive C.Y. Leung may not be the best tactic, because it requires Beijing to accept that it made a mistake in facilitating his selection in 2012. True, his “voluntary” resignation might improve the atmosphere for an exit from the crisis. But the question of how to terminate the crisis still remains.

More promising, at least on the surface, are the proposals of individuals who argue that some sort of mutually acceptable compromise is possible. These include political scientist Sonny Lo, who put forward some ideas before the crisis began, and Lawrence Lau (a prominent economist and business executive) and a colleague, who offered similar thoughts in the last few days. Each is absolutely right that in theory there are ways to engineer the Nomination Committee to allow greater competition among candidates and ensure that the public has some choice when it goes to vote.

Politically, however, the issue here is the range of choice with which voters are likely to be presented. Would it be between two members of the establishment who may have legitimate differences on policy but whom the public would regard as a choice between Tweedle-dum and Tweedle-dee? In the most representative elections in Hong Kong (for members of the Legislative Council selected from geographic seats), the pan-democratic forces win between 55 and 60 percent of the vote. Will that part of the electorate be happy with an election in which one of their own is not running? Will the winner of an intra-establishment contest have legitimacy, even if he is elected on a one-person, one-vote basis? (Note in this regard that the White House statement on September 29th came down on the side of a broader range of choice: “We also believe the legitimacy of the Chief Executive will be enhanced if the election provides the people of Hong Kong a genuine choice of candidates that are representative of the people’s and the voters’ will.”)

The other problem with well-intentioned proposals for compromise is that after years of a long-running political struggle, the democrats, even moderate democrats, won’t want to enter into negotiations without having some confidence that, whatever concessions they make, the end result will meet their minimum requirements. They believe that they have put their faith in promises before and have gotten little or nothing. They have asked repeatedly for some sort of timeline that would give them confidence that an incremental concession now will actually lead to the ultimate goal that they seek (a real democracy). To make matters worse, moderate democrats have been criticized before by their radical colleagues for “betraying the cause” by settling for too little, and they are wary of exposing themselves to such criticism again.

As I noted at the outset, each side must itself regard the “way out” that its adversary creates as at least a reasonable exit.

Authors Image Source: © Bobby Yip / Reuters         
Categories: Blog

The Hutchins Roundup: Infrastructure Spending, the Government Spending Multiplier, and Government Debt Management

Brookings Institute Blog - Thu, 10/02/2014 - 09:00

What’s happening in fiscal and monetary policy right now? The Hutchins Roundup is a new feature to help keep you informed on the latest research, charts, and speeches.

The time is right for infrastructure spending

In its 2014 World Economic Outlook, the International Monetary Fund suggests that given low borrowing costs and weak demand, the time is right for increased government spending on infrastructure. IMF economists find that in advanced economies, a one percentage point increase in infrastructure spending leads to a 0.4 percent boost to output in the first year and a 1.5 percent increase four years out.

Current multiplier estimates are understated

Daniel Riera-Crichton of Bates College, Carlos Vegh of Johns Hopkins University, and Guillermo Vuletin of the Brookings Institution argue that government spending multipliers are higher than the existing literature suggests. They note that economies do not respond to increases and decreases in government spending symmetrically. In a recession, when spending is increasing, the multiplier is roughly 2.3, whereas the previous research – which does not distinguish between increasing and decreasing spending – estimates a multiplier of 1.3.

The Treasury and the Fed working at cross-purposes

In a paper presented here at the Hutchins Center for Fiscal and Monetary Policy, Harvard’s Robin Greenwood, Samuel Hanson, Joshua Rudolph and Lawrence Summers find that by extending the average duration of its debt, the Treasury offset roughly one-third of quantitative easing’s impact on long-term yields and the economy. The authors suggest that the Treasury and Fed issue an annual joint strategy statement on debt management to avoid working against each other in the future.
Watch a panel debate the author’s findings on the Brookings Youtube channel »

Chart of the week: Growth forecasts continue to fall, particularly in the emerging markets

