High-Level Seminar on the International Monetary SystemKeynote address by Dominique Strauss-Kahn, Managing Director, International Monetary Fund
Nanjing, March 31, 2011
As Prepared for Delivery
Good afternoon. As the morning discussions have shown, there is a wide range of opinions regarding the extent to which the international monetary system needs to be reformed, and how. A gathering like this one can help us progress toward a common understanding of the way ahead, which is critical if the global recovery is to be sustained beyond the near term. I am thankful to our hosts for organizing this seminar, and for inviting me to deliver this keynote address.
What is at issue? In a nutshell, the current international monetary system has enabled remarkable progress in global economic and financial integration, fostering strong global growth in living standards. And it recently survived a global financial crisis of historical proportion.
But this system has also exhibited symptoms of instability many times over the years: frequent crises, persistent current account imbalances and exchange rate misalignments, volatile capital flows and currencies. And these have been increasingly the source of tensions that, left unaddressed, could threaten the progress of globalization and the prosperity it brings.
If the system is to support the recovery and sustained stable growth beyond it, we must try to address the root causes of these instabilities. What are they? I see four:
- First, the absence of effective global adjustment mechanisms to deal with imbalances—be they generated by bad policies, bad luck, or structural differences such as demographics and savings rates;
- Second, the volatility of cross-border capital flows, whose size now dwarfs that of global output or trade;
- Third, access to global liquidity is not reliably available in times of systemic crises. Insofar as it encourages speculative attacks, this is a source of instability in itself—a problem that is inefficiently dealt with on a country-by-country basis by recourse to excessive self-insurance through reserve accumulation.
- Fourth, demand for safe global assets has been growing much faster than potential supply, reflecting in part the fact that global monetary and financial assets are far less diversified in currency terms than global GDP. This has contributed to imbalances and asymmetric exposure to risks arising in the economies issuing safe global assets.
These are the challenges that must be dealt with. Significant progress has been made since the crisis on most fronts. But my contention is that it remains insufficient, and bolder steps should be given very serious consideration.
First, how can we promote more effective global adjustment?
Stronger policy cooperation is an obvious answer. The crisis marked a watershed moment for international policy cooperation. Can it be sustained? Two important processes underway provide ground for cautious optimism.
One is the G-20’s Mutual Assessment Process. The agreement on indicators that was reached at the Paris ministerial meeting was encouraging, even if the process was painful. The next steps are to develop actual assessment guidelines, and then agree to use them. This will not be easy.
Another is the Fund’s experimental launch of “spillover reports” on the five most important systemic economies—China, Euro Area, Japan, UK, and US. These will allow us to increase our focus on the impact of countries’ policies across their borders, and allow policymakers to voice their concerns about the impact of other countries’ policies.
IMF surveillance more generally should, as a matter of principle, be a key instrument in promoting effective global adjustment, or reducing the need for it by discouraging countries from running policies that lead to global imbalances. In practice, it has not always been successful in this endeavor. We must think of ways to remedy this.
Clearly, the design of the international monetary system is not the sole culprit for this state of affairs. But it is limiting in one important way, namely that—except in the case of exchange rate policies—countries have no obligation to run their policies in ways consistent with systemic stability. This hardly seems sensible in our interdependent world.
It is also true that our mechanisms to ensure that countries do act in ways consistent with systemic stability are not very effective--even in the case of exchange rate policies. This is why some, including some present in this room, have suggested that not only should multilateral obligations be strengthened, but also accountability for failing to uphold them, for example through policy norms or sanctions. These are legitimate issues to raise.
Second, can we make cross-border capital flows safer?
This issue is often presented as one for emerging market economies to worry about. And for sure it is, but in reality it is one that policy-makers in all countries should worry about. The bulk of cross border capital flows actually take place among advanced economies, and the last few years have shown that they are not immune to the asset bubbles and busts associated with large and volatile capital flows. And of course these economies also suffer from the exchange rate volatility generated by cross border capital flows.
