View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.




Developments in the Global Economy and Implications for the United States
January 11, 2007
Timothy F. Geithner, President and Chief Executive Officer
Remarks at the Council on Foreign Relations' C. Peter McColough Roundtable Series on International Economics, New York City

It is a pleasure to be here at the Council on Foreign Relations, and to be here with Jerry Corrigan.
A few brief remarks about the global economy, both the real and financial dimensions, to provide a basis for our discussion.
2006 marked the fourth successive year of a global expansion that has been remarkable for its strength, for its breadth, and for its
stability in the face of economic shocks and uncertainty in the geopolitical realm.
This period of broad-based growth in income has been supported by a number of important fundamental forces.
Rapid technological innovation and greater economic integration have brought stronger growth and higher levels of productivity.
The acceleration in productivity growth that occurred in the United States in the second half of the last decade seems likely to
remain intact. And productivity growth is accelerating outside the United States, most strikingly in some of the large emerging
Financial innovation and greater integration of national financial systems has contributed to the strength of real economic activity
by improving the allocation of resources within and among economies. Improvements to risk management and to capital cushions
are likely to have made the financial system more stable and more resilient.
And macroeconomic policy has improved around the world. The increase in monetary policy credibility in a broad range of
countries has produced lower rates of inflation and more stability in inflation expectations. Greater public confidence in monetary
policy was critical to laying the foundation for the improvements in real economic performance, by providing a stable foundation
for long-term investment decisions.
In emerging markets, better monetary policy has been accompanied by more disciplined and conservative fiscal policy and a range
of other policies that have reduced, though not eliminated, vulnerability to changes in confidence, capital flows and exchange rate
These factors are each fundamentally important, and they are, of course, interrelated. The policies that delivered better inflation
outcomes, more openness and competition and stronger financial systems were critical to fostering an environment in which
improvements in productivity and growth could occur.
This expansion has also been notable for the financial conditions that have prevailed over the past several years.
Long-term interest rates have remained relatively low in nominal and real terms. Equity and other asset prices have moved higher.
Credit spreads have declined to quite low levels. Market participants report exceptionally high levels of liquidity. And volatility,
both realized and expected, has remained low across many different types of financial assets, market and economies.
This general constellation of market conditions and asset prices is unusual, at least in comparison to what we have seen over the
past several decades. This has been a distinguishing feature of the present expansion, but it is not something we fully understand,
and we cannot be confident in judgments about how durable it will prove to be.
To a significant extent, these financial developments reflect a high degree of confidence in future macroeconomic and financial
stability, reinforced by the improvements in inflation performance, growth outcomes and financial resilience of the past several
Better monetary policy has lowered expectations of future inflation and inflation volatility and has contributed to lower risk
premiums in general. Changes in the cyclical behavior of financial intermediation and credit provision, coupled with the increased
stability of the real economy, seem likely to have reinforced the improvements on the monetary policy front.
And rapid growth in the major emerging market economies, together with the substantial earnings of energy-producing and
commodity-exporting countries, have produced a substantial increase in wealth and savings relative to perceived investment
opportunities. In a world where capital can now flow much more freely across national borders, a significant portion of these
savings has moved across national borders.

