## _072211 - Broadening coverage of surveillance; Broadening participation in surveillance ## Source details **Canonical URL:** [_072211 - Broadening coverage of surveillance; Broadening participation in surveillance](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2011/_072211.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2011/_072211.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2011/_072211.pdf.json) --- ### Broadening coverage of surveillance: findings and implications - Surveillance assesses a country’s economic performance, but judgments depend on which indicators are used, how they are used, and what weight is given to each. - Focus should be on variables of interest in their own right (the well-being of the citizens of the country, today and in the future), not on intermediate variables except when: - there is a clear relationship between intermediate variables and ultimate variables of interest, and - intermediate variables can be more accurately or easily assessed than variables of ultimate interest. - Suggested ultimate indicators: - median income per capita (appropriately defined) and wealth (and the change in those variables). - Inequality may be of direct concern for shaping society and economic stability; good indicators of inequality are desirable. - Employment matters for well-being beyond income; high unemployment contributes to increased inequality and lowering of median income. - The IMF has focused heavily on inflation because of its link with stability and inequality, though: - the linkage of inflation to inequality is questioned in some schools of thought, particularly where labor markets are competitive and social insurance is adequately indexed; - some economists argue that a focus on price stability may come at the expense of greater real instability. - Instability (real or price) may lower welfare (in the absence of adequate insurance), lower growth, or increase inequality; whether real or price instability has greater adverse effects remains disputed. - Surveillance must go beyond simply reporting "high inflation" and prescribing higher interest rates; it should: - lay out the diagnosis, - identify alternative responses, and - analyze the effects and trade-offs of each alternative. - Examples and nuances: - Low inflation may be undesirable if resulting from exchange rate appreciation tied to large, unsustainable capital inflows. - During crises, inflation caused by depreciation can be a wrong signal if authorities respond with monetary tightening that worsens recession. - The source of inflation matters (domestic labor-market tightness vs. imported oil/food); monetary tightening in the presence of high unemployment or imported food-price inflation can harm the poor without addressing the source. - "Flexible inflation targeting" is noted as a more nuanced approach taken by many advocates today. - Regulation and deregulation: - Warnings about the risks of deregulation are sometimes valid; surveillance should focus not only on deregulation but on how regulatory objectives can best be achieved. - Issues that received short shrift in prior surveillance include anticompetitive practices in payments mechanisms, risks of floating rate mortgages, abusive lending practices, derivatives and excessive financial sector interdependence, flash trading, securitization, and predatory lending. - Insufficient attention to these issues undermined surveillance credibility. - Surveillance must address short-run and long-run simultaneously, and be sensitive to data availability and country differences: - In emerging markets, focus on changes in the degree of informality as a major adjustment mechanism rather than only open unemployment. - In the US, the broader measure of unemployment (U-6), which includes discouraged workers and those working part-time involuntarily, may be a better measure of slack than the formal unemployment number. - When analysis indicates inequality contributes to instability, surveillance must include what is happening to inequality. ### Broadening the range of models underlying the analysis: findings and implications - There is widespread recognition that pre-crisis models were badly flawed and did not predict the crisis—the most important economic event in three quarters of a century. - Deficiencies of standard models included: - lack of attention to details of banking and the shadow banking system; - insufficient modeling of market imperfections arising from information asymmetries, agency, and corporate governance problems; - failure to adequately capture excessive interdependence and contagion risks associated with financial market integration. - Before the crisis, models celebrated benefits of economic integration; after the crisis, focus shifted to contagion risks that increase with financial market integration. A coherent approach should balance benefits of integration with costs, and focus on architectures that minimize costs while maximizing benefits. - Labor markets do not instantaneously clear; many mainstream models assumed they do. Attempts to incorporate unemployment via search models explain frictional unemployment but struggle to explain high cyclical unemployment. - There will be substantial debate over the structural vs. cyclical nature of current unemployment; models