Typical street scene in Santa Ana, El Salvador. (Photo: iStock)
September 25, 2011
Policymakers must tackle the root causes of the global economic crisis, not just the symptoms, said former Bundesbank president Axel Weber.
Weber: main lesson of financial crisis is that world needs better-regulated financial market environment--that would be the best safety net (IMF photo)
PER JACOBSSON LECTURE
The global crisis was not a random event but “can be traced back to specific causes such as inadequate institutional arrangements or mistakes by market participants and policymakers,” Weber said in a lecture at the IMF in Washington D.C. Therefore, the objective should be to tackle the roots of the crisis by formulating good monetary, fiscal, and regulatory policies rather than “creating ever more instruments to fight the symptoms.”
As devastating as the global economic crisis was, authorities were able to manage with the array of tools they had, said Weber, who headed the German central bank from 2004 until last April. In the annual Per Jacobsson lecture, Weber rejected proposed new instruments, including several that would involve an expanded role for the IMF.
But Weber said the crisis also demonstrated “that the IMF is an indispensable global institution” that played a crucial role in fighting the crisis at the global level by bringing its unsurpassed analytical skills to bear on the crisis and its root causes, for its provision of resources to distressed countries, and its technical advice.
Global scope
Weber said that globalization means that there will be no more purely regional economic crises and that the IMF is the only institution that brings a global scope to financial crises. The IMF’s great strength, he said, is its unsurpassed analytical ability.
In the ongoing sovereign debt crisis in Europe, Weber said, the IMF is playing an important role in encouraging the political process to deal with the underlying cause of the problem—excessive debt—and to impose conditions on loans that require borrowing countries to take steps to reduce their indebtedness.
Weber, in his address on September 25 titled “The IMF and the International Monetary System: Lessons from the Crisis,” also cited the problems caused by large inflows of foreign capital into emerging markets and said the IMF should play an enhanced role in monitoring the flows and advising countries on proper policies to deal with them.
Undesirable expansion
Weber said he would not take a single item in the toolkit away from the IMF. But he said proposals to enhance IMF capacity for financial management are undesirable—such as creation of a permanent international liquidity mechanism with the IMF at its core or expanded funding through public issuance of its own bonds.
The IMF—which provides economic and financial analysis, technical assistance, and emergency financing to its 187 member countries—has sought no such powers.
The Per Jacobsson lecture, in honor of a former managing director of the Fund, is a key event during the Annual Meetings of the IMF and World Bank. The lecture is delivered by a leading figure in international finance. Weber, 54, now a visiting professor at the University of Chicago, is slated to join the giant Swiss bank UBS next year and become its chairman in 2013.
Weber said the crisis, the worst since the Great Depression of the 1930s, showed that not only could a national crisis quickly morph into an international crisis but also that the global financial system and the global real economy that produces goods and services “are so intertwined” that a financial crisis can affect the real economy in both emerging and advanced economies.
Tackle root causes
A core problem during the crisis was the lack of international liquidity after money markets dried up, he said. This particularly affected banks with foreign currency needs. To help those banks, central banks typically borrowed (or swapped) foreign currency from other central banks that they could then deliver to their national banking systems. These ad hoc measures “proved to be successful in securing the supply of international liquidity,” Weber said.
Replacing ad hoc swaps with “a more permanent mechanism in which the IMF would play a central role” would not be advisable, he said. Such an institutionalized safety net would require central banks to commit in advance to cover the potential IMF financing needs during periods of stress. That would reduce discipline and interfere with monetary policies of member countries, and he doubted independent central banks would be amenable.
The main lesson of the financial crisis is that the world needs a better-regulated financial market environment. He said that would be the best safety net.
No bonds
Weber also said that the IMF should not be permitted to sell bonds on capital markets to raise additional funds that it would lend to financially troubled member countries. Now the IMF taps capital paid in by all member countries to make short-term loans to countries in distress. If it sold bonds, Weber said, its “unique character as a monetary institution” would be lost. Central banks might leave the institution, making it the province of ministries of finance, as the World Bank now is.
It could also enhance the IMF’s lending capacity, which some analysts think is too small. But, the “quasi-unlimited availability of Fund resources” would make it hard to impose adjustment conditions on borrowing countries, Weber said.
Capital flows
He said the recent large inflows of foreign capital to emerging markets present two threats: They not only could contribute to asset bubbles in recipient countries, they could also disrupt those countries if foreign investors abruptly pulled out their funds—a phenomenon economists have dubbed a “sudden stop.”
But he said countries must formulate their own policies to deal with the inflows, and any measures to deal with managing the inflows should never be a substitute for sound domestic policies.
He said the IMF “should play an enhanced role in the global monitoring of capital flows” and help close any data gaps essential to the monitoring effort. But the IMF’s role should not go beyond advising appropriate policy responses to volatile capital flows. It should not become an “umpire” of capital flows and country responses to them.
“The IMF’s principal strengths and role” should not be as an enhanced player, but rather as purveyor of analytic capacity, “which is ever more important” in international crisis prevention and crisis management.
Global imbalances
Weber pinpointed large internal and external imbalances as a threat to an otherwise robust international monetary system. Countries “with large current account surpluses, such as China, have to remove structural deficiencies that limit internal demand” and make their currencies more flexible. “Countries with large current account deficits should consolidate their public finances as quickly as possible.”
He said the European Union, which has no overall current account imbalances, could also contribute to global stability by solving the internal imbalances within the region, which are manifesting themselves in the sovereign debt crisis on the continent. He said the core issue is “excessive debt” and that the crisis will not be solved until the countries in crisis undertake spending and taxing changes to reduce their debt.