These are powerful and fundamental forces, and they certainly help explain the broad reduction in risk premiums and the
substantial demand for credit risk and financial assets.
There are other factors at work as well, however, that have less favorable implications. Part of this recent dynamic in financial
markets is a consequence of the present state of the international monetary system, in which a substantial part of the world
economy runs exchange rate regimes tied in some way to the dollar. This has entailed a sustained period of very substantial official
accumulation of dollar reserves, putting downward pressure on U.S. interest rates and upward pressure on U.S. asset prices.
These forces are surely transitory, but their impact on capital flows, interest rates and asset prices are important, not just in terms
of their short-term impact on growth. If they are large enough, they have the potential to alter or distort current decisions about
investment and consumption in a way that could be detrimental to our longer-run growth prospects. And they are important
because they work to mask or dampen the effects on risk premiums in financial markets that we might otherwise expect to be
associated with the expected trajectory of the fiscal and external imbalances in the United States.
Given this broad context, I want to touch briefly on some of the policy issues that are likely to be important to the prospects for
economic performance, here and around the world. Despite the relatively favorable performance of the global economy, we face a
range of daunting longer-term economic policy challenges. The improvements in the conduct of monetary policy were critical to
the improvements in productivity and growth that we are now seeing on a global scale. And monetary policy will, of course,
continue to be critical, but monetary policy alone cannot provide the elements of the framework necessary to provide an
environment for innovation and long-term decisions that will be so vital for future growth. Economic policy, in general, needs to
be more forward looking in providing a longer-term framework for stability.
On the fiscal policy front, demographic changes confront governments around the world with exceptionally difficult choices. For
the United States, these challenges are less acute than for many of the major economies, but they are still formidable in their scale
and complexity. Even for the near term—for the period before the increase in number of retirees starts to have a major impact on
Social Security and Medicare expenditures—we are running an unsustainably large fiscal deficit. Despite the recent improvements
in revenues, the expected trajectory for the fiscal deficit will mean that federal government debt will continue to rise as a share of
GDP. The restoration of fiscal rules—such as those that require new tax cuts or expenditure programs to be funded with offsetting
policy measures—will help reduce the risk of further deterioration. However, they need to be complemented by a consensus on
policy changes that will produce smaller future deficits.
Restoring confidence in U.S. fiscal management would be important and necessary independent of the broader context of the
global economy today, but it is more important given the size of our external imbalance, now running at the unprecedented level of
7 percent of GDP a year. The trade balance in real terms has been broadly stable over the past two years, but our net income
payments have shifted to deficit, and the size of that component of the current account deficit seems likely to continue to expand.
These large global imbalances, our current account deficit and the surpluses that are the counterpart to our deficit, will have to
come down over time. How that process unfolds will depend on a complex mix of factors around the world. Confidence that the
U.S. political system will act to generate a sustainable fiscal trajectory is important to raising the probability that this process of
adjustment unfolds with less risk.
A successful conclusion of the Doha round of trade negotiations would provide some insurance against the risk that the process of
economic integration will be interrupted or reversed. Despite the relatively favorable average income gains of the past few years, a
common feature of the political context in economies around the world is the fragility or weakness of public support for openness
and economic integration.
The political challenge of sustaining support for the process of integration may be the most important economic challenge of our
time. To paraphrase Lawrence Summers, it is not enough to explain that globalization is inevitable and that policies that look
politically attractive as a response to economic anxiety will only hurt the economy as a whole. Nor is it a politically effective
strategy to state simply that economic integration is a necessary and powerful force in raising average incomes, or that
technological change may be more important than trade or immigration as an explanation for slower growth in real wages for
many Americans.
Raising the quality of education and exploring ways to improve the safety net are a necessary part of the solution to this challenge.
But these reforms will have a long fuse and they may not yield the hoped-for increase in support. Trade does not appear to be more
popular in countries with more generous safety nets, universal health care and highly subsidized higher education than it is today
in the United States.
The political challenges of sustaining support for global economic integration and fiscal sustainability will be more difficult in the
United States because of what has happened to the distribution of income and economic insecurity. Several broad economic forces
substantially complicate an already difficult set of political challenges: the long-term increase in income inequality, the slow pace
of growth in real wages for the middle quintiles of the population, the increase in the volatility of income that is a reflection of the
greater flexibility of the U.S. economy, and the greater exposure of households to the risk in financing retirement and the burden
of paying for health care.

More generally, the global financial system and the monetary arrangements that underpin it are in the process of a delicate and
consequential transition as the major emerging market economies—particularly in Asia—move toward more mature monetary
policy frameworks, more flexible exchange rate regimes and more open capital markets. This transition will require careful
management, and the economic dimensions of getting it right would be complicated even without the political pressures those
governments face.
One final note on the financial system. The global financial system is in the process of very dramatic change. The changes of even
just the last five years are extraordinary, in terms of the size, and strength, and scope of the major global firms, the role of private
leveraged funds, the extent of risk transfer and the increase in the size of the derivatives market, the change in the structure of the
credit market, the increase in and changes in the pattern of cross border financial flows.
These changes, and others, seem likely to have made the financial system both more effective in moving capital to its most
productive use and more stable and resilient over time. But they do not, of course, mean the end of systemic risk in financial
markets. They could in some circumstances work to magnify rather than mitigate stress. Central banks, supervisors and those
running the major private financial institutions need to continue to work to ensure that what Jerry Corrigan calls the “shock
absorbers” in the financial system—capital and liquidity and the operational infrastructure—are sufficiently strong and robust to
withstand economic and financial conditions more adverse than we have seen in the recent past.
Thank you.