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International Policy Cooperation: Essential for Securing the Global Economic Recovery and Modernizing the Global Financial Architecture, Address by Dominique Strauss-Kahn, Managing Director, IMF
March 17, 2010
As Prepared for Delivery
Good morning. It is a great pleasure to take part in this important annual meeting of European parliamentarians. Today, I would like to discuss with you the state of the global recovery, and priorities for modernizing the global financial architecture in support of long-term growth.
We find ourselves at a critical moment in history. We have just been through the most devastating financial crisis since the 1930s—a crisis that has inflicted tremendous costs on people around the world.
The crisis has also been a deeply humbling experience. It has revealed serious weaknesses in our economic and financial institutions. Here in Europe, the crisis has even caused some to question the survival of the European Union.
Now, in the wake of the crisis, we have the opportunity—and the duty—to reshape our institutions—to make them stronger, more resilient to crisis, and hence better able to promote growth and prosperity.
The question is whether we—at the international level, and at the European level—are making the most of this historic opportunity. I fear that as financial markets bounce back and economic growth resumes, the determination to make lasting changes is already receding.
I’d like to focus today on the importance of international policy cooperation for achieving lasting change. By working together, we can lay the groundwork for stronger and more stable growth—and ultimately, for greater prosperity for all nations of the world.
Global economic recovery
Let me begin with the prospects for global economic recovery, and the policies needed to keep it from faltering.
The recovery is shaping up to be better than expected, and we are forecasting global growth of 4 percent this year. But it is clearly a multispeed recovery, with growth varying significantly across the globe. In most advanced economies, the recovery is still rather tepid, and remains dependent on policy support. For the EU, we are forecasting growth of 1 percent this year. In contrast, most emerging economies are already recovering robustly from the crisis, with private demand in good shape to carry growth forward.
As the financial crisis winds down, what are the policy priorities?
In many countries, the most critical task for the next several years is to bring public debt back to sustainable levels—to avoid it burdening interest rates and growth, and stealing room for maneuver in the event of future shocks. This will be hard: in the advanced economies, public debt is set to rise to an average 110 percent of GDP by 2014, about 35 percentage points higher than before the crisis.
What we need now are strategies that can restore fiscal sustainability, but that do not jeopardize the economic recovery by withdrawing support too soon. Key elements of such strategies include strengthening fiscal institutions and reforming health and pension entitlements. Containing the growth of primary spending is also essential, and where needed, increasing revenues. At the same time, however, policymakers must safeguard social safety nets, which remain essential for protecting the most vulnerable victims of this crisis.
Looking farther ahead, how can the recovery be sustained over the longer run? One key is to achieve a better balance of global demand.
This is not a new insight: you will recall that the IMF long called for action to reduce global imbalances. Now, in the wake of the crisis, the leaders of the G-20 have identified it is a high priority, to make growth more sustainable. In the years leading up to the crisis, the U.S. and other economies spending beyond their means were the main drivers of economic growth. This made the entire global economy heavily dependent on these countries—and thus left it vulnerable to a downturn in their economies.
What does rebalancing mean at the country level? While the specific changes will of course vary from country to country, they all have one thing in common: the need to identify new sources of growth.
In economies that have been running persistent current account deficits—such as the U.S., but also several European countries—domestic saving must increase. And to support demand, exports will need to contribute more to growth.
In economies with persistent current account surpluses—such as China, Germany, and many oil-producing countries—domestic demand must go up. Broadly speaking, this means boosting growth in consumption; in some cases, exchange rate appreciation will also play an important role.
The G-20’s new Mutual Assessment Program, the so-called MAP, is promising in this regard. Through this framework, the leaders of the world’s largest economies are accountable, to each other, for the adoption of national policies that are compatible with the greater global economic good. The IMF is providing important analytical support to the MAP, which is expected to complete its initial assessment by April.
International monetary system
Before addressing financial sector issues, let me also say a few words on the international monetary system, which is an important element of the global financial architecture.
On the whole, the existing system has served us rather well. During the crisis, the U.S. dollar played its anchoring role, and the Fund provided effective support to many of its members.
But the massive build-up in reserves over the last decade has put the international monetary system under some strain.
What can be done to ease these pressures?