exist arguing Keynesian policies combined with active labor market policies can be effective if unemployment is structural. - If markets often do not work well, surveillance should focus on market failures and government failures to correct them. This is especially important for multilateral surveillance and for systemically significant countries (e.g., the US) whose regulatory failures can have spillovers. - Exchange rates are only one channel for cross-border effects; capital flows, especially short-term flows, are often the main source of instability. Actions by multiple parties affect exchange rates and external imbalances; for example, restrictions on inflows (e.g., investments by Sovereign Wealth Funds) can lead to a lower exchange rate even if that was not the motive. - Policy advice takes place under uncertainty—about data, the economy’s trajectory, and the appropriate structure/model of the economy. Pretending economics has resolved these uncertainties contributed to the crisis. - Key modeling uncertainties and policy-relevant questions include: - whether optimal interventions should be price or quantity interventions in a world with incomplete risk markets; - whether inequality contributes to instability, implying labor market flexibility might increase both inequality and instability; - whether deficiencies of aggregate demand in many countries mean more labor market flexibility could raise unemployment rather than reduce it; - whether debt-deflation dynamics (Irving Fisher) imply that greater wage and price flexibility could deepen recessions. - Empirical studies must be used with care: e.g., fiscal multipliers estimated near full employment may be irrelevant when unemployment is high; multipliers for "normal" tax cuts may be irrelevant when households face high unemployment risk and legacy debt. - Domestic actors may reject outside advice because outsiders’ models may not reflect institutional nuances and country-specific realities. Undervalued exchange rates may have different effects when countries can use administrative controls over banking and aggregate demand—models must reflect such differences or they will not be taken seriously. - The IMF must explore consequences of different modeling approaches to improve surveillance effectiveness. ### Policy recommendations and procedural implications (from coverage and models) - Broaden the coverage of surveillance to include: - median income per capita and wealth measures and their changes; - robust indicators of inequality; - employment measures beyond headline unemployment (e.g., U-6 in the US; informality measures in emerging markets); - financial-sector practices and institutions (payments mechanisms, mortgage structures, securitization, derivatives, interdependence, flash trading, predatory lending). - Present surveillance judgments with: - clear diagnoses, - alternative policy responses, and - analyses of trade-offs, distributive and intertemporal incidence, and uncertainties. - Broaden the range of economic models used in analysis to: - incorporate banking and shadow banking details, information asymmetries, agency issues, and interdependence; - assess benefits and costs of financial integration and architectures to manage contagion; - examine market failures and government failures, especially for spillovers from systemically important countries. - Use empirical work cautiously, ensuring relevance of econometric estimates to prevailing macroeconomic conditions (e.g., high unemployment, legacy debt). - Increase sensitivity to country-specific institutional differences so that surveillance recommendations reflect local realities and are more likely to be accepted. ### Broadening participation: rationale and concerns - The IMF is viewed by many as reflecting disproportionately the interests and perspectives of financial markets rather than workers, small businesses, civil society, etc. - Workers prioritize unemployment; rhetoric that inflation has its worse effects on workers "has never been fully persuasive." "Most would rather have a little more inflation if it led to higher levels of employment." - High unemployment typically leads to weakening of real wages; workers and their representatives remain unconvinced by natural rate arguments that say there is no trade-off. - Some form of participation by workers, small businesses, civil society, etc. could garner more support for surveillance, particularly in systemically significant countries where IMF influence is exercised through persuasion rather than conditionality. - Greater engagement "entails engagement of more than the finance ministry or financial markets." (See footnote reference to Lombardi and Woods (2008).) ### Enhancing the IMF's role as mediator in multilateral surveillance - Multilateral surveillance is more problematic than bilateral surveillance because alternative policy frameworks have differential impacts across countries and groups; there is seldom a Pareto-dominant strategy in the short run. - International compensation for domestic-policy-induced losses is especially hard to implement. - Systemically significant countries often pay little attention to externalities when pursuing policies centered on domestic concerns (example: lowering interest rates to stimulate domestic demand can have