## _wp13224

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### IMS definition, mandate, and scope
- IMS objective: contribute to stable and high global growth while fostering price and financial stability.
- IMS comprises:
  - exchange arrangements and exchange rates;
  - international payments and transfers relating to current international transactions;
  - international capital movements;
  - international reserves.
- IMF obligations and mandate:
  - Oversight of the IMS per Articles of Agreement.
  - Member obligations: pursue orderly economic growth with reasonable price stability, avoid manipulation of exchange rates, and follow compatible exchange rate policies.
  - 2007 broadened surveillance concept to “external stability” — “a balance of payments position that does not, and is not likely to, give rise to disruptive exchange rate movements” (IMF, 2007).
- Distinctions and limits:
  - IMS ≠ international financial system; IMF appraisal limited to domestic policies and conditions that may encompass the financial sector.
  - FSAP mandatory for 25 countries as part of surveillance since 2009.
- Political and institutional constraints:
  - Reform obstacles: inertia, ideology, vested interests, and network externalities.

### Aggregate performance and metrics (key statistics preserved)
- Real GDP Growth — World (Average Percent): 1970–1979 4.2; 1980–1989 3.1; 1990–1999 3.5; 2000–2007 4.0; 2008–2011 2.1.
- Real GDP Growth — World (Variability Percent): 1970–1979 36.5; 1980–1989 40.4; 1990–1999 19.8; 2000–2007 28.2; 2008–2011 12.1.
- Real GDP Growth — AEs (Average Percent): 1970–1979 3.6; 1980–1989 3.1; 1990–1999 2.8; 2000–2007 2.6; 2008–2011 0.2.
- Real GDP Growth — AEs (Variability Percent): 1970–1979 52.2; 1980–1989 50.0; 1990–1999 27.4; 2000–2007 33.2; 2008–2011 17.5*.
- Real GDP Growth — EDEs (Average Percent): 1970–1979 5.7; 1980–1989 3.4; 1990–1999 5.0; 2000–2007 6.4; 2008–2011 5.2.
- CPI Inflation — World (Average Percent): 1970–1979 10.3; 1980–1989 15.8; 1990–1999 15.3; 2000–2007 3.8; 2008–2011 3.9.
- CPI Inflation — AEs (Average Percent): 1970–1979 8.6; 1980–1989 6.5; 1990–1999 2.9; 2000–2007 2.1; 2008–2011 1.9.
- CPI Inflation — EDEs (Average Percent): 1970–1979 15.1; 1980–1989 41.7; 1990–1999 47.3; 2000–2007 6.7; 2008–2011 6.9.
- Great Moderation specifics:
  - Real GDP growth in AEs during Great Moderation (1984–2007): 3.0 percent.
  - Preceding 14-year period (1970–1983) AEs: 3.1 percent; coefficient of variation halved from 63 percent to 32 percent.
  - Inflation declined from 8.9 percent (1970–1983) to 3.0 percent (1984–2007); coefficient of variation increased from 34 percent to 44 percent.
  - Considering 1984–2011 together: AEs real GDP growth 2.6 percent (1984–2011) vs 3.6 percent (1970–1983); coefficient of variation broadly unchanged (62 percent vs 63 percent).

### Symptoms of malfunction: crises and public indebtedness
- Incidence of crises (No. per Year):
  - Gold Standard (1870–1913): Banking Crisis 1.3; Currency Crisis 0.6; External Default 0.9.
  - Interwar Period (1925–1939): Banking Crisis 2.1; Currency Crisis 1.7; External Default 1.5.
  - Bretton Woods (1948–1972) aggregate: Banking Crisis 0.1; Currency Crisis 1.9; External Default 1.1.
  - Post-Bretton Woods (1973–2010) aggregate rows in source include elevated crisis incidence (refer to source Table 2 for decade breakdowns).
- Public indebtedness:
  - Latest financial crisis produced historically high and rising public debt in AEs.
  - Cecchetti, Kohler and Upper (2009): in 40 financial crises, one-fourth resulted in cumulative output losses > 25 percent of pre-crisis GDP; one-third of crisis-related contractions lasted three years or more.
- Conclusion: post-Bretton Woods arrangement has not delivered global financial stability.

### Exchange rate flexibility, volatility, and reserve currency questions (key figures)
- Variability in Major Exchange Rates (coefficient of variation in percent):
  - 1970–1979: Yen/US Dollar 16.5; Pound Sterling/US Dollar 13.9; Swiss Franc/US Dollar 30.6; Euro/US Dollar 21.9*.
  - 1980–1989: Yen/US Dollar 26.0; Pound Sterling/US Dollar 13.5; Swiss Franc/US Dollar 18.9; Euro/US Dollar 21.7*.
  - 1990–1999: Yen/US Dollar 13.5; Pound Sterling/US Dollar 6.9; Swiss Franc/US Dollar 8.5; Euro/US Dollar 15.1*.
  - 2000–2009: Yen/US Dollar 8.6; Pound Sterling/US Dollar 14.7; Swiss Franc/US Dollar 17.9; Euro/US Dollar 18.3.
  - 2000–2012: Yen/US Dollar 13.0; Pound Sterling/US Dollar 24.5; Swiss Franc/US Dollar 27.9; Euro/US Dollar 18.2.
- Note: *: Data for euro/US dollar prior to 1999 pertain to deutsche mark/US dollar.
- Conclusion: floating exchange rates over the past half-century appear to have imparted instability to balance of payments and the global economy.

### Exchange and payment arrangements; capital controls
- Regime composition changes (1999–2010):
  - “Floaters” among IMF membership declined to 36 percent.
  - Managed floats rose from 15 percent to 20 percent.
  - Freely floating regimes fell from 27 percent to 16 percent.
  - Hard pegs declined from 25 percent to 13 percent.
  - Soft pegs increased from 34 percent to 51 percent.
- Article VIII adherence rose as EDEs dismantled controls on international payments and transfers.
- Almost all countries impose some controls on capital transactions, including major AEs: Belgium, Canada, Denmark, France, Germany, the United Kingdom and the United States.

### High flux in capital flows: magnitudes and boom-bust cycles
- Net private capital flows to developing countries (US$ billion):
  - 2002 US$165 billion; peak 2007 US$1.2 trillion; 2009 US$621 billion; 2010 and 2011 around US$1 trillion each.
- Net capital flows to developing countries (percent of GDP):
  - 1970 1.4 percent; 1977 4.1 percent; 1986 1.5 percent; 1997 5.1 percent; 2000 2.7 percent; 2007 7.7 percent; 2009 3.6 percent.
- Components and regional patterns (selected):
  - Net debt flows percent of GDP averages: 1970s 2.3 percent; 1990s 1.8 percent; 2000s 1.1 percent.
  - Regional net debt flows (US$ billion, selected decades): East Asia and Pacific 41 (1970s), 12 (1980s), 4 (1990s), 25 (2000s); All Developing Countries total capital flows 366 (1970s), 819 (1980s), 191 (1990s), 466 (2000s).
- Advanced Economies vs EDEs:
  - 2006 pre-crisis: capital inflows to the AEs almost eight times those of the EDEs.
  - Net capital inflows (2003–10 average, percent of GDP): EDEs 1.9 percent; AEs 1.2 percent.
  - Example volatility: net capital inflows to the AEs fell from US$9,384 billion in 2007 to US$4 billion in 2008.

### International assets and liabilities (Table 7 excerpts)
- Total assets (US$ trillion): 2003 47; 2004 57; 2005 63; 2006 80; 2007 102; 2008 99; 2009 102; 2010 110. (Percent of world GDP shown in source: (125), (134), (138), (163), (182), (162), (177), (174).)
- Advanced economies total assets (US$ trillion): 2003 43 (144); 2004 52 (156); 2005 57 (165); 2006 72 (199); 2007 91 (228); 2008 88 (208); 2009 90 (226); 2010 96 (231).
- Emerging and developing economies total assets (US$ trillion): 2003 4 (52); 2004 5 (54); 2005 6 (55); 2006 8 (61); 2007 11 (68); 2008 11 (59); 2009 13 (69); 2010 14 (66).

