Raimundo Soto: Catholic University of Chile ERF 24th Annual Conference The New Normal in the Global Economy: Challenges & Prospects for MENA July 8-10, 2018 Cairo, Egypt

1. RAIMUNDO SOTO
PONTIFICIA UNIVERSIDAD CATÓLICA DE CHILE
ERF 24TH ANNUAL CONFERENCE
THE NEW NORMAL IN THE GLOBAL ECONOMY:
CHALLENGES AND PROSPECTS FOR MENA
CAIRO, JULY 2018
A Macroeconomic Framework for
Growth under the New Normal

2. Mandate
Questions:
 When dealing with shocks and secular global developments, are there
important lessons to be learned by contrasting the experiences of the
MENA region and Latin America?
 What combination of exchange rate regimes, monetary policy and
fiscal policy have created favorable macroeconomic and political
economy prerequisites for steady real exchange rate depreciation,
which in turn allowed the agricultural and industrial sectors of several
Latin American countries to act as a shock absorber in the face of
declining oil, mineral and commodity prices?
 This plenary will examine how normal the new normal is likely to be,
the optimal macroeconomic framework for dealing with secular
commodity price decline, and the likely growth consequences of
different approaches.

3. Outline
 The “new normal”
 World economy in the “new normal” era
 The “new normal” era for resource-rich countries
 Modern macroeconomic regimes in the world under “new
normal” era
 Open policy questions

4. The New Normal

5. The New Normal
 I truly could not find a definition beyond:
 “A previously unfamiliar or atypical situation that has become standard, usual, or
expected”
 When in doubt … ask the IMF
 I checked one decade of World Economic Outlooks to assess if
 A previously atypical situation had become expected or
 If there had been major changes in the perception of the status of the world economy that
could be termed a “new normal”
 No luck! IMF mainly focus on growth (always lower than desired, expected, needed)
and financial risks (always higher, lurking, inevitable, ominous)
 In most papers it is vaguely defined as the “post-global crisis period”
 C. Legarde (2015) “Six months ago, I warned about the risk of a “new
mediocre”—low growth for a long time. Today, we must prevent that new
mediocre from becoming the “new reality”.

6. The New Normal
 Does the US define the “New Normal?
 A permanent downward departure from America’s historic 3% growth rate.
 A secular decline in TFP growth due to slow growth of innovation and declining
labor force participation (Fernald et al. 2018)
 Does China define the new normal?
 A permanent decline in GDP growth from an annual growth rate of 10% before
2008, to around 7% recently, and perhaps 5.5% in 2023 (IMF, 2018)
 An increased reliance on internal growth sources, as opposed to foreign trade
(Belt & Road Strategy) with concomitant lower global trade expansion
 Do commodity prices and trade volumes define the new normal?
 Burst of the commodity super-cycle signals permanent low prices
 And much higher commodity price uncertainty

7. World Economy in
the “New Normal” Era

8. Economic Growth Prospects
Real, annual GDP growth (%)
3.9
2.5
4.9
3.2
3.7
2.2
5.1
3.63.7
1.5
5.0
3.4
0.0
1.0
2.0
3.0
4.0
5.0
6.0
World Advanced
Economies
Emerging
Countries
MENA
2018
2019
2020-23
Source: IMF World Economic Outlook, April 2018

9. World Economic Growth in Perspective
Real, annual GDP growth (%)
Population
growth 2+%
Population
growth 1%
Prospects quite
good for historical
standards
Source: World Bank Database

10. Economic Growth Prospects
Real, annual GDP growth (%)
3.9
2.5
4.9
3.2
3.7
2.2
5.1
3.63.7
1.5
5.0
3.4
0.0
1.0
2.0
3.0
4.0
5.0
6.0
World Advanced
Economies
Emerging
Countries
MENA
2018
2019
2020-23
Source: IMF World Economic Outlook, April 2018
MENA is
growing but not
catching up

