Laurence Meyer April 14,2004

Meyer’s

The Global Outlook & Challenges for Monetary Policy Global Issues and the U.S. Outlook Global Interdependence Center April 14, 2004 Laurence H. Meyer Senior Adviser, Macroeconomic Advisers

Outline

Meyer’s

• New and Old Challenges for Monetary Policy • Global Outlook Themes • Global Influences on the U.S. Outlook • Country/Regional Developments • Challenges to Monetary Policy

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Global Disinflation & the Great Moderation

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US Consumer Price Index and Trade-Weighted Foreign Consumer Price Index 16

Percent H F

Foreign

14 12 10 8 6

US

4 2 0 84

86

88

90

92

94

m Macroeconomic Advisers, LLC

96

98

00

02

04

www.meyersmpi.com 3

Global trend to Higher Interest Rates US 10-year Treasury Yield Trade-Weighted Foreign Government Bond Yield 14

Percent H F

12 10 8 10-year

6 Foreign

4 2 84

86

88

90

92

94

m Macroeconomic Advisers, LLC

96

98

00

02

04

www.meyersmpi.com 4

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U.S. and Foreign Real GDP Growth

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US GDP Growth and Trade-weighted Foreign GDP Growth 6

4-quarter growth, percent

5

United States

Foreign World

4 3 2 1 0 H

F

-1 1999

2000

2001

2002

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2003

2004

2005

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Global Issues

• • • • • • • • •

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Synchronous global recovery Initial conditions: low nominal, real rates and inflation Little scope for monetary/fiscal stimulus Diversity in challenges facing central banks Adjustment of global imbalances/an asymmetry Cyclical rebounds vs structural considerations Common transitions: fiscal consolidation/global aging China & India: threat or opportunity/managing success Geopolitical uncertainty and terrorism

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The U.S. Current Account Deficit

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Net Exports and Real Trade-Weighted Foreign Exchange Rate 120

1997=100

Billions of US $

-320

115

-360

110

-400

105 100

-440

Real Trade-Weighted 35-Country Foreign Exchange Rate

95

-480 -520

Net Exports H

F

90

-560 2000

2001

2002

2003

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2004

2005

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Adjustment of Global Imbalances

• U.S. current account deficit part of the global imbalance – – – –

More difficult for us or our counterparties?

Gradual or chaotic?

Sooner or later?

Narrowly or more broadly based?

• Implications of Asian accumulation of $s – – – –

Transition from private demand to official accumulation Reduces breadth and overall amount of adjustment Reduces immediate need for adjustment Course of adjustment now depends on policy considerations

• Challenges – – – –

High U.S. import elasticity and initial conditions Difficult to make adjustment unless ROW grows faster than U.S. Japan, Euro area addicted to external demand Difficult to be successful unless U.S. raises national saving

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Meyer’s

Depreciation and U.S. Net Exports

Meyer’s

Net Exports and Trade-Weighted Foreign Exchange Rate 135

1997=100

Billions of US dollars

-320

130

-360

125

-400

120

-440

115

Trade-W eighted 35-Country Foreign Exchange Rate

-480

110

-520 net exports H

105 2000

2001

2002

2003

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F

2004

-560 2005

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The Global Rebound and Commodity Prices Crude Core PPI 30

12-month percent change

20 10 0 -10 -20 1990

1992

1994

1996

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1998

2000

2002

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Higher Oil Prices

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West Texas Intermediate 40

US Dollars

36 32 28 24 20 16 2000

2001

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2002

2003

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How Much Pass-Through to Import Prices?

Nonpetroleum Import Prices 8

3-month percentage change, annualized

4 0 -4 -8 -12 2000

2001

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2002

2003

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Country/regional Issues

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• U.S.: productivity, employment and monetary policy • Japan: finally a breakout and if so, why?

• Is China overheating and if so, hard or soft landing?

• Euro area: destined and content to under perform?

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Productivity Growth: How much will it slow?

Productivity Growth 6

percent H F 1-year

5 4

5-year

3 2 1 96

97

98

99

00

m Macroeconomic Advisers, LLC

01

02

03

04

05

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Aggregate Demand vs. Productivity Growth GDP Growth and Productivity Growth 10

percent

8 GDP

Productivity 6 4 2 0 -2 2000

2001

2002

2003

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2004

2005

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W hat Drives Monetary Policy?

