The international monetary system (IMS) is a topic that encompasses a wide range of issues—reserve currencies, exchange rates, capital flows, and the global financial safety net, to name a few. It is one of the key issues on the G-20’s work agenda for 2011, and a topic that is eliciting lively discussion—for instance the recent, insightful report of the group chaired by Michel Camdessus, called the “Palais-Royal Initiative”.
Some are of the view that the current system works well enough. While not perfect, they point to its resilience during the crisis, citing the role of the U.S. dollar served as a safe haven asset. And now that the global recovery is underway, they see little reason to worry about the IMS. In other words, “if it ain’t broke, don’t fix it”.
I take a less sanguine view. Certainly the world did not end in 2008, but mostly because extraordinary international policy cooperation helped avert a far worse outcome. Moreover, the recovery underway today is not the recovery we wanted. It’s certainly a recovery, but it is uneven. It’s a recovery where unemployment is not really going down and there are widening inequalities within countries.
And global imbalances are back, with issues that worried us before the crisis—large and volatile capital flows, exchange rate pressures, rapidly growing excess reserves—on the front burner once again. Left unresolved, these problems could even sow the seeds of the next crisis.
So, there is good reason to think that reforms to the IMS that help us get to the root of these imbalances could both bolster the recovery and strengthen the system’s ability to prevent future crises.
Let me set out three key questions that are guiding the IMF’s work in this area.
First, how can we strengthen policy cooperation and reduce volatility?
The crisis marked a watershed moment for international policy cooperation—leaders took the actions necessary to overcome domestic and global economic challenges. Now that the worst of the crisis has passed, how can we sustain this cooperation—so that countries adopt policies consistent with less volatile global growth?
The G-20’s Mutual Assessment Process has been an important first step towards creating a more permanent framework for global policy cooperation. IMF surveillance is a critical complement to the MAP—and also lies at the core of our mandate. Through this activity, the IMF seeks to identify the country-level policies that can deliver more stable global growth.
We have also strengthened Fund surveillance—for example, the early warning and vulnerability exercises. We are now increasing our focus on the impact of countries’ policies across their borders, particularly for the five most systemic economies—for which we have new dedicated “spillover reports” in preparation.
At the same time, we are delving deeper into macro-financial linkages. For the world’s 25 most systemic financial systems, Financial Sector Assessment Programs (FSAPs) are becoming mandatory. This tool will facilitate our efforts to catch dangerous build-ups of systemic risk in the financial sector—which is precisely what preceded the recent crisis. Beyond this, we should explore whether even more ambitious changes to our surveillance are needed—and we are conducting a major review to that effect.
My second question is: how best to cope with capital flow and exchange rate volatility?
Over the past decade, we have witnessed a dramatic increase in the size and volatility of capital flows. Broadly speaking, such flows are beneficial to the receiving economies. But they can also complicate macroeconomic management and threaten financial stability.
So, what are the tools? They are many, including macroeconomic adjustment, reserve accumulation, prudential measures and—when all this is put in place and still a country experiences some disruptive inflows—capital controls. Naturally, countries’ responses are driven primarily by domestic considerations. But their actions can have consequences for the rest of the world.
Given these spillovers, should we have globally agreed “rules of the road” for managing capital flows? Our members have asked us to look into this question, and we expect to present some concrete ideas in the near future.
A related issue is the volatility of exchange rates. The major currencies have fluctuated widely vis-à-vis each other and have not moved consistently in a direction promoting an orderly adjustment of imbalances. Large and persistent deviations of exchange rates from fundamentals can result in significant systemic distortions, which can be particularly problematic for small open economies. Addressing this issue requires setting economic and financial policies that promote global balance and reduce the volatility of capital flows, as I have just discussed.
My third and final question: how can we enhance liquidity provision in times of extreme volatility?
Since the crisis, we have come a long way in strengthening the global financial safety net. The Fund’s resource base has been increased significantly, and our financing toolkit has been made more flexible, in particular by adding the Flexible Credit Line and the Precautionary Credit Line.
But many countries remain to be convinced that the global financial safety net is strong enough to deal with the next crisis—and so the costly accumulation of reserves continues well in excess of precautionary needs. What else can be done?
One important avenue is to strengthen partnerships with regional financing arrangements. Another is how to improve the predictability of systemic liquidity provision more generally—as opposed to leaving this task to national central banks. A complementary question is how best to gauge the adequacy of precautionary reserves, and which benchmarks to use.
Over time, there may also be a role for the SDR to contribute to a more stable IMS. A paper the IMF is releasing today presents a range of ideas on this topic. But, increasing the role of the SDR would clearly require a major leap in international policy coordination. For this reason, the global reserve asset system will evolve only gradually, along with changes in the global economy, and at a pace that is not disruptive.
Let me wrap up. Reform of the IMS is wide-ranging and complex. Global debate is only just starting. But we must all recognize that this is not something academic or abstract. We need concrete ideas. This is linked to achieving the kind of well-balanced and sustainable recovery that the world needs—and it is linked to preventing the next crisis.