exchange rate effects and global trade repercussions). - Policy actions that create externalities are hard to attribute; "ascertaining motives" behind interventions (e.g., exchange rate intervention intended "to increase exports") is difficult. - Agricultural subsidies in some advanced industrial countries can drive down global agricultural prices, contributing to inequality in poorer countries; imposing countervailing duties or subsidizing local agriculture poses trade-offs for emerging markets. - Reaching agreements on policy responses (e.g., global imbalances, reforming the global reserve system) is difficult because countries differ in diagnoses, concerns, and models used. - A global general equilibrium model would be desirable to assess each systemically significant country's effect on the global equilibrium, but consensus on such a model is unlikely given the lack of consensus on single-country models. - What is often required is not econometric precision but broad understandings; the IMF could mediate and "developing consensus around certain policies that could enhance global growth and stability." - The IMF must be seen to have successfully moved along "all of the first three reforms" (broader scope, better models, more participation) to be an effective mediator. ### Example: the China exchange rate debate as a mediation case - US position sometimes: China should let its exchange rate be market determined; China argues for a managed exchange rate. - Even with a market-determined rate, Chinese simultaneous policy actions (e.g., lowering interest rates) could lower the exchange rate and cause U.S. dissatisfaction—suggesting the core concern is a "lower exchange rate" rather than flexibility. - Accusations that the US "knows better than China what is in China’s own best interests" can be viewed as condescending; other countries will be skeptical of motives and potential hidden agendas. - The IMF could have an advantage as mediator "if it could distance itself from its largest shareholders," but credibility requires it not be seen as primarily reflecting Western financial institutions or relying on suspect model assumptions. - Mediated solutions aim for policies where "everyone could (in principle) gain"—example: a growth strategy where U.S. policies enhance growth while China commits to appreciation as global growth increases, alleviating unemployment concerns from appreciation. - The IMF could explain how reserve build-ups diminish global aggregate demand and adversely affect reserve countries; while no consensus on a new reserve system exists, "there is widespread (though far from universal) agreement that reform is needed." ### Bilateral surveillance of non-systemically significant countries - Individual policies of non-systemically significant countries may have limited direct global impact, but correlated policy choices across many such countries can produce systemic consequences. - If all countries liberalize following the same flawed "model," systemic consequences can arise (as occurred in the US in the crisis); "There is virtue in diversity." - Excessive harmonization may be counterproductive from the perspective of systemic stability. - Conditioning assistance on adoption of particular policy perspectives can yield more effective implementation but at high cost: - Such policies are often not sustainable after aid ends or with a change in government. - IMF prescriptions can be viewed as the only option when there are no alternatives; systemically significant countries are less compelled to follow IMF prescriptions. - Persuasion, not conditionality, is preferable to the extent possible; persuasion would be easier if the earlier reforms (broader scope, better models, more participation) were implemented effectively. ### Credibility, governance, and enforcement - Two reiterated points: - If the United States is unwilling to subject itself to surveillance on key issues, "it is hard to see why other countries...should be willing to do so." - Past mistakes of the IMF impair its ability to conduct effective surveillance today; overcoming perceived and real errors in both economics and politics will take effort. - Examples of past shortcomings: - The IMF's 2007 report on Iceland asserted: "The banking sector appears well placed to withstand significant credit and market shocks"—a judgment later contradicted by events. - Failures to recognize risks from large capital flows to Eastern Europe were cited as avoidable oversights. - IMF reforms and an improved track record are necessary before any mandatory enforcement mechanism could be viable; in the foreseeable future, "it is unlikely...to have effective enforcement mechanisms." - Surveillance must work through the "credibility of its advice"; only through reforms suggested in this paper is that credibility likely to be achieved. - IMF surveillance could also influence markets and, through markets, national authorities—however, literature review suggests "there is little evidence of market impact" as of the cited analyses; some suggested reforms may enhance market impact. *Source: _072211 - 1. Broadening coverage of surveillance, seeing issues such as inflation, within a broader economic and social context; 3. Broadening participation in surveillance.