Olivier Blanchard, Chief Economist of the International Monatery Fund, thinks the current geopolitical risks are not systemic risks to the global economy.

Mr Blanchard, the recent update of the World Economic Outlook (WEO) paints a fairly optimistic global economic scenario of this year as well as 2015. How do you assess the downside risks, which are the greatest?
Starting with the geopolitical risks, we believe that at this time in terms of their immediacy, they are just that, geopolitical and not systemic global economic risks. In the affected regions however, the situation is different. The economic consequences for Ukraine are obvious, and as far as Russia is concerned, we have already revised our growth projections downward and may have to do so again. Investment has more or less stopped. There are large capital outflows. Sanctions will have a further effect. As to the conflict in the Middle East the key question, for the moment, is how this will impact the price of oil. As things stand now, we believe that supply disruptions can be offset by an increase in production in Saudi Arabia. This belief is also reflected in the futures markets, which do not appear to be overly concerned. What we cannot rule out, of course, is that a further deterioration in either region will at some point also begin to have an economic effect in other countries. And the effects of large increases in oil prices can be very substantial indeed.

And the remaining risks addressed in the WEO, such as uneven growth in the industrial nations?
As far as the Euro area is concerned, growth in some countries, for example in France, is disappointing, whereas Germany has turned out to surprise pleasantly. In the US however, the situation is more balanced. At this point, I would even say that the probability of growth exceeding our current forecast is higher that the chance of it falling short of current predictions. Factors, that have thus far hampered growth, have effectively largely disappeared. The drag from fiscal consolidation is very limited, and both the labors as well as the housing markets have rebounded strongly.

How about the potential drag resulting from the withdrawal of monetary stimulus and the expectation of an interest rate hike in the US?
On the road to normalization of monetary policy there will undoubtedly be some bumps. We do not, however, think that these bumps will derail the recovery. There is always the chance of some re-pricing as a reaction to the effects of the withdrawal of monetary accommodation. But we believe that the financial system can absorb these changes in prices without triggering a financial crisis.

Numerous US economists, on the other hand, have warned about what they perceive to be a new bubble emerging in the housing market, primarily as a result of the historically low rates. Do you agree with this assessment?
At this stage, we are not worried. Looking around the world, we see a few places where prices seem high, for example in London. But we do not see generalized bubbles. Focusing on the US, we do not feel that prices are out of line. Naturally prices have gone up since the trough, but if you take the S&P/Case-Shiller Index as a benchmark, it reached 180 at the height of the housing boom, today it stands at 150. In fact, I’m more worried about certain restraints in the housing market, such as high credit requirements imposed by banks, which eliminate some potential buyers. The recovery in housing is undoubtedly proceeding, but it could be even faster.

In the context of the Fed, what does Chair Yellen mean by keeping interest rates at their current level «for a substantial period of time» after  having completed the withdrawal of monetary stimulus: When exactly do you think rates in the US will go up?
We agree with the expected timing of US monetary policy and expect rates to begin rising by the middle of next year. When it will be exactly will depend on events, and is not, from a macroeconomic viewpoint, a major issue. The markets should be prepared for a hike during any one of those months. What concerns me is that some investors are taking positions the success of which depends on the precise timing, the exact month.

What do you make of the qualitative aspects of the labor market recovery? Yellen has introduced into monetary policy, such as long term unemployment and the labor market participation rate.
The Fed has a dual mandate, achieving price stability and full employment. What full employment means exactly is difficult to assess. The participation rate, for example, has done some strange things both during the recession and the recovery, so it does need to be looked at. Chair Yellen does have to look at all of these aspects so as to be able to carefully calibrate when the economy may be under- or overheating. She is doing the right thing.

IMF Managing Director Christine Lagarde coined the term of «low-flation» and the risks associated with that, especially in Europe. Is that a politically correct way of avoiding discussion of a deflationary risk?
No. For the moment, the reality, and our baseline forecast is indeed for low inflation, not deflation. Deflation is however a risk. We continue to assign a probability of about 25 percent to seeing deflation by the end of 2015. Debt, public and private, is high in most Euro area members. And deflation, which further increases the weight of this debt, could derail the Euro recovery.

In the WEO, the Fund suggests that the introduction of the minimum wage in Germany be supplemented by additional measures that ensure a higher labor market participation rate and more equal income distribution. What exactly would you like to see?
If you rely only on the minimum wage to decrease wage inequality, at some stage, you inevitably start seeing negative employment effects as a result. In advanced countries such as Germany, the right policy is a combination of the minimum wage and a negative income tax. As to the right level of the minimum wage, the empirical evidence suggests that a minimum wage around 60 percent of the average wage has limited adverse employment effects. Once you enter the 70 to 80 percent range, that’s where it becomes problematic.

The IMF has admitted that the fiscal multipliers were and are still larger than had thus far been assumed, meaning that the impact consolidation has on growth is greater than was previously believed. What does this mean for the design of IMF programs?
Yes, we did realize around 2010-11 that the economic impact of fiscal consolidation was greater than we had assumed based on past experience. But adjusting our understanding of the economy is what we have to do all the time. The world economy is a very complex machine, and one which evolves through time. As information comes in, we learn and we adjust. To use a quote attributed to Keynes: «When the facts change, I change my mind. What do you do Sir?»

Only a few years ago it would have been unthinkable that we speak of slowing growth in the Emerging Market Countries (EMCs) and growth picking up steam in the industrial countries. Has the convergence process stopped?
No. Growth for example in the US and Germany is still far behind the growth rates in the EMCs. In the years prior to the crisis the EMCs had extremely high economic growth. Growth has now tapered off somewhat, but the EMCs are still considerably growing faster than even the healthiest industrial countries. Convergence continues.

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