The Triple Comeback -- the Impact of the Financial Crisis on Global Economic Governance
IMF News, December 8, 2010
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- Authors: Dominique Strauss-Kahn
- Published: December 8, 2010
Overview
- Speech by Dominique Strauss-Kahn, Managing Director, International Monetary Fund.
- Geneva, December 8, 2010. As prepared for delivery.
- Central thesis: the financial crisis necessitates a "triple comeback" — renewal of global economic governance, the IMF’s return to the center of global governance, and a reassertion of the IMF’s original mission adapted to a changed global economy.
Causes and diagnosis of the crisis
- Key systemic weaknesses identified:
- An unbalanced, unsustainable global growth model relying on excess borrowing by some countries and excess saving by others.
- Large increases in inequality; in the United States, inequality on the eve of the crisis "was back where it was just prior to 1929."
- Insufficient financial regulation and supervision.
- Financial institutions took unprecedented risks, using "complicated financial engineering that both magnified and disguised risk."
- Regulators and supervisors often "had bought into a culture of deregulation and a belief that financial markets could police themselves effectively."
- Immediate macroeconomic outcome:
- The Great Moderation "turned into the Great Recession."
First comeback: renewal of global economic governance
- International cooperative responses during the crisis:
- Coordinated monetary policy actions, including interest rate cuts, swap lines between the Fed and many other central banks, and unconventional monetary policy measures.
- A "2 percent of GDP global fiscal stimulus," implemented by countries with fiscal space, as advised by the IMF.
- Collective action averted "a second Great Depression."
- Financial sector reform progress and gaps:
- The FSB, together with the IMF and other institutions, is leading reform.
- Basel III is described as "a major step" expected to improve bank capital qualitatively and quantitatively.
- Identified next priorities: regulation of non-bank financial institutions; strengthening supervision; developing effective crisis resolution mechanisms.
- Warning: "Very little has been done" on supervision and crisis resolution; delays here "could well lead to the next crisis."
- Emphasis on three pillars: regulation, supervision, and crisis resolution — with supervision possibly "even more important than regulation."
Second comeback: the IMF returning to the center of global governance
- Timeline and IMF roles:
- Davos (January 2008) to London (April 2009): from warning to response.
- January 2008: IMF issued a warning and called for budgetary support ("the famous stimulus").
- April 2008 Spring Meetings: IMF moved from warning to alarm, highlighting banking system losses and the need for coverage.
- Early October 2008 (Fund’s Annual Meetings): first global response; broad recognition that government intervention and stimulus were necessary.
- April 2009 (G20, London): second response; IMF resources were tripled and the Fund was authorized to issue "$250 billion in SDRs" to be distributed proportionately based on quota.
- Decision to sell "400 tons of the Fund’s gold" to help the poorest countries; proceeds funded interest-free loans available beginning that summer.
- Pittsburgh (September 2009): G20 decided to continue cooperation, creating the Mutual Assessment Process (MAP) and agreeing IMF governance reform work.
- Seoul (November 2010): start of the "Long March" and entry to a second phase of G20 efforts.
- New instruments and programmatic changes:
- IMF resources increased substantially and used with lessons from past crises.
- Fund-supported programs since 2008 have been streamlined to focus on urgent problems and to account for historical and political contexts and support for vulnerable populations.
- Creation of the Flexible Credit Line and the Precautionary Credit Line to provide contingent support and allow countries to hold fewer reserves.
- Financial safety nets and cooperation with regional organizations (e.g., the European Union, possibly the Chiang Mai Initiative) described as decisive steps.
- G20 innovations and IMF support:
- Mutual Assessment Process (MAP): holds members accountable to implement policies for better global outcomes.
- "Spillover reports" to be produced by the IMF for five systemic economies: China, the Euro area, Japan, the UK, and the US.
- Mandatory Financial Sector Assessment Programs for all systemic countries (previously voluntary; the United States and China had not participated).
The IMF's return to its original mission and governance reform
- Mandate and institutional role:
- Rebalancing between regulation and markets; rejection of reliance solely on markets for sustainable growth.
- Public sector role in repairing damage and potentially preventing crises if governments act with foresight.
- Need for supervision willing "to say no to powerful interests," a comprehensive macroprudential framework, and coherent domestic and cross-border resolution mechanisms.
- Proposal (so far without success) for "a tax on financial activities" so the financial sector bears a substantial yet fair share of crisis costs.
- Governance, legitimacy, and representation:
- Concern about the G20's legitimacy: it accounts for "more than 80 percent of the world’s output" but excludes 167 countries of the IMF’s 187 members.
- Recent IMF governance reforms approved a shift of "over 6 percent in quota shares to dynamic emerging market countries."
- Resulting changes: "Brazil, China, India, and Russia will now be among our top ten shareholders."
- Voting shares of the poorest countries protected; advanced European countries agreed to give up "two seats on the Executive Board."
- Movement toward an "all-elected Board," described as making the IMF "more democratic" and "a momentous change, unparalleled in the history of our institution."
- Suggested alignment: closer alignment between an expanded G20 composition and the "24 countries on the IMFC that represent the 24 constituencies" of the Fund’s 187 members to enhance legitimacy.
Policy recommendations and imperatives
- Strengthen three pillars of financial stability:
- Regulation: continue implementing Basel III and extend attention to non-bank financial institutions.
- Supervision: prioritize robust supervision and compliance enforcement.
- Crisis resolution: establish effective domestic and cross-border resolution mechanisms to end too-big-or-too-important-to-fail and avoid socializing losses.
- Institutional and governance actions:
- Adapt mandates of international institutions such as the IMF and the WTO to the changing global economy.
- Undertake the task of redefining the Fund’s mandate and amending its Articles of Agreement.
- Ensure IMF legitimacy through representation and quota realignment to reflect the changing global balance.
- Macro policy coordination:
- Embrace the MAP and spillover analyses to manage "economic butterfly effects" and global imbalances.
- Use the IMF’s contingent instruments (Flexible Credit Line, Precautionary Credit Line) and safety nets responsibly to support countries in difficulty.
Closing scenario and call to action
- Two possible paths for the international community:
- Choose a new growth model and a new governance model to secure higher and more sustainable growth, strengthen democracy, and contribute to peace.
- Choose inertia and nationalism, risking years of instability and laying the groundwork for another crisis.
- Final admonition: "When the next financial crisis hits—and it is a matter of when, not if—we must be prepared." The imperative is to heed the crisis’s lesson and build a new, legitimate, and effective global economic governance.
Speech by Dominique Strauss-Kahn, Managing Director, International Monetary Fund, Geneva, December 8, 2010.