Transcript of an IMF Economic Forum: New Perspectives on Financial Globalization

June 1, 2007

Washington, D.C.
Friday, April 27, 2007


STIJN CLAESSENS, Chief, Financial Studies Division, International Monetary Fund


GUILLERMO A. CALVO, School of International and Public Affairs, Columbia University

JEFFREY A. FRANKEL, James W. Harpel Professor of Capital, Formation and Growth, Kennedy School of Government, Harvard University

KENNETH S. ROGOFF, Thomas D. Cabot Professor of Public Policy, Department of Economics, Harvard University

Transcript Contents

Introduction by Stijn Claessens

Guillermo A. Calvo's, remarks

Jeffrey A. Frankel’s, remarks

Kenneth S. Rogoff’s, remarks

Question and Answers

Introduction by Stijn Claessens

MR. CLAESSENS: Good afternoon, everybody. My name is Stijn Claessens, and we welcome you all for this panel which is concluding the day-and-a-half conference that we have had on New Perspectives on Financial Globalization. We hope that this panel kind of summarizes but also takes us forward as to what the issues are that we're still facing in this important area. The organizers have laid out some questions for the panel to answer, and they're in the announcement for this. I won't repeat them. I just want to get going right away. Each of them will have about 20 minutes to make their presentation.

Before we start, maybe I will do a little bit of advertisement of some of the findings that exist as summarized in this Finance and Development piece that you found outside. In addition, a reason to pick it up is that there's an interview with Guillermo himself in there which means that I don't have to introduce, not that he needed an introduction to begin with, nor do any of the other people on the panel. So let me just give the words straight away to Guillermo Calvo, Professor at Columbia University to talk about the new perspectives on financial globalization.

Guillermo A. Calvo’s remarks

MR. CALVO: Good afternoon and thank you very much for inviting me to this conference and especially to this panel.

I thought I was going to focus on a couple of points, first with some observations which I have been saying so many times that I'm sure that you are familiar with. And then zero in on the relatively narrow aspects of financial globalization, which money policy. These are issues that I am beginning to study, so much of what I'm going to be saying is tentative, but I find always that it is much more exciting to talk about things that you see coming in the future than stuff that is already familiar to everybody.

In the first place, I think one has to set the background very clearly or at least let me say my opinions. My opinion is that still external factors are very important for emerging markets. The big example is the 1997-1998 Asia-Russia crisis for reasons that I think are very familiar as this is a shock that does not have obvious roots in fiscal imbalances or stuff of that sort and it seems to have an important financial component. So it's external and financial which becomes more obvious when you study the implications or the mechanisms that connect the external shocks to other aspects of the economy, in particular, domestic vulnerability. One of the variables that we found in our empirical analysis being quite robust is being what we call domestic liabilities which are foreign exchange laws given by the domestic banking system. You can of course develop an argument behind that, but that's not the point of my presentation, so I'm going to go down the list. Then in the Q-and-A section of this, if you are interested, I'll be happy to come back and comment.

The point is that when you are in the midst of financial turmoil, real big shocks magnified by domestic vulnerabilities, then inflation trend considerations take the back seat to financial considerations. Central banks all over the world including in advanced countries are always looking at these two aspects of the monetary financial economy and under regular conditions there is a lot of attention paid to inflation-type considerations, but at the moment there is financial turmoil, the central banks start looking at other aspects which are quite different from day-to-day operations of central banks under normal conditions. The only point that I will make in that connection is that for emerging markets the shocks are clearly much bigger.

As for external factors, there is very ample literature about that, but you see this is the impact of the Russian crisis, you see how this is the average of Latin American countries, and you see the big impact that it had on investment or at least the figures suggest that there was an association there. Also growth seems to have some connection with the Russian crisis at least in Latin America. This doesn't prove anything, obviously. I'm just showing you these pictures of what we have found with more systematic work. Initially it begins prior to the Russian crisis, but also you see that this crisis takes a long time for recovery to take place which also suggests that there are financial elements -- all that we know specifically about those countries.

Then recently we also have been going through a couple of shakeups. A few months ago we had a shakeup in the financial markets that affected emerging markets and we're going to be returning very quickly to the April-May experience in 2006. Fortunately it appears not to have had the negative effects of the Asia-Russian crisis, but still it's quite remarkable that this is a situation of much higher volatility caused by something that appears to be relatively minor which is the feeling that maybe inflation rates in the U.S. were rising faster than everybody was expecting and that led or was associated with a very large drop in emerging markets and everywhere else, but the emerging markets were the ones that suffered the largest declining beginning with emerging Europe and then Iraq. All of these declines were followed by a recovery later on, so it wasn't like a purely financial shock experience with no side effects on the real economy, and I will have something to say about that, but just to show all the pictures before we talk a little bit about the economics of this. We see also an impact in that episode of credit spreads increased and again the emerging markets were the ones that suffered the most.

While that was happening, the interest rates, especially the long-term interest rates in the U.S., Europe, and Japan went down. So it seems to be a clear case of a flight to quality. So that thing seems to be going around. It did not have the negative implications of the repeat of the Russian-Asian crisis, and when you go talk to people on Wall Street they say this is the proof that the markets now understand that emerging markets are much more mature and therefore very quickly we go back to normal.

But on the other hand, one has to be able to explain why is it that there is such a big loss in value. If it is so obvious to everybody that the drop in value is something that is going to recover very quickly, then there is a profit opportunity and for obvious reasons then the price will not fall that sharply. So there seems to be something funny going on there and I don't have an answer for that, but just to indicate, and I'm bringing this up and now I'm going to talk about the central issue which is monetary policy, that we live in a world where we have seen shocks that we never thought before they happened that they would have such a widespread negative effect in emerging markets and I guess the most telling case study in my mind is the Russian crisis and the impact that that had on Latin America. You can if you wish leave Asia outside there because they had their own crisis, so that's something that you could argue well, but we have not gone through a roller coaster like that for a long time, it's almost 10 years, so maybe the markets are mature. The point of showing these more recent shakeups is that certainly there seemed to be a difference, but on the other hand we have had shakeups which are hard to explain if there is still not some kind of information of malfunctioning in the market, something that we need to know more.

So for me if I take basic pieces of evidence and you ask me what do you make of those, what I do is to go with this message to the policymakers and to the central banks until they seem to be out of the woods maybe momentarily, but we have to be careful not to be excessively complacent because the sharks are still around and we are lucky that they have not eaten us alive, but the risks are there.

The question is what to do with the risks and how do we think about monetary policy in that context, so I am going to narrow down my discussion to monetary policy in particular. So first of all, where is the world going? What kinds of measures are we doing these days? I think there is a lot of complacency. In first place, there is more the tendency to say now we have gone through all of this and now we are much more mature. What we have to do is to understand how advanced markets do monetary policy and so we use interest rates as an instrument, and that's becoming very popular, and that's called floating. But it is not textbook floating, it's what I call Taylor floating. With Taylor floating you have fixed a nominal interest rate and then your money becomes endogenous and the (off mike) becomes endogenous, something that the textbook examples, at least the (off mike) cases do not have. You either have the money supply determined by the central bank or (off mike) here you have something completely different, the interest rate which is (off mike)

For a long time economies thought that fixing (off mike) and this is a lingering feeling which I share, that interest rates could be anchors, but they are kind of weak anchors and they could become particularly weak for emerging markets. I think that's a point that I'm going to be making. So we life in a world of many countries of Taylor floating. That doesn't mean that the fear of floating has disappeared. Obviously if you look at Argentina you still have pegging going around, and certainly with China you have pegging, but I'm talking about trends. So there's a trend and whenever a country can do that, the central bank will receive you with a more pompous attitude, perhaps feeling that it is now a part of the big club of Northern type BIA of central banks.

