## _spn0926 - Executive Summary

## Source details

**Canonical URL:** [_spn0926 - Executive Summary](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/spn/2009/_spn0926.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/spn/2009/_spn0926.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/spn/2009/_spn0926.pdf.json)

---

### Executive Summary
- The global crisis revived concerns about the functioning of the international monetary system (IMS), highlighting inherent weaknesses of a system with a dominant country-issued reserve currency.
- Core tension:
  - (1) scale and volatility of global capital flows, motivating ever larger reserve buffers; and
  - (2) anchoring the IMS on one country’s currency (the U.S. dollar), despite the crisis originating in the U.S. financial system.
- Paper’s focus:
  - Demand side: explore alternative insurance arrangements to mitigate precautionary demand for reserves.
  - Supply side: assess alternative reserve assets that could offer sustained stability and efficiency.
- Many proposals would require fundamental changes in international cooperation and amendments to the IMF’s Articles of Agreement; incremental strengthening of the current system may be more realistic in the short term.

### What Is Wrong with Today’s System?
- Long-term structural concerns:
  - Instability and perceived unfairness of an IMS based on one country’s currency.
  - Recurrence of concerns and phases of instability suggests need for durable remedies.
- Modern Triffin dilemma:
  - Growing demand for safe (Treasury) assets can lead to indebtedness and ultimately undermine confidence in the reserve asset.
  - In practice, global demand tends to lower the reserve issuer’s real interest rates and provide incentives to dissave; refusal to accommodate can lead to alternative, potentially lower-quality reserve assets and a deflationary bias.
- Exorbitant privilege and related effects:
  - Reliance on one country as key supplier of reserve assets gives that country an “exorbitant privilege”: greater macroeconomic policy space, liquidity of markets, ability to borrow in its own currency abroad at lower cost, and seignorage.
  - Example: the United States enjoyed a net capital gain from gradual dollar depreciation for several years in the run up to the crisis of over $1 trillion.
  - Dollar primacy since the 1970s has been earned by policy track record, open capital account, and deep financial markets.
- Asymmetric adjustment:
  - Greater pressure on nonreserve deficit countries to adjust than on surplus or reserve-issuing deficit countries, facilitating persistent surpluses and the buildup of global imbalances.
- Anchoring the center:
  - Remedies include stronger financial regulation, sustainable public finances, central bank independence, inflation-indexed instruments, and credible fiscal responsibility frameworks.
  - IMF surveillance and multilateral mutual assessment processes could help, but surveillance lacks enforcement.
- Large reserve holdings:
  - Large official holdings distort global capital flows toward the center, reducing benefits of capital account liberalization and breeding market uncertainty, especially when holdings are concentrated.
  - Insurance motives account for about two thirds of current reserve holdings, or $4 to $4½ trillion, and over half of the increase over the past decade.
  - “Unallocated reserves” share growth: from 25.6 percent in 1995 to 37.1 percent in 2008.
  - Reserve concentration figures (avg 2006-08): 23.1, 5.8, 4.7, 4.1, 3.5, 45.2, 13.7.
  - Example country reserve amounts shown in Figure 1: ($0.9 tr), ($3.0 tr), ($1.6 tr).

### Lowering the Demand for Reserves
- Drivers of reserve accumulation:
  - Emerging markets hold reserves to buffer exchange rate adjustments, backstop potential banking crises, and boost policy credibility.
  - In some cases (e.g., oil exporters and China) reserve accumulation exceeds conceivable precautionary needs and reflects public savings motives or export-led growth strategies.
- Alternatives to self-insurance (focus on precautionary demand):
  - Third-party insurance:
    - Theoretically efficient but difficult due to absence of liquid markets, significant upfront underwriting costs, difficulty pricing tail events, moral hazard, adverse selection, counterparty risks, and inability to diversify sovereign risks.
    - Even if market failures addressed, insurance likely limited to small- or medium-sized sovereign clients.
  - Borrowing from a global or regional reserves pool or access to a global lender of last resort:
    - Viable if credible and less costly than self-insurance.
- Longer-run reductions could occur if the “core” expands to include more emerging markets with policy credibility and truly floating exchange rate regimes holding minimal reserves, plus improved prudential/regulatory measures and stronger surveillance.

