A Stronger Financial Architecture for Tomorrow’s World

IMF Blog, February 10, 2011

Source details

Title: A Stronger Financial Architecture for Tomorrow’s World
Author: Dominique Strauss-Kahn
Date: February 10, 2011
Versions available in: Español Français 日本語
Context: The international monetary system (IMS) covers reserve currencies, exchange rates, capital flows, and the global financial safety net. The topic is on the G-20’s 2011 agenda and has generated debate, including the report of the group chaired by Michel Camdessus, the “Palais-Royal Initiative”.
Key framing observations:
- Some view the current system as "not perfect" but resilient, citing the role of the U.S. dollar as a safe haven during the crisis and argue: “if it ain’t broke, don’t fix it”.
- The author takes a less sanguine view: the world did not end in 2008 largely because of extraordinary international policy cooperation, but the recovery is not the desired one—uneven, with unemployment "not really going down" and "widening inequalities within countries".
- Global imbalances are back, including "large and volatile capital flows, exchange rate pressures, rapidly growing excess reserves", which could sow the seeds of the next crisis if left unresolved.

Central question: "How can we strengthen policy cooperation and reduce volatility?"
Findings and initiatives:
- The crisis was a watershed for international policy cooperation; sustaining such cooperation is necessary for less volatile global growth.
- The G-20’s Mutual Assessment Process (MAP) is an important first step toward a more permanent framework for global policy cooperation.
- IMF surveillance is a critical complement to the MAP and central to the IMF’s mandate; it seeks to identify country-level policies that can deliver more stable global growth.
- Strengthened Fund surveillance includes early warning and vulnerability exercises.
- Increased focus on cross-border impacts of countries’ policies, with new dedicated "spillover reports" in preparation for the five most systemic economies.
- Deeper analysis of macro-financial linkages.
- Financial Sector Assessment Programs (FSAPs) are becoming mandatory for the world’s 25 most systemic financial systems to help detect dangerous systemic risk build-ups.
- A major review of surveillance is underway to explore whether more ambitious changes are needed.
Policy implication: Sustained, structured international policy cooperation and enhanced surveillance tools are needed to reduce volatility and manage spillovers.

Central question: "How best to cope with capital flow and exchange rate volatility?"
Observations:
- Over the past decade there has been a dramatic increase in the size and volatility of capital flows.
- Capital flows are broadly beneficial to receiving economies but can complicate macroeconomic management and threaten financial stability.
- Countries’ responses to flows are driven primarily by domestic considerations but have spillover effects on others.
Tools and policy options enumerated:
- Macroeconomic adjustment
- Reserve accumulation
- Prudential measures
- Capital controls (used when other measures are in place and disruptive inflows persist)
Open question: Given spillovers, should there be globally agreed "rules of the road" for managing capital flows? IMF members have asked the IMF to look into this and concrete ideas are expected in the near future.
Exchange rate volatility:
- Major currencies have fluctuated widely vis-à-vis each other and have not moved consistently to promote orderly adjustment of imbalances.
- Large and persistent deviations of exchange rates from fundamentals can cause significant systemic distortions, particularly harming small open economies.
- Addressing exchange rate volatility requires setting economic and financial policies that promote global balance and reduce capital flow volatility.

Central question: "How can we enhance liquidity provision in times of extreme volatility?"
Progress since the crisis:
- Strengthening of the global financial safety net.
- The Fund’s resource base has been increased significantly.
- The financing toolkit has been made more flexible, notably by adding the Flexible Credit Line and the Precautionary Credit Line.
Remaining challenges:
- Many countries remain unconvinced that the global financial safety net is strong enough to handle the next crisis, prompting costly accumulation of reserves "well in excess of precautionary needs".
Potential policy avenues:
- Strengthen partnerships with regional financing arrangements.
- Improve the predictability of systemic liquidity provision so it is not left primarily to national central banks.
- Develop better benchmarks and methods to gauge the adequacy of precautionary reserves.
- Explore a possible gradual role for the SDR to contribute to a more stable IMS; the IMF is releasing a paper presenting a range of ideas on this topic.
Caveat: Increasing the role of the SDR would require a major leap in international policy coordination; evolution of the global reserve asset system will be gradual and non-disruptive.

Reform of the IMS is wide-ranging and complex; global debate is only beginning.
The urgency is practical, not merely academic: concrete ideas are needed to support a well-balanced and sustainable recovery and to prevent the next crisis.

Source: A Stronger Financial Architecture for Tomorrow’s World, Dominique Strauss-Kahn, February 10, 2011.

明日の世界のための、一段と強固な金融アーキテクチャーを目指して: ドミニク・ストロスカーン, iMFダイレクトブログ, 2011年2月10日
- 明日の世界のための、一段と強固な金融アーキテクチャーを目指して: ドミニク・ストロスカーン, iMFダイレクトブログ, 2011年2月10日 (Markdown version)
- 明日の世界のための、一段と強固な金融アーキテクチャーを目指して: ドミニク・ストロスカーン, iMFダイレクトブログ, 2011年2月10日 (PDF)