### Shadow banking and interconnectedness (key figures)
- Shadow banking system size:
  - Grew from US$26 trillion in 2002 to US$62 trillion in 2007; declined slightly in 2008; increased to US$67 trillion in 2011.
  - US$67 trillion equivalent to 111 percent of the aggregated GDP of all jurisdictions.
- Share of total financial intermediation: around 25 percent in 2011; pre-crisis peak 27 percent in 2007.
- Risks: maturity transformation and leverage performed by shadow entities; higher dependence on wholesale bank funding; concentration of risk and strong interconnectedness with regular banking system.

### IMF support capacity and constraints (examples)
- IMF peak program comparisons:
  - Portugal and Greece expected to peak at around US$ 26-27 billion in 2013-14 (2300-2400 percent of their respective quotas).
  - Brazil: US$ 28 billion in 2003 (600 percent of its quota).
  - Turkey: US$ 24 billion in 2002 (around 1700 percent of its quota).
  - Russia: US$ 19 billion in 1998 (around 300 percent of its quota).
  - Mexico: US$ 16 billion in 1995 (around 600 percent of its quota).
- Observation: funding needs of European economies have been a multiple of what IMF programs delivered; European institutions provided the remainder.
- Question: can the existing IMS handle much greater needs of large economies?

### Capital flows: empirical evidence and institutional view
- Empirical conclusions:
  - Benefits of capital account liberalization on growth are weak (CGFS, 2009; IMF, 2012a).
  - Reduced reliance on foreign capital associated with higher growth (Prasad et al., 2007).
  - Many fast-growing countries achieved high growth without open capital accounts.
  - Equity liberalization shows benefits; debt-flow liberalization generally not associated with positive growth impact.
  - EMEs with greater restrictions on capital inflows fared better during the NAFC (Ostry et al., 2010, 2011).
  - Rey (2013): exchange rate flexibility may not guarantee independent monetary policy under financial globalization.
  - Korinek (2011): full capital mobility may not be desirable under certain circumstances.
- IMF institutional view:
  - Recognizes benefits and risks of capital flows; allows some role for capital controls as temporary and secondary recourse.
  - Critiques: risk of mechanical application; danger of one-size-fits-all in surveillance.

### Policy recommendations on capital flows and surveillance
- Emphasize managing capital flows for domestic and systemic stability with country-differentiated tools.
- Authorities should retain flexibility to adopt macroeconomic, prudential and capital account management policies.
- Stigma attached to capital controls is unjustified given past usefulness.
- Capital account management measures may be first-line defenses and may need long-term retention for prudential reasons.
- Prudential regulations on external liabilities of banks, other financial institutions and corporations are part of capital account management.
- Surveillance reforms:
  - Post-crisis IMF reforms: Early Warning Exercise, Fiscal Monitor, Spillover Report, Pilot External Sector Report, G20 Mutual Assessment Process; Integrated Surveillance Decision (ISD) adopted July 2012 linking bilateral and multilateral surveillance.
  - Caution: integration should not compromise robust bilateral surveillance or bottom-up approaches.

### Self-insurance, reserve accumulation, and supply-demand projections (preserving scenario figures)
- Reserve accumulation facts:
  - Between end-March 2000 and end-June 2012, global reserves recorded a six-fold increase.
  - Reserve levels in EDEs rose 10 times over the same period; AEs reserves rose three-fold.
- Currency composition: close to 60 percent of global reserve holdings in US dollars; around 26 percent in euro (source tables referenced).
- IMF (2010b) projection:
  - If global reserves growth falls to 8.5 percent per year by 2035 from an average of 15.4 percent in 1999–2008, their level will reach 690 percent of US GDP.
  - Shorter-term extrapolations: reserves approaching 120 and 200 percent of US GDP in 2015 and 2020, respectively.
- Seven major EDE reserve-holders demand scenarios (2012–2017 NFAs required, US$ billion):
  - Net Foreign Assets ratio to reserve money 2011: Brazil 1.1; China 1.1; India 1.1; Korea 4.4; Russia 1.8; Saudi Arabia 9.4; Hong Kong 2011 NFAs 280 (see table below).
  - Projected NFAs required (2017) under scenarios:
    - Brazil: 2011 actual = 349; 2017 Scenario A = 883; Scenario B = 591; Scenario C = 470.
    - Hong Kong: 2011 actual = 280; 2017 Scenario A = 479; Scenario B = 329; Scenario C = 305.
    - China: 2011 actual = 3,776; 2017 Scenario A = 9,510; Scenario B = 6,483; Scenario C = 5,129.
    - India: 2011 actual = 286; 2017 Scenario A = 665; Scenario B = 460; Scenario C = 373.
    - Korea: 2011 actual = 309; 2017 Scenario A = 500; Scenario B = 330; Scenario C = 319.
    - Russia: 2011 actual = 491; 2017 Scenario A = 1,456; Scenario B = 755; Scenario C = 623.
    - Saudi Arabia: 2011 actual = 547; 2017 Scenario A = 1,393; Scenario B = 592; Scenario C = 569.
    - Total (seven countries): 2011 actual = 6,036; 2017 Scenario A = 14,886; Scenario B = 9,540; Scenario C = 7,788.
  - Increase range implied: US$1.8–8.9 trillion depending on scenario.
- Supply-side constraints example (US dollar supply):
  - Assuming unitary income elasticity of money demand and money multiplier 3.6 (end-2011 level), US monetary base increases from US$2.7 trillion (end-2011) to US$3.5 trillion (end-2017), an increase of US$0.8 trillion — smaller than US-dollar portion of estimated EDE demand (US$1.1–5.4 trillion).
  - Money multiplier fell from ~9 to 3.6 between end-2007 and end-2011 as monetary base rose from US$0.8 trillion to US$2.7 trillion.

### Currency internationalization: prerequisites, evidence, and limits
- Prerequisites for internationalization:
  - Deep and liquid financial and FX markets, convertibility, credible commitment to open capital account, liquidity in normal and stress times, a full yield curve, depth across credit qualities, macroeconomic and political stability.
- Stylized evidence:
  - China share in world GDP: 2012 = 11.1 percent; 2017 = 13.5 percent.
  - All EDEs share in world GDP: 2012 = 37.7 percent; 2017 = 42.5 percent.
  - FX turnover: EDE currencies individually generally < 1 percent of global turnover; BRICS share in turnover reported as 1.0 and later 2.1/2.2 in table excerpts.
- Costs and risks of internationalization:
  - Complicates monetary management; strains domestic financial system absorption capacity; reserve currency status might reduce international competitiveness via appreciation.
  - Internationalization entails costs such as potential sacrifice of domestic monetary and financial stability and vulnerability to Triffin-type dilemmas.
- Conclusion: emergence of EDE currencies as major reserve currencies will be gradual and contingent on market development, policy credibility, and overcoming network externalities.

### Central banks, financial stability, and policy prescriptions
- Diagnosis:
  - Price stability alone is insufficient for financial stability.
  - Financial sector size and structure can harm growth when excessive: credit/GDP ratios above 100 percent linked to higher volatility; when financial sector > 3.5 percent of total employment, further increases tend to be detrimental to growth.
- Recommendations:
  - Broaden central bank mandates beyond simplistic inflation targeting to include price and financial stability and growth considerations.
  - Return financial regulation and supervision to central banks (examples noted: United Kingdom, ECB).
  - Revisit separation of debt management from central bank functions.
  - Empower central banks with macroprudential instruments alongside conventional and non-conventional monetary instruments.
  - Ensure close coordination between central banks and governments given fiscal deficits and public debt levels.
- Illustrative EME example — India:
  - Reserve Bank of India retained multiple responsibilities and adopted a multiple indicator approach, exercised circumspect capital account opening and exchange rate management, and used financial regulation as an integral tool; India escaped the worst consequences of the international financial crisis.

