March 7, 2011
Good afternoon. I am grateful to have the opportunity to address such an eminent gathering of economists and distinguished guests. My Fund colleagues and I are delighted to welcome the participants to this event from around the globe-- representing a broad range of views and experiences -- to share their wisdom and insights. I am particularly pleased to see so many long-standing friends gathered together at the Fund, and I thank you all for making the effort to join us today.
I’d like to take a few minutes of your time to focus on the practical efforts underway to draw the key lessons of the recent crisis, and to bolster the prospects for effective economic policy cooperation. The origins of these new efforts derive from the formation – at the height of the crisis in late 2008 – of the G-20 Leaders process. Faced with an unanticipated and unprecedented risk of financial meltdown and deep economic downturn – and, it should be recalled, in the face of widespread skepticism about their seriousness of purpose and prospects for success – the G-20 authorities forged in short order a broad Action Plan, and then proceeded to implement more forceful and effective measures than most observers had expected.
With global growth having resumed by 2009’s second half, the importance of the G-20’s policy cooperation and coherence in forestalling the downturn and in setting the stage for renewed progress was recognized widely. This recognition has underpinned the G-20’s efforts to adopt the process of policy cooperation to the demands of sustaining the global expansion in the post-crisis period. As the global recovery approaches its second year, however, many observers maintain that the momentum for international policy cooperation already has waned, and that the traditional primacy of national priorities are draining any sense of urgency from the multilateral efforts exemplified by the G-20 Leaders process.
Of course, policy cooperation in the post-crisis context of a multispeed global expansion inevitably is going to be more complex than it was when it was perceived that we were at the center of the maelstrom. This is why the Managing Director earlier today described current circumstances as representing a second phase of the crisis, with individual economies facing differing circumstances and priorities, to which they are responding quite naturally with heterogeneous policies. In this setting, it is not so surprising that frustration has been expressed regarding whether policy measures being implemented by key authorities are appropriate when viewed in a global context. Nonetheless, as the Managing Director emphasized in his remarks this morning, global policy cooperation remains critical to creating confidence in the strength and sustainability of the expansion.
My goal today is to provide a brief but specific counterweight to the skeptical views increasingly voiced about the prospect for post-crisis policy cooperation. In fact, the G-20 process is focused this year on initiatives in five key areas: global rebalancing, cross-border capital flows, the global financial safety net, the future role of the SDR and the ongoing work on financial sector reform. I’ll discuss briefly the efforts underway on the first four issues, leaving aside the demanding but better known efforts on financial reform that will be addressed in the next session.
The MAP
Central to the G-20’s work is the formal mechanism that is being established for coordinating and monitoring macroeconomic policies under the title of the Mutual Assessment Process, or MAP. I view this effort as central to the G-20 because it was conceived and created by the G-20, is being conducted by the G-20, is concerned with the policies of the G-20 economies, and is associated with the economic and financial policy focus that the G-20 Leaders defined as their principal responsibility.
At the MAP’s operational beginning in late 2009 and early 2010, G-20 members shared with each other—and with IMF staff—their policy plans and economic projections for the next three to five years. Taken at face value, these forecasts collectively were consistent with the G-20’s principal economic goals of strong, sustainable, and balanced growth. However, they were not backed by equally ambitious and detailed policy plans. In particular, they did not provide for sufficient fiscal adjustment. Nor did they point to much progress toward reducing current account imbalances.
As a result, the G-20 authorities recognized that additional effort would be needed to achieve their shared objectives. With the assistance of the IMF and other international institutions, the G-20 developed – and the G-20 Leaders subsequently pledged to pursue –an alternative upside scenario in which coherent policy actions across the G-20 would produce better outcomes for all, including significant strides in global rebalancing.
At their Seoul Summit, G-20 Leaders accepted that there was a realistic prospect for attaining such a superior, cooperative outcome. As a result, they decided that the MAP should be carried forward, and made more concrete. They agreed to set indicative guidelines that would be used to assess progress on reducing imbalances. The first step was agreed last month by G-20 Ministers and Central Bank Governors, and it is expected that the indicative guidelines will be presented for approval at the April G-20 Ministerial. Fund staff continues to provide active support in this effort to the G-20’s Framework Working Group that is responsible for the detailed oversight of the MAP. And I would emphasize that the broad outlines of the needed policy adjustments on all sides is well accepted and well understood.
