Rubenstein Lecture | Gita Gopinath, Harvard Economics Professor, former IMF

I grew up in India.

Absolutely not.

I, when I was, this was back in India in 1989, and I was figuring out what to do with my life. And at that time, no Indian kid says they want to be an economist. I mean, that was like a failure, right? You wanted to be an engineer or a doctor was what was the standard path to go. My parents thought it would be a good idea for me to try something else, which is to join the Indian Administrative Service, which is the leading civil service in India. And therefore, economics would be a good subject for it. So I was basically pushed into it. And then I stuck with it because 1990 and 91 was when India had the so-called external account crisis, a sort of balance of payments crisis. And that's how I got into economics.

It was actually a common thing to do. So it was not out of the ordinary. And I wanted to get a Ph.D. and it was considered like that was a good way to get a Ph.D. in economics. And so that was nothing surprising.

There were a couple of people you may never have heard of. One is Ben Bernanke and the other, Ken Rogoff.

Yeah, they were phenomenally smart.

Great. So the IMF is one of the institutions that got created after, actually just before the end of the Second World War, with the idea that we need to find a way to avoid countries going into wars with each other. And maybe that can happen if we work together, have more economic interactions, and find a way to resolve the differences. And so the more interconnected we are in economics and finance, the more stability we have in the world. You know, we may have fewer such crises. So there are three things that the IMF does. The first, which it's most famous for, is it's a lending institution. So it lends only to governments. So it doesn't lend to the private sector. It lends only to governments. And these are to countries that are in a crisis. So countries that are running out of dollar reserves, foreign exchange reserves, they can't pay for their imports, or they borrowed in dollars and they can't repay it and nobody's willing to roll it over. That's when the IMF comes in. It's the lender of last resort. It helps the country with the funding, also helps put the country on the path to a better place in terms of macro policies, so that you don't have a repeat crisis. At least that's the hope. So that's the one that the Fund is famous for. But it does two other things which are really very important. One is surveillance, which means basically the IMF, it has 191 member countries. The IMF goes to each of these countries, and every year provides a report card on your macro management of your economy, your fiscal policy, your monetary policy, your financial reforms. What are you doing? And this is quite unique because this is the only institution that every country who's a member of has agreed to. This is a part of their obligations to the IMF, is that they subject themselves to this, you know, article that's called the Article IV. So that's very important, which is why the IMF, I think, has a unique vantage point in terms of what's happening in the global economy. And then the last is what's called capacity development, which is helping countries, for example, countries in sub-Saharan Africa, on how to just build institutions to have a good macro environment. Right. So, for example, if you're setting up a central bank, how do you set up a central bank? What exactly does a central bank do if you want to target interest rates? How do you actually do that? What do you wake up and do the first thing? So those are the things that the IMF does.

Well, yes, absolutely. It has an Article IV. It just came out.

Has been saying that for several years now.

So the thing with the US is, it's not just where the US is right now in terms of the debt levels, which is if you take the general government, that's 120% of GDP, but is expected by 2031 to hit 140% of GDP. And if you keep looking ahead, the US economy is going to be running deficits and you're looking at debt continuously growing. So while there is no crisis at this current moment in the sense of if you look at markets and the rates at which they're lending to the US, you know, there's a lot of appetite still for US debt. And we can talk about where that comes from. But yes, at this, the way the trajectory of this looks unsustainable. And that's a point that has been repeatedly made. The question is how are you going to fix it? It's going to take actions on both sides, both on revenues and on entitlements.

I can answer that question better now after having done my job at the IMF, which is it is hugely consequential to large, you know, millions, billions of people on the planet, whether you do good economic policy or not. You know, it's just when I, when you track countries, starting at 191 countries, the countries that work, they work because they do the simple first principles. They get the first principles of economics right. And therefore it is hugely consequential. When countries fail, they fail because they get some of these big questions about how to manage inflation, how to manage your debt wrong. In addition to obviously the other structural aspects, which is on making sure you have good education and health care, it is remarkably consequential. And I think that's why.