Speech of the week: Fed policy heading towards a new normal

“The steps taken by the U.S. Federal Reserve, the central bank closest to the epicenter of the crisis, prevented the crisis and subsequent recession from being much worse. And they continue to support the U.S. and global economies through that long healing process. The Fed’s unconventional monetary policies affected Canada through various channels, notably by pushing down market interest rates worldwide. By the same token, as Fed policy returns to normal – which is likely to be a different state than before the crisis – that will tighten financial conditions in Canada. But this will be happening against the backdrop of stronger economic growth.”
-Timothy Lane, Deputy Governor, Bank of Canada

Categories: Blog

Revisiting Industrial Policy in Latin America

Brookings Institute Blog - Thu, 10/02/2014 - 07:48

In early September, I participated in a mission to Peru to discuss the government’s National Plan of Productive Diversification. Over the last few decades Peru achieved macroeconomic stability and, relative to the region, considerably improved a number of economic indicators. However, Peru’s exports are still highly concentrated in the mining sector, and thus, as a small open economy, the country is highly vulnerable to the behavior of world markets. In order to overcome this problem, the Peruvian government has decided to pursue active policy that will lead to the diversification of the economy into new competitive sectors with high growth potential and significant global demand.

This is not precisely music to the ears of many. It brings back bitter memories of previous attempts in the region to pursue industrial policies by heavily subsidizing or imposing high tariffs on “hand-picked” sectors. This led to undesirable rent seeking behavior and, quite frankly, not a great deal of diversification. So, why is this again on the agenda for some countries?

Revisiting the industrial policy “taboo” can, however, lead to a healthy discussion. Most of the debate in academic circles is on whether industrial policy, as a whole, is justifiable or not. However, the proper debate should focus on how to design these policies so that they can fix the prevalent market failures where a fix is possible. No effective policy can be designed without a clear identification of the market failure, regardless of whether it is industrial or any other kind of policy. In this sense, criticism of industrial policy interventions should not be directed at the policy per se, but rather on whether it is justified and appropriate in terms of the existent market failures. Ruling out interventions of this type just because they failed to bear fruit is not enough reason. That policies did not achieve their goals might have been because they were not addressing the underlying market failure.

In the midst of the re-emergence of the industrial policy debate, I believe the two most important questions to be asked are: what went wrong back then? And, perhaps most importantly, what have we learned in the decades since?

These questions, and others, are addressed in the newest Inter-American Development Bank (IADB) annual report “Rethinking Productive Development.” The report revives this discussion while carefully analyzing some of the (good and bad) experiences of the past. Co-edited by IADB’s Gustavo Crespi, Eduardo Fernandez-Arias and Ernesto Stein, the report provides a rigorous, yet intuitive, framework to think about policies that aim to boost productivity in the region.

The report analyzes policies that aim to increase productivity in developing countries by correcting market errors in areas related to innovation, entrepreneurship, labor markets, finance, clusters and diversification of the economy.

The book does a great job in reviving these topics, which are critical to overcome the “productivity curse” many developing countries are in. Perhaps, most importantly, it presents insightful evidence-based thoughts, which set the stage for an open discussion on industrial policy as a way to induce productivity. This type of debate is not only relevant for the Latin-American context, but for the developing world as a whole.

Categories: Blog

Việt Nam: Một kỳ thi quốc gia có đánh giá được hết năng lực học sinh?

Học sinh Việt Nam tham dự kỳ thi tốt nghiệp trung học phổ thông.
Photo: Van Chung/World Bank

Sau nhiều tháng thảo luận sôi nổi, Bộ Giáo dục và Đào tạo cuối cùng đã ra thông báo về việc tổ chức một kỳ thi quốc gia chung để xét công nhận tốt nghiệp trung học phổ thông (THPT) và lấy kết quả làm căn cứ tuyển sinh đại học, cao đẳng.