So my suspicion is that this sense that you can use your interest rate as an instrument has a lot to do with volatility. Look at volatility of the EMB. In principle, the nominal interest rate in the country would be the international interest of (off mike) has three factors. In I guess around 1998 during the Russian crisis, let me first explain what I've done here. This volatility, this is the standard deviation within a month, so it's no overlap. I took daily observations month by month and compute the standard deviation in basis. Very simple. So in 1998 you had 300 basis points, 3 percent, and now it's been going down and down and down, and even in the recent turmoil doesn't show up here because I showed you in the picture that there is a rise in the spread, but nothing compared the 75 basis points, not 300, and so when you put it in this picture, it showed like nothing. There seemed to be a trend, and whether this trend is sustainable or not I don't know, but to the extent that there has been still room for the shakeups, we have to be careful.

The point is and more fundamental that perhaps in the midst of that if you're fixing your nominal interest rate you have to take account of EMB. So increasing your rate by 25 basis points which is something that an advanced central bank would do if they see inflation creeping up may not mean anything. Maybe notices what you are doing. In the first place you have to explain what EMB is to the public, so it becomes very abstract. And besides, as you know, we don't determine the interest rate, but the interest rate very few people deal with directly. So it is not that the exchange rate that is something not only you understand because you buy it on the street and you buy stuff with that and when you go abroad you use the foreign exchange. The interest rate of the central banks is a very, very abstract concept, and when you have to move it up and down so much because of external conditions, you may have to, then it may become an instrument that means very little.

So the central point is that my conjecture is that the popularity of the interest rate rule may have a lot to do with this volatility, but central banks should be prepared for that. And I think central banks are aware that the situation can become much more tricky and the evidence proving that is the fact that as you know, central banks know emerging markets well and can (off mike) so one possible explanation is that they realize that this situation is temporary.

I guess one of the issues that I'm going to raise just to jump ahead in case I don't have much time -- how much time do I have?

MR. CLAESSENS: Five more minutes.

MR. CALVO: Five more minutes. The point is that central banks that have enough foresight, and I think they do, they are not so complacent as well, they are giving it reserves, but the issue is to do with reserves when the shock hits, and I think that that is a very, very important policy issue which is not an obvious one. If you are not that careful, you can have fueled capital flight. So what to do is something that we should think more about. I don't think there is good enough literature as yet.

Here I am simply reminding you that the interest rate rules are not good anchors if prices are flexible and we know that we have a fiscal theory of the price level and so on, but in the midst of a crisis one of the problem is fiscal discipline. So if you don't have fiscal discipline, then you cannot have (off mike) not going to help you very much. So then let me not waste time on that.

One of the remarkable things that I never expected and was never discussed in the open economy textbooks that I learned from is the incredible power of Taylor anchoring because with Taylor anchoring which requires, let me just talk about the standard model, that you increase the referenced interest rate more than the increase in the spread of inflation, for example (off mike) that assures under some conditions a uniqueness of equilibrium, and the whole thing is anchored on price stickiness. So it's a combination of price stickiness and these Taylor conditions that give you a unique solution.

I should not be negative to price stickiness given my last name (off mike) thought that they would be useful purpose, but it seemed to work, but it worked so much. In the first place, it's a wonderful system because money supply is endogenous and exchange rates are endogenous and we know that when the shocks are nominal you would like the money supply to be endogenous, so it helps adjusting money supplies automatically to some extent, and if the shocks are real then you would like the nominal exchange rate to help while it's helping there. So maybe it's a system that has also some other (off mike) and however would really set me off completely is when I stop to say more seriously about this is you don't need to follow Taylor rules every day, you can just say that you will start following Taylor rules one-thousand years from now and you anchor the system. This is new stuff. I'm discussing this with Marcus Miller. It appears that, yes, you can anchor the system but then the system could become very unstable even though anchored.

Since I'm sure I'm running out of time, why Taylor anchor (off mike) in the first place, as I said before, that's the kind of stuff where I feel most comfortable saying it now is the fact that if EMB volatility increases tremendously then it's going to be very difficult to use the interest rate as an instrument. But there are other more technical things that may kick in like liabilities utilization if the exchange rate at one point could have negative effects on output. So once you have negative kickbacks into outputs, then it is very easy to build up models where you have multiple equilibrium or at least negative solutions -- to build up models, I'm sorry, where you have multiple equilibrium and you go from one equilibrium, a good equilibrium, to the bad equilibrium. That's my reading of what Turkey tried to do last year when they let the exchange rate go up by 30 percent, but then at one point they stopped and said we are going to intervene because we are still heavily dollarized and this is going to break the back of the domestic financial system which is the most costly thing.

So the (off mike) we don't know how stable it is. Under a crisis I think there is a very fascinating research agenda that opens up there and we have to know more. If interest rates have negative effects on outputs directly when you can have multiple equilibria, and there is a recent paper by (off mike) is at the IDB. He is a young fellow going to Los Angeles, to UCLA now. And besides, even the standard literature shows that Taylor gives you local uniqueness but you can still have other kinds of solutions going around. Maybe those solutions are irrelevant for advanced countries because everybody zeroes in on the (off mike) but when you are subject to big shocks, it is quite possible that the economy finds another solution out there.

So I put that as issues to think about, and I think issues that explain why countries when push comes to shove they move out of interest rate targeting or floating exchange rates and they run it back and I think that is what is behind the accumulation of reserves. The issue is that we as analysts are not given a lot of guidance to the central bankers and central bankers want to say that they float, but they follow these advanced countries type monetary policy and they are very happy while they can do it. But there are instances where they have to intervene and I think they are aware that they will have to intervene. That's why they are accumulating international reserves. So the issue is when, what does the theory -- can we build that, an apparatus to help them decide when is the right time to intervene, number one. And number two is how to intervene. Those do not have obvious answers. I don't have an obvious answer. This is my current research, actually.

So first of all I think central banks should engage in what I'm beginning to call foreign exchange intervention drills. Think about that. In tranquil periods, that's the time to think about what to do like we do with fire drills. You don't do fire drills when there is a fire, you do it when there is no hint of a fire. That's the time to think about that. And if they have international reserves, certainly they must be thinking of using them at some point I'm hoping.

So second, the road for exchange intervention can lead to capital flight. You have the case of Brazil in August 2002 which is very interesting and I would like to know more about how it really worked, but the central bank instead of intervening in the regular sense just gave lines of credit to the commercial banks for those flights of credit to be lent to exporters. Is that the right thing to do? It's something that we all hate of course. But in the midst of the crisis of high turmoil, maybe the central bank should think about that.

This ends my presentation, but let me then summarize where I am. I think we have gone through periods that showed very clearly in my mind that external factors could be quite important; that financial conditions in the rest of the world can have an impact on emerging markets aside from their own fundamentals; that the financial conditions at home in the emerging markets compounded with the external conditions could be a very dangerous quotient. We have seen all of that. And my feeling is that some countries like Turkey, like Peru, are still heavily dollarized and therefore the vulnerabilities are still there. So the central banks should be advised to be aware that the situation can get very complicated and financial conditions could deteriorate to the point that they will have to forget about the inflation targeting and pay more attention to the health of the domestic financial system. I think they are doing a lot but accumulating international reserves. I don't think they are doing a lot about thinking deeply, and this is the role I think of the IMF and other institutions, helping them see more deeply on when is the time to do it, under what conditions you should do it, how you should transmit that to the public because the public should see this not as a break of the rules but as part of the rules, and how to do it if you do it, it should be just straight intervention or direct credit which is something we don't want to do but the case Brazil suggests that if done wisely it could be useful. Thank you very much.