### Concluding synthesis: diagnosis and policy priorities
- Major diagnosis:
  - IMS malfunction across multiple dimensions: volatile floating exchange rates, destabilizing free cross-border capital flows, amplified contagion via interconnected financial markets, and an increasingly tested US dollar role.
  - Liquidity needs of fast-growing EDEs likely to overwhelm supply of safe reserve assets.
- Long-run structural forces:
  - Aging in AEs implying progressive decline in savings and growth; East Asia and China may remain global savers until ~2025; later decades may tighten global liquidity.
- Institutional evolution:
  - New institutions and arrangements (FSB, G20, ESM, regional arrangements) suggest a shifting IMS with shared responsibilities.
- Policy priorities (preserved phrasing and order):
  - First: Domestic macroeconomic and financial stability is necessary for stable IMS. Central banks should be entrusted with broader mandates including financial regulation and supervision, and provided macroprudential instruments.
  - Second: Source countries should better internalize implications of their monetary policy for the global economy; international monetary coordination is desirable though difficult.
  - Third: EDEs should continue cautious capital account liberalization and practice active capital account management to respond to destabilizing flows.
  - Fourth: Reduction in volatility of capital flows could reduce precautionary reserve accumulation needs, but monetary/credit requirements of fast-growing EDEs may still require foreign asset acquisition to expand central bank balance sheets non-inflationarily.
  - Fifth: Regional currency arrangements can help in crises but cannot substitute for sustained reserve asset needs.
  - Combined approach: domestic macroeconomic and financial stability and EDE capital account management, together with major AE central banks internalizing global effects of their policies, can minimize pressures on the IMS and reduce incidence and virulence of financial crises.

*Italic: Source: _wp13224 (PDF chapter/section content provided).*

### References                                                                                                              

### References

### I. Introduction
- Global financial crisis of 2008-2009, the Great Recession and the euro area sovereign debt crisis renewed interest in reforming the international monetary system (IMS).
- Deficiencies of the IMS cited: global imbalances, exchange rate misalignments, volatility, high mobility and sudden stops in capital flows.
- Market volatility since May 2013 after a hint of tapering by the US Federal Reserve highlighted IMS deficiencies.
- Political context for reform: reflected in G20 deliberations.
- Reform obstacles: inertia of governments and international organizations, ideological concerns, vested interests, and network externalities associated with existing arrangements (Eichengreen and Sussman, 2000).
- Debate points:
  - Some argue the NAFC of 2008–2009 did not jeopardize international monetary stability (IMF, 2009c).
  - Crisis revealed IMS imperfections that facilitate unsustainable developments and expose the system to difficult-to-address shocks.
- Purpose of the paper: evaluate proposals on IMS facets and present responses reflecting an emerging and developing economy (EDE) standpoint.
- Paper organization (overview of sections):
  - Section 2: definition, ambit, scope, legal framework and core problems of the IMS.
  - Section 3: IMF surveillance function.
  - Section 4: new multilateral approaches for management of capital flows.
  - Section 5: rapid reserve accumulation and remedies including internationalization of EDE currencies.
  - Section 6: role of central banks in fostering financial stability.
  - Concluding section: synthesis.

### II. The International Monetary System — definition, mandate and scope
- IMS objective: contribute to stable and high global growth while fostering price and financial stability.
- IMS comprises four elements:
  - exchange arrangements and exchange rates;
  - international payments and transfers relating to current international transactions;
  - international capital movements;
  - international reserves.
- IMF obligations and mandate:
  - IMF required to exercise oversight of the IMS per Articles of Agreement.
  - Member country obligations: direct economic and financial policies to achieve orderly economic growth with reasonable price stability (“domestic stability”), avoid manipulation of exchange rates, and follow compatible exchange rate policies.
  - In 2007 IMF broadened surveillance concept to “external stability” — “a balance of payments position that does not, and is not likely to, give rise to disruptive exchange rate movements” (IMF, 2007) — while retaining focus on exchange rates.
- Mission creep concerns:
  - IMF expanding outreach ambit to topics such as poverty, climate change, inequality and financial supervision; these warrant caution as they could collide with national sovereignty and specialization.
  - Fund’s rationale: explore fiscal and financial stability consequences of these trends to incorporate them in strategic planning (IMF, 2013a).
- Distinction: IMS is not synonymous with the international financial system; IMF oversight is limited to appraisal of domestic policies and conditions that may encompass the financial sector.
- Since 2009, the Financial Sector Assessment Program (FSAP) (jointly with the World Bank) made mandatory for 25 countries as part of surveillance.
- Systemically important countries’ policies can create large negative externalities for the IMS through balance of payments or confidence channels; feasibility question: can IMF effectively constrain such policies?

### IMS Performance — evolution and metrics
- Historical evolution:
  - Gold standard era: free capital flows, fixed exchange rates, no independent monetary policy.
  - Interwar period: confusion leading to Bretton Woods — semi-fixed exchange rates and controlled capital flows allowing independent monetary policy.
  - Post-Bretton Woods (early 1970s onward): floating exchange rates, free capital flows, independent monetary policy in major advanced economies (AEs).
  - Monetary frameworks shifted from monetary targeting (1970s–1980s) to inflation targeting frameworks.
  - Financial regulation moved from intrusive to light-touch, reflecting preference for open capital accounts and belief in efficient financial markets.
- Impossible-trinity analogue: IMS caught in bind — domestic stability versus external stability versus global stability (Fleming, 1962; Mundell, 1963).
- Aggregate performance observations:
  - Average global growth tended to slow and become volatile, mainly due to developments in the AEs.
  - Growth in EDEs has recently provided some stability to global growth.
  - Inflation and inflation variability moderated globally in both AEs and EDEs (see Table 1).
  - Great Moderation commonly dated from early 1980s to 2007, but decadal comparisons show mixed signals.
- Key tabulated metrics (preserve exact figures as presented)
  - Table 1: IMS — Key Metrics (Average (Percent) and Variability (Percent)) — selected entries reproduced exactly as in source:
    - Real GDP Growth — World: 1970–1979 4.2; 1980–1989 3.1; 1990–1999 3.5; 2000–2007 4.0; 2008–2011 2.1; Variability 1970–1979 36.5; 1980–1989 40.4; 1990–1999 19.8; 2000–2007 28.2; 2008–2011 12.1.
    - Real GDP Growth — AEs: 1970–1979 3.6; 1980–1989 3.1; 1990–1999 2.8; 2000–2007 2.6; 2008–2011 0.2; Variability 1970–1979 52.2; 1980–1989 50.0; 1990–1999 27.4; 2000–2007 33.2; 2008–2011 17.5*.
    - Real GDP Growth — EDEs: 1970–1979 5.7; 1980–1989 3.4; 1990–1999 5.0; 2000–2007 6.4; 2008–2011 5.2; Variability 1970–1979 23.5; 1980–1989 37.3; 1990–1999 35.6; 2000–2007 28.1; 2008–2011 46.4.
    - CPI Inflation — World: 1970–1979 10.3; 1980–1989 15.8; 1990–1999 15.3; 2000–2007 3.8; 2008–2011 3.9; Variability 1970–1979 35.6; 1980–1989 11.7; 1990–1999 58.5; 2000–2007 9.6; 2008–2011 39.8.
    - CPI Inflation — AEs: 1970–1979 8.6; 1980–1989 6.5; 1990–1999 2.9; 2000–2007 2.1; 2008–2011 1.9; Variability 1970–1979 34.9; 1980–1989 53.2; 1990–1999 43.8; 2000–2007 13.9; 2008–2011 75.8.
    - CPI Inflation — EDEs: 1970–1979 15.1; 1980–1989 41.7; 1990–1999 47.3; 2000–2007 6.7; 2008–2011 6.9; Variability 1970–1979 40.0; 1980–1989 21.2; 1990–1999 70.5; 2000–2007 15.8; 2008–2011 26.5.
  - Note: Variability measured by coefficient of variation. Asterisk footnote: *: The jump reflects the impact of the negative growth in the AEs in 2009. Source: International Financial Statistics (IFS). IMF.
- Great Moderation specifics:
  - Real GDP growth over Great Moderation period (1984–2007) in AEs: 3.0 percent.
  - Preceding 14-year period (1970–1983) AEs: 3.1 percent; coefficient of variation halved from 63 percent to 32 percent.
  - Inflation declined from 8.9 percent in 1970–1983 to 3.0 percent in Great Moderation; coefficient of variation increased from 34 percent to 44 percent.
  - Considering 1984 to 2011 together, real GDP growth in AEs falls to 2.6 percent during 1984–2011 from 3.6 percent during 1970–1983; coefficient of variation broadly unchanged (62 percent during 1984–2011 vis-à-vis 63 percent during 1970–1983).

