Tough Political Decisions Needed to Fix the Financial System
IMF Blog, June 20, 2011
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Bibliographic details
- Authors: Jose-Vinals
- Published: June 20, 2011
Context and framing
- Author: José Viñals
- Date: June 20, 2011
- Setting: Presentation of latest assessment of global financial stability in Sao Paulo.
- High-level framing:
- Three key messages:
- First, financial risks have increased since April.
- Second, policymakers in both advanced and emerging economies need to step up their efforts to preserve financial stability and safeguard the recovery.
- Third, we have entered into a new phase of the crisis - a political phase - when tough political decisions will need to be made, because the window for substantial policy action is closing. Time is of the essence.
Increased financial stability risks — detailed findings
- Investor reassessment and downside risks:
- A string of negative surprises in recent economic data is prompting investors to reassess the sustainability of the economic recovery.
- While a global recovery remains the most likely scenario, downside risks to this forecast have increased.
- Any weakening in the economic outlook will threaten to stall—and possibly reverse—improvements in the balance sheets of banks and households.
- Political resolve and European contagion concerns:
- Increasing concerns about the political resolve to support the adjustment efforts in Europe.
- The lack of a comprehensive solution has led to increased financial market pressures on some European governments, and has rekindled worries about potential contagion within and beyond Europe.
- United States and Japan vulnerabilities:
- United States: increased financial market concerns due to the continuing political stalemate over the debt ceiling and the longer-tern fiscal path.
- Japan: medium-term fiscal adjustment targets may have become even more challenging because of the impact of the recent earthquake and tsunami.
- Effects of a prolonged period of low interest rates:
- Accommodative monetary policies remain necessary in advanced economies, partly because of the limited progress in resolving structural problems.
- A prolonged period of low interest rates may lead investors to underestimate risk in their search for yield, promoting the buildup of financial imbalances.
- Two observed trends:
- The declining cost of debt is prompting some companies and investors to rediscover their appetite for financial leverage. There is evidence of such re-leveraging in the market for corporate high-yield bonds and leveraged loans.
- Investors’ search for yield has also spurred strong capital inflows into some key emerging markets, although such flows have recently eased. For example, buoyant foreign demand has led to a recent surge in international corporate bond issuance, notably from Latin America, and a decline in corporate bond yields.
Policy priorities and recommended actions
- Overarching imperative:
- Policymakers need to increase their efforts to tackle longstanding financial challenges once and for all.
- Europe — two-pronged approach to reduce contagion risk:
- (i) Push for a comprehensive plan to repair the financial system.
- (ii) Reduce sovereign risk through credible medium-term fiscal consolidation.
- Financial system actions:
- Insufficient progress so far in strengthening bank funding and capital positions in some European Union countries.
- The forthcoming stress tests by the European Banking Authority will be a decisive opportunity to enhance transparency and address the weak tail of undercapitalized banks.
- Government fiscal actions:
- Political resolve is required to address medium-term fiscal adjustment needs in several advanced countries, including the United States and Japan, which have yet to take decisive action in this area.
- Advanced economies versus emerging economies:
- Advanced economies need an orderly de-leveraging, which means they would cut back on the amount they borrow.
- Emerging economies need to focus on orderly re-leveraging.
- They should guard against overheating and the buildup of financial imbalances characterized by strong credit growth, rising inflation, and surging capital inflows.
- Corporate leverage is also rising, and weaker firms are now accessing international capital markets, which could make corporate balance sheets more vulnerable to external shocks.
- With strong domestic demand pressures—especially in emerging Asia and Latin America—macroeconomic measures are needed to avoid overheating, accumulating financial risks, and undermining policy credibility.
- Macroprudential and capital flow measures:
- Macroprudential tools, such as higher reserve requirements, and, in some cases, a limited use of capital controls, can play a supportive role in managing capital flows and their effects.
- However, they cannot substitute for appropriate macroeconomic policies.
Risks to policy effectiveness and political constraints
- Policymakers continue to face potentially large future shocks to the financial system, at a time when its resilience is not yet assured.
- There is less room for maneuver to counter these shocks through traditional fiscal and monetary policies.
- In increasingly gridlocked political systems, policymakers may find it progressively harder to take substantial policy action to address sovereign and financial risks.
- Concluding imperative: We are now in a new phase of the crisis - the political phase - and tough political decisions need to be made. Time is of the essence.
Source: Tough Political Decisions Needed to Fix the Financial System, José Viñals, June 20, 2011.
Content in this bundle
- 062011a
- 2011 年 6 月 20 日发布;修复金融体系需要做出艰难的政治决策;José Viñals
- Необходимо принять трудные политические решения, чтобы наладить финансовую систему