Toward a More Stable International Monetary SystemOpening Remarks by Dominique Strauss-Kahn, Managing Director, International Monetary Fund
At the Lecture and Discussion on: "Towards a more stable international monetary system"
Washington DC, February 10, 2011
As Prepared for Delivery
I’m delighted to welcome everyone to the Fund for our discussion on the international monetary system. I’d like to thank Tim Adams, Fred Bergsten, and Kemal Derviş for joining us today. Their expertise in this area is universally recognized, and I look forward to the conversation with them and also with you, the members of the audience.
The international monetary system 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—witness for instance the recent, insightful report of the “Palais Royal Initiative” (or “Camdessus group”).
Some are of the view that the current system works well enough. While not perfect, they point to its resilience during the crisis, citing in particular the fact that 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 international monetary system. In other words, “if it ain’t broke, don’t fix it”.
I take a less sanguine view. While the world as we know it did not end in 2008, it was only through extraordinary international policy cooperation that a far worse outcome was averted. Moreover, the recovery underway today is not the recovery we wanted. Unemployment remains at record highs, with widening income inequality adding to social strains.
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.
In my opinion, reforms to the international monetary system 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 of the key questions that are guiding the IMF’s work in this area, and on which I look forward to hearing your views. I will start from the premise that when we worry about the deficiencies of the international monetary system, we are mostly worrying about volatility: a sense that money sometimes flows around the globe in too volatile a fashion, and that countries need a more stable, more predictable external environment in order to prosper.
First, how can we strengthen policy cooperation?
Clearly, one driver of volatility is economic policies, especially when they are not consistent across countries. 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 this cooperation be sustained—so that countries adopt policies consistent with sustainable 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 already taken a number of significant steps to strengthen 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.
We are also delving deeper into macro-financial linkages. Here, we will be helped by the fact that countries representing the world’s 25 most systemic financial systems have agreed to mandatory Financial Sector Assessment Programs (FSAPs). 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. Even 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: how best to cope with capital flow and exchange rate volatility?
Even if we do all we can on the policy front, volatility is not going to go away entirely.
Beginning with capital flows, over the past decade, we have witnessed a dramatic increase in the size and variability of capital flows. There is no doubt that broadly speaking, such flows are beneficial to the receiving economies. But they can also complicate macroeconomic management and threaten financial stability, especially in countries whose financial sectors lack depth.
How best to respond to such flows? Policymakers have many tools at their disposal, including macroeconomic adjustment, reserve accumulation, prudential measures and, in some cases, capital controls. Naturally, countries’ responses are driven primarily by domestic considerations. But their actions can have a significant impact on others.
Given these spillovers, does this call for 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 point is the volatility of exchange rates, and indeed the large and persistent deviations of exchange rates from fundamentals these sometimes display. While it may not be possible to eliminate these entirely, there may be ways to mitigate their adverse effects, such as increasing the use of the SDR as a unit of account, which I will return to later.
Now my third and final question: how can we enhance liquidity provision in times of extreme volatility?
I also believe it is an illusion that we can stop crises entirely, and there will be occasions—few, we hope—where countries are faced with a sudden stop in their access to financial markets. 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 for exploration is how 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 international monetary system.
In a paper the IMF is publishing today, we present a range of ideas on this topic. These include:
• Increasing the global stock of SDRs could help meet countries’ demand for precautionary reserves.
• Using the SDR to price global trade and denominate financial assets would provide a buffer from exchange rate volatility.
• Issuing SDR-denominated bonds could create a potentially new class of reserve assets.
The currency composition of the SDR basket is another relevant issue. Adding emerging market currencies—such as the renminbi—could help the process of internationalization of these currencies, which would benefit the system as a whole.
A number of technical hurdles would stand in the way of moving in this direction. They include how best to ensure that SDR allocations are used in a manner that is consistent with global macroeconomic stability, and how to facilitate trading of SDR-denominated assets.
Looking beyond these issues, increasing the role of the SDR would clearly require a major leap in international policy coordination. For this reason, I expect the global reserve asset system to evolve only gradually, and along with changes in the global economy.
Let me wrap up. The issues that touch on the international monetary system are wide-ranging and complex. The global debate is only just getting started. But we must all recognize that this is not something academic or abstract. As I said earlier, it 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.
So again, I look forward to our discussion this morning.