### Symptoms of Malfunction — crises and public indebtedness
- Increased incidence of crises in post-Bretton Woods period relative to earlier eras; notable rise in banking and currency crises.
- Table 2: IMS — Incidence of Crises (No. per Year) — exact figures reproduced:
  - Gold Standard (1870–1913): Banking Crisis 1.3; Currency Crisis 0.6; External Default 0.9.
  - Interwar Period (1925–1939): Banking Crisis 2.1; Currency Crisis 1.7; External Default 1.5.
  - Bretton Woods (1948–1972):
    - a) 1948–1958: Banking Crisis 0.1; Currency Crisis 1.7; External Default 0.7.
    - b) 1959–1972: Banking Crisis 0.0; Currency Crisis 1.4; External Default 0.3.
    - (aggregate Bretton Woods row shows 0.1, 1.9, 1.1 for Banking Crisis, Currency Crisis, External Default respectively).
  - Post-Bretton Woods (1973–2010):
    - a) 1973–1989: Banking Crisis 2.6; Currency Crisis 3.7; External Default 1.3.
    - b) 1990–2010: Banking Crisis 2.2; Currency Crisis 5.4; External Default 1.8.
    - (aggregate Post-Bretton Woods row shows 3.0, 2.4, 0.8 for Banking Crisis, Currency Crisis, External Default respectively).
  - Source: Bush, Farrant and Wright (2011) [Table A, p,7].
- Public indebtedness:
  - Latest financial crisis produced historically high and rising levels of public indebtedness across AEs.
  - Empirical evidence links large public debt overhang to lower growth and potentially massive cumulative shortfall in output (Reinhart, Reinhart and Rogoff, 2012).
- Crisis impact studies:
  - Cecchetti, Kohler and Upper (2009): financial crises are frequent and lead to larger-than-expected losses. In sample of 40 financial crises: one-fourth resulted in cumulative output losses > 25 percent of pre-crisis GDP; one-third of crisis-related contractions lasted three years or more.
- Conclusion: post-Bretton Woods system (flexible/floating exchange rates, freer capital flows, independent monetary policy) has not delivered global financial stability.

### Exchange Rate Flexibility — volatility and reserve currency questions
- Historical debate centers on exchange rate evolution of major currencies and its role as nominal anchor.
- Triffin dilemma (Triffin, 1960) questioned US dollar credibility and motivated creation of SDRs (Rangarajan and Patra, 2012).
- Floating exchange rates were expected to facilitate external adjustment and stability but experience showed wide gyrations and persistent misalignments in 1970s and 1980s; Plaza Accord (1985) was ineffective.
- Currency crises concentrated in 1990s: ERM crisis (1992-93), Mexican peso (1994), Asian crisis (1997-1998), collapse of Russian ruble and LTCM (1998), Turkish lira (2000-2001), Argentine peso (2001), Brazilian real (2002).
- Introduction of the euro in 1999 expected to impart stability; since early 2010 euro stresses (Greek crisis) raised questions on euro’s role as international reserve currency (IMF, 2012c).
- US dollar maintained dominance despite NAFC, but concerns persist: disruption of confidence in US sustainability would impair dollar’s role — Triffin dilemma re-emerges (Rangarajan and Patra, 2012).
- Volatility metrics:
  - Figure 1: Coefficients of Variation (10-year Moving Average) of Major Currencies (Yen/US$, £/US$, Swiss Franc/US$, Euro/US$) — figure referenced in text.
  - Table 3: Variability in Major Exchange Rates (coefficient of variation in percent) — exact figures reproduced:
    - Period 1970–1979: Yen/US Dollar 16.5; Pound Sterling/US Dollar 13.9; Swiss Franc/US Dollar 30.6; Euro/US Dollar 21.9*.
    - Period 1980–1989: Yen/US Dollar 26.0; Pound Sterling/US Dollar 13.5; Swiss Franc/US Dollar 18.9; Euro/US Dollar 21.7*.
    - Period 1990–1999: Yen/US Dollar 13.5; Pound Sterling/US Dollar 6.9; Swiss Franc/US Dollar 8.5; Euro/US Dollar 15.1*.
    - Period 2000–2009: Yen/US Dollar 8.6; Pound Sterling/US Dollar 14.7; Swiss Franc/US Dollar 17.9; Euro/US Dollar 18.3.
    - Period 2000–2012: Yen/US Dollar 13.0; Pound Sterling/US Dollar 24.5; Swiss Franc/US Dollar 27.9; Euro/US Dollar 18.2.
  - Note: *: Data for euro/US dollar prior to 1999 pertain to deutsche mark/US dollar. Source: IFS, IMF.
- Conclusion: floating exchange rates over past half-century appear to have imparted instability to balance of payments and global economy.

### Exchange and Payment Arrangements — regime composition and capital controls
- Exchange arrangement composition changes (1999–2010):
  - Proportion of “floaters” among IMF membership declined to 36 percent.
  - Managed floats rose from 15 percent to 20 percent.
  - Freely floating regimes fell from 27 percent to 16 percent.
  - Hard pegs (no separate legal tender and currency boards) declined from 25 percent to 13 percent.
  - Soft pegs (conventional pegs, stabilized arrangements, crawling pegs and other crawl-like arrangements, pegged rates with horizontal bands, and other managed arrangements) increased from 34 percent to 51 percent.
- Article VIII adherence (1970–2009):
  - As globalization progressed, EDEs dismantled controls on international payments and transfers; number of countries accepting Article VIII obligations steadily increased while those with transitional arrangements declined substantially.
- Capital transaction controls:
  - Almost all countries impose some controls on capital transactions (Table 4).
  - This includes major AEs: Belgium, Canada, Denmark, France, Germany, the United Kingdom and the United States.
- Table 4 referenced: IMS — Summary Features of Exchange Arrangements for Current and Capital Transactions (columns and further details appear in source text).

*Italic: Source: _wp13224 - References (source PDF content provided)._

### 1. Article  VIII  status  (no  restrictions  on  payments

### _wp13224 - 1. Article  VIII  status  (no  restrictions  on  payments

### High Flux in Capital Flows — overview and historical patterns
- Post-Bretton Woods IMS characterized by massive increase in capital flows across borders, marked by high volatility, surges, sudden stops, reversals and attendant macroeconomic and financial instability, with concomitant impact on exchange rates.
- 1970s: private capital flows to developing countries rose strongly; by the end of the 1980s, direct investment inflows to developing countries were only one-eighth of flows to developed countries, and portfolio flows to developing countries were virtually non-existent.
- 1990s: FDI accounted for the bulk of private capital flows to EDEs, going through a six-fold jump between 1990 and 1997; share of FDI in net capital flows increased from a fourth in 1990 to over a half by 1997.
- US monetary conditions and capital flows:
  - US federal funds rate fell from 10 percent in April 1989 to 3 percent by January 1993.
- Net private capital flows to developing countries:
  - increased from US$165 billion in 2002 to a peak of US$1.2 trillion in 2007,
  - fell to US$621 billion in 2009,
  - recovered to around US$ 1 trillion each in 2010 and 2011.
- Recent volatility: large outflows during June-August 2013; near-term growth prospects of major emerging economies affected by May-August 2013 episodes on news of possible UMP tapering by the US Federal Reserve.

### Capital flows as percent of developing countries' GDP — boom-bust cycles
- Net capital flows to developing countries (percent of GDP) history:
  - 1970: 1.4 percent of GDP
  - 1977: 4.1 percent of GDP
  - 1986: 1.5 percent of GDP
  - 1997: 5.1 percent of GDP
  - 2000: 2.7 percent of GDP
  - 2007: 7.7 percent of GDP (all-time peak)
  - 2009: 3.6 percent of GDP
- Implication: large short-term changes in capital flow volumes create excessive volatility in exchange rates, domestic liquidity and monetary conditions, and asset prices, complicating macroeconomic management.