I think I've been doing something very useful. But yeah, I have, I mean, absolutely all of these different lines of work that you can get into in terms of the financial sector. Phenomenal. Get into it. There isn't, where you need all of these different institutions. One of the things that, you know, developing countries still have a deficit in is well-developed financial markets. And so I have full respect, and I think that that's a great line of inquiry to go into. So I have no problem with it. I personally do love research too, which is why I'm back at Harvard.

We did have the pandemic in 2020 when the US economy shrank, but that was the pandemic. And you're right, the business cycles in the US and then pretty much other parts of the world tend to be once in eight years. Can you say that there's going to be a recession happening? Nothing that's happening right now points to that. There could be a recession in the near horizon. Consumption is strong. US households are in good shape as a whole in terms of consumption spending, in terms of their balance sheets. Banks have fairly strong balance sheets, but there are a bunch of areas where things can go wrong and their risk is building up. So some of them are, one, I would say in terms of AI is a big driver of the US economy right now, both in terms of the scale of investment that's happening, but also the appreciation in the stock market that you had over the last couple of years. That's helping raise wealth and consumption through that. That's a space where you could see a correction. You know, one of my, the question I ask myself every time when I look at these companies is what is going to generate, what is going to give them the kinds of profits they will need to justify the very large scale of trillions of dollars of investment being made in AI. This is not a statement about the technology itself. I actually think it's profoundly transformational. I think it's going to have a very discrete effect on productivity. I personally use it. I think it's really great, but I think there's a lot of competition and you could see another company, another DeepSeek-like event that, you know, for a fraction of the cost is able to provide the exact same product, in which case the incumbents right now may be highly overvalued.

I think we are in a world where we are suddenly being exposed to a lot more shocks that look like supply-side shocks. So it's not that demand is too weak or too strong, but supply is too weak or too strong. And we saw that, you know, the pandemic was a big supply shock. When Russia invaded Ukraine and you saw oil prices and gas prices shoot up, that was a big supply shock. We're seeing in Iran, Hormuz, that's another supply shock. The world fragmenting is also another supply shock. So I think we're going to be in this world where we will see more volatility in inflation. I don't think that translates necessarily into the on-average inflation rate drifting up decisively. I suspect the Fed at this point is okay with inflation as long as it starts with the two, a number two at the start, you know, but maybe 2.8, maybe 2.9, but maybe it's okay with that as opposed to a three number. So I don't think there's a reason to expect that they will drift to 4 or 5% on-average inflation. But we could easily have months. And I think the month inflation for March will pop at right over 3%, 4%.

So by the way, this is classic because every politician in the world wants to lower interest rates. I don't know a single politician who doesn't want lower interest rates. And there are many occurrences where you will have politicians say that publicly that they would like lower interest rates. All of that is talk. I think it's a huge problem when you are using the machinery of the state to put more pressure on the central bank. Now, again, nobody's saying that the central bank is completely unaccountable. I mean, that's not the way central bank independence is defined. Central bank independence is you are accountable, which is why the head of the central bank goes to Congress, explains what's happening. They get the mandate from Congress in terms of what the goals are, which is inflation stability and price stability, and full employment. It's the operational side, which is how do you accomplish those targets, that is where the central bank is supposed to have independence, and that's critical. And we've seen, and I think this is where the IMF can really speak to, because when you see countries going off the rails, it is because you have these attacks on central bank independence.

If the Fed could credibly communicate that 3% is where we're going to stay at and this is it, then that works. But the problem with anything of this kind is that once you're at three, then the sense is, well, maybe we'll go to four. And the expectations shift in terms of where inflation may settle. So I think that the Fed will not say that this is, we're okay with 2.8 or 2.9%. They will not publicly say that they are okay with it. They may allow for periods of that level of inflation, but they will want to come back to 2%. It's just, you know, you use the fear of drifting away as a problem.