* ### 1. Broadening coverage of surveillance, seeing issues such as inflation, within a broader economic and ### _072211 - 1. Broadening coverage of surveillance, seeing issues such as inflation, within a broader economic and social context. ### Broadening coverage of surveillance: findings and implications - Surveillance is aimed at assessing a country’s economic performance, but judgments depend on which indicators are used, how they are used, and what weight is given to each. - The focus should be on variables of interest in their own right (the well-being of the citizens of the country, today and in the future), not on intermediate variables except when: - there is a clear relationship between intermediate variables and ultimate variables of interest, and - intermediate variables can be more accurately or easily assessed than variables of ultimate interest. - Suggested ultimate indicators: median income per capita (appropriately defined) and wealth (and the change in those variables). - Inequality may be of direct concern for shaping society and economic stability; good indicators of inequality are desirable. - Employment matters for well-being beyond income. High unemployment contributes to increased inequality and lowering of median income. - The IMF has focused heavily on inflation because of its link with stability and inequality, though: - the linkage of inflation to inequality is questioned in some schools of thought, particularly where labor markets are competitive and social insurance is adequately indexed; - some economists argue that a focus on price stability may come at the expense of greater real instability. - Instability (real or price) may lower welfare (in the absence of adequate insurance), lower growth, or increase inequality; whether real or price instability has greater adverse effects remains disputed. - Surveillance must go beyond simply reporting "high inflation" and prescribing higher interest rates; it should: - lay out the diagnosis, - identify alternative responses, and - analyze the effects and trade-offs of each alternative. - Examples and nuances: - Low inflation may be undesirable if resulting from exchange rate appreciation tied to large, unsustainable capital inflows. - During crises, inflation caused by depreciation can be a wrong signal if authorities respond with monetary tightening that worsens recession. - The source of inflation matters (domestic labor-market tightness vs. imported oil/food); monetary tightening in the presence of high unemployment or imported food-price inflation can harm the poor without addressing the source. - Flexible inflation targeting ("flexible inflation targeting") is noted as a more nuanced approach taken by many advocates today. - Regulation and deregulation: - Warnings about the risks of deregulation are sometimes valid; surveillance should focus not only on deregulation but on how regulatory objectives can best be achieved. - Issues that received short shrift in prior surveillance include anticompetitive practices in payments mechanisms, risks of floating rate mortgages, abusive lending practices, derivatives and excessive financial sector interdependence, flash trading, securitization, and predatory lending. - Insufficient attention to these issues undermined surveillance credibility. - Surveillance must address short-run and long-run simultaneously, and be sensitive to data availability and country differences: - In emerging markets, focus on changes in the degree of informality as a major adjustment mechanism rather than only open unemployment. - In the US, the broader measure of unemployment (U-6), which includes discouraged workers and those working part-time involuntarily, may be a better measure of slack than the formal unemployment number. - When analysis indicates inequality contributes to instability, surveillance must include what is happening to inequality. ### Broadening the range of models underlying the analysis: findings and implications - There is widespread recognition that pre-crisis models were badly flawed and did not predict the crisis—the most important economic event in three quarters of a century. - Deficiencies of standard models included: - lack of attention to details of banking and the shadow banking system; - insufficient modeling of market imperfections arising from information asymmetries, agency, and corporate governance problems; - failure to adequately capture excessive interdependence and contagion risks associated with financial market integration. - Before the crisis, models celebrated benefits of economic integration; after the crisis, focus shifted to contagion risks that increase with financial market integration. A coherent approach should balance benefits of integration with costs, and focus on architectures that minimize costs while maximizing benefits. - Labor markets do not instantaneously clear; many mainstream models assumed they do. Attempts to incorporate unemployment via search models explain frictional unemployment but struggle to explain high cyclical unemployment. - There will be substantial debate over the structural vs. cyclical nature of current unemployment; models exist arguing Keynesian policies combined with active labor market policies can be effective if unemployment is structural. - If markets often do not work well, surveillance