During the years that followed the euro’s introduction, financial integration proceeded rapidly and markets and governments hailed it as a sign of success. The financial symptoms of the crisis in Europe are thankfully receding with a new sense of optimism in markets. But the underlying problems—lack of convergence of productivity and the structural flaws in the architecture of the monetary union—have only been partially addressed.
Simulations show that despite increasing financial integration, output costs associated with global financial shocks in Latin America have declined in the past 15 years. Of course, the progress made so far does not make the region immune, but has helped it to ride more safely through the recent global financial waves. As we’ve pointed out previously, the region should take precautions in case of a bigger global downturn. But so far it can take credit for its hard work on the policy front.
With economic growth expected to continue at a reasonably good clip this year and next, it’s all too easy to think there’s not much to worry about. Even as Diwali celebrations begin across India, the outlook for the world economy is fairly uneven and uncertain. More worrisome than the subdued global growth outlook, risks are building up especially in Europe—and these include an extreme scenario with financial disruption. Although India’s economy has generally been less prone to external forces than many others, we still need to contend with the larger than typical risks in the global economy. These risks harken the need for a new wave of reforms. What does the more somber darker global outlook mean for India? And exactly what policies are needed?
Banks―and the loans they provided in the run-up to the crisis―are at the heart of Europe’s problems today. Yet it would be wrong to conclude that the crisis was caused by too much financial integration. In fact, the real problem may have been that there was too little financial integration. Policies to promote deeper integration of Europe’s banks―including through cross-border merger and acquisitions―should be part of the solution. Further progress in strengthening the institutions of the European Union (EU) is also needed. What’s more, further European economic integration would unlock substantial efficiency gains, which would help to restore growth in the crisis-affected countries.
The crisis has forced economists and policy makers to go back to their drawing boards. Where did they go wrong, and what implications does the crisis have for both macroeconomic theory and macroeconomic policy making? This was the topic of this year’s IMF Jacques Polak Research Conference. The twelve papers presented at the conference provided rich fodder for discussion. Here, Olivier Blanchard shares some flavor of the major themes, including: (i) the increased attention to fiscal policy; (ii) the scope for monetary policy to lessen the adverse ‘real economy’ effects of financial disruptions; (iii) the role of international capital flows in weakening financial stability; and (iv) the prominence of regulatory issues and the interplay with the real economy.