MR. CLAESSENS: Thank you very much, Guillermo. Next is Jeffrey Frankel. We switch from Columbia to Harvard University, although Jeffrey of course has not only been there but also the CA and that's Berkeley. He is current the Professor of Capital Formation and Growth which is a very nice title, and so Jeffrey I understand you will use some quotes from other colleagues at Columbia, Harvard and elsewhere.

Jeffrey A. Frankel’s remarks

MR. FRANKEL: It's very good to be here. I want to thank the IMF for the invitation. I see many, many old friends and colleagues in the room.

I am going to group my comments into six points, first to suggest that either the proposition that financial markets are good, or the proposition that financial markets are bad or too simplistic, that those are straw men. A second point or better approach is to weigh the pros and cons and perhaps come with a more nuanced view as to how they work differently in different countries. Third is to talk about where we are now which I think is in the boom phase of the third consecutive emerging market cycle, and I am going to argue that the frequency of the cycles is 15 years, that the length of the cycles is 15 years. Fourth, ask the question that Ken Rogoff addressed in a column a couple of years ago, Is this time different than the previous times. Fifth, talk about some recent research, and I am being selective here, but it is particularly research, most of it, that bears on the question, In what kinds of countries does financial market opening work better? What are the local characteristics of the country that best suit it for financial liberalization? And then my all-time favorite, eternal favorite, the car crash analogy.

The way that you will know that I am on to a new category is I have a little icon for each one. The first topic is, financial markets are good or bad, is a straw man, and to illustrate I want to play a little game, and the game I have here is chess, and that is in Ken's honor. Here is the game. I am going to give you a list of names of well-known people and then a list of quotes, and it is an audience participation game and you have to match the names with the quotes.

Here are the names, and these are all upstanding members of the establishment, the financial and academic establishment. Jagdish Bhagwati is a pro-globalization guru; George W. Bush, Republican President; "The Economist" magazine; Milton Friedman; Ken Rogoff, a few years ago who was the chief economist at the IMF; a couple secretaries of the Treasury. You might argue that James Tobin is a little bit of a leftie, and Jeff Sachs, it depends whether it is Mister shock therapy Jeff Sachs or Mister bleeding heart Jeff Sachs. But basically these are not bomb throwers, these are establishment people.

I am going to show you the quote, and just yell it out if you want to guess. I am not going to give prizes, but remember you have to come up with a name from this list. The first one is, and this should be easy, "Market fundamentalists have a fundamentally flawed conception of how financial markets operate. They attribute the fluctuations to external influences, so-called exogenous shocks. This view is plain wrong. There are times like the present," and here is the signature phase, "when financial markets swing more like a wrecking ball than a pendulum, knocking over one economy after another."


MR. FRANKEL: George Soros is correct. So a premiere international speculator. He is the one who is operating the wrecking ball most people think, and yet he has this critique, and I have the citations for each one.

The next one, and this is important, "Liberalization of foreign financial flows is not regarded as a high priority." Someone got it, John Williamson. The reason this is significant is this is taken from the Washington consensus. The Washington consensus which everyone thinks is first and foremost open capital markets was originally by written by John Williamson in this article 1990. He has a list of 10 reforms and in one of them he says specifically "liberalization of foreign financial flows is not regarded as a high priority." I guess the term has come to mean something else in the meantime, but I have some sympathy with John.

Third, "International loan markets are prone to self-fulfilling crises in which although individual creditors may act rationally, market outcomes produce sharp, costly, and fundamentally unnecessary panicked reversals in capital flows." Someone said Jeff Sachs. That is Jeff.

"I remember when the Korean crisis first became serious calling people at a couple of the banks that had been extending credit to Korea and it was astounding to me how little they knew about the country to which they had extended credit. When times are good, people reach, and when they reach, sooner or later it leads to excesses, and excesses soon or later lead to trouble." Bob Rubin.

"Left alone, market forces will direct too much effort into speculation and too little into the development of new products."


MR. FRANKEL: Hayek could have said it, I suppose. One clue, this was from 25 years ago, 20 years ago.


MR. FRANKEL: Tobin would be a good guess. It's Larry Summers.

"Financial trading activity has increased enormously. Short-term speculation activity makes the markets less stable. Attacks of a half-percent on exchange of financial securities would take much of the juice out of short-term trading." That's a trick question. It's not Tobin. It's Larry Summers before he was Secretary of the Treasury.

"While there is no proof in the data that financial globalization has benefited growth, there is evidence that some countries may have experienced greater volatility as a result."

AUDIENCE: Ken Rogoff.

MR. FRANKEL: Ken Rogoff. This is along with Eswar Prasad, Shang-Jin Wei, our research department. Now I take an official IMF policy.

"The claims of enormous benefits from free capital mobility are not persuasive. Only an untutored economist would argue therefore that free trade in widgets and life insurance policies is the same free cap mobility. Capitol flows are characterized by panics and manias." Bhagwaati, very good.

And the last one, "The capital market has vindicated its critics and embarrassed its would-be defenders too often of late. It has been responsible for or at least deeply implicated in some very costly economic breakdowns. Perhaps the antiglobalists are onto something." "The Economist" magazine in a review that is called "A Cruel Sea of Capital" in one of their surveys.

The point is that there are people who you think of as being very free market for the most part all serious flaws with capital markets. So I think to point out that there are flaws with capital markets and therefore that the classical textbook models are not right and people fail to realize that, and policymakers fail to realize that, is really not worth expressing because that is not the issue. So it is a sterile debate to accuse others of believing that international financial markets work perfectly, I also think it is a sterile debate to accuse anyone who says there is a useful role for public policy of failing to understand the virtues of free markets because they do have plenty of virtues which I will get to in a moment. A better approach is to weigh the pros and cons.

Let me list some advantages and list some disadvantages. Advantages. For a country with a high return to investment domestically, a high return to capital domestically, borrowing from abroad can finance investment more cheaply than can domestic saving alone. One advantage. The other is for the high-saving countries which we usually think of as being in the richer countries, they can earn a higher rate of return by investing in emerging markets. The third is the opportunity to diversify. The fourth I should really list separately, smoothing disturbances. Next, letting foreign banks in improves the efficiency of domestic financial markets, overregulated and potentially inefficient domestic banks are subject to discipline. And lastly, governments face the discipline of international capital markets if they make policy mistakes, and Tom Friedman had this analogy of the golden straightjacket that, yes, it limits your policy effectiveness, but suddenly the whole world is willing to give you money provided that you stick by it.

But on the other side, international financial markets in practice may not work as claimed, and here are three reasons. First, the famous Lucas Paradox, capital often flows from poor countries with low capital labor ratios to rich with high capital labor ratios. We think we understand part of that. There is more to determining the return to capital than just the capital labor ratio. You also need for example protection of property rights. If a country has a very low capital labor ratio and in theory a high marginal profit to capital but you cannot get the profits from it because it is going to be taken away from you, then that is not a high return to capital, but it is relevant.

Number two, capital flows empirically tend not to be countercyclical as the intertemporal theory says, and I think this is extremely important. Often capital flows are pro-cyclical. This is especially true in developing countries, and especially true in commodity boom countries, so that is exaggerating the boom. And then sometimes they seem to be the source of the disturbance rather than the smoother. Although sometimes they discipline governments, at other times they seem to aid and abet profligacy and allow governments to run up bigger deficits than they would have been able to if they had not been able to borrow.

Then last and most saliently, financial markets experience recurrent disruptions. We all know the litany from the 1982 international debt crisis through the most recent big ones in 2001, Turkey and Argentina. Looking at this record, I think it is hard to argue that investors punish countries when and only when the governments are following bad policies. So this disciplining the policies think does not quite seem to fit, and there are three reasons for that.