Cho đến năm học vừa qua, học sinh Việt Nam vẫn phải tham gia hai kỳ thi riêng sau khi hoàn thành 12 năm học phổ thông: một kỳ thi tốt nghiệp THPT và sau đó là kỳ thi tuyển  sinh đại học, cao đẳng. Cả hai kỳ thi này đều có tính quyết định cao và tạo nhiều áp lực lên các em học sinh và gia đình.

Categories: Asia, Blog

Should the Treasury and the Fed Cooperate on Debt Management?

Brookings Institute Blog - Wed, 10/01/2014 - 10:23

A paper by four Harvard scholars, who argue that the impact of the Federal Reserve’s purchases of long-term debt securities in its quantitative easing program was diluted by the Treasury’s strategy of lengthening the maturity of their debt issuance, sparked a lively conversation at the Hutchins Center on Fiscal and Monetary Policy this week.

Responding to the paper written by Harvard’s Robin Greenwood, Sam Hanson, Josh Rudolph and Larry Summers were Lou Crandall of Wrightson ICAP; Jason Cummins of Brevan Howard; Federal Reserve Board member Jerome Powell and Mary John Miller, who until recently served as Under Secretary of the Treasury for Domestic Finance.

You can watch a video of the whole event on YouTube, but if you don’t have time for that, here are three takeaways.

Federal Reserve Independence. The authors’ call for greater coordination between the Federal Reserve and Treasury was hotly contested by the panel. Cummins remarked that complete Federal Reserve independence is vital to its inflation-fighting credibility. Miller pointed to the practical difficulties of sticking to a year-long agreement, as advocated by the authors, namely the unpredictability of the government’s financing needs and the institutions’ differing goals. She added that that “coordination is a bridge too far, but strong communication is key.” Summers responded that the Federal Reserve and Treasury have worked together in the past while preserving the Fed’s independence, citing the introduction of the inflation-indexed bond in 1997.

Regular and Predictable. Cummins commented that regular and predictable government debt issuance is essential for preserving the Treasury security’s status as a risk-free benchmark. Miller pointed out that altering course during a time of great economic instability would have introduced uncertainty in the market. Summers disagreed. He questioned whether overall debt management policy was “regular and predictable” from the perspective of the marketplace, when consistent Treasury policies were paired with unpredictable Federal Reserve actions.

Private Demand for Safe Assets. New rules that require banks to hold more high quality liquid assets will increase their demand for short-term safe assets. Crandall warned that if the Federal Reserve and Treasury do not provide a robust supply of such assets, the private sector will, with a cost to overall financial stability. He also noted that, as the Federal Reserve’s balance sheet starts to shrink, investor demand for safe assets may require the Treasury to make up the balance. To this point, Miller noted that the Treasury’s newest debt instrument, the floating rate note, meets investor demand for safe assets while achieving the Treasury’s other debt management goals.

For more coverage of the event, check out The Washington Post, The Wall Street Journal, Market Watch, Reuters and The New York Times.

Authors Image Source: © Brendan McDermid / Reuters         
Categories: Blog

Hutchins Center Launches Gauge of Federal, State, Local Fiscal Impact

Brookings Institute Blog - Wed, 10/01/2014 - 08:18

On the first day of the federal fiscal year, the Hutchins Center on Fiscal and Monetary Policy at Brookings unveiled our Fiscal Impact Measure, a gauge of the contributions that federal, state and local governments make to the near-term pace of economic growth.

The FIM, as we’re calling it, is included in the new Fiscal Barometer on the Hutchins web site that tracks trends in federal, state and local spending, revenues and employment. The new measure and the other charts on the site will be updated regularly. It’s part of our effort to help the interested public keep tabs on government economic policy and to inject facts into the public debate. The data also highlight the important role of state and local government policies, sometimes overlooked in the Washington debate over federal taxes and spending.

The FIM is at the heart of this project. Constructed by Louise Sheiner, a Brookings senior fellow and policy director for the Hutchins Center, the measure summarizes all the ways in which spending and taxes at all levels of government are influencing the current pace of economic growth.