This suggests that the good functioning of the international monetary system depends crucially on orderly cross border capital flows. But here there is no system at all. These flows are driven by policies—monetary, prudential, and capital account—that have been until now pursued with perhaps a too narrow focus on domestic stability.
Yet these actions have a significant impact on others, and hence it is worth asking whether globally agreed “rules of the road” might be useful. A recent discussion of this issue at the IMF Executive Board, focused on dealing with inflows, suggested that there is broad, although not universal, support for this view. In substance, in any event, it is clear that our views are evolving. In the IMF, in particular, while the tradition had long been that capital controls should not be part of the toolbox, we are now more open to their use in appropriate circumstances, although of course countries should be careful not to use them as substitutes for good macroeconomic policies.
Of course inflows are not the only issue. A country’s inflows are another’s outflows. There is an urgent need for source and recipient countries to cooperate, bearing in mind that most countries are both source and recipient. Often, the policy tools at hand will be limited to financial regulation and macro-prudential policies. These also have cross-border impacts and should be run cooperatively.
What do I mean by “cooperatively”? Well, we have mechanisms for coordinating macroeconomic policies in times of stress. The G20’s coordinated fiscal response in 2009 is an outstanding, if rare, example. Why not extend the idea to capital flows and work on a mechanism to bring together the originators and recipients of capital flows in times when such flows create macroeconomic and financial stresses in the system? This is precisely the sort of international cooperation that the Fund’s founders had in mind.
Third, how can we strengthen the global financial safety net?
Since the crisis, we have come a long way in enhancing the provision of liquidity in times of extreme volatility. 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—and so the costly accumulation of reserves continues. The Fund has done some work to help determine how much reserves is enough. What else can be done?
One important avenue for exploration is how to strengthen partnerships with regional financing arrangements. Another is how to improve systemic liquidity provision more generally, as leaving this task exclusively to national central banks may not make it sufficiently predictable. We will be putting forward proposals to that effect.
Fourth, how can reserve asset diversification be promoted?
There could be scope to enhance the stability of the system by encouraging greater international use of other currencies than the four currencies currently in the SDR basket, including those of large dynamic emerging markets, and by promoting financial deepening in emerging market countries. The Fund has work under way in both areas that should cast light on what may be done to speed up these processes.
As financial deepening takes hold in emerging markets and the supply of global financial assets become more diversified across countries, we should expect a more multi-polar system to emerge, with several currencies playing a key and broadly comparable role globally. While such a system would by no means be problem-free (the three challenges previously discussed would still apply!), the more structural sources of systemic vulnerability would be much reduced.
Over time, there may also be a role for the SDR to contribute to a more stable international monetary system. As a first step, adding emerging market currencies to the SDR basket could help internationalize these currencies.
Over the long term, the scope for the SDR to strengthen the international monetary system would depend on its playing a greater role. We recently presented a range of ideas on this topic. They include:
• Increasing the global stock of SDRs to help meet demand for precautionary reserves.
• Using the SDR to price global trade and denominate financial assets, thereby helping cope with exchange rate volatility.
• Issuance of SDR-denominated bonds by sovereigns and international financial institutions.
A number of technical hurdles would stand in the way of moving quickly in this direction. The main obstacle however may be that it would require a major leap in international policy coordination (even more so than in the other areas discussed earlier).
Let me wrap up. The international monetary system we have is not broken, but it has serious holes in it—holes that get bigger and bigger as globalization increases. Left unaddressed, they leave the system vulnerable. The global economy made it back from the brink in 2009. Perhaps it could do so again if the need arose. But is this really a chance we want to take? For all its problems, globalization has worked well. The system should be strengthened so that it continues to do so. Steps in this direction include stronger multilateral commitments from all countries; a collaboration framework for orderly cross border capital flows; reliable access to global liquidity in crisis times, and a broader range of safe global assets, all of which are mutually reinforcing. As the debate continues in coming months, I encourage you to seize the opportunity to push a package of reforms that together make a difference.
Thank you for your kind attention.