### The Fund’s Role: Central Functions, Instruments, and Constraints
- The Fund’s central role and constraints:
  - The IMF has a central role in fostering and offering alternatives to reserve accumulation given its global membership and crisis prevention and resolution mandates.
  - Effectiveness is hampered by concerns about governance and stigma.
  - On-demand financing needs to be sufficient to offset a sudden stop or stem a bank run.
  - Advanced countries may need external financing; Fund resources would need to be bolstered significantly to play a meaningful role in potentially financing all but the smallest advanced countries.
  - Regional pools and bilateral swaps are useful complements but have more limited scale, scope for risk sharing, and surveillance arrangements.
- Access to precautionary resources:
  - Creation of the Flexible Credit Line (FCL) and mainstreaming of high-access precautionary arrangements (HAPA) added contingent credit line instruments.
  - Not all countries qualify; unpredictability of access and perceptions of unfairness limit their substitutability for reserves.
  - Recommendation: enhance predictability and reliability of access to the FCL with an objective qualification process.
    - Trade-off: confidentiality vs. market-confidence benefits.
    - Side benefit: objective qualification could incentivize better policy track records.
- Increasing access to unconditional resources (proposals):
  - A pure liquidity line:
    - Model: an overdraft facility analogous to commercial bank central bank arrangements.
    - Access rights could be proportionate to quota or another indicator of capacity to repay.
    - First credit tranche policy: currently at 25 percent of quota and available effectively without conditionality.
    - Proposed size: substantially larger (e.g., 100 percent of quota subject to debt sustainability checks).
    - Impact larger if combined with a quota increase.
  - Contingent general SDR allocations:
    - SDRs could be generated automatically at a predetermined pace and allocated only in case of systemic crises predefined by global conditions.
    - Safeguard: reinstate a reconstitution requirement so countries rebuild SDR holdings up to a minimum share of cumulative SDR allocations over a certain time horizon.
  - Supporting insurance markets:
    - Fund could help develop insurance markets against exogenous shocks or encourage private hedging via technical support and surveillance information.
    - Design features: restrict payouts to crises not caused by domestic policies; link availability and cost to IMF surveillance; make instruments contingent on exposures to specific global conditions (e.g., commodity prices, the VIX index) with premia rising with risk profile.
    - Purely exogenous triggers feasible only for small economies; clear preconditions tied to global indexes are key.
    - Limitations: balance sheet impact, conflict of interest for surveillance, risk of inducing irresponsible behavior by other insurers.
    - Conclusion: Fund role should probably be limited to supporting insurance or acting as a temporary market maker.
    - Feasibility: insuring against systemic shocks is nearly impossible; insuring against country-specific external risks (e.g., commodity price slumps) is feasible.
- A dependable governance structure:
  - Emerging markets’ limited confidence in Fund financing may reflect governance concerns.
  - Remedies: rebalance IMF quotas and increase management/staff diversity; alternatively, have qualification decisions reviewed by a politically independent body of technocrats.
  - Challenge: forming a politically acceptable, insulated group to take or review qualification decisions would be difficult.

### Should the IMF Provide Country Capital Insurance? (Box 2 summary)
- Observations:
  - Private-sector insurance against sudden stops has not been extended to sovereigns spontaneously.
  - Private contingent credit lines to sovereigns are limited; options on the VIX, EMBI, or CDS spread are rare.
  - GDP-indexed bonds are rare and generally not tradable.
  - Market failures justify considering a global institution like the IMF to generate economies of scale, pool country-specific risks, and reduce pricing.
- Potential advantages and key issues:
  - Availability to entire membership with fundamentals reflected in risk premia rather than binary qualification.
  - Challenges: pricing systemic risks; balance sheet effects from near-global shocks; role and potential conflict of surveillance; reverse moral hazard for private insurers.
- Design options to minimize concerns:
  - Exclude global shocks from insurance; use clear automatic criteria for suspending payouts under global crises; Fund market-making role can be temporary.
  - Encourage private-sector insurance via surveillance, risk premia estimation, and promoting data dissemination standards.