First, large inflows often give way suddenly to large outflows with little having happened in between, with little new information. Take Thailand in 1997. If you think there was corruption or something in July 1997, nothing changed in Thailand, so it is a little hard to explain that. Second, contagion sometimes spreads to countries that are unrelated. And third, recessions that have resulted have been too big to argue that the system is working perfectly.

The next topic. I think there is a cycle, and we are now in the third one of capital inflows to development countries, and it is a biblical years, seven fat years followed by seven lean years. In the first seven fat years we were recycling petro dollars which ended in the 1982 debt crisis, and then we had seven lean years. The second phase was the emerging market boom of the early 1990s, ending in the Asia crisis in 1997, and seven lean years. And starting in 2003, we entered the third boom.

It shows up in quantity, so this is the quantity of net capital flows to low- and middle-income countries. Here is the first boom, then the crisis, then the second boom, then the crisis. This data only goes through 2004, but you can see the beginning of the third boom.

It shows up in quantities, and it also shows up in prices. This is the spreads, this EMB. This graph I have stolen from Guillermo from a paper he gave at the BIS. I have always found it easier to steal other people's graphs than to fiddle and get the graph right myself. You see it at first quite low in the early 1990s and then shooting up sharply. So this is 500 basis points here, and then shooting up sharply in the crisis of the 1990s. On the same graph he also has the quantity, that this is the current account balance which was in deficit, and then after the Russia crisis they were all forced to shift into surplus.

This is more recent years. I stole this one from "The Economist." Sovereign spreads down sharply, EMB down sharply, between the peak of Russian's default and today where we are down to under 2 basis points which is extraordinarily low, so we are definitely in a boom phase by either measure.

Is this time different? Ken had this column in 2004 and said people always say this time is different and they are always wrong. I think it's worth recognizing that some things are different this time, and I do not think Ken would disagree with that, and these are things that I think are helpful for reducing the probability and the severity of future crises.

First, reserve holdings are much higher, and I will give you some graphs on some of these in a moment. Second, something we do not think normally goes with this, but it does in this case, in theory it should not, but exchange rates are much more flexible, many more of them have more flexibility than before. It is not the disappearing middle is not what dominates if you look at (off mike) or anybody, it is the increased number of flexible currencies is the real trend.

Third, everybody diagnosed one of the big problems in the 1990s as too much dollar-denominated debt, not hedged, and whether you want to call it original sin or currency mismatch or all of that, there was an idea that I associated with Barry Eichengreen, among others, that if we could get more exchange rates volatility in there then borrowers and lenders would have a greater appreciation for the fact as to this uncertainty and they would stop borrowing as much in dollars and start borrowing more in their own currencies. I was a little skeptical of that at the time, but events have sort of born this out. The main point is that many more countries are borrowing in their own currencies today and less in dollars whether it is for this reason or other reasons, and that is only probably a part of it, but just that they see that that makes them less vulnerable and international investors, contrary to Ricardo Hausmann's phrase of original sin, apparently are willing to do this now. And having one graph on that, the thing I stole from "The Economist," what did it say, death to EMB or something. The point of that article from a couple weeks ago is EMB is disappearing in importance because there is not that much dollar-denominated debt in the world, there is much less than there used to be which is pretty extraordinary if that has developed so quickly.

Next after years of discussion, collective-action clauses have become more common. And lastly, countries are more open to trade in FDI. Here are a few illustrations. First, that countries this time around are using capital inflows not to finance current account deficits or at least not to the extent as in the past, and this is just some of the major emerging market countries, if we had a country like China up there, this would be the dramatic one way up here. But in general they are above this line meaning that this time around the current account deficit is smaller than it was in the 1990s, and there are only two here that are below the line, Turkey and South Africa, and here is a graph showing it another way. So this is the same one that I showed you about net capital flows and we are now entering the third boom phase, but whereas in the 1990s it went to finance big current account deficits down here, this time the current accounts are in surplus and instead it is going to finance skyrocketing reserves. And even if you agree as I do that the reserves are too high to be useful in some countries like China, nevertheless, it does reduce the odds of crises.

This is openness. If you are above the line you are more open, higher ratio of trade to GDP than in the 1990s, and most of the countries are above the line. Here there is only one that is not and that is Ecuador, and it is even pretty close to the line.

So my conclusion, and the way I answer Ken's question is this time different is, no, there will be a new crisis, but number one, it will not necessarily be currency crises, and it will not be speculative attacks if they are floating, but it will take some other form. And I do not think we are ripe for it now. I think it is too soon. Memories are still fresh.

So what is the reason for my biblical cycle of 15 years? It is because after 15 years have gone by, there is somebody new on the trading desk who did not personally live through the last crash. They sort of know about it, but it is easier for them to say the world has changed than if they lost money in it. So it is too soon, memories are fresh, Argentina and Turkey, they were not that long ago, so I think it is too soon.

Also, global monetary policy has been very easy and I think that is an important determinant. Guillermo had a series of papers with Leiderman and Reinhart in the early 1990s that were quite prophetic that said maybe we are just going to see a repeat of what happened in the 1980s which is all this money that is flowing we think for a good reason is really just flowing because of low real interest rates in the North and as soon as real interest rates go back up we are going to have a crash, and I am sort of persuaded by that. And commodity prices are near historic peaks and that helps a lot of the developing countries.

Can recent research give us a verdict? I am just going to hit a number of people's work. Peter Henry has work on what happens when countries open up their stock markets to international investment. He gets quite positive results and quite striking. This is averaging across a lot of countries. Liberalization occurs in year zero, first, cost to capital which is measured as a dividend rate goes down sharply after they open up which is what the theory says. That is sort of the point, you really get capital more cheaply. Second, investment goes up which is what you would expect in theory, but it is a little surprising that it shows up this clearly. The third one is not quite as clear, but I would not expect it to be. This is growth rates, and definitely growth rate is higher after liberalization. Obviously there are a lot of other things that go on to determining growth.

So this is the idea as with exchange rates regimes that maybe there is not a single answer for all countries, that it depends on local circumstances exactly how much you want to liberalize or how fast or what kinds of deviations you might want to keep in place for a while or just exactly who does benefit the most from liberalization. There is by no means a consensus in the results that I am going to show you, but there is roughly a common direction to them I think.

There is a claim that financial openness lowers volatility and raises growth only for rich countries and that for poor countries it is more likely to lead to market crashes, and I cite four different authors here and sets of co-authors that fit into that.

But then on the other hand here comes a paper by Aaron Tornell and Westermann who find that countries experiencing occasional financial crises grow faster on average than countries with stable financial conditions. To me there is something intuitive, very plausible about the idea that it is like the U.S. in the 19th century that we had crashes, banking panics, they were very sharp, they led to very high unemployment, but they did not last long, a year, and then you are off and going again. The average growth rate during this period was the highest, this was the U.S. industrialization period, and maybe that is true of other countries. So I find that kind of intuitively pleasing. Some of the research is consistent with that idea, some of it is not.

Another claim is that capital account liberalization raises growth only in the absence of macroeconomic imbalances such as overly expansionary monetary or fiscal policy, and this is Arteta, Eichengreen, and Wyplosz, and they specifically reject statistically the claim that it is the level of development that matters, that poor countries can benefit just as much as rich countries provided they have sufficient macroeconomic discipline. You could say macroeconomic discipline was supposed to be one of the benefit of open financial markets, but I think this is saying that that discipline, straightjacket, does not actually work that well and that will not give it to you, you need to get it somewhere else, or you need to already have it.

