The economic crisis has sparked a deep reevaluation of the global financial system, one of the topics addressed in a new IMF book (AFP Photo/Stan Honda)
GLOBAL ECONOMIC CRISIS
A new IMF book, Reconstructing the World Economy, presents a number of proposals to improve the stability of the global economy in light of the recent crisis.
In addition to discussing the immediate policy challenges, such as when to exit from stimulus measures, the book considers issues of a longer-term nature, such as how to correct flaws in the prevailing macroeconomic policy framework, redesign financial regulation and supervision, and strengthen the international financial architecture.
Edited by IMF Chief Economist Olivier Blanchard and Il SaKong, Chairman of the Presidential Committee for the Group of Twenty (G-20) summit of industrial and emerging market countries, the book is based on five papers prepared by IMF economists for a workshop last February in Seoul, Korea. The workshop provided an initial forum for discussing these challenges, a topic that will be taken up again in November at the G-20 summit in Seoul.
The conference volume is being released as the IMF and the Korean government conclude a jointly organized high-level conference to examine Asia’s economic dynamism and evolving role in international policymaking.
Reconstructing the World Economy contains the Seoul conference papers on the five topics listed below, as well as comments by eminent policymakers and academics, including Charles Bean, deputy governor of the Bank of England; Justin Lin, chief economist of the World Bank; Philip Lowe, assistant governor of the Reserve Bank of Australia, and Yung Chul Park, professor of economics at Korea University, among others.
Exit strategies
Advanced economies face a daunting challenge to bring fiscal and monetary policy back to normalcy. “Assuming no further fiscal action, the general government gross debt-to-GDP ratio of advanced economies is projected to rise from 73 percent at end-2007 to 109 percent at end-2014,” the authors of the book’s first section say.
They propose five basic principles to guide an exit from macroeconomic stimulus: the need for consistency across policy instruments, flexibility, clear communication, ensuring strategies rely on market-based incentives, and the need for cross-country consultation and coordination.
Global imbalances
This section addresses future sources of growth and asks how the world’s economies can avoid the global imbalances that precipitated the current crisis.
It warns that a failure to address remaining domestic and international distortions “could result in the world economy being stuck in midstream.”
If global growth is to be put on a more sustainable footing, it says, the United States will need to save more, whereas major surplus countries such as China will need to consume more domestically. Similarly, oil-exporting countries will be able to boost domestic demand, if oil prices remain stable or higher in the medium term.
Rethinking macroeconomic policy
In addition to challenging conventional thinking on the ideal target inflation rate, this section also questions whether financial stability—including asset price performance—should be an explicit goal of policy, and if so, how that should be achieved.
It notes that monetary policy is a blunt tool and suggests that better and more targeted instruments should be developed. “Regulatory ratios, such as capital ratios for banks or loan-to-value ratios for household, that vary over the cycle could be a promising start,” the book says, adding that more work is needed on how to design a new macroprudential framework.
The future financial system
The economic crisis, with its origins in the financial sector, has sparked a deep reevaluation of the global financial system. This section proposes a number of reforms, including widening the scope of regulation to include all systemically significant financial institutions and limiting excessive leverage and risk-taking, but warns against stifling innovation.
The international linkages highlighted by the crisis have underscored the importance of creating a new regulatory framework that is consistent across countries, say the authors.
Reforming the international monetary system
This section addresses the question of how a new international financial architecture, and in particular a strengthened international monetary system, can help address some of the current challenges.
It discusses how the monetary system could be structured to dissuade economies from building up reserves to insure against capital account crises—an issue that has long preoccupied the Fund.
This section proposes alternative insurance arrangements to mitigate this precautionary demand for reserves, while exploring a menu of alternative reserve assets which, the authors suggest, “could offer sustained stability and efficiency.”