### A Larger Pool of Resources — Some Considerations
- The needed resource base:
  - Academic assessments of minimum Fund resources range from $1 trillion (Johnson, 2008) to an unlimited amount as implied by Calvo (2009).
  - A rough estimate of precautionary reserves currently held is around $4 to $4.5 trillion, six times the Fund’s lending capacity after the agreed tripling from pre-crisis levels.
- Ways to grow Fund lending capacity:
  - Indexed quotas:
    - Expand quotas and keep them growing in line with benchmarks (e.g., GDP, capital flows); a treaty-based presumption of indexation could be an alternative.
  - A reserve pool:
    - Willing members might pool part of their reserves (e.g., in a trust fund) offering control proportional to contributions; could supplement the Fund or finance alternative facilities.
  - New SDRs:
    - SDRs are currently created for long-term global needs and allocated unconditionally based on quotas.
    - Reforms could allow SDRs to be created and temporarily allocated to specific members to finance the Fund’s credit lines, with predetermined criteria to cancel SDRs once crisis passed and Fund repaid.
    - This mechanism could serve as a preprogrammed “lender of last resort” during intense global liquidity demand.
- Other incentives and reserve-hoarding disincentives:
  - Proposal: impose a charge via a remunerated reserve ratio above certain thresholds, with proceeds used to bolster global reserve pools for emergency lending; remuneration at the market SDR rate.
  - Stronger incentives (e.g., a tax on persistent current account surpluses) are unlikely to find global support unless most countries had broadly balanced external positions or no excess reserves.
  - Asymmetric penalties could be announced with a long transition period and only after superior alternatives to self-insurance are secured.

### Supply-side Alternatives for Reserve Currencies (introductory)
- Alternatives considered: multiple or competing reserve currencies; an SDR-based system pooling main reserve currencies; and a bancor-style global reserve currency circulating alongside other currencies.
- Assessment criteria: stability, efficiency, political feasibility, ease of implementation, fairness.
- Multiple-currency system:
  - Several broadly substitutable reserve currencies could emerge (Euro, yen, Chinese RMB) if authorities take required steps.
  - Network externalities favoring a dominant currency are strong; historical bi-currency systems tended to converge to one dominant currency.
  - Such a system would impose policy discipline on reserve issuers and spread the “exorbitant privilege,” but may sacrifice some efficiency from scale economies and could increase exchange rate volatility unless key issuers coordinate policies.
  - Instability risks would be lower if precautionary reserve demand is tamed so reserves are held mainly for transactions purposes.

### SDR Resurrected: Properties, Transition, and Implementation
- Overview:
  - The SDR is a claim on a basket of currencies but not a currency itself; recent limited revival accounts for about 4 percent of global reserves.
  - If promoted to become the principal reserve asset, the SDR could permit a shift away from a dollar-centric system while preserving network externalities favoring a single currency-anchored IMS.
  - To play a significant role its liquidity would need to increase massively.
- Properties of an SDR-based system:
  - Stability:
    - SDR provides instant diversification by pooling main reserve currencies; more stable store of value and unit of account than component currencies taken separately.
    - Weights of currencies in the SDR basket are defined in “hard” terms (e.g., 44 U.S. dollar cents per SDR); relative weights adjust automatically with exchange rate movements, providing policy discipline on reserve issuers.
  - Balance:
    - An SDR-based system would spread the “exorbitant privilege” across countries whose currencies are in the SDR basket.
    - SDRs issued by the Fund, if targeted to emerging markets and developing countries in sufficient volume, would reduce the need for them to export capital to reserve-issuing countries.
    - A reconstitution rule might be necessary to prevent SDR allocations becoming pure transfers.
  - Coordination requirements:
    - Moving to an SDR-based system would require considerable global policy coordination, including U.S. support; mobilization seems doubtful unless the current system fails in a major way.
    - Less ambitious alternative: make the SDR one of the alternative reserve currencies in a multi-currency system.
- Liquidity and market development recommendations:
  - Increase issuance by the Fund.
  - Enhance SDR market liquidity through targeted Fund efforts.
  - Encourage and subsidize development of a private SDR market (e.g., Treasuries and private borrowers issuing SDR-denominated debt; some major countries pegging to and invoicing in the SDR).
- Substitution account and transition dynamics:
  - A global substitution account could speed transition if support mobilized, but may not be in broader membership’s interest because it socializes costs of adjusting large balance sheet positions concentrated in the dominant currency.
  - If demand for SDR-denominated reserve assets grows faster than supply of U.S.-issued reserve assets shrinks, the process could lead to an increase in U.S. interest rates, affecting interest rate differentials and bilateral exchange rates; pace of transition requires careful consideration.
- Historical precedent and implementation challenges:
  - Substitution account concept from the late 1970s involved swapping dollar assets for SDRs and converting short-term T-bills into longer-term claims on the U.S. Treasury; lack of agreement on cost sharing prevented implementation.
  - Making substitution account a reality today would require agreement on socializing exchange rate risk concentrated in large balance sheet positions.
- Wider alternatives:
  - A radical redesign could introduce a new “outside” money issued by an international monetary institution with governance geared to ensuring a stable value; political sovereignty concerns make this solution challenging.
  - Step from an SDR-based system to a sui generis global currency may be less of a leap than from today’s system, but political coordination, governance, balance sheet, and credibility issues remain substantial.

