Speech

As prepared for delivery

Thanks. Let me start by thanking each of you for coming to today’s conference on the International Monetary System, for presenting a range of useful and at times provocative ideas, and debating a very timely topic. The events of recent days have reinforced the need for a robust global monetary and financial system, and though such immediate concerns are at the forefront of our attention, it is good that we are able to set aside time to discuss these broader issues. Let me also extend a very special thanks to Philippe Hildebrand and the Swiss National Bank for graciously hosting us.

Crisis is an opportunity. Many of you have spoken of the need to strengthen the system and increase its resilience to recurrent crises—and current events only add intensity to this sentiment. This crisis, and the still on-going aftershocks, is an opportunity to put in place reforms that will durably achieve this. In these concluding remarks, I shall outline some of the key lessons that I am taking from our deliberations, bearing in mind the need for pragmatism. Of course, pragmatism about what can be done in the near-term should not constrain us from thinking about even better systems, which we should continue debating.

What are the Key Issues?

Imperfections. We have heard a wide range of views, but by and large they seem to focus on a few key “imperfections” of the system that need to be plugged, if the system is to become more resilient:

• Volatile capital flows. Considerable volatility in capital flows—episodes of large flows and “sudden stops”—create significant problems for economic management.
• Adjustment. There is no automatic or smooth adjustment mechanism to current account imbalances, which have prevailed for long periods of time. When adjustment occurs, it is asymmetric, falling more heavily on deficit, non reserve issuing countries, rather than on surplus countries or reserve issuing deficit countries.

Reserve accumulation. These imperfections have been reflected in the rapid buildup of foreign exchange reserves across countries—a three-fold increase globally in reserves over the past 10 years and, for many EMs, reserve coverage far in excess of traditional norms, reaching nearly 5 times short-term external debt in 2008. This itself can be a problem because accumulating reserves is costly—consumption and investment are foregone as a part of national savings are invested in safe, low-yielding international assets. Systemically, to the extent that the counterpart of reserve accumulation is that many countries pursue current account surpluses, an aggregate deflationary impact may emerge to the extent that the rest of the world is no longer willing to incur current account deficits.

Possible Reforms

Addressing the imperfections of the international monetary system requires finding durable solutions to the problems that drive reserve accumulation, and to the narrow supply of reserve assets.

On the demand side, reserve accumulation for structural reasons is generally seen as advisable. So, reforms should focus on precautionary and export-led motives. Feasible reforms could include:

• Reserve adequacy: the IMF could give guidance on desirable ranges of precautionary reserve levels taking into account country circumstances. Since some countries may feel compelled to acquire sufficient reserves not only to meet their needs but also to compare favorably with others, such guidance could help overcome this desire to keep up with others if countries could agree to align their reserve accumulation policies to these guidelines over time.
• Better surveillance of capital flows: filling information gaps in cross-border flows and exposures, which would enhance understanding of volatile capital flows and of the measures to address them, possibly in a multilateral context.
• Improved financial safety net: the IMF could provide better insurance facilities (e.g. improvements to the FCL, a Precautionary Credit Line); support regional financial arrangements; and develop a Multi-Country Swap/Credit Line instrument for systemic crises that liquidity quickly and simultaneously to several countries with strong underlying fundamentals and policies.
• Multilateral framework: to address non-precautionary reserves demand, one approach would be a multilateral framework among countries to implement needed policy adjustments for the effective operation of the system. The G-20 MAP is a step in this direction. As part of the understandings on policy adjustments, steps could also be taken to diversify the global reserve system, such as a more systemic role for the SDR. Another idea floated is a system of penalties, such as a reserve requirement on “excess” reserves or a tax on persistent current account imbalances beyond a certain threshold, but penalties have a particularly poor history of implementation.

On the supply side, a more diversified allocation would reduce the system’s (and individual countries’) exposure to risks stemming from any single country. Achieving the needed diversification would require coordination over the long term to gradually increase the supply of reserve assets.

Many expect a gradual move to a more multi-polar reserve system over time.

• on the near term, there are no clear contenders to match the depth and liquidity of the U.S. dollar markets. More widespread use of alternative reserve assets, e.g. euro or yen or renminbi denominated, could be encouraged, as could enhancing EM assets—e.g., through pooling arrangements, or a repo window. A more multi-polar system may not enjoy the network effects of broad use of a single (sound) money, but the presence of alternatives provides a safety valve from unsound policies of any single reserve issuer. Greater exchange rate volatility could result, however, with potentially deleterious effects on resource allocation.
• To encourage an orderly transition to a more diversified system, reserve holders may need to adjust portfolios only gradually, with mechanisms for collaboration (e.g. reporting on currency composition) to bolster the stability of the adjustment process.

Another option could be to seek a more prominent role for the IMF’s Special Drawing Right (SDR). With a value determined in terms of a basket, the SDR diversifies the currency and interest rate risks of its constituent parts. Thus, it has more stable store of value and unit of account attributes. Moving to a more SDR-based system would require: (i) increased supply, (ii) greater liquidity, and (iii) transparent, automatic rules for determination of the currency composition of the SDR basket, which are essential for wider private sector use. In addition, issuance by governments of SDR-denominated bonds or activation of a substitution account could promote theuse of the SDR basket.

Finally, in principle, a new global currency issued by a global central bank, with robust governance and institutional features, could provide a nominal anchor and risk-free asset for the system independent of national currencies. This global central bank could also serve as a lender of last resort. But any such step requires considerably more debate on its merits, including on the need for a safety valve for the system given errors that might inevitably occur, as well as of its feasibility, given the very substantial multilateral effort required. I fear we are still very far from that level of global collaboration.

Let me conclude.

Benefits and costs. The current IMS has many benefits. Discretion in the choice of exchange rates, reserves policies, and policies on capital flows has given countries important instruments to help achieve domestic policy objectives, while underpinning a large expansion in global trade and global output. But it has its imperfections, such as the absence of automatic adjustment to imbalances and uneven provision of liquidity caused by volatile capital flows. These imperfections have been reflected in rapid reserve accumulation in recent years, concentrated on a narrow supply of assets.

Strengthening the system. A number of steps can be taken to strengthen the IMS, including better surveillance of capital flows and analysis of spillovers, an improved global financial safety net, and an enhanced role for the SDR. These steps can be implemented more readily than others, as we seek to mitigate the risks and effects of crises. Of course, governance reform of the IMF remains a critical ingredient for the IMF to play an effective role here, as in other areas. While these steps are being taken, the debate needs to continue on the merits and feasibility of much more ambitious options such as a multilateral framework for capital flows and a sustained move to an SDR-based system, which would require considerable coordination.

Thank you very much.