11. Financial Risks
 Continued uncertainty in global equity markets despite very
low volatility and interest rates

12. Very low volatility
of Treasury notes
and equity
Very low
interest rates in
advanced economies

13. Financial Risks
 Continued uncertainty in global equity markets despite very low
volatility and interest rates
 Monetary policy normalization (end of QE).
 Financial markets correction.
 Buildup of financial vulnerabilities
 How will asset classes that positively benefited from QE respond to the
unwinding?
 Impact from U.S. tax policy changes
 How would the economy react to the lowering in corporate taxes?
 What impact on the US fiscal stance and debt?
 Policy uncertainties

14. Geopolitical and Globalization Risks
A retreat from cross-border economic integration
• Anti-globalization: Trump-China, ultra-nationalist European political
parties, anti-immigration, rising protectionism
EU disintegration
• Brexit, Scotland, Catalonia, Greece.
Regional conflicts and wars
• Middle East; Russia; China and neighbors; North Korea
Corruption and internal political distress
• Lava Jato (South-America), Africa, Eastern Europe.
• Political polarization and left-right swings.

15. Further Risks for Emerging Economies
 Technological changes will alter dramatically the production
landscape and even the social contract.

16. Source: PwC Tech Breakthroughs Megatrend, The
Essential Eight Technologies that Matter Now (2016).

17. Further Risks for Emerging Economies
 Technological changes will alter dramatically the production
landscape and even the social contract.
 While slow in coming, artificial intelligence will induce
massive changes in:
 Labor markets.

18. Automation and Labor Markets
Current work-hours that could automated by 2030
(midpoint scenario)
USA China Japan Germany
23% 16% 26% 24%
Mexico India Chile Brazil
13% 9% 10% 14%
Morocco Egypt Kuwait Oman
10% 11% 21% 22%
Source: McKinsey Jobs Lost, Jobs Gained: Workforce
Transitions In A Time Of Automation, 2017.
Are our labor market
regulations ready for
this shock?

19. Further Risks for Emerging Economies
 Technological changes will alter dramatically the production
landscape and even the social contract.
 While slow in coming, artificial intelligence will induce
massive changes in:
 Labor markets.
 Substantial changes in firms’ insourcing and outsourcing
 Substantial changes in localization and globalization.
 Threat and opportunity.
Are our
regulations
(doing business)
ready for this?

20. The “new normal” era for
resource-rich countries

21. Further Risks for Resource-Rich Economies
 Commodity Prices
 Levels and volatility: do they define a “New Normal”?

22. Commodity Prices
(real prices, 2010=100)
The super-
cycle may be
over but prices
are from being
low
Source: World Bank Database

23. Volatility of Commodity Prices
(deviations from long-run trend)
Period Energy Agricultural
Goods
Minerals Precious
Metals
Raw
Materials
Manufac-
tures
1960s 3% 2% 7% 6% 2% 1%
1970s 23% 11% 9% 17% 9% 4%
1980s 15% 8% 16% 17% 7% 5%
1990s 12% 5% 10% 5% 6% 3%
2000s 15% 4% 16% 4% 4% 3%
2010s 14% 4% 7% 9% 6% 4%
High volatility but
no change since
1980s
High volatility but
more stability in
2010s
Volatility not zero
and similar to some
commodity markets
Source: IMF World Economic Outlook, April 2018

24. Further Risks for Resource-Rich Economies
 Commodity Prices
 Levels and volatility: do they define a “New Normal”?
 However, resource-rich countries are particularly sensitive to
technological innovations:
 New renewables energies: solar, wind, electric vehicles
 New competitors with decreasing marginal costs: fracking.
 Will there be a secular decline in commodity pieces?