Another finding is that countries that are open to trade are less likely to experience sudden stops or currency crashes. I showed you before that one of the things that is different is that countries have higher levels of trade and FDI, we could say the same thing about FDI, as a share of GDP they are higher now than they were in the past and I maybe just asserted that that was a good thing, but there are some who might think high openness, I would think that would make you more vulnerable. You could argue it either way.

There are a number of papers, and this tends to be dominated by Argentines who are all wondering why Argentina is always cursed, and one answer is the low ratio or trade to GDP. So one by Guillermo and co-authors, one by Sebastian Edwards, and one that I did with Eduardo Cavallo, and in all three cases we get the answer that countries that have higher openness as measured by trade to GDP use different measures but are less prone to sudden stops or to currency crashes, or if they have them they will be less serious.

Another important finding is that institutions which as shareholder protection and accounting standards determine whether liberalization leads to development of the financial sector and then in turn to long-run growth, so these are two different papers, but this is certainly consistent with what we hear so much about in growth theory, that institutions, property rights, rule of law, and so on is what is important. We hear it for long-term growth, but now we also hear it for fewer crises.

A related finding is that corruption tilts the composition of capital flows toward the form of banking flows and away from FDI, and also toward dollar denomination away from denomination and domestic currency, this is Wei and Wu, and all the things that have been associated with crises, the countries that rely more on banks than FDI, that rely more on dollar denomination than local denomination, and short-term debt rather than long-term debt, they are more likely to get into trouble. So I would conclude from that that liberalization can be helpful if the institutions are strong and other fundamentals are favorable but might hurt if they are not.

So with all of these findings, let me try to generalize. They are all consistent with what is after all a lesson that we learned some decades ago about the sequencing of reforms, that countries will do better in a development process if they postpone opening their capital accounts until after other institutional reforms, and there is one recent paper consistent with this, Kaminsky and Schmukler.

My last point, my last topic, my theorem, is that all important generalizations about emerging market crises can be phrased in terms of the car crash analogy, so I have ten. One, sudden stops. It is not the speed that kills, it is the sudden stops that I attribute to Dornbush and Calvo. Second, superhighways. Modern financial markets get you where you want to go fast, so we are better off with them. That is an important conclusion. But when accidents happen they are bigger, and so more care is required. I think this is Bob Merton. Second, Stiglitz says if a lot of countries all get into a crisis at the same time, it cannot be their fault, or the analogy is Jan and Dean's "Dead Man's Curve," does anybody remember that? If everybody keeps having accidents on the same stretch of road, there must be something wrong with that stretch of road, not Stiglitz, but Summers's reply is, yes, some stretches are more difficult than others, obviously in periods when world real interest rates are high, they are going to be more difficult than when they are low, but that does not mean that it is not also important to follow good policies and to be sufficiently cautious and to have your car in good shape, have you brakes good, and to be alert and not drunk, et cetera, because not every car goes over dead man's curve.

Fourth is the obvious analogy with contagion, that even if you are driving along and minding your own business but the car in front of you crashes, if you have not left enough following distance, you could crash into them. Once again, it may not be your fault, but on the other hand, the way to live with it, the way to deal with this fact, is to leave more following space and be more cautious.

Number five, correlation does not imply causation, so this is something that should be near and dear to the heart of the IMF. They are sometimes implicated by saying every time a country goes into the crash, the IMF is there and it must be their fault. That is like saying look how many people in hospitals, that just because the doctor is there at the scene of a fatal accident does not mean that it is their fault.

Six, moral hazard. G-7 and IMF bailouts that reduce the impact of a given crisis may in the long run undermine the incentive for investors and borrowers to be careful. I think this a true point, but I think it is way, way overdone particularly by those who say this is the market failure, this is why we have crises, and I think that is demonstrably not true, and I am putting down the Meltzer report as one voice of that viewpoint. There are studies, only economists would do this, of seatbelts and airbags and ambulances that show that when they are available and introduced that people drive faster. They sort of internalize it. So moral hazard therefore is an issue. Does that mean that we should not have seatbelts or airbags or ambulances? Obviously not. It is a partially offsetting factor, but we are still better off with them than without them. Here is Mike Musa. His way of phrasing it is if you think that moral hazard means we should abolish the IMF, that would be like saying that to make sure we do not have any accidents, let's mandate that in the steering wheel column of every car there will be a sharp spike pointed at the heart of the driver, and then everybody will just creep along at 5 miles an hour. A true statement, but nobody would get anywhere.

Three more. Reaction time, and this is me. I am struck in the literature about how we always talk about speculative attacks. But if you look at what actually happens in most countries, there is a period of time, maybe a year, between the time that investors start to lose their enthusiasm with a country and start pulling their money out, and the easiest way to see this is the monthly numbers on reserves, and Mexico in 1994 is a perfect example of this. For various reasons there is an embarrassment of different possible reasons that people started pulling out at the beginning of 1994, it could have been Chiapas, it could be the assassination of Colosio, it could be rising U.S. interest rates, it could be (off mike) that it is an election year and they are going to expand. But people started pulling their money out, but it took 4 months before the speculative attack occurred. How the driver reacts, this is how they taught us in driver's training in America, one of the things they impress on you is between the time you see the hazard on the roadside up ahead and then the number of seconds before you step on the brake and the number of seconds before the car comes to a stop, that turns out to be important, that those are two different events and what you do in the meantime is important. I always forgot whether you are supposed to steer into the skid or steer out of the skid, but I know that it is very important.

So in this case it basically means adjust rather than procrastinating. What many countries do, and particularly Mexico in 1994, is procrastinate by using up reserves, by switching out of (off mike) local currency debt into dollar debt, switching out of long-term debt into short-term debt, which does succeed in postponing the collision but makes it worse once it actually happens.

Number nine is this point about the optimal sequence of reform. I am not sure about this. I think maybe I got this from Masood Ahmed. He is not in the room is he? I am not sure. It would have been years ago. So a highway off-ramp from this new useful superhighway should not dump high-speed traffic into the center of a rural village before the streets are paved, before the intersections are regulated with traffic lights, and before pedestrians learn that they should not walk in the street. Analogously, a country with a primitive domestic financial system should not necessarily be open to the full force of international capital flows before domestic reforms and prudential regulation.

Lastly, that there may under certain conditions be a role for speed bumps. I always like Chile's, even though they no longer have them, 1990s attacks on short-term capital inflows. Other possibilities are high reserve requirements on local banks borrowing in dollars, and various other things. I like indexing debt to commodity prices. If you are a commodity producer I do not understand why that is not done.


MR. CLAESSENS: Thank you very much, Jeffrey. Next is Ken who does not need any introduction. Also I should point out for people still standing in the back, if you want to come to the front there are still a few empty seats in the front.

Kenneth S. Rogoff’s remarks

MR. ROGOFF: (In progress) -- having this session now 10 years after the Asian crisis, 5 years after Argentina, where the issue today as much as anything is that very few of the IMF's large member states are experiencing a financial crisis and therefore the IMF is.

I think that we got some insights though from these wonderful talks by Guillermo and Jeff. Guillermo was encouraging in a way saying there are a lot of vulnerabilities out there that have not been exposed. But Jeff gave a very interesting analysis where he warned us that you should be doing 15-year budgeting cycles here at the IMF and not 1-year cycles.

Jeff, I just had to say a couple of things about your quotes at the very end. First of all, your number two that you attribute to Merton I attribute to Summers. He said it at a speech at the Treasury in 1997. You can get it on the Web. And actually, your number five about causation does not imply correlation in the IMF, I said it is in my debate with Joe Stiglitz, and Martin Wolf and many others quote me. Speaking of which, I just have to say I gave my first big talk at the World Bank, I have done a number of seminars and a number of events, but big public talk, and I was sort of reminded that one of the things that motivated me to say what I did there was of course, first, he had called all the young economists at the IMF third-rate economists from first-rate universities and a number of things like that. But he also of course had gone after Stan Fischer kind of calling him a crook. He did say afternoons, okay, maybe not, but don't you agree that even the appearance of impropriety ought to be disqualifying for a position like that? That is the pot calling the kettle black these days. I don't know.