These indicative guidelines subsequently will be used to provide an assessment of progress to date, and to support the development of a new Action Plan, to be prepared for the next G-20 Leaders Summit in early November. In addition, the Fund has been asked by the Leaders to provide its independent assessment of each G-20 economy’s fiscal, monetary, exchange rate and structural policies. In support of this effort – and in the interest of deepening the Fund’s multilateral surveillance – Fund staff is carrying out innovative spillover analyses regarding policies of five systemically critical economies.
Of course, it would be unrealistic to expect too much from the MAP too soon. At the same time, there is no reason to underestimate its promise and potential. There is no exact precedent for this multilateral process, while the recent crisis provided a sobering demonstration of the degree of economic and financial interconnectedness and of the risks of incoherent and inconsistent policies. As a result, the incentive for meaningful participation in the MAP is clear: If successful, every G-20 economy stands to benefit. Failure would only heighten downside risks. And at every crucial decision point so far, the G-20 Leaders have endorsed new action to make the MAP more likely to be effective.
International Capital Flows
Turning to the next item on the 2011 G-20 policy Agenda that I intend to address, it is clear that the combination of financial sector reform, the persistence of large international payments imbalances and the prospect of sustained divergences in trend economic growth rates virtually guarantees that cross-border capital flows will represent a significant issue for some time to come. Although the crisis gave rise to a threatening sudden stop in the previously record-high capital flows to emerging economies, flows have since restarted. Moreover, securities trading among advanced economy financial institutions created one of the key causes of the recent crisis, but such transactions no doubt will continue to grow in the future.
The broadly beneficial role of international capital flows is widely accepted. Thus, advanced economies are taking the lead in addressing the regulatory, supervisory and other areas of market weakness that were exposed by the crisis. The broadly beneficial impact of well-functioning capital markets also is accepted in most emerging economies.
However, sudden surges of capital inflows also are widely viewed as complicating macroeconomic management and potentially posing risks to financial and economic stability. For some time, policy makers in emerging economies have been wrestling with the question of whether and how to respond to capital inflow surges. Depending on the specific circumstances, the Fund’s recommended policy answer can be to allow exchange rates to adjust, monetary policy to be eased, and/or fiscal policy to be tightened. Prudential financial market policies also may form part of the recommended policy response.
When these fundamental policy options already have been implemented, capital flow management measures can be considered part of the policy toolkit. In particular, it is generally assumed that they can be used temporarily on a case-by-case basis in appropriate circumstances. But the specific economic and financial impact of capital flow surges is not well-understood, while evidence is unclear on the effectiveness of specific controls, thus making detailed guidelines for their use uncertain.
Moreover, the unilateral implementation of controls can create systemic impacts. After all, capital controls are by their nature a discriminatory measure, potentially undermining the credibility of a multilateral approach to policy issues. The proliferation of capital controls could undercut the benefits of financial integration, vitiate necessary external adjustment, or divert capital to countries that may not be in a position to absorb it effectively.
It is not surprising that in the current circumstances, in which capital flows to emerging economies have restarted, while exhibiting significant structural shifts, that there is interest among the G-20 authorities – and more broadly among Fund members – in exploring whether a consensus is emerging around some broad “rules of the road” regarding international capital flows. Of course, it is not yet clear exactly what these rules might comprise. I am sure that some interesting perspectives on this subject will be expressed in the session this afternoon on capital account management.
Global Financial Safety Nets
The third item on the G-20 Agenda that I would like to address is the prospect for improving international financial safety nets. The underlying idea is well understood: In times of international economic and financial stress, liquidity tends to seek out safe havens. This process can render other markets illiquid, undermining stability and threatening global growth. If well designed and operated, financial safety nets can help to prevent the emergence of circumstances that create an unnecessary and disruptive “flight to quality”, while avoiding the creation of moral hazard that itself can undermine systemic stability.