A glance at the chart shows the significant impact of President Obama’s American Reinvestment and Recovery Act in boosting the economy during the Great Recession, and how subsequent spending cuts and tax increases at the federal, state and local government have restrained the economy in the past few years. (Read about the construction of the FIM). The measure is similar to one that Federal Reserve staff economists calculate for internal use of Fed policymakers. One big difference is that our measure is publicly available.

The new Hutchins Center’s Fiscal Barometer also tracks recent trends in government employment, spending and taxes at all levels of government, and monitors longer-run projections of federal revenues, outlays, deficits and debt. If you look at the individual charts, for instance, you can see the declines in state and local government employment during the recession as well as the sharp drop in state and local infrastructure spending in the past few years.

Earlier this year, the Hutchins Center launched Janet Yellen’s Dashboard, a regularly updated site that tracks several economic indicators that are important to Federal Reserve policymakers.

Click here to view the interactive Fiscal Barometer »

Authors Image Source: © Brendan McDermid / Reuters         
Categories: Blog

Hong Kong: On Crisis Management

Brookings Institute Blog - Wed, 10/01/2014 - 08:16

There hasn’t been too much change in the Hong Kong situation in the last twenty-four hours. Each side is sticking to its core demands (Government: “The protests must end”; Protesters: “Chief Executive C.Y. Leung must go”). I was worried that some activists might seek to disrupt a formal ceremony marking China’s National Day, but the principal leaders were able to ensure restraint by their followers.

The unity and leadership of the opposition camp is a matter for concern. The New York Times had a good article this morning on the amorphous, loosely led character of the movement (“Hong Kong Protests Are Leaderless but Orderly”). Those who are seeking more democracy than Beijing is willing to grant are quite “democratic” within their ranks. The pro-democracy camp has suffered serious fragmentation over the last two decades, to its own detriment.

This is a cause for serious concern. The beginning of the current crisis began when one faction of the pro-democracy camp decided on Friday evening to independently undertake action that was more radical than other factions preferred.

And this is a crisis. In a stressful circumstance like this one, a good-enough outcome will be possible only if each of the contending sides is united in its assessment of the situation (hopefully a fairly accurate assessment); in the definition of its goals and the options available; and in the leadership’s ability to implement its decisions on their followers. Successful crisis management also requires that each side takes pains to give the opposing side a way out of the impasse. Backing the opposition into a corner almost guarantees escalation and failure. The Hong Kong opposition’s amorphous character may impede its ability to manage the crisis.

This is not a re-run of the Tiananmen Crisis in Beijing in the spring of 1989 (not yet, at least). The underlying circumstances are very different. But some aspects of Tiananmen are relevant here. There is a strong case to be made that the standoff between the regime and the protesters in Tiananmen Square in 1989 was on the way to winding down in late May and very early June and that a violent outcome was not inevitable. But each side was split. Deng Xiaoping was convinced that the regime was in peril and rejected the advice of colleagues who argued for moderation. On the demonstrators side, the students from the Beijing area that had initiated the movement lost power to more radical activists from outside the capital itself. Each side saw little interest in giving the other a way out. The new leaders of the protesters wanted validation through a violent martyrdom; the regime believed it was under siege and had no choice but to re-impose control through force.

I suggested yesterday that some division within the establishment camp may be conducive to Beijing and the Hong Kong government moving off their current hard line stance. That remains true. At the same time, the pro-democracy camp needs more unity than it has shown if it is to avoid bad choices and a bad outcome.

Authors Image Source: © Bobby Yip / Reuters         
Categories: Blog

Vietnam: Can One National Exam Test All?

Students in Vietnam attend the high school completion exam.
Photo: Van Chung/World Bank

After months of impassioned public discussion, Vietnam’s Ministry of Education and Training has finally announced that one national exam will determine high school graduation and the exam results will be used as the basis for university entrance admission.

Until recently, Vietnamese students took two tests after completing 12 years in school: one was for high school graduation and the next was for university entrance. Both were high stakes tests that created pressure on students and their families.

Categories: Asia, Blog
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