I came here mainly to talk about the topic of financial globalization and Jeff really did a marvelous job covering a broad range of the recent literature, and Guillermo as well. So I will have to retread a couple of things that Jeff said in my remarks.

I have had the privilege of doing a series of papers here with Eswar Prasad, Ayhan Kose, and Shang-Jin Wei, who are all here today. We first wrote a paper in 2003 that came out as an occasional paper, and we have written a couple of others since, most recently one at the end of 2006 that we are hoping will appear in a journal, surveying the literature. Of course, in our 2003 paper I think Jeff did describe it accurately as to what the theme was, that if you are really trying to take a detached point of view about what does the research say about what financial globalization does, it is very hard to say. The evidence was very mixed at best when you looked at growth, and when you looked at volatility it was less so.

However, when we did our more recent paper, we took a bit more positive spin because the literature of which there had been a lot in the interim also takes a more positive spin, and I think the basic organizing principle we had was that the effects of financial globalization are much more indirect than direct. That is why it is hard to detect. And that is the most significant channel, so these things like governance, institutions, financial liberalization internally, market liberalization, all of these things, and how financial globalization affects them is very, very important. The financing channel per se is much less important. I think a good example of that is really illustrated by China today where, I don't know, 42 to 43 percent of GDP is still invested, but a big part of the productivity comes from that very small amount that comes from abroad where that is privately directed as opposed to a great of financing which is state directed, and you can see that these channels that it is operating through. I freely acknowledge everybody uses China for whatever they want to use it for, but it does illustrate the complexity of the issue.

There is a long literature looking at the direct effects of financial globalization and finds it is very hard to get an effect. It is not just empirical, it is theoretical. If you look at risk diversification, Maury Obstfeld worked on this at one point and a number of people at the Fund have also, and you find the effects just are not that big. It is very, very parallel to a different Lucas paradox where he tried to show stabilization policy just is not all that important, that it is hard to get big effects out of risk diversification. Then I should have said when I mentioned my co-authors that we also cited many, many papers by people at the Fund. One paper that certainly influenced us in our newer papers by Gourinchas and Jeanne where they make a very convincing argument that even if you look at the capital accumulation argument, it is very hard to argue that international capital flows could matter all that much to growth, that it is really likely to be of second order. Indeed, one of overarching things that see these days is capital flowing from the poor countries to the rich countries. And just another small piece of self-advertisement, when Lucas wrote about this in 1990, he argued that it had to do with increasing returns in investment. That was the channel. I do not think anybody thinks that is the channel today. We think it has to do with financial markets as anything, and Mark Gertler and I had a paper in 1987 that was not published until 1990 giving exactly that capital could flow from the poor countries to the rich countries because of endogenous differences in financial markets.

Going back to the empirical literature, and not talking about the theoretical literature, it is very tough of a number of reasons to pin things down in cross-country growth regressions. It is hard to measure financial liberalization. It is hard to hold things equal, what is the counterfactual. I think that if we look across the literature, the piece of it which is the most enthusiastic about financial liberalization abstracting from Rick Michkin's book which is more a polemic than an empirical exercise, is the work by Peter Henry that Jeff cited where all the people who work on equity market liberalization find that it is fantastic, Loro Faros here and Beckert and Harvey and Eliza Hammel who is a graduate student at Harvard find this. And yet at first when people are looking at this say how can that be? There hardly is any equity, now there is, but over the periods where these studies were done. And I think it is exactly the point, it could be, I'm saying I think, but we don't know, it could be exactly the point that equity liberalization is often accompanied by a lot of other reforms, it is just hard to get equity markets going without having some other things working in your economy, without having some kind of corporate governance, without having some kind of clarity of private ownership, and that may be the reason that equity market liberalization worked well.

I think that we also have to in some sense give ourselves a reality check on financial globalization when Rodrick, Bhagwati, and Stiglitz were writing how horrible it was and all the risk, they were writing in the late 1990s where we were in a very clear part of the cycle Jeff talks about, and I think now the onus is much more on countries to justify maintaining financial repression. If I go around the world and I ask why isn't there faster growth and not just India, but Chile, Korea, they have very crude financial systems. They have not become more sophisticated in a way that they have in many other countries, notions of private equity, notions of things that hedge funds do are very distant still in those countries and they are just starting to emerge. Ragu Rajan who of course was also economic counselor here wrote some very interesting papers about that before he came to the Fund arguing that the kind of technology that we have today does not lend itself very well to bank financing because nowadays you have an idea and that is what you want to get financed, but it is not like some wheat in your silo or some manufacturing output that can be collateralized. Rajan had argued with Zingales that you need these more sophisticated financial markets, and in many ways I think the onus now is on opponents of deeper financial globalization to show that they are right to maintain the degree of financial repression that they do, and I think that is a challenge.

There are very few papers like the Ranciere et al. one, there are a few, and Kristin Forbes has made this point that it may well be that you have more volatility if you deepen your financial markets, and yet you grow faster. I think it is an interesting question. I suspect many countries will continue deepening their financial markets in an effort to grow faster and then we will see some of the vulnerabilities that Guillermo talks about, but that does not necessarily mean that it was terrible policy that one way to maintain a very constant out is just to have very, very low growth as China did before its reform and India did for many years.

A couple of further things on comparing today to the past. Jeff did this very nicely already, and Guillermo alluded to it too. I certainly think having more flexible exchange rates is a big deal, and of course where countries do not they have these gigantic reserves. I do not know that anyone who is ever talking about floating in the textbook sense that Guillermo did, that monetary policy is exogenous because that is not an optimal policy that you would have ever gotten out of any models, and I think once we had crossed the bridge of having flexible exchange rates combined with independent central banks, you had really gone a long way toward improving things and making the system more durable. It is encouraging that countries are finding ever better ways to do it, although I think you, Guillermo, way overstate how many countries have Taylor rules. They will say they have Taylor rules if it is thought to be good in those circles to have Taylor rules. A lot of countries do not have the degree of financial liberalization to talk about interest rate markets.

I do not think we can leave this topic today without saying something about the great moderation which I do not think Guillermo or Jeff addressed. This is not something just with emerging markets, it is the entire world. We have less volatility. This is relatively new or markets. I am talking about output. It is not clear that market volatility has gone down. It might be low now, but if you look over the last 5 years, it actually has not been low, it is not particularly low than it was from 1990 to 1995. But we definitely have great moderation in output. A little bit of it might have to do with better national income accounting and more uniform national income accounting, so it is just not really moderation but some of it is certainly fundamental. And we do not completely understand it. Better monetary policy is a piece of it.

The studies I have seen and to the extent I have thought about it, I think it is way overrated and some of the focus that you see on central bank policy has to do with the fact that there is lots and lots of money in markets leveraged on both sides -- a quarter point change than the Federal Reserve does, so there is a lot of focus in the press on that because there is a bit market for it, but it does not necessarily mean that it is as important or that central banks are as omnipotent as many seem to believe, but it certainly a piece of it.

