Maurice Obstfeld The Numbers Must Add Up

In an exclusive interview, the IMF's chief economist talks about his frustrations with the United States, the trouble with free trade, the current dangers facing Europe and Greece's challenging budget.
Maurice Obstfeld, chief economist at the International Monetary Fund, says we live in worrying times.

From his desk at the IMF's headquarters in Washington, Maurice Obstfeld stares at an empty shelf. That's because most of his books are still in California, where he is still a professor at the University of California at Berkeley. As the International Monetary Fund's chief economist since last year, Mr. Obstfeld tells us that bringing over the books isn't worth the expense. The IMF probably has better ways to spend its money.

The 64-year-old U.S. economist has German roots. His parents fled the Nazis. In the United States, he developed a name for himself as one of the most influential experts on trade issues and the global financial system. His textbook "International Economics: Theory and Policy," written with Paul Krugman and Mark Melitz, remains one of the seminal texts for teaching the subject.

From 2014 to 2015, he was a member of President Barck Obama Council of Economic Advisors. In September he moved just a couple of blocks down the famed Pennsylvania Avenue in Washington, from the White House to the IMF's headquarters. He says he doesn't regret the move.

The interview below was carried out before the recent release of a telephone transcript  – courtesy of Wikileaks – that revealed the IMF's anger over Greece's lack of reform progress and has rocked the boat in European circles.

But Mr. Obstfeld is quite clear himself: "The numbers on the budget have got to add up, no matter what." While Europe should give Greece more flexibility to tackle the refugee crisis, Greece still urgently needs to tackle pensions and other structural reforms to get on a firm footing for the long term, he said.

Handelsblatt: Before you took this job, you were already a leading global economist and advisor to U.S. President Barack Obama. What motivated you to change to the IMF?

Maurice Obstfeld: First of all, it was a huge privilege to work for the president. I would have been very happy to stay until the end of his administration but this opportunity came up and I felt it was an opportunity to leverage whatever skills I have to help a broader set of countries than just the United States. I worked for a long time on the international system and on the Fund, so it was a great opportunity. I should add that the president was very encouraging in my taking this job. He is a big fan of what the Fund does and he is very happy to see someone from his administration to go out and contribute to the Fund’s work.

As an advisor to Mr. Obama, looking at the numbers the U.S. economy is producing, it looks like a pretty strong recovery. But at the same time, some people are very unhappy. Did you get a sense of this hidden in the data while you were working for the president?

I don’t think it’s deeply hidden. If you look at the data, real wage growth has been very slow, median wages have stagnated for a very long time. Even though we have seen rapid job growth for many months, the people who get the jobs are not necessarily those who have been long-term unemployed or who have left the labor force. We also saw this steady downward trend of participation, which is in part related to demographics – the baby boom generation reaching retirement age.

Monetary policy is being asked to do a lot and I think we could have much more effective policy packages if we could get the fiscal and the structural parts going. Maurice Obstfeld, IMF Chief Economist

One of the striking things I saw when I joined the administration was a report from the Council of Economic Advisors on labor force participation, which found that male participation has been falling for decades. So when we read there’s a demographic of angry older men who have lost their jobs, or who feel the economy has left them behind, it’s not at all surprising if you look at these data.

There are growing concerns about the world economy. The fall in the oil price hasn’t led to further growth. Why?

The fall in the oil price has helped some countries which import oil. Consumers in Europe have profited and are spending more. But there are greater negative consequences for oil exporting countries. On top of that, investments in the oil industry have collapsed, which has effects on growth in some countries, mainly in the United States. There are other factors too.

What are they?

The deflationary effect of the fall in the oil price becomes a factor when central banks are no longer able to further reduce the key interest rate to counteract the low rate of inflation. Cheap oil reduces price levels. That in turn means the real, inflation-adjusted burden of loans increase and the economy suffers.


Have central banks spent all of their ammunition?

I think there’s still room. I don’t think ammunition has run out. I think what the European Central Bank did in its latest portfolio of actions, actually trying to subsidize lending, is a sort of new dimension that could be pretty effective. I do think, however, that they’re increasingly under a burden of acting alone. They’re not really getting support form fiscal policy, and they’re not even getting much support from structural policy. So monetary policy is being asked to do a lot and I think we could have much more effective policy packages if we could get the fiscal and the structural parts going. There’s a lot more that could be done in the policy sphere to help central banks, which have been working pretty courageously to shoulder pretty much the entire burden of maintaining growth and combatting deflationary pressures.

More broadly, have economists and policymakers ignored for too long the effects of pro-growth policies on income distribution, such as Wall Street deregulation but also free trade? Among elites, there’s a consensus that these are a good thing but apparently voters see it differently.

I wouldn’t necessarily take the view that pro-growth policies worsen income distribution, because there are some policies that don’t do that. If you deregulate network industries – something we actually look at in the new world economic outlook – it’s very pro-growth but it’s not clear that it has negative income distribution. But at the same time, if you talk about financial deregulation, the extent to which these policies are pro-growth is highly debatable. There’s a big literature on finance and growth and I think it’s probably still unresolved whether it drives finance or whether finance drives growth. The evidence is very mixed.