should focus on market failures and government failures to correct them. This is especially important for multilateral surveillance and for systemically significant countries (e.g., the US) whose regulatory failures can have spillovers. - Exchange rates are only one channel for cross-border effects; capital flows, especially short-term flows, are often the main source of instability. Actions by multiple parties affect exchange rates and external imbalances; for example, restrictions on inflows (e.g., investments by Sovereign Wealth Funds) can lead to a lower exchange rate even if that was not the motive. - Policy advice takes place under uncertainty—about data, the economy’s trajectory, and the appropriate structure/model of the economy. Pretending economics has resolved these uncertainties contributed to the crisis. - Key modeling uncertainties and policy-relevant questions include: - whether optimal interventions should be price or quantity interventions in a world with incomplete risk markets; - whether inequality contributes to instability, implying labor market flexibility might increase both inequality and instability; - whether deficiencies of aggregate demand in many countries mean more labor market flexibility could raise unemployment rather than reduce it; - whether debt-deflation dynamics (Irving Fisher) imply that greater wage and price flexibility could deepen recessions. - Empirical studies must be used with care: e.g., fiscal multipliers estimated near full employment may be irrelevant when unemployment is high; multipliers for "normal" tax cuts may be irrelevant when households face high unemployment risk and legacy debt. - Domestic actors may reject outside advice because outsiders’ models may not reflect institutional nuances and country-specific realities. Undervalued exchange rates may have different effects when countries can use administrative controls over banking and aggregate demand—models must reflect such differences or they will not be taken seriously. - The IMF must explore consequences of different modeling approaches to improve surveillance effectiveness. ### Policy recommendations and procedural implications - Broaden the coverage of surveillance to include: - median income per capita and wealth measures and their changes; - robust indicators of inequality; - employment measures beyond headline unemployment (e.g., U-6 in the US; informality measures in emerging markets); - financial-sector practices and institutions (payments mechanisms, mortgage structures, securitization, derivatives, interdependence, flash trading, predatory lending). - Present surveillance judgments with: - clear diagnoses, - alternative policy responses, and - analyses of trade-offs, distributive and intertemporal incidence, and uncertainties. - Broaden the range of economic models used in analysis to: - incorporate banking and shadow banking details, information asymmetries, agency issues, and interdependence; - assess benefits and costs of financial integration and architectures to manage contagion; - examine market failures and government failures, especially for spillovers from systemically important countries. - Use empirical work cautiously, ensuring relevance of econometric estimates to prevailing macroeconomic conditions (e.g., high unemployment, legacy debt). - Increase sensitivity to country-specific institutional differences so that surveillance recommendations reflect local realities and are more likely to be accepted. *Source: _072211 - 1. Broadening coverage of surveillance, seeing issues such as inflation, within a broader economic and social context.* ### 3. Broadening participation in surveillance. ### 3. Broadening participation in surveillance ### Broadening participation: rationale and concerns - The IMF is viewed by many as reflecting disproportionately the interests and perspectives of financial markets rather than workers, small businesses, civil society, etc. - Workers prioritize unemployment; rhetoric that inflation has its worse effects on workers "has never been fully persuasive." "Most would rather have a little more inflation if it led to higher levels of employment." - High unemployment typically leads to weakening of real wages; workers and their representatives remain unconvinced by natural rate arguments that say there is no trade-off. - Some form of participation by workers, small businesses, civil society, etc. could garner more support for surveillance, particularly in systemically significant countries where IMF influence is exercised through persuasion rather than conditionality. - Greater engagement "entails engagement of more than the finance ministry or financial markets." (See footnote reference to Lombardi and Woods (2008).) ### Enhancing the IMF's role as mediator in multilateral surveillance - Multilateral surveillance is more problematic than bilateral surveillance because alternative policy frameworks have differential impacts across countries and groups; there is seldom a Pareto-dominant strategy in the short run. - International compensation for domestic-policy-induced losses is especially hard to implement. - Systemically significant countries often pay little attention to externalities when pursuing policies centered on domestic concerns (example: lowering interest rates