*Source: _spn0926 - Executive Summary (IMF).*

### Executive Summary ......................................................................................................

### _spn0926 - Executive Summary ......................................................................................................

### Executive Summary
- The global crisis revived concerns about the functioning of the international monetary system (IMS), highlighting inherent weaknesses of a system with a dominant country-issued reserve currency.
- Core tension: (1) scale and volatility of global capital flows, motivating ever larger reserve buffers; and (2) anchoring the IMS on one country’s currency (the U.S. dollar), despite the crisis originating in the U.S. financial system.
- Paper’s focus:
  - Demand side: explore alternative insurance arrangements to mitigate precautionary demand for reserves.
  - Supply side: assess alternative reserve assets that could offer sustained stability and efficiency.
- Many proposals would require fundamental changes in international cooperation and amendments to the IMF’s Articles of Agreement; incremental strengthening of the current system may be more realistic in the short term.

### I. Introduction
- Definition: IMS refers to rules and institutions for international payments, including currency/monetary regimes, rules for intervention, and institutions backing those rules through official credits, controls, or parity changes.
- Current characterization: a “non-system” with major currencies floating freely and other countries with varying degrees of exchange rate and capital flow controls.
- Since the demise of gold, the U.S. dollar has been the world’s principal reserve asset.
- Paper’s limits: does not attempt definitive solutions, given required scale of global policy coordination and legal changes.

### II. What Is Wrong with Today’s System?
- Long-term structural concerns:
  - Instability and perceived unfairness of an IMS based on one country’s currency.
  - Recurrence of concerns and phases of instability suggests need for durable remedies.
- Modern Triffin dilemma (Box 1):
  - Growing demand for safe (Treasury) assets can lead to indebtedness and ultimately undermine confidence in the reserve asset.
  - In a world with global capital flows, a single country producing global risk-free assets could, in principle, maintain external balance if public and private sectors offset foreign purchases; in practice, global demand tends to lower the reserve issuer’s real interest rates and provide incentives to dissave.
  - If the reserve issuer’s public sector refuses to accommodate foreign demand, alternative reserve assets (e.g., agency paper) could arise and may be lower quality/less usable in stress, causing “debasement” and deflationary bias.
- Exorbitant privilege and related effects:
  - Reliance on one country as key supplier of reserve assets gives that country an “exorbitant privilege”: greater macroeconomic policy space, liquidity of markets, ability to borrow in its own currency abroad at lower cost, and seignorage.
  - Example: the United States enjoyed a net capital gain from gradual dollar depreciation for several years in the run up to the crisis of over $1 trillion.
  - Dollar primacy since the 1970s has been earned by policy track record, open capital account, and deep financial markets.
- Asymmetric adjustment:
  - Greater pressure on nonreserve deficit countries to adjust than on surplus or reserve-issuing deficit countries, facilitating persistent surpluses and the buildup of global imbalances.
- Anchoring the center:
  - World is exposed to reserve issuer’s ability to preserve its currency value; remedies include stronger financial regulation, sustainable public finances, central bank independence, inflation-indexed instruments, and credible fiscal responsibility frameworks.
  - IMF surveillance and multilateral mutual assessment processes (e.g., G-20 Pittsburgh Summit agreement) could help, but surveillance lacks enforcement.
- Large reserve holdings:
  - Large official holdings distort global capital flows toward the center, reducing benefits of capital account liberalization and breeding market uncertainty, especially when holdings are concentrated.
  - Reserve concentration: a handful of countries account for more than half of total reserve holdings (see Figure 1).