The Unemployment Rate and Core Inflation in the Forecast 10

percent H F

8 6

unemployment rate

4 core CPI

2 0 1-quarter GDP growth

-2

2000 2001 2001 2002 2002 2003 2003 2004 2004 2005 2005 2000

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Meyer’s

Real GDP Growth and Inflation in Japan

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Japan Real GDP and Consumer Prices 5

H

F

Percent

4

Real GDP

3 2 1 0 -1

consumer prices

-2 -3

H

F

-4 95

96

97

98

99

00

m Macroeconomic Advisers, LLC

01

02

03

04

05

www.meyersmpi.com 17

Real GDP Growth and Inflation in Euro Area

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Eurozone Real GDP and Consumer Prices 5

H

F

Percent

H

F

4 Real GDP

3 Consumer Prices

2 1 0 95

96

97

98

99

00

m Macroeconomic Advisers, LLC

01

02

03

04

05

www.meyersmpi.com 18

China and India

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China and India Growth of Real GDP 12

Percent

India

China

10 8 6 4

H

F

2 95

96

97

98

99

00

m Macroeconomic Advisers, LLC

01

02

03

04

05

www.meyersmpi.com 19

Real GDP Growth and Inflation in China

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China Real GDP and Consumer Prices 25

H

F

Percent

20 Consumer prices

15 10

Real GDP

5 0 H

F

-5 95

96

97

98

99

00

m Macroeconomic Advisers, LLC

01

02

03

04

05

www.meyersmpi.com 20

Change in Chinese Exchange Rate Regime?

• U.S., Euro, Asian, and Chinese perspectives • Sequencing and the reluctance to float • Consistency with domestic policy objectives • Intermediate steps – – – –

Widening the band Discrete revaluation Moving to a market basket Partial and gradual relaxation of capital controls

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The Outsourcing Debate

Meyer’s

• The magnitude of the problem?

• Bearing backlash to globalization, productivity • Widening job insecurity related to globalization • Winners and losers and the Pareto principle • Reducing the gains from trade?

• The policy response m Macroeconomic Advisers, LLC

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Monetary Policy around the W orld

• Exit problems and return to neutrality • Learning about nonconventional policy (Japan) • Structural constraints (Euro area and Japan) • Productivity and monetary policy (U.S.) • Transparency and inflation targets • Monetary policy and bubbles m Macroeconomic Advisers, LLC

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Monetary Policy in the U.S.: Sooner or Later

•Return to neutrality: – What is the neutral value of the funds rate?

– What is the implicit inflation target and what is the NAIRU? – Timing of the start of tightening • Preconditions and triggers • Higher hurdle for first move and never surprise the market • Should the Fed still “err on the side of ease?”

• The two gaps story: how far from full employment & neutrality?

• Accelerators: role of equity valuations, term and risk spreads • Patiently preemptive?

• Does the election influence the timing of tightening?

– The pace of tightening and interaction with timing (via Greg Ip) • “Baby Steps”: Start early and move slowly • “Backloading”: Start later and then converge more quickly • “Late and Leisurely”: Start later and move slowly

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Meyer’s

Sooner or Later

Meyer’s

• Later – – – –

Slow decline in unemployment rate, stable core inflation Concern about inflection point/2nd half slowdown Limited concerns with financial imbalances as accelerator Maximin and comfort in still erring on side of ease

• Sooner – – – –

Faster decline in unemployment rate/upward rend in core inflation Two gaps: not so far from potential/long way to neutrality Reluctance to continue erring on side of ease Preference for gradualism

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The Taylor Rule and the MPI Call

Meyer’s

Taylor Rule Using Short-Run NAIRU 10

H F Prescribed

8 6 4 Actual, Forecast Actual, MPI MA Forecast

2 0 88

90

92

94

96

m Macroeconomic Advisers, LLC

98

00

02

04

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Evolution of Monetary Policy in Japan

• February 1999: zero rate policy • April 1999: first statement re precommitment – “until deflationary concerns dispelled”

• August 2000: terminated ZRP/raised policy rate ¼ pp • February 2001: returned to (near) zero policy rate • March 2001: adopted “quantitative easing” – Targeting current account balance at BOJ – Clarified precommitment: until CPI inflation stable at zero or above

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Effectiveness of Nonconventional policy

• Limits to monetary policy: broken multiplier • Quantitative easing • Precommitment • Improving the transmission mechanism

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ECB

Meyer’s

• Differences in objective conditions or strategy?

• Dismissive of “stabilization policy” • Asymmetric re response to inflation • Limits on monetary policy/structural constraints

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Inflation Targets and Inflation Targeting

• • • • • • • •

Trend toward inflation targeting U.S. and Japan: do not have explicit targets Exit issue: what is the “implicit” inflation objective Price stability vs. price stability + cushion Transparency, accountability, and effectiveness Hierarchical vs. dual mandates Trade-off between inflation target & flexibility?

Explicit inflation objective within dual mandate

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Monetary Policy and Asset Bubbles

• Lessons from equity bubble: – Difficult to reach timely judgment about danger of bubble – Indirect vs. direct approaches – In close call, encourages tighter policy

• Today concerns with housing bubbles in UK, Australia – Contributed at margin to decisions to tighten

• U.S. – Some talk about bond market bubble – Reaching for yield across term and risk structure – Increases exit problem

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Meyer’s