European Central Bank in Frankfurt, Germany. Euro area is one of five most systemic economies covered by IMF spillover reports (photo: BAO/Newscom)
INTERNATIONAL MONETARY SYSTEM
In the wake of the global economic crisis, a number of leading economists, policymakers, and several groups have offered diverse perspectives on problems in the international monetary system (IMS) and how to reinforce it.
The IMS refers to the set of internationally agreed rules, conventions, and supporting institutions that facilitate international trade and cross-border investment, and the flow of capital among countries.
A new IMF staff paper, “Strengthening the International Monetary System—Taking Stock and Looking Ahead,” aims to inform those interested in the debate and forge a common understanding of the reform agenda.
The paper says that the system, which has survived for over 40 years, has underpinned strong growth in GDP and in the international exchange of goods and capital, one of its core objectives. “As a result, interdependence among the world’s economies has grown dramatically, making the existence of a sound system ever more important.”
Many symptoms of instability
But IMF economists say that, at the same time, the system has exhibited many symptoms of instability—frequent crises, persistent current account imbalances and exchange rate misalignments, volatile capital flows and currencies, and unprecedentedly large reserve accumulation.
“These symptoms have come to a head since the 2008 crisis and brought renewed international momentum to the idea of attempting to reform the IMS. Yet the debate so far suggests little consensus on the underlying problems, let alone on the solutions,” the paper says.
Going beyond the symptoms, the paper identifies four root causes for instability in the current system:
• inadequate global adjustment mechanisms to prevent or resolve inconsistent policies among systemic countries; this reflects in part the fact that the current system leaves to each country the choice of its exchange rate and capital account regimes, but also limits obligations on domestic policies to aiming for domestic stability.
• lack of a global oversight framework for growing cross-border capital flows and linkages, covering both source and recipient countries;
• inadequate systemic liquidity provision mechanisms to ensure continued access to much needed international liquidity in ties of systemic crises; and
• structural challenges in the supply of safe assets, reflecting in part the transition under way whereby emerging market economies are becoming systemic and accounting for a fast growing share of global output.
The paper identifies four broad ways to strengthen the system—strengthened policy collaboration; global monitoring and management of capital flows; more reliable global financial safety net; and structural strengthening of the system through financial deepening and diversification in the supply of reserve assets.
Strengthened policy collaboration
During the global economic crisis, countries embarked on a coordinated global stimulus to escape the threat of a worldwide great depression. Now, two processes are under way to sustain this type of global policy collaboration:
• Under the auspices of the Group of Twenty (G-20), the Mutual Assessment Process involves extensive information sharing among major economies, with analysis from the IMF about the combined effect on the global economy, including efforts for adjusting to imbalances.
• Separately, the IMF has launched “spillover reports” for the five most systemic economies—China, the Euro area, Japan, the United Kingdom and the United States—to assess the impact of policies by one country or area on the rest of the world.
Going forward, a key objective is to find ways to help countries take more into consideration the effect of their policies on others. This effort could be underpinned by changes in the legal framework of surveillance. Outside the IMF, some have also called for changes aiming at strengthening accountability and incentives for global stability–consistent policies.
Monitoring and management of global capital flows
The IMF is developing a framework to help contain instability from large global capital flows; a first element focusing on dealing with large inflows was recently considered by the Executive Board. Further work will focus on the multilateral aspects of macroprudential policies and capital flow management measures, capital account liberalization, and dealing with capital outflows.
The paper also identifies a need to strengthen global collaboration among financial supervisors, a goal that could be facilitated by the Fund, in cooperation with others such as the Financial Stability Board.
Eventually, given the direct links between global financial flows and the functioning of the international monetary system, explicitly incorporating oversight over global financial stability into the IMF’s legal framework might be worth considering.
Creation of a global financial safety net
Realization of the magnitude of the global shock created by the financial crisis led to a major revamp of the IMF’s lending tools (including introduction of a Flexible Credit Line; and a Precautionary Credit Line). Support for a tripling in resources of the IMF at the G-20 Leaders’ Summit in London in April 2009 also contributed to restoring global market confidence, while agreement on a doubling of the Fund’s quota resources further strengthened its ability to act as a global safety net.
To reinforce this safety net, the analysts suggest examining the creation of a global swap network, whereby the Fund would work with relevant governments, central banks, and regional pools to facilitate provision of large-scale liquidity during a crisis and act as lender of last resort. Strengthening collaboration with regional financial arrangements and exploring the possibility of the IMF borrowing from markets to expand its resources in times of crisis would be other avenues worth considering, the paper argues.
In taking these various steps to enhance the global safety net, the problem of inadvertently encouraging risk taking (moral hazard), thereby increasing the probability of crises, should be considered, IMF economists say.
Financial deepening and currency internationalization
The IMF is trying to assess how the deepening of financial markets can help strengthen the international monetary system. It is also looking at how the IMF’s quasi-currency, its Special Drawing Rights (SDR) could play a more useful role, along with expanding the number of currencies that can be readily used in international trade and finance.
Augmenting the supply and diversity of globally traded assets could improve capital allocation and risk sharing, contributing to reducing global imbalances and enhancing the system’s resilience to shocks.
In sum
“While the system effectively rests on a presumption that if every country keeps its own house in order, the system will be conducive to stable growth, the reality is different,” the paper says.
All four reform avenues would contribute both to prevent crises and to contain the costs of residual ones. The paper says a system reformed along these lines might lessen policy discretion for individual countries, but should yield a more stable system.