Key numeric statements preserved exactly as in source:
- Insurance motives account for about two thirds of current reserve holdings, or $4 to $4½ trillion, and over half of the increase over the past decade (drawing on Obstfeld, Shambaugh, and Taylor, 2009).
- “Unallocated reserves” share growth: from 25.6 percent in 1995 to 37.1 percent in 2008.
- Reserve concentration figures (avg 2006-08): 23.1, 5.8, 4.7, 4.1, 3.5, 45.2, 13.7 (as presented in Figure 1).
- Example country reserve amounts shown in Figure 1: ($0.9 tr), ($3.0 tr), ($1.6 tr).
- United States net capital gain estimate: over $1 trillion (in the run up to the crisis).

### III. Lowering the Demand for Reserves
- Drivers of reserve accumulation:
  - Emerging markets hold reserves to buffer exchange rate adjustments, backstop potential banking crises, and boost policy credibility.
  - In some cases (e.g., oil exporters and China) reserve accumulation exceeds conceivable precautionary needs and reflects public savings motives or export-led growth strategies.
- Different motivations imply different responses; focus in this paper is on lowering the precautionary demand.
- Alternatives to self-insurance:
  - Third-party insurance:
    - Theoretically most efficient, but difficult to implement due to market failures: absence of liquid markets, significant upfront underwriting costs, difficulty pricing tail events, moral hazard, adverse selection, counterparty risks, and inability to diversify sovereign risks.
    - Even if market failures addressed, insurance likely limited to small- or medium-sized sovereign clients.
  - Borrowing from a global or regional reserves pool or access to a global lender of last resort:
    - Viable if viewed as credible and less costly alternatives to self-insurance.
- Longer-run reductions in self-insurance could occur if the “core” expands to include more emerging markets with policy credibility and truly floating exchange rate regimes holding minimal reserves, plus national and global prudential/regulatory measures and stronger surveillance over global financial stability.

*Source: _spn0926 - Executive Summary (IMF).*

### 12.      The IMF’s role. The IMF, given its global membership and crisis prevention and

### 12.      The IMF’s role. The IMF, given its global membership and crisis prevention and

### The Fund’s central role and constraints
- The IMF has a central role in fostering and offering alternatives to reserve accumulation given its global membership and crisis prevention and resolution mandates.
- The Fund already fulfills this role to some extent, but effectiveness of its instruments is hampered by concerns about governance and stigma.
- On-demand financing needs to be sufficient to offset a sudden stop or stem a bank run.
- The current crisis has rekindled the possibility that advanced countries may need external financing; Fund resources would need to be bolstered significantly to play a meaningful role in potentially financing all but the smallest advanced countries.
- Regional pools and bilateral swaps are useful complements to the IMF but have more limited scale, scope for risk sharing, and surveillance arrangements.

### Access to Precautionary Resources
- Creation of the Flexible Credit Line (FCL) and mainstreaming of high-access precautionary arrangements (HAPA) added contingent credit line instruments to the IMF toolkit.
- Not all countries qualify for these instruments, and there is no assurance of qualification when money is needed—this is exacerbated by perceptions of unfairness in the Fund’s governance.
- These instruments cannot be a direct substitute for reserves because of unpredictability of access.
- Recommendation: enhance predictability and reliability of access to the FCL with an objective qualification process to determine which member countries qualify (see Ostry and Zettelmeyer, 2005).
  - Trade-off: qualification decisions might need confidentiality to avoid destabilizing nonqualifying countries, but nonpublic decisions reduce market-confidence benefits.
  - Side benefit: objective qualification could incentivize countries to build track records of good policies.