### Components of capital flows — stability and regional distinctions
- Net FDI flows: relatively high degree of stability.
- Net debt flows (percent of GDP) trend:
  - 1970s average: 2.3 percent of GDP
  - 1990s average: 1.8 percent of GDP
  - 2000s average: 1.1 percent of GDP
- Regional patterns (annual averages, US$ billion; Table 5 excerpts):
  - Net Debt Flows
    - East Asia and Pacific: 41 (1970s), 12 (1980s), 4 (1990s), 25 (2000s)
    - Europe and Central Asia: 36 (1970s), 14 (1980s), ? (1990s), 71 (2000s)
    - Latin America and Caribbean: 16 (1970s), 17 (1980s), 33 (1990s), 17 (2000s)
    - Middle East and North Africa: 46 (1970s), 2 (1980s), -1 (1990s)
    - South Asia: 27 (1970s), 4 (1980s), 15 (2000s)
    - Sub-Saharan Africa: 48 (1970s), 4 (1980s), 5 (2000s)
    - All Developing Countries: 325 (1970s), 58 (1980s), 2 (1990s), 131 (2000s)
  - Total Capital Flows (net)
    - East Asia and Pacific: 41 (1970s), 56 (1980s), 7 (1990s), 139 (2000s)
    - Europe and Central Asia: 36 (1970s), 21 (1980s), ? (1990s), 138 (2000s)
    - Latin America and Caribbean: 182 (1970s), 380 (1980s), 191 (1990s), 103 (2000s)
    - Middle East and North Africa: 57 (1970s), 4 (1980s), ? (1990s), 15 (2000s)
    - South Asia: 27 (1970s), 8 (1980s), ? (1990s), 42 (2000s)
    - Sub-Saharan Africa: 5 (1970s), 10 (1980s), 11 (1990s), 28 (2000s)
    - All Developing Countries: 366 (1970s), 819 (1980s), 191 (1990s), 466 (2000s)
- Note: table entries follow source presentation; some decade cells in the source show compressed formatting.

### Advanced Economies (AEs) vs Emerging and Developing Economies (EDEs)
- 2006 (pre-crisis): capital inflows to the AEs were almost eight times those of the EDEs (per source tables and figures).
- Net capital inflows (2003-10 average, percent of GDP):
  - EDEs: 1.9 percent of GDP
  - AEs: 1.2 percent of GDP
- Example extreme volatility in AEs:
  - Net capital inflows (from non-residents) to the AEs fell from US$9,384 billion in 2007 to US$4 billion in 2008.
- Table 6 (selected aggregates, US$ billion):
  - Net outflows by residents: 2,881 (2003), 4,838 (2004), 6,137 (2005), 7,461 (2006), 10,293 (2007), 279 (2008), 213 (2009), 3,723 (2010)
  - Net inflows from non-residents: 3,458 (2003), 5,299 (2004), 6,703 (2005), 8,160 (2006), 11,231 (2007), 1,061 (2008), 1,102 (2009), 4,555 (2010)
  - Net capital inflows: 577 (2003), 462 (2004), 566 (2005), 699 (2006), 938 (2007), 782 (2008), 889 (2009), 832 (2010)
  - Of which: Developing Asia net capital inflows: 62 (2003), 138 (2004), 128 (2005), 90 (2006), 221 (2007), 84 (2008), 219 (2009), 346 (2010)
- Note: source indicates both inflows and outflows are exclusive of movements in foreign exchange reserves.

### International assets and liabilities — scale and change (Table 7)
- Total assets (US$ trillion):
  - 2003: 47
  - 2004: 57
  - 2005: 63
  - 2006: 80
  - 2007: 102
  - 2008: 99
  - 2009: 102
  - 2010: 110
  - Percentages to world GDP shown in parentheses in source: (125), (134), (138), (163), (182), (162), (177), (174)
- Advanced economies total assets (US$ trillion) and percent of AE GDP:
  - 2003: 43 (144)
  - 2004: 52 (156)
  - 2005: 57 (165)
  - 2006: 72 (199)
  - 2007: 91 (228)
  - 2008: 88 (208)
  - 2009: 90 (226)
  - 2010: 96 (231)
- Emerging and developing economies total assets (US$ trillion) and percent of EDE GDP:
  - 2003: 4 (52)
  - 2004: 5 (54)
  - 2005: 6 (55)
  - 2006: 8 (61)
  - 2007: 11 (68)
  - 2008: 11 (59)
  - 2009: 13 (69)
  - 2010: 14 (66)
- Total liabilities follow similar magnitudes; see source table for full detail.

### Interconnectedness and the Shadow Banking System
- Large two-way capital flows increased interconnectedness across financial institutions and countries, magnifying and propagating risks globally.
- Shadow banking system size:
  - Grew from US$26 trillion in 2002 to US$62 trillion in 2007,
  - Declined slightly in 2008,
  - Increased to US$67 trillion in 2011 (equivalent to 111 percent of the aggregated GDP of all jurisdictions).
- Shadow banking system's share of total financial intermediation:
  - Around 25 percent in 2011,
  - Pre-crisis peak was 27 percent in 2007.
- The aggregate size of the shadow banking system is around half the size of banking system assets (FSB, 2012).
- Risks associated with shadow banking:
  - Can perform bank-like functions such as maturity transformation and leverage.
  - Shadow banking entities are generally more dependent on wholesale bank funding on the liability side and more heavily invested in bank assets than banks themselves on the asset side.
  - Such structures can concentrate risk and increase systemic vulnerability, especially through strong interconnectedness with the regular banking system.

### IMF support and limits of the IMS
- IMF credit examples (stock of existing and prospective Fund credit):
  - Portugal and Greece expected to peak at around US$ 26-27 billion in 2013-14 (2300-2400 percent of their respective quotas).
  - Previous largest Fund program peak support: US$ 28 billion for Brazil in 2003 (600 percent of its quota).
  - Other major programs: Turkey US$ 24 billion in 2002 (around 1700 percent of its quota); Russia US$ 19 billion in 1998 (around 300 percent of its quota); Mexico US$ 16 billion in 1995 (around 600 percent of its quota).
- Observation: funding needs of European economies in recent episode have been a multiple of what IMF programs delivered; the rest provided by European institutions.
- Question raised by source: will the existing IMS be able to handle much greater needs of large economies should such needs arise?

### Policy implications and recommendations (as stated in source)
- EDEs manage exogenous shocks through active management of capital flows and reserve accumulation, given limited absorption capacity.
- To minimize exogenous shocks originating from AEs:
  - Continue banking sector reforms through tighter regulation and supervision;
  - Better measurement of risks that accompany financial innovations;
  - Build a forward-looking national risk accounting system (Gorton, 2012).

### Reserve accumulation — facts and regional patterns
- Between end-March 2000 and end-June 2012, global reserves recorded a six-fold increase.
- Reserve levels in the EDEs rose 10 times over the same period, compared with a three-fold increase in the AEs (Table 8 note).
- Currency composition of allocated reserves has remained concentrated in US dollars (from somewhat incomplete data).
- Regional shares by 2011:
  - Asia’s share in global reserves: 38 percent (dominant), accounting for more than half of the reserves of all emerging economies combined.
  - Emerging Europe: reserves shot up five-fold in the 1990s.
  - 2000s: oil-exporting Middle Eastern and North African countries experienced a nine-fold rise in reserves.

*Source: IMF (excerpts from _wp13224 - 1. Article  VIII  status  (no  restrictions  on  payments).*

### 1. World 1,809

### _wp13224 - 1. World 1,809

### World (row 1)
- 1,809 
- (5.6) 
- 1,401 
- (77.4)
- 71.52.96.30.3        17.51.5

### Advanced economies (row 2)
- 1,132 
- (4.4) 
- 1,019 
- (90.0)
- 70.72.97.20.3        17.21.7

### Emerging and developing economies (row 3)
- 677 
- (10.3) 
- 382 
- (56.5)
- 73.52.93.90.3        18.31.2

### June 2012 (rows 4–5)
- World
  - 10,523 
  - (14.6) 
  - 5,845 
  - (55.5)
  - 61.93.83.80.1        25.15.3
- Advanced economies
  - 3,542 
  - (7.9) 
  - 3,152 
  - (89.0)
  - 64.12.54.50.1        24.54.3

*Source: _wp13224 - 1. World 1,809 (PDF chapter/section).*

### 6. Emerging and

### 6. Emerging and developing economies

### IMS: Overall assessment
- Objective: IMS to contribute to stable and high global growth in an environment of macroeconomic and financial stability.
- Key findings:
  - Global growth has been both lower and more volatile in the post-1984 period than in the preceding decade.
  - The frequency of banking and currency crises has increased in the post-Bretton Woods regime compared to the Bretton Woods regime and exceeds that of the inter-war period.
  - Flexible exchange rates in the post-Bretton Woods regime led to higher exchange-rate volatility without benefits to the real economy.
  - Increased openness of capital accounts in AEs and EDEs coincided with volatile capital flows driven significantly by monetary policy stance of major AEs, producing surges and sudden crashes in flows and associated booms and busts in asset prices.
  - EDEs accumulated foreign exchange reserves to foster domestic macroeconomic and financial stability; these reserves were recycled back to AEs, contributing to lower long-term interest rates in AEs but originating from excess private capital flows driven by AE policies.