Financial deepening has got to be a bigger piece of it where financial diversification has moved things around and spread risk. The big question is will a big shock make this vehicle which has been good into something that has become a source of vulnerability. That is the big open question. Geopolitical stability I think is a big factor in why things have been better in the global financial system. The way I like to frame it is that people point to the fall of the Berlin Wall, and I do not really think that is quite it. I think it is the rise of China substituting as the counterpart for the U.S. in place of Russia. Russia pretty much wanted to conquer the world, China wants to conquer the world's markets, but not necessarily the world, and that is a very big difference. China is a much more constructive partner. Its whole orientation or whatever, hysterical things are written, I think if you look at China's actions, it is very much a stabilizing influence in geopolitics compared to what Russia was earlier and many countries I think have been able to liberalize because of that. Geopolitical instability, while I am very concerned about the Middle East and Darfur and a number of other areas, and there are big problems and it is a big concern, a positive factor has been this rise of China.

Let me just close then with the role of international financial institutions. I do not want to get off into a huge question. I do think one thing that is really clear is there is a bigger role for research. I obviously know about the IMF, but Angus Deaton headed a commission that I was on that Francois Bourguiguon organized to look into the last 10 years of research at the World Bank. I learned a lot about development and it was very interesting, but one thing that was just stunning is that if you look at the World Bank's budget, the entire research budget at the World Bank is 2.5 percent of expenditure, that is a broad definition, whereas the Executive Board is 6.57 percent, we do not have an exact number, Mervin King cited 10 percent at the Fund, but it is a smaller institution but still a very big number, but research is something that is important going forward. If you look at central banks which have definitely done well over this period, they have all figured that out. They have all figured out that having more research helps deepens their thinking, helps give more credibility, and I think that is a direction that we also have to see at the international financial institutions aside from the broader issues. Thank you.


MR. CLAESSENS: Thank you very much, Ken. What we will do is a round of questions that I will collect, but before starting with that, I will give Guillermo and Jeffrey if they want some little time to react to what has followed after them. Guillermo, a minute, and then we will do the Q and A.

MR. CALVO: Very quickly, simply to put some additional fire into this panel. I think Jeff has a very thorough and useful presentation touching up on most of the relevant issues. There are two issues that he mentioned that I do not disagree with but I would like to give a word of caution because we are looking at many countries that are dedollarizing and that is a good trend. On the other hand, we have to be very careful because currency denomination is something that can mutate very quickly partly because the governments react to certain pressures sometimes by changing the denomination. We saw that in the 1994-1995 Mexican crisis where all of a sudden the debt that was denominated in pesos became a debt denominated in dollars practically overnight, and we see that all the time, so we should not be too complacent about that.

The second is current account surpluses. Is that a good thing? I think certainly in principle it is, but be careful because we can fall into the trap of thinking of these issues in terms of the representative individual. In that case certainly the representative individual is lending to the rest of the world so that he cannot suffer a sudden stop. But if you go a little deeper and you realize that some of these current surpluses particularly in Latin America may have their etiology in the fact that interest rates had improved, then it could very well be the case that you have a certain sector is benefiting from interest rates and is pushing money out to the country while the rest of the economy is pushing in, it is borrowing from the rest of the world, and if there is a sudden stop then still the borrowers could be hurt.

Let me give you two pieces of evidence. In the first place, we went back and looked at all the sudden stops in our sample of sudden stops and we found out that 20 percent of the sudden stops in the last 20 years the way we define it happened in countries with a current account surplus, so that is one piece of evidence. And the other one opens up an issue to different interpretations is that in Latin America at least for the first time when you look back to the 1990s, in this period what you see is net capital inflows are falling but gross capital outflows increasing while gross capital inflow is increasing at the same time. So that is perfectly in line with the case that the world's sector is sending the money out and the other sector is taking loans. So this is just a word of caution about how to interpret these evidence. Thank you.

MR. FRANKEL: I will just give one reaction to what Guillermo said about dedollarizing, but just to repeat it, it is striking how quickly it has happened that more and more countries have issued debt in their own currencies particularly for those of us who are persuaded of the original sin argument that this was something deep and structural and that basically foreign investors just were not willing to expose themselves. I agree with Guillermo completely that denomination can switch back pretty quickly and that this is what happened in Mexico in 1994, but at least it is encouraging that countries are able to do this at all. Mexico was one of the few, South Africa and maybe a couple of others that were able to issue debt in their own currencies back then. Now lots of countries are able to do it and I think that is basically a good sign.

There is one note of caution. There is the possible moral hazard of an incentive to inflate it away if they get into trouble. That is presumably why foreign investors traditionally have been reluctant to expose themselves in local currencies, but I think a good thing.

Questions and Answer session

MR. CLAESSENS: So let's collect some questions. Identify yourselves and let's do four or five questions.

QUESTION: (In progress) -- financial deepening and financial globalization -- empirical causes you were raising which is some more than they did here for the World Economic Outlook in the spring with (off mike) they documented even just across industrial countries the differences in the debt of financial markets going beyond just bank intermediation and documenting all these other forms including hedge funds, et cetera. That the United States has -- such fast paced even the rest of the industrial countries relative to the United States have remained basically just as slack as they were 10 to 15 years ago today. So it seems at least (off mike) countries to globalization has not become compounded by financial development at the same pace.

QUESTION: In England in the 19th century, rapid financial development was associated with financial crises and this led to collective action clauses for private debt and lender of last resort. We have been told that in the late 20th century, rapid capital account liberalization on a global scale did also lead to high volatility, we now have collective action clauses, but we also have large reserve accumulation. My question is, is this the new steady state or is there not some role for the global financial institutions?

QUESTION: Also the panelists elaborate on the credit expansion we observed in many small countries whose financial systems are actually dominated by foreign financial institutions.

QUESTION: Just one quick question mainly for Ken. One thing very impressive between these private equity hedge funds and the like is the ability by which they can jack up the leverage it seems to be. But so much of it is happening in lightly regulated part of the financial market, so I wonder what is your view whether you should be for the regulation or if they should be just left to do their own business.

QUESTION: Just one different question. If the world political leaders were to ignore your conventional wisdom that a global currency should not be implemented and they were to implement a global currency tomorrow, the political leaders, how would that change your analysis of financial globalization?

QUESTION: One question for Professor Calvo. Does it make sense to characterize monetary policy in emerging markets as the optimum policy perhaps as a combination of the two things that you were describing, so to sort of Taylor rules in tranquil times and then some intervention rules in the midst of a crisis. From (off mike) work we know that models describe the sudden stop as rare but costly events and then generate long-term business cycle movements that are not too different economies without these constraints and that suggest that the optimal rule then should not be too different from an advanced economy. But at the same time, once around the middle of the shock, indeed departing from that rule will bring big gains.

MR. CLAESSENS: Let's take a break here and let's give the panel a chance. Let's start in reverse order. Ken, if you want to start with the ones addressed to you.

MR. ROGOFF: First, Ji Wu's question about the hedge fund regulation. That is a very tough question. It makes sense to have some transparency more than we have. I think hedge funds have by and large been a positive force in global diversification, but there was a task force headed by Secretary Paulson that came to the conclusion you should do absolutely nothing and struck me as a bit dogmatic that it makes sense have at least some transparency rules. Now there are other questions that hedge funds really care about which is they pay a capital gains tax basically on their income instead of the income tax, so it is like 20 percent lower, that is what they are really fighting about, but the transparency issue is important.

The question of credit expansion in emerging markets, credit needs to expand. Financial systems are very crude and they have not deepened and there are lots of troubles, and Enrique alluded to that. Credit expansion is not necessarily a bad thing, but of course the fundamentals --

QUESTION: Excuse me, I meant risks and associative current account deficits in that context.

MR. ROGOFF: You mean sort of the Hungarian households mortgaging themselves in Swiss francs kind of thing? Yes, if we have a big geopolitical problem or something to raise volatility. Right now we have had the five best years like ever in global growth so it has been hard to make mistakes, but if we have a different situation, some of those things will happen. However, it depends on your forecast. If you take the IMF's forecast which was pretty rosy, then you should be out there making money and leveraging yourself and doing things, but that is a tough question. It varies tremendously by country. It is a tough call.