### Increasing access to unconditional resources (proposals)
- A pure liquidity line:
  - Model: an overdraft facility similar to those enjoyed by commercial banks with central banks.
  - Access rights could be set in proportion to members’ quotas, or linked to another indicator of capacity to repay.
  - The first credit tranche policy provides a model: currently at 25 percent of quota and available effectively without conditionality.
  - Proposed size: substantially larger (e.g., 100 percent of quota subject to debt sustainability checks).
  - Impact would be larger if combined with a quota increase.
- Contingent general SDR allocations:
  - Instead of ad hoc allocations requiring an 85 percent majority of the IMF’s Governors, SDRs could be generated automatically at a predetermined pace, allocated only in case of systemic crises predefined on the basis of global economic and financial conditions.
  - Safeguard: ensure these resources address crises but do not become permanent transfers, e.g., by reinstating a reconstitution requirement whereby countries must rebuild SDR holdings up to a minimum share of cumulative SDR allocations over a certain time horizon.
- Supporting insurance markets:
  - The Fund could help develop insurance markets against exogenous shocks or encourage greater use of private sector hedging instruments by offering technical support.
  - Use surveillance to inform insurers and the public on the risk profile of potential clients.
  - Design features and moral hazard considerations:
    - Restrict insurance payouts to crises not caused by domestic policies.
    - Link availability and cost of safety net instruments to IMF surveillance assessments to strengthen incentives for good policies.
    - Make instruments contingent on country exposures to specific global conditions (e.g., commodity prices, the VIX index) with premia rising with risk profile.
    - Purely exogenous triggers may be feasible only for small economies relative to the world economy.
    - Clear preconditions tied to global indexes are key to prevent insurers reneging on contracts.
  - Limitations of greater Fund involvement in coordinating or providing insurance:
    - Balance sheet impact of systemic events.
    - Possible conflict of interest for surveillance assessments.
    - Risk of inducing irresponsible behavior by other insurers.
    - Conclusion: Fund role should probably be limited to supporting insurance or acting as a temporary market maker.
  - Feasibility: While designing insurance against systemic shocks is nearly impossible, insuring against country-specific external risks (e.g., commodity price slumps) is feasible and useful.
  - The Fund could provide a backstop to a potential global liquidity squeeze.

### A dependable governance structure
- Emerging markets’ limited confidence in Fund financing may reflect governance concerns.
- Remedies:
  - Rebalance IMF quotas and increase management/staff diversity to increase confidence that decisions are fair.
  - Alternatively, make qualification decisions (or have them reviewed) by a politically independent body of technocrats with incontrovertible analytical credentials (as suggested for early warnings by Stern, 2009).
- Challenge: forming a politically acceptable, insulated group to take or review qualification decisions would be difficult.

### Box 2 — Should the IMF Provide Country Capital Insurance?
- Observations:
  - Private-sector insurance against sudden stops has not been extended to sovereigns spontaneously.
  - Private contingent credit lines to sovereigns are limited; options on the VIX, EMBI, or CDS spread are rare; strategies to obtain significant payoffs from S&P500 declines are likely expensive.
  - The global catastrophe reinsurance market is mainly within advanced economies.
  - GDP-indexed bonds are rare and generally not tradable.
  - Market failures justify considering a global institution like the IMF to generate economies of scale, pool country-specific risks, and reduce pricing.
- Potential advantages of Fund-provided insurance:
  - Availability to entire membership with countries’ fundamentals and policies reflected in risk premia rather than binary qualification.
- Key issues to assess:
  - Pricing systemic risks: pricing rare systemic events is challenging despite the Fund’s capacity to identify systemic risks.
  - Balance sheet effects: near-global shocks with simultaneous payouts require premia to be invested to build a cushion; any Fund insurance facility should draw on a separate pool of resources than the General Resources Account.
  - Role of surveillance: surveillance assessments could determine risk premia, limiting adverse selection and moral hazard; but potential conflict of interest exists between unbiased surveillance and retaining an insured clientele. Very objective and automatic qualification criteria may minimize conflict.
  - Reverse moral hazard: private insurers might take more risks knowing Fund-backed countries are relatively safe.
- Design options to minimize concerns:
  - Exclude global shocks from insurance (still useful for idiosyncratic shocks).
  - Use clear and automatic criteria for suspending payouts under global crises; Fund liquidity-provider role would be key in such events (see ¶ 16).
  - Fund market-making role can be temporary, exiting once the market is deep enough.
  - Encourage greater use of private-sector insurance via surveillance, estimation of risk premia for alternative tail events, and promoting adherence to data dissemination standards.