### IMF surveillance: critique and reforms
- Pre-2008 surveillance shortcomings:
  - Warnings were too scattered and unspecific; IMF surveillance significantly underestimated combined risk across sectors, and the importance of financial sector feedback and spillovers.
  - Optimistic bottom-line messages for “core” economies (United States, United Kingdom); missed key connections to shadow banking dangers.
- Post-crisis surveillance improvements (undertaken within existing legal framework):
  - Enhanced synergies among IMF products: greater integration of multilateral macro-financial analysis in WEO and GFSR; introduction of an Early Warning Exercise, the Fiscal Monitor, the Spillover Report, the Pilot External Sector Report, and the G20 Mutual Assessment Process.
  - Bilateral surveillance: Article IV reports with multi-country/cross-country/cluster analyses; improvements in timeliness.
  - Financial Sector Stability Assessment (FSSA) made mandatory for 25 countries with systemically important financial sectors.
  - Closer cooperation with standard-setting bodies, including the FSB.
- IEO (IMF, 2011a) observations on 2004–07 surveillance failures:
  - Hindered by groupthink, intellectual capture, mindset that a major financial crisis in large advanced economies was unlikely, incomplete analytical approaches, weak internal governance, unclear responsibility lines, lack of incentives to work across units and raise contrarian views, and a review process that did not “connect the dots”.
- Governance point:
  - Traction (translation of policy advice into action) depends on trust and perception of even-handedness; modernization of surveillance must flow from and cannot precede reforms in governance.

### Integrated Surveillance Decision (ISD)
- Adopted July 2012: Decision on Bilateral and Multilateral Surveillance (ISD).
- Enhancements:
  - Conceptual link between bilateral and multilateral surveillance; Article IV consultations can address multilateral spillovers from a member’s policies.
  - Adds guidance on domestic policies relevant to domestic stability in bilateral surveillance.
  - Clarifies scope and modalities for multilateral surveillance and a framework for possible multilateral consultations.
- Caution:
  - Integration should not compromise robust, even-handed bilateral surveillance nor the incisiveness of bottom-up approaches.

### Capital flows: multilateral framework debate
- Drivers for debate:
  - Continued volatility in capital flows after the NAFC; challenges include volatility, interconnectedness/shock transmission, size, global drivers (aging, growth differentials, global liquidity, asset-liability practices, market microstructure), and information gaps.
  - The IMF has sought an institutional view and consistent framework for managing capital flows as part of IMS reform.
- Monetary policy coordination question:
  - Deviations of AE monetary policies from rule-based policies (e.g., Taylor rule) can induce other economies to impose capital controls, intervene, or set interest rates to follow AEs; the earlier view that no international coordination of monetary policies is needed must be revisited.

### Capital account liberalization: empirical evidence
- Conventional wisdom: capital flows improve resource allocation and benefit source and recipient countries.
- Empirical evidence: benefits of capital account liberalization on growth are weak (CGFS, 2009; IMF, 2012a).
- Key empirical points:
  - Reduced reliance on foreign capital is associated with higher growth (Prasad et al., 2007).
  - Developing economies often constrained by investment opportunities rather than savings (Rodrik and Subramanian, 2009); foreign finance can appreciate the real exchange rate and hurt traded goods sector profitability.
  - Many fast-growing countries achieved high growth without open capital accounts (Japan, East Asia, Western Europe in Bretton Woods era).
  - Free movement of debt flows generally not associated with positive growth impact; equity market liberalization shows benefits but may reflect supportive reforms that accompany liberalization (Henry, 2007).
  - EMEs with greater restrictions on capital inflows fared better during the NAFC; higher pre-crisis capital inflow restrictions linked to smaller growth declines (Ostry et al., 2010, 2011).
  - Little convincing documentation of direct positive impact of financial opening on welfare/growth in developing countries (Obstfeld, 2009).
  - Evidence supports calibrated, well-sequenced opening and active management with complementary reforms (CGFS, 2009; Obstfeld, 2009).
  - Rey (2013): exchange rate flexibility no longer guarantees independent monetary policy under financial globalization; independent monetary policies possible only if capital account is managed directly or via macroprudential policies.
  - Under certain circumstances full capital mobility may not be desirable (Korinek, 2011); vulnerability to financial crises is a principal cost (Reinhart and Reinhart, 2008; Furceri, Guichard and Rusticelli, 2011).

### New proposals and pitfalls (IMF institutional view & policy stance)
- IMF institutional view: recognizes benefits and risks of capital flows; sees some role for capital controls but stresses temporariness and secondary recourse.
- Critiques:
  - Institutional view may be premature; risk that staff could apply it mechanically as a checklist in Article IV surveillance.
  - Formalizing bilateral surveillance principles on capital account policies risks one-size-fits-all approaches without deep understanding of flow drivers.
- Policy recommendations from chapter:
  - Emphasize managing capital flows for domestic and systemic stability with appropriate, country-differentiated tools and the right policy mix rather than ad hoc liberalization.
  - Authorities should retain flexibility and discretion to adopt macroeconomic, prudential and capital account management policies.
  - Stigma attached to capital controls is unjustified given their usefulness in past episodes.
  - Capital account management measures may be first-line defenses and may need to be retained long-term for prudential reasons; they need not imply less openness.
  - Prudential regulations on external liabilities of banks, other financial institutions and corporations are part of capital account management.

### Self-insurance (reserve accumulation) and internationalization: trends and risks
- Reserve accumulation:
  - Past two decades: massive reserve accumulation, primarily by EDEs.
  - Reserves increased relative to GDP, imports, gross capital formation and short-term debt (Table 10 shows, e.g., Global months of imports: 4.4, 5.2, 13.5 for 1990, 2000, 2010; Percent of GDP: 5.2 @6.9 17.1; Emerging and Developing Economies months of imports: 5.6 6.2 16.3; Percent of GDP: 6.6 @11.3 28.7; Percent of short-term debt for EDEs: 107.5 @229.5 556.5).
  - Close to 60 percent of global reserve holdings are in US dollars; around 26 percent in euro (Table 8, Figure 6 referenced).
- Risks from US dollar concentration:
  - Large global demand for US government debt lowers yields below market equilibrium, creating incentives for higher deficits and debt, potentially undermining reserve asset value (Triffin dilemma risk).
  - Lower benchmark yields can encourage search-for-yield and under-pricing of risk, contributing to vulnerabilities (observed mid-2000s).
  - Reserve concentration in US government debt introduces idiosyncratic risks to the IMS stemming from US policies.
- Can capital outflow liberalization by surplus EMEs alleviate Triffin issues?
  - Proposal: liberalize capital outflows to diversify domestic savings abroad (Bayoumi and Ohnsorge (2013) estimate China outflows 4-18 percent of GDP).
  - Limitations: home bias, dubious quality of capital controls indices, existing sovereign wealth funds already invest abroad, investments in AE assets would sustain dollar pressures, outflow liberalization often accompanies inflow liberalization, empirical evidence indicates limited benefits and risks of crises following liberalization.
  - Conclusion: outflow liberalization may help only marginally and could introduce more challenges.