Of course, the recent crisis motivated substantial progress in the development of safety net facilities. In particular, the IMF’s crisis prevention arsenal has been strengthened through a combination of increased financial firepower and more flexible and effective instruments. As the crisis unfolded, the IMF’s membership agreed to triple the financial resources at the Fund’s disposal. Our members also endorsed important innovations in the IMF’s lending framework, including the creation of a new financing instrument—the Flexible Credit Line (FCL)—that can provide contingent financing to economies with strong macroeconomic fundamentals and excellent policy frameworks. In other words, the FCL is an insurance-like instrument intended explicitly to be used as a crisis-prevention tool.
More recently the Fund’s Executive Board has approved enhancements to the IMF’s insurance-like facilities. The FCL has been made more attractive, notably by lengthening its tenure and raising its maximum level of support. And a new Precautionary Credit Line (PCL) has been added for countries with moderate vulnerabilities. Finally, our members recently agreed to double the total amount of IMF quotas, effectively doubling the Fund’s permanent resource base.
Despite this progress, gaps remain in the global financial safety net. For instance, the global crisis has demonstrated that financial market breakdowns can lead to temporary liquidity constraints even in countries with strong fundamentals and appropriate policies. Thus, in many cases during 2009, liquidity needs were met in an ad-hoc and reactive basis through the granting of bilateral credit lines. Moreover, recent European experience indicates that uncertainty about financial safety nets can impose significant costs.
From the point of view of enhancing systemic stability, it might be better to create a more predictable system of international liquidity support. For example, the Fund could offer a precautionary short-term liquidity line (or SLL), similar to the Short-term Credit Facility (SCF) that was created temporarily on a non-precautionary basis in late 2008, but that was cancelled when the FCL was created. An SLL-type facility could be created on a standing basis, or imbedded in a possible Global Stability Mechanism that would be activated at times of systemic stress. Moreover, the Fund is exploring how to develop greater synergies with regional arrangements, with respect to both surveillance and financing. These possibilities will be explored by the G-20 as part of its 2011 agenda. It will be interesting to see what other ideas conference participants might have in this area.
Role of the SDR
Another G-20 agenda item is the future role of the SDR in the international monetary system. At its heart, this is a discussion about whether a meaningful degree of multilateral responsibility should exist for the creation of international reserve assets, or whether this instead should result from a combination of market outcomes and bilateral policy choices. As is well known, the proportion of dollars in global foreign currency reserves—at least the part that is reported to the IMF—has declined by about 10 percentage points over the past decade to a little over 60 percent of the total.
If the IMF’s members decide to allocate SDRs in larger quantities, this could satisfy some of the precautionary demand for reserves of emerging markets and others. And SDRs could play a more substantial role in ensuring there is a well-functioning safety net as countries cope with the changing concepts of international liquidity. Another possibility would be for the SDR to expand beyond its current role as an official asset, for example if the IMF or another multilateral agency issued SDR-denominated instruments that could be privately held and traded.
Another question regarding the SDR is the possible evolution of its constituent currencies, so long as it remains a “basket” currency. For example, should the SDR basket be limited to convertible currencies? In other words, would the inclusion of the Renmimbi or other major non-convertible currencies smooth these currencies’ internationalization, provide official holders a tool for managing their exposure to these currencies, and/or spur private interest in SDR-denominated instruments? Or would such a move only make hedging SDR positions more difficult, further undermining already scarce liquidity in SDRs? It will be interesting to get conference participants’ perspective on the issue of whether the SDR can play a more relevant role in the future.
Concluding remarks
Summing up, the agenda for policy cooperation has become more complex in the second phase of crisis. But we shouldn’t forget that the need for policy coherence and consistency was underscored in dramatic fashion by the crisis’ first phase. Of course, more than just a perception that policy cooperation is critical has survived this phase. The crisis also motivated the creation of the G-20 Leaders process, the MAP and the rest of the G-20 reform agenda. Thus, new possibilities exist for effective action. What are needed in addition are clear ideas to guide action. And that is where your discussions today and tomorrow can prove to be timely and important. I thank you for your participation, and look forward to your suggestions and conclusions.
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