If countries had access to better financial insurance, the need to build up precautionary reserves could be lessened. The IMF’s Flexible Credit Line, which provides upfront financing with no subsequent conditionality, tries to meet this need. It has already supported several major emerging markets during the crisis—including Mexico, which just renewed its credit line, and Poland. But I think that some further modifications of the FCL could make it more useful to a wider set of our member countries.
Of course, the precautionary build-up of reserves is only part of the story: in some countries, export-led growth strategies have contributed to the reserve build-up. Hopefully, as global demand is rebalanced, this source of reserve accumulation will also taper off.
Building a more resilient global financial framework
Let me turn now to financial sector issues. How can we reshape the financial sector so that it can do its job of supporting economic growth—but without inflicting costly crises on economies and taxpayers?
At the country level, the priorities for reform are well-known. They include widening the regulatory perimeter, beefing up supervision, improving the measurement and regulation of systemic risk, and strengthening crisis resolution mechanisms. In addition, financial institutions should be required to hold more and better quality capital, and improve their liquidity management and buffers.
While some progress has already been made on these priorities, understandably the public is growing impatient with the slow pace of reform. And as taxpayers see bankers continuing to draw outsized bonus payments, even as unemployment continues rising, it is fair for them to question whether politicians are still committed to achieve serious and lasting reform.
While financial markets have staged an impressive comeback, we should not fool ourselves into believing that this means smooth sailing going forward. Even as we take steps to address the risks of yesterday, we must already be thinking about the new risks of tomorrow—and how best to manage them.
The international dimension of financial sector risks will without doubt feature very prominently in this regard. But many countries are approaching bigger-picture reforms from different directions and at different speeds. This presents a great risk of uncoordinated policies, distorted capital flows, and regulatory arbitrage.
Another major challenge is how to handle the large complex financial institutions that dominate global finance. Recent proposals for “special resolution authority” and “living wills” to handle the failure of such institutions at the parent level are very important. There is also a need to consider preventive measures, such as limits on the size and complexity of financial institutions. But the reach of these mechanisms does not always extend beyond the national borders. Nor do all jurisdictions have such resolution authority over financial holding companies. Pending a global agreement, we have a system with holes and go-it-alone national approaches.
Indeed, global approaches stand the best chance of avoiding a competitive race to the bottom, while at the same time limiting the potential for arbitrage across regions.
How far has financial sector reform come in Europe?
There has already been good progress in overhauling the cross-border financial stability framework. The envisaged establishment of a European Systemic Risk Board and a European System of Financial Supervisors, and the European Parliament’s proposals to improve their effectiveness, hold out great promise for improving the monitoring of risk, and hence the ability to forestall crises. I urge the Council and the Parliament to reach agreement on this reform package soon, to make these important reforms a reality.
But the reform proposals have yet to address crisis management and resolution, in particular for cross-border banks. In my view, Europe needs an integrated framework for crisis prevention and management, crisis resolution, and depositor protection. The framework should include a European Resolution Authority, with the mandate and tools to deal cost-effectively with failing systemic cross-border banks. While technically challenging, the elaboration of such a framework is feasible—but it will require strong political leadership to come to fruition.
Two concluding remarks
In closing, let me make two final points.
First, the IMF could do a better job of supporting our members as they face the challenges of the 21st century.
To enhance our ability to prevent crises, we must improve our oversight of systemic and financial sector risks, including those related to capital flows. And to strengthen our ability to respond to crises, we need better and more versatile financing instruments. I’ve already mentioned the FCL. Another possibility is to increase our collaboration with regional reserve pools—following on the positive experience of EU lending in parallel with Fund programs. We could also do more for our low-income members, for example by providing insurance against global volatility and other such shocks.
And second, the key message I would like to leave with you today is that without international collaboration, we cannot be successful in overcoming the challenges of the post-crisis era.
During the crisis, it was the unprecedented extent of collaboration that saved the world from another Great Depression. Now, the need for international collaboration is even greater, as we seek to create a new economic and financial landscape—that delivers strong economic growth, supported by an innovative yet safe financial sector, to the benefit of all nations.
And here in Europe, you face the challenge—and the opportunity—of creating stronger, better mechanisms that can take the European project to the next level. But you must also use your political influence to make sure that a global solution will emerge.
Thank you for your attention.
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