25. Secular price decline of
non-renewable resources?
 Energy:
 Less global demand
 More global production
 Disruptive technologies
 Non-energy
 Slowly increase in demand
 China and India may have a significant impact
 Disruptive technologies

26. Source: 2017 Energy Outlook (BP)
Only renewable energies will increase in 2035

27. Projections suggest a peak in oil demand
Source: 2017 Energy Outlook (BP)
During the mid-2040s
During the 2030s
Source: IEEJ Outlook 2018 (The
Institute of Energy Economics of
Japan)

28. Why will the oil demand probably decline?
1) Electric revolution by 2035 2) OECD demand by 2035
Source: 2017 Energy Outlook (BP)

29. World Energy Outlook 2017 (IEA)
Evolution of global average costs
for selected technologies

30. Oil participation in energy markets will decline
Source: 2017 Energy Outlook (BP)

31. Energy markets: price projections 2018-2030
0
30
60
90
120
150
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
2025
2030
Coal,Australianprice($/mt)
Coal, Australian (Nominal) Coal, Australian (Real)
0
30
60
90
120
150
1960
1963
1966
1969
1972
1975
1978
1981
1984
1987
1990
1993
1996
1999
2002
2005
2008
2011
2014
2017
2020
2023
2026
2029
Energyindexprice(2010=100)
Energy index (Nominal) Energy index (Real)
0
4
8
12
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
2025
2030
NAturalgas,USprice($/mmbtu)
Natural gas, US (Nominal) Natural gas, US (Real)
0
30
60
90
120
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
2025
2030
Crudeoil,averageprice($/bbl)
Crude oil, average (Nominal) Crude oil, average (Real)
Energy
index
Coal
Natural Gas
Oil
Source: Commodity Markets Outlook, World Bank (2017). Notes: Real (2010 US dollars), Nominal (US dollars).

32. Modern Macroeconomic Regimes
for the “New Normal” Era

33. My New Normal
 My “new normal” is expect faster, continuous, deeper, and far reaching
changes and challenges to be the norm for policy makers.
 Key issue: in what policy environment do you prefer to design and
implement policies to face such changes and challenges?
 Being Chilean (and orthodox) I would prefer an environment with
macroeconomic institutions for sustained growth
 Fiscal responsibility: rules and monitoring
 Monetary responsibility: targets, exchange regimes
 Intertemporal responsibility: SWF, reserves, FDI
 Can LAC’s experience be of use for MENA economies?

34. MENA and Latin America
 Selected 32 economies
 On the basis of data availability
 Drop some desperate cases (Venezuela, Libya)
 Classify countries according to macroeconomic institutions

35. Region Oil/Gas
exporter
Fixed
Exchange
Rate
Inflation
Targeting
Fiscal Rules
MENA (18)
Algeria, Bahrain,
Egypt, Iran, Israel,
Jordan, Kuwait,
Lebanon, Morocco,
Oman, Qatar, Saudi
Arabia, Sudan,
Syria, Tunisia,
Turkey, United Arab
Emirates, Yemen
Algeria, Bahrain,
Egypt, Iran, Kuwait,
Oman, Qatar, Saudi
Arabia, Sudan,
Syria, United Arab
Emirates
Bahrain, Jordan,
Kuwait, Oman,
Qatar, Saudi Arabia,
United Arab
Emirates
Israel, Turkey Iran, Israel
LAC (14)
Argentina, Bolivia,
Brazil, Chile,
Colombia, Costa
Rica, Dominican
Republic, Ecuador,
El Salvador,
Guatemala, Mexico,
Panama, Peru,
Uruguay
Bolivia, Ecuador,
Mexico
Ecuador, Panama,
El Salvador
Brazil, Chile,
Colombia,
Guatemala, Mexico,
Peru
Brazil, Chile,
Colombia, Costa
Rica, Ecuador,
Mexico, Panama,
Peru, Uruguay

36. MENA and Latin America
 Selected 32 economies
 On the basis of data availability
 Drop some desperate cases (Venezuela, Libya)
 Classify countries according to macroeconomic institutions
 Focus on performance after the Global Recession
 Real exchange rates, GDP growth, inflation, etc.
 Fixed vs. Floating Exchange Regimes
 Inflation Targeter vs. the rest
 Fiscal Rulers vs. the rest

37. Real Exchange Rate
by Region
Very similar trajectories
since 2000
MoreAppreciatedCurrency⇨

38. Real Exchange Rate
by Natural Resources
Volatility much
higher (as expected)
MoreAppreciatedCurrency⇨

39. Real Exchange Rate
by Exchange Regime
Less tendency to
appreciation in the
1990s and 2000s
MoreAppreciatedCurrency⇨

40. Real Exchange Rate
by Conduct of Monetary Policy
Beginning of
Inflation Targeting
Brazil
Chile
Colombia
Guatemala
Israel
Mexico
Peru
Turkey
MoreAppreciatedCurrency⇨