to stimulate domestic demand can have exchange rate effects and global trade repercussions). - Policy actions that create externalities are hard to attribute; "ascertaining motives" behind interventions (e.g., exchange rate intervention intended "to increase exports") is difficult. - Agricultural subsidies in some advanced industrial countries can drive down global agricultural prices, contributing to inequality in poorer countries; imposing countervailing duties or subsidizing local agriculture poses trade-offs for emerging markets. - Reaching agreements on policy responses (e.g., global imbalances, reforming the global reserve system) is difficult because countries differ in diagnoses, concerns, and models used. - A global general equilibrium model would be desirable to assess each systemically significant country's effect on the global equilibrium, but consensus on such a model is unlikely given the lack of consensus on single-country models. - What is often required is not econometric precision but broad understandings; the IMF could mediate and "developing consensus around certain policies that could enhance global growth and stability." - The IMF must be seen to have successfully moved along "all of the first three reforms" (broader scope, better models, more participation) to be an effective mediator. ### Example: the China exchange rate debate as a mediation case - US position sometimes: China should let its exchange rate be market determined; China argues for a managed exchange rate. - Even with a market-determined rate, Chinese simultaneous policy actions (e.g., lowering interest rates) could lower the exchange rate and cause U.S. dissatisfaction—suggesting the core concern is a "lower exchange rate" rather than flexibility. - Accusations that the US "knows better than China what is in China’s own best interests" can be viewed as condescending; other countries will be skeptical of motives and potential hidden agendas. - The IMF could have an advantage as mediator "if it could distance itself from its largest shareholders," but credibility requires it not be seen as primarily reflecting Western financial institutions or relying on suspect model assumptions. - Mediated solutions aim for policies where "everyone could (in principle) gain"—example: a growth strategy where U.S. policies enhance growth while China commits to appreciation as global growth increases, alleviating unemployment concerns from appreciation. - The IMF could explain how reserve build-ups diminish global aggregate demand and adversely affect reserve countries; while no consensus on a new reserve system exists, "there is widespread (though far from universal) agreement that reform is needed." ### Bilateral surveillance of non-systemically significant countries - Individual policies of non-systemically significant countries may have limited direct global impact, but correlated policy choices across many such countries can produce systemic consequences. - If all countries liberalize following the same flawed "model," systemic consequences can arise (as occurred in the US in the crisis); "There is virtue in diversity." - Excessive harmonization may be counterproductive from the perspective of systemic stability. - Conditioning assistance on adoption of particular policy perspectives can yield more effective implementation but at high cost: - Such policies are often not sustainable after aid ends or with a change in government. - IMF prescriptions can be viewed as the only option when there are no alternatives; systemically significant countries are less compelled to follow IMF prescriptions. - Persuasion, not conditionality, is preferable to the extent possible; persuasion would be easier if the earlier reforms (broader scope, better models, more participation) were implemented effectively. ### Credibility, governance, and enforcement - Two reiterated points: - If the United States is unwilling to subject itself to surveillance on key issues, "it is hard to see why other countries...should be willing to do so." - Past mistakes of the IMF impair its ability to conduct effective surveillance today; overcoming perceived and real errors in both economics and politics will take effort. - Examples of past shortcomings: - The IMF's 2007 report on Iceland asserted: "The banking sector appears well placed to withstand significant credit and market shocks"—a judgment later contradicted by events. - Failures to recognize risks from large capital flows to Eastern Europe were cited as avoidable oversights. - IMF reforms and an improved track record are necessary before any mandatory enforcement mechanism could be viable; in the foreseeable future, "it is unlikely...to have effective enforcement mechanisms." - Surveillance must work through the "credibility of its advice"; only through reforms suggested in this paper is that credibility likely to be achieved. - IMF surveillance could also influence markets and, through markets, national authorities—however, literature review suggests "there is little evidence of market impact" as of the cited analyses; some suggested reforms may enhance market impact. *Source: 3. Broadening participation in surveillance. (chapter/section text provided in content unit)* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2011/_072211.pdf_