It's always been the case that there has been a dominant currency. At least, you know, the last 200 years you've had the British pound that was the dominant currency. And then the dollar took over decisively after the Second World War. There are good reasons to have a few currencies, not to have, you know, there are about 180 currencies in the world. You don't want all of them being used all the time in international transactions because there are network effects. It helps to have all of us using. It's like sometimes speaking a common language is helpful. Having a common currency for a lot of international transactions is also helpful. What are the problems with it? Of course, the problems come if you do end up, if there is any kind of weaponizing of the currency, if you have sanctions that are being imposed and, you know, taking into account the fact that you have this monopoly power of your currency in the world market, those are the times when it is particularly worrisome. To your question of what about the dollar? I mean, what's likely to be the case? It remains the case that the dollar is the dominant currency. So if I were to, I think in terms of a few facts for you to keep in mind, the dollar is about 60% of trade transactions, 60% of foreign exchange reserves, 60% of international bank claims. The US economy is about 20, 24% of the world economy. So it's about, you know, it's significantly, its share in all of these international transactions is very high. It's been around there for about the last ten years and moves around a lot. Where have we seen any kind of meaningful changes? One, I think people should know that when it comes to China, about 15 years ago, China, the renminbi in its use in China's transactions with the world was at 0%. So zero, China was doing entirely most 80%, 20% other currencies, 0% renminbi. That was 15 years ago. Right now, 50% of China's transactions with the rest of the world is in renminbi. So China has internationalized in terms of their own transactions. Russia has clearly moved away from the dollar, but these are all on the fringe. And the other currency that's gained a lot of attention is gold. Gold has gotten more attractive. And central banks are also acquiring more gold reserves. But these are, many of the changes otherwise are at the margin. And, you know, and we saw this also during the Iran conflict is everybody moved to the dollar. There was a safe haven effect.

Right. So two things. One, I think it's a very flawed argument which has persisted for a long time. And several people in this administration have pushed this view that the dollar, being the reserve currency of the world, is what makes it end up running these deficits, because it's just a strong currency. And the dollar strength is a big factor behind. That's simply not the case. If you just look at the data and you look at what are the main drivers of deficits, trade deficits in the US, it's not coming from the exchange rate. The reason I'm making that point also is because if you think of which are the big episodes of global imbalances of trade, big trade deficits in the world, one was in the 1980s. Then there was the late 2000s, which was before the Great Financial Crisis. And now. So I think those are the three major episodes. Before the 1980s, before you went for the Plaza Accord and so on, the dollar was appreciating. Before the Great Financial Crisis, the dollar was depreciating. And now it did depreciate for a bit, but it's gone sideways. So that logic is incorrect. Your question of whether the dollar could weaken, just like business cycles, it also has these cycles, and it's had about a 15-year period of fairly continuous appreciation. Usually when such a cycle happens, you have another period of about several years when the dollar can depreciate. So there are reasons why you could expect the dollar to depreciate. But I think it has nothing to do with, you know, what the administration says should be the direction of the dollar.

Trade deficits matter to the extent that it tells you about the problems that may be underlying it. The trade deficit, just mechanically as an identity, is tied to the fiscal deficit and the household saving investment deficit. Right. And so I worry about the US trade deficit because I think it's a reflection of unsustainable fiscal deficits in the US. That is a problem. It is also a reflection of China having an unbalanced growth strategy, which is reliant mainly on exports and investments and not enough on domestic consumption. And so trade deficits are a problem because they represent unbalanced growth strategies: the US having excessive fiscal deficits, China having too weak domestic consumption. This is not sustainable. And therefore that's a sense in which it's a problem. But tariffs are not a solution. They just don't work.

But so obviously this varies by country. It depends upon what are the structural features you have in your country. And there are countries, for example, where it is very hard to, you know, labor markets are not very flexible. If you hire a worker, it's hard to fire the worker. Those economies tend to have higher unemployment rates. There's, you know, people are afraid to hire people because they think they're not going to be able to lay them off if something goes wrong, and the other way. So there's structural aspects. So every country's structural level of unemployment is different. In Europe it's higher. It's around five, six, 7%. In the US the structural unemployment rate is more like closer to four, 3 to 4%. That's where we are now. Can you go to 2%? Well, there's a trade-off because if you go to 2%, the sense is then you are having to live with high levels of inflation. And there was a time before the pandemic when everybody had the sense that somehow we could run the economy hot. In fact, the Fed talked about that. They talked about running the economy hot because it seemed like you could reduce unemployment and still not worry about the effect on inflation. The inflation wasn't showing up. But I think what we've seen in the last few years is that that's, you know, not really the ideal model of the world. And unemployment rates, if you're trying to push unemployment rates down to 2%, then you're going to have to accept higher inflation.