41. Annual GDP Growth
(simple average, %)
ITs Higher growth
3.6% vs 2.5%

42. Total Investment
(% of GDP)
ITs with lower sacrifice
22% vs 24%

43. Annual Inflation
(simple average, %)
ITs lower inflation
and more stable

44. Unemployment Rates
(percent)
ITs significantly lower
unemployment

45. Current Account Balance
(% of GDP)
Non ITs worsening
current account

46. Average Primary Fiscal Deficit
(% of GDP)
ITs noticeable
fiscal stability

47. Procyclicality of Gov. Expenditures
(simple average of correlations)
FRs have much
lower procyclicality
Note: Considers only National Rules

48. Macroeconomic Institutions
Inflation
Target
Fiscal
Rule
Fiscal
Council
Floating
Exchange
Regime
Sovereign
Wealth
Funds
Brazil Yes Yes No Yes Yes
Chile Yes Yes Yes Yes Yes
Colombia Yes Yes Yes Yes Yes
Guatemala Yes No No No No
Israel Yes Yes No Yes No
Mexico Yes Yes Yes Yes Yes
Peru Yes Yes Yes Yes Yes
Turkey Yes No No Yes No
No need for having everything in
place to reap the benefits

49. Modern Macroeconomic Framework
 Would aim at reducing and controlling
 Interest and objective conflicts between politicians and citizens
 Discretion management of government policies (esp. fiscal)
 Short-term focus and myopia of authorities
 Political cycles and instability
 Information asymmetry and lack of transparency
 Common components of different institutions
 Clear, simple rules and policies
 Clear mandates for authorities
 Clear escape clauses
 Transparency and information procedures
 Coordinating and anchoring expectations

50. Empirical Evidence
 Inflation reduction and stabilization
 IT: Kamar and Soto (2018), Samarina and de Han (2014), Mishkin and Schmidt-
Hebbel (2007), Pertusson (2005).
 FR: Schmidt-Hebbel and Soto (2017), Elbadawi et al. (2016)
 Economic growth enhancement and sustainability
 IT: Mishkin and Schmidt-Hebbel (2007), Pertusson (2005),
 FR: Schmidt-Hebbel and Soto (2017)
 SWF: Zaki et al. (2018)
 Exchange rate stability
 IT: Mishkin and Schmidt-Hebbel (2007), Pertusson (2009)
 FR: Schmidt-Hebbel and Soto (2017)
 SWF: Zaki et al. (2018)

51. Empirical Evidence
 Reducing procyclicality and enhancing fiscal sustainability
 FR: Schmidt-Hebbel and Soto (2017), Nerlich and Reuter (2015), Dabla-Norris
et al. (2010), Kumar et al. (2009)
 FC: Hagemann (2011), Beetsma et al. (2018) via improving compliance with FR
and budgetary discipline.
 IT: Minea and Tapsoda (2014)

52. Open policy questions for
policy makers in resource-rich
countries

53. Open Questions for Policy Makers
 Institutional design
 Mandate, independence, accountability
 Goals definition, compatibility, prioritization
 Policy instruments
 Institution sequencing (IT⇒FR⇒FC?), simultaneity or reverse causality?
 Policy coordination
 Day-to-day operations.
 Strategic long-horizon planning.
 Optimal institutional arrangements for microprudential and
macroprudential policies.

54. Open Questions for Policy Makers
 This is a very expensive project …
 Political capital
 Financial capital
 Human capital
 … with very costly mistakes …
 LAC’s crises attests to the dire costs of wrong macro-policies
 … but the payoff is extremely high.

55. Appendix

56. Exchange Rate Evolution in Chile
A 40% nominal depreciation
but only a 10% real depreciation
MoreAppreciatedCurrency⇨

57. Labor Mobility in Traded Sectors in Chile
AgricultureandManufacturing
Mining