### A Larger Pool of Resources — Some Considerations
- The needed resource base:
  - Academic assessments of minimum Fund resources range from $1 trillion (Johnson, 2008) to an unlimited amount as implied by Calvo’s (2009) call for the Fund as a lender of last resort.
  - A rough estimate of precautionary reserves currently held is around $4 to $4.5 trillion (¶ 10), six times the Fund’s lending capacity after the agreed tripling from pre-crisis levels.
- Ways to grow Fund lending capacity:
  - Indexed quotas:
    - Expand quotas and keep them growing in line with benchmarks of the size and perhaps volatility of the global economy (e.g., GDP, capital flows).
    - A simple indexation mechanism would be ideal but may be unrealistic given members’ budgetary frameworks.
    - A treaty-based presumption of indexation could be an alternative.
  - A reserve pool:
    - Willing members might pool part of their reserves (e.g., in a trust fund) offering control proportional to contributions.
    - Such a pool could supplement the Fund (similarly to the New Arrangements to Borrow, NAB) or finance alternative facilities not supported by the whole membership.
    - Contributors could have predominant say over resource use, addressing governance concerns.
    - Members could establish such a pool independently, but relying on the Fund to manage it offers convenience and efficiency.
  - New SDRs:
    - SDRs are currently created for long-term global needs and allocated unconditionally based on quotas.
    - Reforms could allow SDRs to be created and temporarily allocated to specific members to finance the Fund’s credit lines, enabling crisis response with limited resource constraints.
    - Predetermined criteria would cancel SDRs once the crisis passed and the Fund was repaid (see Cooper, 2009).
    - This mechanism could serve as a preprogrammed “lender of last resort” during intense global liquidity demand.
    - As SDRs are claims on stronger members’ reserves, this is conceptually analogous to a contingent reserve pool involving all strong members.

### Other incentives and reserve-hoarding disincentives
- Dampening reserve hoarding:
  - Proposal: impose a charge to cover potential instability caused by reserve hoarding through a remunerated reserve ratio above certain thresholds, with proceeds used to bolster global reserve pools for emergency lending.
  - Countries subject to the reserve requirement would be remunerated at the market SDR rate and thus not face incentive to reduce their own reserves; availability of these pooled resources to meet others’ liquidity needs would reduce demand for reserves.
  - Stronger incentives (e.g., a tax on persistent current account surpluses as mooted by Eichengreen (2009)) are unlikely to find global support unless most countries had broadly balanced external positions or no excess reserves.
  - To garner support, asymmetric penalties could be announced with a long transition period and only after superior alternatives to self-insurance are secured.

### Supply-side alternatives for reserve currencies (introductory)
- Alternatives to the dollar-based system considered: multiple or competing reserve currencies; an SDR-based system pooling main reserve currencies; and a bancor-style global reserve currency circulating alongside other currencies.
- Assessment criteria: stability, efficiency, political feasibility, ease of implementation, fairness.
- Trade-offs and winners/losers will affect feasibility; synchronous behavior change by major central banks and coordination among governments would be required for any change.
- Multiple-currency system:
  - Several broadly substitutable reserve currencies could emerge (Euro, yen, Chinese RMB) if authorities take required steps.
  - Overcoming strong network externalities that favor a dominant currency will be challenging; historical bi-currency systems have tended to converge to a dominant currency.
  - Such a system would impose policy discipline on reserve issuers, spread the “exorbitant privilege,” but may sacrifice some efficiency from scale economies and could increase exchange rate volatility unless key issuers coordinate policies.
  - Instability risks would be lower if precautionary reserve demand is tamed so reserves are held mainly for transactions purposes.

*Source: IMF staff chapter on “The IMF’s role” (content unit)_spn0926*

### 21.      SDR resurrected. The SDR—which is a claim on a basket of currencies but not a

### SDR resurrected.

### Overview
- The SDR—which is a claim on a basket of currencies but not a currency itself—is experiencing a renaissance after decades of near oblivion.
- Recent materialization of both demand (from BRIC central banks) and supply of SDR assets (from the Fund) has occurred, though on a limited scale—about 4 percent of global reserves.
- If promoted to gradually become the principal reserve asset in the system (as envisaged by the IMF’s Articles of Agreement), the SDR could permit a shift away from a dollar-centric system while preserving network externalities that favor a single currency-anchored IMS.
- As a composite product, the SDR offers a convenient means of reserve diversification and a stable store of value, but for it to take on a significant role its liquidity would need to increase massively.