### Central banks, monetary policy and reserve demand projections
- IMF (2010b) projection:
  - If global reserves growth falls to 8.5 percent per year by 2035 from an average of 15.4 percent in 1999–2008, their level will reach 690 percent of US GDP.
  - Shorter-term extrapolations: reserves approaching 120 and 200 percent of US GDP in 2015 and 2020, respectively (IMF, 2010b).
- Concentration: in 2012, China held almost 30 percent of global reserves; Japan held 11 percent.
- Demand-side scenario analysis for seven major EDE reserve holders (2012–2017):
  - Method: use WEO (April 2012) projections for real GDP growth and inflation, trends in implicit income elasticity of money demand from 2000s to project nominal money demand/supply and reserve money; generate three scenarios for NFAs contribution to reserve money expansion:
    - Scenario A: NFAs/reserve money ratio remains at end-2011 levels (around 1.1 for Brazil/China/India; 1.8 Russia; 2.0 Hong Kong; 4.4 Korea; 9.4 Saudi Arabia).
    - Scenario B: NFAs contribute 50 percent to reserve money expansion (2012–2017).
    - Scenario C: NFAs contribute 25 percent to reserve money expansion (2012–2017).
  - Table 11 (Net Foreign Assets ratio to reserve money) excerpt: Brazil 2011 = 1.1; China 2011 = 1.1; India 2011 = 1.1; Korea 2011 = 4.4; Russia 2011 = 1.8; Saudi Arabia 2011 = 9.4.
  - Table 12 (US$ billion) projected NFAs required (2017) under scenarios:
    - Brazil: actual 2011 = 349; 2017 Scenario A = 883; Scenario B = 591; Scenario C = 470.
    - Hong Kong: actual 2011 = 280; 2017 Scenario A = 479; Scenario B = 329; Scenario C = 305.
    - China: actual 2011 = 3,776; 2017 Scenario A = 9,510; Scenario B = 6,483; Scenario C = 5,129.
    - India: actual 2011 = 286; 2017 Scenario A = 665; Scenario B = 460; Scenario C = 373.
    - Korea: actual 2011 = 309; 2017 Scenario A = 500; Scenario B = 330; Scenario C = 319.
    - Russia: actual 2011 = 491; 2017 Scenario A = 1,456; Scenario B = 755; Scenario C = 623.
    - Saudi Arabia: actual 2011 = 547; 2017 Scenario A = 1,393; Scenario B = 592; Scenario C = 569.
    - Total (seven countries): 2011 actual = 6,036; 2017 Scenario A = 14,886; Scenario B = 9,540; Scenario C = 7,788.
  - Increase range: US$1.8–8.9 trillion (depending on scenario).
- Supply-side constraints:
  - Reserves demanded by EDEs are supplied mainly in US dollar (~60 percent) and euro (~26 percent).
  - US case: assuming unitary income elasticity of money demand and money multiplier 3.6 (level at end-2011), US monetary base increases from US$2.7 trillion (end-2011) to US$3.5 trillion (end-2017), an increase of US$0.8 trillion — smaller than the US-dollar portion of estimated EDE demand (US$1.1–5.4 trillion).
  - QE/UMP caveat: continuation or reversal of QE affects US monetary base and consequently availability of reserve assets; money multiplier fell from ~9 to 3.6 between end-2007 and end-2011 as monetary base rose from US$0.8 trillion to US$2.7 trillion.
  - If Fed reverses QE, US monetary base may not expand, widening the gap between EDE demand and available reserve assets.

### Currency internationalization: prerequisites, stylized evidence, and prospects
- Phenomenon: as EMEs integrate into global trade and finance and deepen domestic financial markets, their currencies may play a larger role internationally; local-currency assets and mutual funds are slowly expanding.
- Prerequisites for internationalization (Rangarajan and Patra, 2012):
  - Deep and liquid financial and FX markets; convertibility and credible commitment to open capital account; liquidity (narrow bid-offer spreads in normal and stress times); a full yield curve; depth across credit qualities.
  - Wide private sector use linked to share in world GDP, trade, and finance; macroeconomic and political stability.
- Stylized evidence:
  - Economic size is an important determinant; EDEs collectively accounted for 38 percent of global GDP in 2012 and projected 43 percent in 2017, but only a few EDE currencies (Brazilian real, Chinese renminbi, Indian rupee, Russian ruble, South African rand) have economic weight and regional importance.
  - Share in world GDP table (selected): China 2012 = 11.1 percent; China 2017 = 13.5 percent; All EDEs 2012 = 37.7 percent; All EDEs 2017 = 42.5 percent.
  - Shares in global exports and capital flows remain dominated by euro area and US; China notable but other EDE currencies have small shares.
  - Secondary financial indicators (financial depth, capital account openness, FX market turnover, bid-ask spreads) generally weaken case for rapid emergence of EDE currencies as global reserve currencies.
  - FX turnover shares: EDE currencies individually constitute less than 1 percent of global turnover, though sharp increases occurred in 2000s for some (Hungary, Turkey, China, India).
- Conclusion:
  - Currency internationalization is constrained by network externalities, home bias, depth/liquidity requirements, and macro-policy credibility.
  - A properly tiered multipolar international currency system can benefit global stability, but EDE currency emergence as reserve currencies will be gradual and contingent on market development and policy choices.

*Source: _wp13224 - 6. Emerging and developing economies*

### 1. Data for the euro area adjusted to exclude intra euro area trade.

### 1. Data for the euro area adjusted to exclude intra euro area trade

### Adjustment description
- The dataset provides data for the euro area that has been adjusted to exclude intra euro area trade.

### Intended use
- To analyze external trade flows of the euro area net of trade occurring between euro area member countries.

*Source: _wp13224 - 1. Data for the euro area adjusted to exclude intra euro area trade.*

### 2. Data for China include Mainland China and Hong Kong SAR. For exports of goods and

### _wp13224 - 2. Data for China include Mainland China and Hong Kong SAR. For exports of goods and

### Global foreign exchange market turnover (Table 16: Global Foreign Exchange Market Turnover)
- Table reports "Share in global daily average turnover in percent".
- Total Turnover @ / Turnover in Derivatives Market # (selected currency shares by year as presented):
  - US dollar: 44.9 44.0 44.9 42.4     44.0
  - Euro: 19.0     18.7 19.0 19.5     17.3
  - Japanese yen: 11.8 10.4 11.8 9.5     9.1
  - Pound sterling: 6.5 8.2 6.5 6.4     6.0
  - Other advanced economies &: 11.6 12.4 11.6 14.9     15.8
  - BRICS: 1.0     1.0 1.0 2.1 2.2
  - Others: 5.2     5.3 5.2 5.2     5.6
- Memo: Total daily average global turnover (all currencies) — US$ billion:
  - 1239
  - 1934
  - 3324
  - 3981
  - 2488
- Notes attached to table:
  - @: includes turnover in the spot, forwards, swaps, options and other products.
  - #: includes turnover in the forwards, swaps, options and other products.
  - &: Other advanced economies include Australian dollar, Swiss franc, Canadian dollar, Hong Kong dollar, Swedish krona, New Zealand dollar, Korean won, Singapore dollar and Norwegian krone.
- Source: IMF (2011c) (based on 2010 Triennial Central Bank Survey, Bank for International Settlements [BIS]).

### Currency denomination of international debt securities and reserve currency shares
- BIS international debt instruments statistics indicate continued dominant role of the US dollar and the euro with a combined share of 83-84 percent over the 2000s.
- The share of the major EME currencies has increased only marginally (IMF, 2011e).

### Costs and benefits of currency internationalization (country-level assessment)
- Potential benefits for an economy internationalizing its currency:
  - Potentially lower transaction costs.
  - Reduced exchange rate risk.
  - Ability to issue international debt at more competitive terms (IMF, 2011e).
- Potential costs and risks:
  - Complicates monetary management.
  - Strains domestic financial system’s ability to absorb capital flows due to potential increased volatility and large shifts in portfolio flows.
  - Reserve currency status might reduce international competitiveness by appreciating the currency (Chinn, 2012).
  - With growth and inflation differentials, interest rates in the EMEs are expected to remain higher than those in the AEs, encouraging large capital flows on a sustained basis.
  - An almost fully open capital account — a prerequisite for international currency status — can lead to large volatility in exchange rates and other asset prices, endangering external and financial sector stability.
- Broader caveats:
  - Internationalization may be necessary but not sufficient — history shows many failures due to preventive and positive checks.
  - Limited potential for EME central banks to diversify reserves into other EME currencies — such holdings would not serve as effective cushions during market turbulence.
  - Intra-EME FDI offers diversification into non-US dollar assets but such investments still need US dollar or other AE currencies.
  - Policy-driven or “managed internationalization” by governments acting alone is cautioned against; international use of a currency is better earned by market confidence in transactions, invoicing, settlement, and holding value.
  - Including not-so-usable currencies in reserve baskets can increase complexity and transaction/hedging/risk management costs; central banks may be unwilling to hold them; a single failure to honor convertibility could collapse a multipolar IMS.
  - Internationalization entails costs — potentially sacrificing domestic monetary and financial stability, running deficits, and facing the Triffin dilemma.

### Self-insurance, reserves and currency internationalization: assessment
- Demand-side:
  - EDEs’ increasing financial openness and volatile financial flows imply continued demand for foreign exchange reserves.
  - Demand for reserves by the EDEs is appropriate given central bank needs to expand balance sheets prudently to meet monetary and credit requirements of growing economies.
- Supply-side:
  - The US dollar remains the predominant source of reserves, with the euro as a distant second (Mohan, 2010).
  - Triffin dilemma likely to persist.
  - Limited potential for expanding acceptable reserve currencies to include major EDEs over the medium-term, barring perhaps China.
- Implication:
  - Continued turbulence in the IMS is expected.
  - Policy question: what can EDE authorities do to maintain high growth with stability?