In the short run, during the refugee crisis ... hopefully European partners will help Greece afford the expenditures they have to lay out. But the numbers on the budget have got to add up no matter what. Maurice Obstfeld

Trade itself is very complicated. Workers in import competing industries are hurt, workers in export industries earn higher wages, so I think I would answer your question by saying probably the more worrying fact that we ignored is that growth has left many behind. Wherever that growth came from, whether it was from policies or technology, growth seems to have left many behind and you see this in stagnation of wages and in pockets of unemployed or unemployable workers.

Are there specific policies that can help those left behind by globalization?

I think things like trade adjustment assistance can certainly help. Retraining programs certainly can help. Investment in education can ensure that those who are entering the workforce find the kinds of newer higher skilled jobs that the economy provides. It is particularly tough for older workers who aren’t really in a position to retool and pick up the latest skills. I think we probably need to have more programs targeted to that demographic.

We’ve also seen a backlash against free trade in Germany, an export economy where one would assume there are less people hurt by free trade than people who benefit from it.  Resistance to TTIP is strong, for example. Are you worried about this backlash? Could that derail further integration of the world economy?

I think it’s definitely concerning. There’s much more of a concern in the U.S about the idea that trade leads to job losses, that leads to stagnant wages. My sense is that there’s much more tendency to blame trade for these things here than in Europe. I think we’ve certainly seen a lot of negative sentiment toward trade in the election campaign in the United States, where even in the Republican Party, which is long the champion of free trade, there’s a frontrunner who is promising to impose large tariffs on trading partners.

And what’s the situation in Europe?

I think the dynamics in Europe are a little different. My sense is there’s much more concern about the aspects of the trade agreement that might allow national regulations to be challenged by foreign exporters, such as through the investor-state dispute mechanism. I don’t get the sense in Europe that people feel that relatively high unemployment is due to trade. Look at Spain: Nobody’s saying Spain could just withdraw from the E.U., have protection and have an unemployment rate of 5 percent. Nobody says that.

Nobody’s talking about leaving in Spain, but in Britain the people are. Would a Brexit be harmful to the European economy and the British economy?

Yes I think it would be harmful to both the British and European economies. They both have long-standing trade relationships. In terms of sovereignty, Britain would probably find that, from the outside, it will wish to have access to European markets on the kinds of terms it has now. It would not be in a materially better situation. But there has been a trend throughout Europe towards rejecting economic integration and looking for nationalistic solutions. Not just Britain but several other countries. A lot of people feel that globalization has not lived up to the promise, and they look to national governments for protection.

Let’s talk about your role at the IMF. From the outside, it seems that the ideological underpinnings of the IMF’s policies have changed in the last decade or two. What was known as the Washington consensus is no longer the dominant dogma. Is that your sense? And is there a new Washington consensus and a more Keynesian approach?

I don’t think there’s necessarily a consensus. I think you’re right that the experience of the last decade has led to a reassessment, both inside the Fund and outside the Fund, of certain long-held beliefs. One topic you mentioned before, the faith in finance as a driver of growth, has been a little bit shaken. I think even more so now we are concerned about the need for prudential regulatory policy and that possible distortions of the financial sector can give rise to problems. Somewhat related to that has been the new thinking about capital controls and their possible usefulness for dealing with a number of issues, including financial stability. In some cases I think the crises of the past decade have also shown the usefulness of fiscal policy in some settings, and the dangers of fiscal austerity in some settings, and that has led to a more nuanced picture about fiscal policy. Certainly we still are very concerned about the sustainability of public finances and long term solvency of governments. But I think we’re willing to look in the short term at the more situational circumstances of recessions that might call for some sort of fiscal policy response, and not be quite as dogmatic about budget deficits as we might have been in the past.

Quelle: Reuters
Mr. Obstfeld's new boss, IMF Managing Director Christine Lagarde, has had a challenging week over Greece.
(Source: Reuters)


That partly answers a bit of my next question. The role of the IMF in the world economy is more to advise countries and help them formulate their own policies and less to dictate a one-size fits all sort of list?

I think we’re trying very hard to tailor our advice to country circumstances. I think there’s certainly recognition that looking at low-income, versus emerging, versus advanced economies, there are different challenges.

Does that tailored advice count for Greece as well? Especially now that Greece is facing another burden, the shock of the refugee crisis. Would it be right for the Fund to consider reducing the reform requirements that have been insisted upon, to give Greece a bit more space?

The humanitarian catastrophe is one that Europe will have to figure out – how to share the burden in order to deal in a humane way and a sensible way with absorbing refugees and getting them into the labor force. That’s going to be a shared burden and not something that just falls on the Greeks hopefully. But it’s also not going to be a problem that lasts forever.