Well, firstly, I think what was very important about that book was to basically say, you know, what is the wealth of nations, right? So this was an issue. He was writing at a time of mercantilism, and everybody was trying to run surpluses because that was a way of accumulating gold. And the idea was you were a rich country if you had more gold. And what Adam Smith said was that, no, no, the metric of whether a country is rich or not is not whether it has gold, but it's about how productive its population is. And he took it back to the point of what are, you know, what do the typical average person who lives in the country, what work do they do? How productive are they? How much do you get paid for it? That was the relevant metric of the wealth of a nation, not the amount of gold that's being accumulated.

What Keynes basically pointed out was that it wasn't a good assumption to assume that the economy was self-equilibrating. Right. So prior to that, there was a sense in which if demand exceeds supply, prices will rise, supply will increase. We're all in a good place. And the other way around, if demand crashes, prices will fall, supply will adjust down. And therefore we're all in a good place. But he says you can go through periods where you don't have this equilibrium mechanism working. You have all kinds of rigidities in the world. And he focused on wage rigidities and price rigidities. That was one. So to basically explain how you can end up with the Great Depression because, you know, our models would otherwise have told us that that's an odd thing that should not happen. So how can you have systematically long periods of unemployment and therefore a very important role for demand management in the world, which is you do need, you do have a role for the government to be able to, you know, spend and therefore raise demand because that will be necessary. The other thing which I think really resonates through time is he spent a lot of time thinking about sentiment and about euphoria and so on. Right. Which is how people feel about the world economy or of their economies matters as much as some of the details of what paychecks they get. That, I think, is playing out very strongly in these days. What's the effect of uncertainty? What effect of sentiment? I mean, those are the kinds of things he brought to the table.

I think Milton Friedman is, what happens through a lot of these cycles of economic thought is sometimes then what happens is you got to go to the extreme on each side. And Milton Friedman's point was firstly, him and a few other people, was to basically recognize that, you know, if you're in a world where all you're trying to do is demand-side management, you could end up with people expecting more and more of this kind of demand-side management, and you just end up with then higher inflation. So there is a relevant trade-off that you have. And of course, he was famous for making the point that inflation is everywhere and always a monetary phenomenon. On that, I can tell you that that's not correct. Having worked with many countries in the world.

Yeah, I've heard that one. When push comes to shove, you have to make a decision. And that's what we did. Oh, you know, when I was at the IMF and we were helping a country in the middle of a crisis, we were not telling them, on the one hand, you can do this, on the other hand, you can do that. We were telling them, here is what we think will help stabilize the economy. But I think it's an honest recognition of the fact that it's a social science. Economics is a social science. So there's no, you know, clear, absolute, clear prediction of what, if you take this action, you will have that outcome.

Okay. So it's, first of all, yeah, you're right. AI is now in every conversation, even about conversations about how to manage the unsustainable debt level. Right. So let me walk through it. It is a transformational technology, which means that if it works out, we could end up with discretely higher growth rates instead of the US economy, which on average tends to grow around 2%. You could end up with, even if it went up to 3%, that would be fantastic on a steady-state basis, right, for many, many years. There's this, there are estimates that say that it could go even higher. We could be talking about 4% growth anyway. So that's the pluses. A sense is that that could generate a lot of productivity improvements and therefore higher growth. Why is that helpful? Besides the fact that growth has many virtues, but also that's one way to repay the debt where, you know, we don't have to tax anybody more because we're just going to grow faster. And through that we're going to be able to repay the debt.

Second is always questions on the job market. Oh, to the first one, if you ask me what is the effect right now of AI on the economy, I would say that the main channels it is affecting the economy, but it's mainly through the investment channel, which is through all of the data center build up and through the effect on the stock markets and through the wealth creation. Right. There are some anecdotes of how it's affecting productivity, but at least right now, based on the data we have, you just really can't look at it and say, well, AI is leading to productivity even though productivity is stronger. But there are many other aspects, as obviously on the job front, what could happen with it? But there's also now, you know, national security concerns, you know, people using it for, you know, for nefarious reasons. Many areas can go into those.