Then finally on the International financial institutions, I do not think there is a short answer to that question. The reserves make it a lot less likely that you are going to have a currency crisis in countries with giant reserves, although the experience of the 1990s currency crises in Europe, there were countries that had enough reserves to buy back all of their money supply even M-1 and they still had a currency crisis because it is possible to get stared down no matter how big your reserves are. That said, as Jeff noted, that is a bit less likely right now.

MR. FRANKEL: There were a lot of interesting comments. I think I am going to just pick up on Marcus Miller's and leave the others to the other panelists so as not to take up too much time.

Collective action clauses -- I almost said is not a panacea but I try to avoid that word because the word panacea has no use outside of the sentence that something is not a panacea, but it is not silver bullet. Well, that is the same thing there.

A collection of ways of working things out to substitute for domestic bankruptcy court or debt workout, I recall that the international debt crisis was in 1982, but it lasted 7 years which is a long time for a crisis to last. Why did it last 7 years? There was this debt overhang and endless negotiations and banks were rolling over their loans and who is going to bear the burden of the adjustment until that got swept away. Ken is very skeptical of the Brady plan and that whole argument, but we are not getting into technical details.

What you want is a system that after a negative shock resolves pretty quickly and then you can move on without being caught in endless litigation or rounds of negotiating with creditors or whatever, and there are different ways of doing that. I am talking about efficient risk-sharing.

One of the positive things we have seen is fewer bank loans and more equity in FDI and equity in FDI have the property that in adverse circumstances price goes down automatically, no fuss, no muss. You do not have to have these endless negotiations, and so I think that is good. And I think collective action clauses is a bit of that too, and other ways of trying to make more efficiency without having to go all the way to an SDRM or an international debtor's court which is politically not very likely. Lastly, another plug for commodity exporters, that I think they should denominate bonds in the price of copper if you are Chile or Zambia would be a very efficient way of dealing with it.

Just on the welfare of the IFIs and the IMF in particular, it is a little bit off the subject. We have been talking just about international capital flows and emerging markets, but let me just say a word about G-7 current account imbalances. Supposedly according to Mervin King, the IMF is sort of out of a job and with nothing to do until the next round of crises comes along and if you think that things have changed permanently, then the IMF is really permanently out of a job. I think there is something that the IMF ought to be doing a little more aggressively than it is doing which is take up the opportunity or even the mandate that it was given a year ago by the shareholders for multilateral surveillance. I know the IMF cannot dictate terms, but both the U.S. and China have a lot to lose if things break down and I think they have a lot to gain by a deal that would be midwifed by the IMF, and the key attributes of such a deal would be China agrees to more currency flexibility, the U.S. agrees that its current account deficits are not primarily China's fault, and in addition to China having more flexibility, the other Asian countries simultaneously agree to let their currencies appreciate as well because it is a lot easier to do it together than individually and the U.S. cuts its budget deficit and increases its national saving rate, and I can tell you there is a role for Europe as well and the IMF can at most help this along. But I think one way that I think would be maybe useful is analysis, for example, at the recent meetings if the newspaper reports are correct, the U.S. just showed here are our projections, we are going to have a budget surplus by 2012 and China I imagine said, look, we have changed our exchange rate regime. You do not have to dictate solutions or to be very controversial to do some objective economic analysis that says that those two statements are wrong. An intelligent projection of the U.S. budget, look at the Concord Coalition or somebody, it is not going to reach surplus by 2012 and technical analysis and forecasting can show that, and China has not really abandoned the peg. So if the IMF were a little more aggressive, it would take some courage, but a little more aggressive to point out these things, it might make it harder for the member countries to be off on their own tangents and might facilitate them actually getting together and doing what needs to be done.

MR. CALVO: Very briefly because we are running out of time and there are many questions. I do not have any big disagreement with the previous panelists. Let me just say about the great expansion that I agree with Ken that essentially you have to look country by country and based on the conditions, and the big concern there is incomplete markets particularly situations where you have (off mike) but it is something that you should expect especially if there is a soft landing in the world and global imbalances tend to disappear, then credit will have to go somewhere else, not to the U.S. And given that the financial markets are not well developed in emerging markets, most likely it is that it is going to be channeled through the banking sector, for example. But that is something that the central banks should look very close to avoid other kinds of domestic imbalances which could be equally very destructive as we know.

On the issue of the currency union or one currency, I think the big problem there is the lender of last resort. I think that is an issue we should come and rethink all the time seriously. In our paper (off mike) in Michigan we called that something related to that, the Mundellian challenge. The Mundellian challenge is that Mundell in his famous 1961 I believe and he had a little note, he wants us to think about why not having different currencies for different states in the U.S. That is an issue that never rises. It is interesting. We can talk about float and fix and everybody gets very furious about the issue. However, very few times you have in the discussion being brought to the surface the fact that if you had a floater, for example, why not think about having floating generate inside Argentina as an example in 2002 if you want one.

Of course we think it does not work and so strongly we think that it does not work that I have never seen in my years at the IMF that being an issue for discussion. So I think we have to put that together. My short answer, because this is a really big issue, is that we are going to have trouble setting up a lender of last resort which is effective at the global level, so it is a political issue more than an economic issue. But once we agree why it would not work as it does for an individual country, and even a large individual country like the U.S.

Another issue that came up was could be the Taylor and foreign exchange intervention, the combination of the two, could not that be an optimal policy. I have a feeling that, yes, maybe that is the way to go, but my concern is that we know very little as I said in my presentation on when it is the time to intervene, how that should be transmitted to the public, and if we do so, do we do that under orthodox principles or maybe we will have to be a little bit more heterodox because of theoretical considerations not as a policymaker in what I am going to say, I tend to lean in the direction of heterodox policies in the midst of crisis. Why? Because in a financial crisis, one of the things that happens in a breakdown in the market system and you are orthodox and an orthodox policy works especially when the markets work. When they do not, sometimes maybe you have to direct credit like Brazil did in 2002, but we need a lot more research. I will not go out on a limb on this because it is really a very key issue.

By the way, in talking about these issues with John Taylor, and I have a paper in NBR you can find it very recently where I raised these issues, he found them very natural. He said, yes, I think for the U.S. also we have to do that. We have the interest rate policy, but things get out of control, then money should be the anchor. So it is not very different from what I am saying or what I am feeling about emerging markets except that perhaps I would put more emphasis on exchange rates because it is a more clear anchor for emerging markets. But the issue that maybe you have to switch to a different anchor or harness the interest rate with something else is the issue that needs more research. And I agree with Ken that the Research Department has a very, very important role here and this could be one of the issues that you may want to explore.

Then to end there was this issue about currency crises and whether currency crises are going to be less likely. I think maybe some of the so quick rebounds that we saw after the recent shakeups in emerging markets had a lot to do with their accumulation of reserves and it will be interesting to see if we can prove it more seriously. But on the other hand, let's not forget that for emerging markets it is not what breaks the back of an emerging market is not so much a currency crisis, but a credit crisis, so you can still have a credit crisis. The point that I was trying to make before is that even if you have current account surpluses, be careful, go a little deeper to see if there are sectors which are falling into debt at home, and if there is a sudden stop of credit around the world, it is not going to be the case that ones who were sending the money out will bring back the money to help those that are in financial trouble. So I think that is another issue because let's be careful with that, but that is all.

MR. CLAESSENS: Thank you very much all of you, and I think we have got many insights and answers to some questions. We also got some new questions, but I think we have reached the end of our time here. I want to thank again the panel very much for good presentations, and thank the organizers once again for their conference.


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