### Financial stability, IMS and role of central banks (lessons and recommendations)
- Historical institutional roles:
  - Central banks were originally set up with explicit objective of fostering financial stability and were entrusted with multiple responsibilities: price stability, currency management, financial regulation and supervision, payment and settlements regulation, and public debt management.
- Trend toward narrowing mandates:
  - Over past two decades many central banks shifted to narrower mandates focused on price stability (inflation-targeting), shedding responsibilities for financial regulation and public debt management.
  - Financial sector regulation moved toward "light touch"; debt management shifted to separate offices.
- Crisis lessons:
  - NAFC (the financial crisis) showed price stability is necessary but not sufficient for financial stability.
  - The Great Moderation coincided with asset price imbalances and financial sector excesses that culminated in crisis.
- Research findings and implications:
  - Bigger financial systems can negatively impact growth:
    - Credit/GDP ratios above 100 percent are associated with higher volatility in consumption and investment (Arcand, Berkes and Panizza, 2012; IMF, 2012c; Cecchetti and Kharroubi, 2012).
    - When financial sector > 3.5 percent of total employment, further increases tend to be detrimental to growth.
  - “More finance is definitely not always better” (Cecchetti and Kharroubi, 2012, 14).
- Policy recommendations for central banks and governance:
  - Central banks should move back from simplistic inflation targeting to multiple responsibilities frameworks ensuring price and financial stability along with growth (Eichengreen et al., 2011).
  - Financial regulation and supervision ought to move back to the central bank (noted examples: United Kingdom returning responsibilities to Bank of England; European Central Bank entrusted with regulation/supervision).
  - Revisit separation of debt management from central bank given high debt and deficit levels (Goodhart, 2010).
  - Broaden central bank mandates to include financial sector regulation and supervision and empower them with macroprudential instruments alongside conventional and non-conventional monetary instruments.
  - Close coordination between central banks and governments is essential given sharp increase in fiscal deficits and public debt ratios; fiscal stability is a pre-requisite for broader central bank mandates to be effective.

### Central banking: the Indian experience (illustrative EME approach)
- Indian institutional stance:
  - Reserve Bank of India (RBI) retained multiple responsibilities: price stability, regulation and supervision of banks and non-bank financial companies, development and regulation of key financial markets (money market, government securities market, foreign exchange market), and public debt management.
  - RBI adopted a multiple indicator approach to monetary policy, considering monetary and credit aggregates as well as price indicators.
  - Financial sector and banking regulation were treated as integral tools of monetary policy focused on financial stability.
  - Financial innovations were introduced cautiously and gradually.
  - Capital account opening pursued with circumspection; exchange rate management focused on containing volatility with growing flexibility over time (Mohan, 2009, 2011).
- Outcome:
  - India escaped the worst consequences of the international financial crisis as it did during the Asian crisis.
- Recent challenges (India and other EMEs):
  - Macroeconomic challenges arise from fiscal and current account deficits widened since 2009 and recent growth deceleration.
  - Market reaction to possible tapering of UMP in the US led to sudden reversal of capital flows, especially debt flows, in India and other EMEs.
  - Despite large capital outflows since May 2013, EMEs have managed the situation relatively well reflecting prudent policies including capital account management, exchange rate flexibility, adequate foreign exchange reserves and appropriate monetary policy responses.
  - Nonetheless, EMEs are showing signs of slowdown and the episode highlights weaknesses in the extant IMS.

### Concluding observations and way forward (key ingredients of a stable IMS)
- Major diagnosis:
  - The IMS has malfunctioned across multiple dimensions: volatile floating exchange rates, destabilizing free cross-border capital flows, amplified contagion via interconnected financial markets, and an increasingly tested US dollar role with few alternatives.
  - Liquidity needs of fast-growing EDEs will rapidly overwhelm the world’s supply of safe reserve assets and the functioning of the US dollar as reserve currency.
- Long-run structural forces:
  - Demographic changes over next half-century — faster aging in the AEs — will be associated with progressive decline in savings and growth, and fiscal pressures in AEs (Europe and Japan).
  - East Asia and China may remain important suppliers of global savings until around 2025; subsequent population aging may tighten global liquidity in later decades.
  - Demand for financial resources from rapidly growing and urbanizing EDEs (e.g., India, Indonesia) will increase competition for resources and raise real interest rates.
- Institutional evolution:
  - Crisis propagation now can originate from systemically important countries as well as periphery.
  - Emergence of institutions: Financial Stability Board (FSB), G20, European Stability Mechanism (ESM), regional arrangements (Chiang Mai Initiative) indicate contours of a new IMS with shared responsibilities.
- Recommended policy priorities:
  - First: Domestic macroeconomic and financial stability is necessary for stable IMS. Central banks should be entrusted with broader mandates including financial regulation and supervision, and provided macroprudential instruments.
  - Second: Source countries should better internalize implications of their monetary policy for the global economy; international monetary coordination (Eichengreen et al., 2011; Taylor, 2013) is desirable though difficult.
  - Third: EDEs should continue cautious capital account liberalization and practice active capital account management to respond to destabilizing flows.
  - Fourth: Reduction in volatility of capital flows could reduce precautionary reserve accumulation needs, but monetary/credit requirements of fast-growing EDEs may still require foreign asset acquisition to expand central bank balance sheets non-inflationarily.
  - Regional currency arrangements (e.g., Chiang Mai Initiative) can help in crises but cannot substitute for sustained reserve asset needs.
  - Combined approach: domestic macroeconomic and financial stability and EDE capital account management, together with major AE central banks internalizing global effects of their policies, can minimize pressures on the IMS and reduce incidence and virulence of financial crises.

*Source: IMF (excerpt from _wp13224 PDF content provided).*

### References

### _wp13224 - References

### International monetary system, reserve currencies, and SDR
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### Capital flows, liberalization, and management
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### Financial globalization, crises, and financial stability
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### Central banking, monetary policy, and macroeconomic frameworks
- Bush, Oliver, Katie Farrant and Michelle Wright (2011). “Reform of the International Monetary and Financial System.” Financial Stability Paper 13, Bank of England.  
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- Obstfeld, Maurice and Alan Taylor (1998), “The Great Depression as a Watershed: International Capital Mobility over the Long Run” in Michael Bordo, Claudia Goldin and Eugene White (ed.), The Defining Moment: The Great Depression and the American Economy in the Twentieth Century, University of Chicago Press, 353-402.  
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### IMF institutional documents, datasets, and legal framework
- Board of Governors of the Federal Reserve System. Federal Reserve Act. Section 2A. Available at: http://www.federalreserve.gov/aboutthefed/section2a.htm.  
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- International Monetary Fund (2011c). “Criteria for Broadening the SDR Currency Basket.” September.  
- International Monetary Fund (2011d). “The Multilateral Aspects of Policies Affecting Capital Flows.” October.  
- International Monetary Fund (2011e). “Internationalization of Emerging Market Currencies: A Balance between Risks and Rewards.” Staff Discussion Note, SDN/11/17. October.  
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- International Monetary Fund (2012a). “Liberalizing Capital Flows and Managing Outflows.” March.  
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- International Monetary Fund (2012c). Global Financial Stability Report. October.  
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- International Monetary Fund (2012). World Economic Outlook Database.

### Historical and theoretical foundations
- Meade, J. E. (1951). The Balance of Payments. London: Oxford University Press. 1951.  
- Mundell, R (1961). “A Theory of Optimum Currency Areas.” American Economic Review 51: 657–665.  
- Kiyotaki, Nobuhiro and Randall Wright (1989). “On Money as a Medium of Exchange.” Journal of Political Economy 97, no. (4: 927–954.  
- Henry, P. B. (2007). “Capital Account Liberalization: Theory, Evidence, and Speculation.” Journal of Economic Literature 45, 887–935.  
- Meade, J. E. (1951). The Balance of Payments. London: Oxford University Press. 1951.  
- Triffin, Robert (1960). Gold and the Dollar Crisis. New Haven: Yale University Press.

*References compiled from the PDF "_wp13224 - References".*

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