### Properties of an SDR-based system
- Stability
  - An SDR-based system inherits many positives associated with a multiple reserve currency system.
  - Provides instant diversification benefits by pooling together the main reserve currencies; therefore, it is a more stable store of value and unit of account compared to its component currencies taken separately.
  - More convenient than managing an equivalent portfolio of the component currencies.
  - As a derivative product, the SDR’s quality as a store of value depends on the stability of the component currencies.
  - The weights of different currencies in the SDR basket are defined in “hard” terms (e.g., 44 U.S. dollar cents per SDR); relative weights adjust automatically on the basis of exchange rate movements, providing a policy disciplining mechanism on reserve issuers.
- Balance
  - An SDR-based system would spread the “exorbitant privilege” across the countries whose currencies make up the SDR basket.
  - Privilege-spreading could be achieved faster and more broadly than in the multiple reserve currency system where economies of scale remain important.
  - SDRs issued by the Fund, if targeted to emerging markets and developing countries in sufficient volume to make up a significant share of their reserves over time, would reduce the need for them to export capital to reserve issuing countries, since SDRs replicate the “hard” currency properties of the underlying components without the need to hold them (as suggested by Clark and Polak, 2004).
  - Adopting a rule requiring countries to reconstitute their holdings of SDRs over a certain horizon after spending them might be necessary to prevent such SDR allocations from being a pure transfer of resources and to make sure they actually boost reserves.
- Coordination requirements
  - Moving to an SDR-based system would be ground breaking and require considerable appetite for global policy coordination, including from the United States, whose reserve asset the SDR would replace.
  - Mobilization and sustained support seems doubtful unless the current system fails in a major way.
  - A less ambitious alternative would be to make the SDR one of the alternative reserve currencies in a multi-currency system.

### Liquidity and market development recommendations
- Increase issuance by the Fund.
- Enhance the liquidity of the SDR market through targeted Fund efforts.
- Encourage and subsidize development of a private SDR market, for example:
  - Treasuries and private borrowers issuing SDR-denominated debt (though settled in one of the component currencies).
  - Some major countries pegging to and invoicing in the SDR.
- If embraced by enough actors, liquidity could grow relatively rapidly.

### Substitution account and transition dynamics
- A global substitution account, as envisaged in the 1970s, could speed up transition to an SDR-based system if support could be mobilized.
- Such an account may not be in the interest of broader membership because it would socialize costs of adjusting a few large balance sheet positions concentrated in the dominant currency.
- If demand for SDR-denominated reserve assets grows faster than the supply of U.S.-issued reserve assets shrinks, the process could lead to an increase in U.S. interest rates, affecting interest rate differentials with other major currencies and bilateral exchange rates.
- The pace of transition would therefore warrant careful consideration.

### Historical precedent and implementation challenges (Box 4 summary)
- The substitution account concept dates to the late 1970s: central banks would swap dollar assets (typically short-term U.S. T-bills) for SDRs; the Fund would convert the U.S. T-bills for longer-term claims on the U.S. Treasury.
- The spread between the long-term interest rate and the short-term rate would help cover exchange rate risk, though there was no assurance this risk would be covered (e.g., shifts in relative demand could flatten the yield curve and reduce the term premium).
- Other risk-sharing mechanisms proposed historically included investing in government bonds of SDR component currencies or using a portion of the Fund’s gold stock to absorb costs.
- The scheme never came into force because members could not agree over cost sharing of these risks.
- Making a substitution account a reality today would require agreement on socializing exchange rate risk concentrated in certain large balance sheet positions.
- The status quo may offer better incentives toward orderly diversification because high costs of moving out of dollar assets too fast make such a move unlikely.

### Wider alternatives and longer-term considerations
- A radical redesign could introduce a new “outside” money issued by an international monetary institution with a governance structure geared to ensuring a stable value; such a currency could serve as the global risk free asset and transfer the “exorbitant privilege” to the institution’s membership.
- The step from an SDR-based system to a sui generis global currency may be less of a giant leap than from today’s system, though political sovereignty concerns make such a solution politically challenging.
- Implementation challenges for a new global reserve currency include political coordination, governance arrangements, size and composition of the institution’s balance sheet, measures to jumpstart network effects, and ensuring impeccable balance sheet credibility.

*Source: _spn0926 - 21.      SDR resurrected.*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/spn/2009/_spn0926.pdf_