Many German economists would be at an extreme end of that spectrum and I can understand that that’s psychologically comfortable, but the middle ground is probably more reasonable. Maurice Obstfeld

On the other hand, fiscal sustainability is a problem that is long term and in order for Greece to succeed and grow, its public finances will have to be put on a sustainable basis for the long term. Given the immense costs of the pension system, it’s hard to see how they could accomplish that without some pension reform. In the short run, during the refugee crisis, I think there will be flexibility in terms of the kind of deficits that they are able to run and hopefully European partners will help Greece afford the expenditures they have to lay out. But the numbers on the budget have got to add up, no matter what, and our view is that structural, fiscal reforms are necessary regardless of the crisis.

Does that include debt relief?

That’s part of making the numbers add up. Just if you look at what can reasonably be demanded of the Greek economy, debt relief has to be on the table.

The refugee situation also has knock-on effects on other European countries, the reinstitution of national border controls in parts of Europe. Can you give us any sense of what kind of economic damage Europe would suffer if it were to go back to these national policies?

The economic costs at the end of the day could be quite large. I think that fundamentally, what makes a currency union work is labor mobility. When the euro was established, one of the critiques of euro-skeptics was that there wasn’t a lot of labor mobility in Europe. If you put up borders, you’re working completely contrary to the idea of monetary union.

Speaking of the euro, how do you rate the efforts of the European partners to save the euro so far?

It’s clearly moved in the right direction and these are reforms which should have been embedded in the original Maastricht treaty. They were not at the time, for reasons that had to do with national sensibilities, and it’s impressive how far they’ve moved beyond that. Having said that, there’s a lot more to do. One of the goals of banking union was to break the sovereign-banking nexus in Europe. Clearly they’re not quite there yet, there’s more to do in that respect.

Like deposit insurance?

Deposit insurance is a big component.

It’s very controversial, especially in Germany.

Yes, Germans hate it. But the thing about deposit insurance is that, while it is potentially expensive, it’s quite effective in reducing the threat of crisis so that it ends up not being expensive. It’s one of those things that, because you have it there, you’re less likely to use it. What we’ve seen in the crisis is some pretty expensive interventions. Right now we’re talking about debt reduction in Greece. There’s a saying in German that my mother taught me, “cheap is expensive, expensive is cheap.” I sometimes think of that when I think of the way Europe has dealt with these reforms in a way that has been maximally expensive.

German economists take a different view. Do you sometimes feel frustrated listening to them clinging to these principles and concerns about monetary policy following strict rules?

Their basic position makes a lot of logical sense, but the problem with rules and moral hazard is that there are cases when accidents just happen and then you need to deal with them. A great example is the principle that there won’t be any bailouts in Europe, that euro-zone states wouldn’t rescue each other. It just wasn’t realistic.

If you put up borders, you’re working completely contrary to the idea of monetary union. Maurice Obstfeld

It’s not always that easy. You find that there are reasonable exceptions to the rules and there’s always a tradeoff between eliminating moral hazard and not having flexibility. Many German economists would be at an extreme end of that spectrum and I can understand that that’s psychologically comfortable, but the middle ground is probably more reasonable. At the end of the day in a big crisis you’re basically forced to break the rules anyway, so why not recognize that there are grey areas?

One recent grey are is the debate about unconventional policies at the European Central Bank has recently shifted to the merits of negative interest rates.

I think it’s new territory even for economists. We’re still studying the effects. In terms of the banking sector, it’s pretty clear that the threat of deflationary pressures would be greater without these policies. Ultimately, the complaints by banks confuse cause and effect. The reason these policies are there is because demand is slow and there are deflationary pressures. These are the things keeping banks from earning bigger profits. I think they could better view these policies as trying to help the banks. For other financial institutions like insurance companies, where profitability is perhaps not so linked to the business cycle, it’s less clear. Insofar as insurance is an important service, I think we might want to give some thought to the effect on those sectors.

It’s not just the banks that are complaining. What about savers? In Germany many go as far as to say that the ECB is stealing their money.

My response would be that, if we were to raise interest rates, the effects on the economy would really be much worse. There might be some retired savers who don’t have jobs, but I think ultimately the negative effects would pass thru to them too. Generally, we try to adopt policies which are in the interest of the economy as a whole. I think monetary policy falls in that category.

The next extraordinary step for monetary policy could be helicopter money. Would it be worth taking a look at in Europe?

Helicopter money involves some institutional difficulties, but I think they could probably be circumvented. One way to think about it is, if you sort of combine quantitative easing with debt purchases by the central bank – basically permanent debt purchases – which is plausible in a deflationary or very low inflation environment. That’s basically equivalent to helicopter money.

It may be that in some countries we’re driven to the helicopter idea. I don’t want to mention countries, but in theory it works. But we have to recognize it involves monetary and fiscal policy working together, and we haven’t really seen that in the case of Europe.


The interview was conducted by Moritz Koch, Handelsblatt's correspondent in Washington DC, where he covers U.S. politics and the global economy. To contact the author: [email protected]