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Finance & Development
A quarterly magazine of the IMF
June 2005, Volume 42, Number 2

Book Reviews

Getting real about financial crises

Nouriel Roubini and Brad Setser

Bailouts of Bail-Ins?
Responding to Financial Crises in Emerging Economies

Institute for International Economics, 2004, 427 pp., $28.95 (cloth).

This book by Nouriel Roubini and Brad Setser should be required reading for anyone dealing with emerging market countries and their debt. The authors manage to give us both a theoretical and policy perspective on the financial crises that have occurred over the past decade. By covering everything from the origins of individual crises to the official community’s policy responses to those crises, they help us distil the lessons learned. They are careful to puncture prevailing myths and lay bare the differences—especially within the Group of Seven (G–7) industrial countries—that help explain the halfway houses that were sometimes constructed in dealing with the individual crises (such as the second lines of defense used in the Asian crisis countries). The text could have been more parsimonious and less repetitious. But that is a quibble! If the international community wants to better anchor the ongoing debate about the IMF’s role in emerging market countries, it would do well to study this book carefully.

The authors bring a deep understanding to the topic. They understand the IMF and the dynamics of crises—including the different sectoral origins of the recent ones and the self-aggravating nature of the forces unleashed as the initial disturbances hit. They implicitly approve of many initiatives taken to strengthen the architecture of the international financial system—including the development of data standards, increased transparency (by the countries themselves as well as by the IMF), financial sector assessments, balance sheet analysis, and debt sustainability templates. However, they fault the international community for its failure to better define the IMF’s future financing role in emerging market countries.

This part of the discussion goes to the core of policies regarding the role of private creditors and the policy on access to the IMF’s financial resources. Many will recall the endless debates about “private sector involvement.” The authors capture these well, showing the complexity of the issue (such as the seniority of claims) and the unreconciled differences of view about official financing and moral hazard.

One response to these debates was a move toward enforcement of the access limits to IMF resources—a policy met, to a large extent, in the breach, as demonstrated in Turkey, Argentina, and Brazil. The authors call for a better strategy, one that would elaborate more clearly a role for possibly large IMF financing, even in cases of coercive restructurings. As they put it: “The biggest problem with the current framework is not the gap between what is said and what is done or that the posited goal of limits is unrealistic even as a long-term policy objective. Rather, it is that the current policy framework has precluded serious discussion of the best use of the IMF’s ability to provide substantial emergency financing to a range of emerging economies. Claiming that substantial liquidity will not be provided in the future allows the custodians of the global financial order to avoid defining the circumstances when such liquidity provision is the right policy—and when it is the wrong policy.”

Integral to this issue is how to secure a reasonably orderly debt workout when needed. The authors present a comprehensive review of the proposals to create a sovereign debt restructuring mechanism, to encourage more widespread use of collective action clauses in sovereign bonds, and to develop a code of conduct for borrowers and their investors. They conclude that while contractual or statutory change could help address the problem of holdouts and threats of litigation, the changes under way are “. . . not well suited to addressing the host of other difficulties facing a sovereign that needs to restructure its debts.” What is more urgently needed, they argue—pointing to Argentina—“. . . is for the IMF, backed by the G–7, to be willing to do more early on to help a country through its restructuring. The IMF should provide real money and real guidance in a real effort to avoid prolonged default.” Other than the real money, recent history unfortunately has run counter to this good advice.

Despite its many insights, the book presents no silver bullet for dealing with future crises. Instead, the authors call for more balance—between the extremes of large financing packages and limited access to official financing, between all financing and all standstill, and between no effort to engage the private sector and coercive debt restructurings. On one level, this is a disappointing conclusion. However, the authors do help us search for that elusive balance by deepening our understanding of the crises and the attempts to deal with them. As valuable as that is, however, uncertainty about how to proceed and sheer ignorance of the facts that will no doubt characterize future crises argue for great care in assessing the risks that still remain in dealing with such events.

Jack Boorman
Advisor to management of the IMF
and former Director of the Policy Development and Review Department

Seeking perfection at the European Central Bank

Tommaso Padoa-Schioppa

The Euro and Its Central Bank
Getting United After the Union

MIT Press, Cambridge, Massachusetts, 2004, 264 pp., $40.00 (cloth).

This exceptionally rich book covers the history of European integration, the genesis of the euro and its central bank, and the functioning of the Eurosystem (the system of central banks comprising the European Central Bank [ECB] and the national central banks of those member states that have adopted the euro). The Eurosystem occupies a central place in the analysis, but not in a narrow sense. The author, a central banker who has been involved in the process of European montary unification since 1979, insists on the importance of the economic and political environment, which in the case of the Eurosystem comprises 12 distinct national entities and one supranational organization.

Such complexity sets the Eurosystem apart from other central banks—including that of the United States. Even though the U.S. economy is similar in size to that of the euro area, the ECB must contend with the fact that the economies for which it sets monetary policy are still mainly national in scope. To complicate matters further, many of these markets are lagging behind in terms of competitiveness. This applies in particular to the euro area’s labor market, which remains divided into 12 distinct political and socal entities. But for TPS (as Padoa-Schioppa’s friends call him), it is possible to design a monetary policy that will meet the needs of such a heterogeneous area—in fact, he thinks the ECB has done an almost perfect job to date. He insists much more on a second problem, which is the leitmotiv of his book: a central bank should not just implement monetary policy, it should also be in charge of supervising the financial system, including in particular the payment system. Only then can it be called a “perfect” central bank.

But because the ECB has no responsibility for supervising payment systems (of which a number of national ones survive) it is far from this concept of perfect. The reason for this lies in the incompleteness of European integration. The Eurosystem comprises 12 proud national central banks, whose combined staff dwarfs that of the ECB. While outsiders understandably concentrate their attention on the decisions made by the ECB at its headquarters in Frankfurt, Germany, the majority of decisions are made by the national central bank governors, whose physical and political home lies in national capitals. It is, for instance, their 12 governors—not the ECB—who are in charge of most of the foreign exchange reserves that could be used for intervening in the currency markets.

For those already familiar with the EU and the euro, the most interesting part of the book comes in the final chapter, which describes five main challenges on the road from “infancy to maturity.” However, the analysis left this reader feeling somewhat disappointed. After noting all the problems associated with the current system, TPS concludes that there is little the ECB can do to change the prevailing state of affairs. This can best be illustrated with reference to two issues: the chronic weak growth in the euro area and the lack of political union. The first is not a problem unique to Europe; Japan during the last decade faced an even more serious growth problem. While it is certainly true that the ECB can do little to influence growth prospects in Europe, the example of Japan also suggests that wrong policies can do considerable damage. The conclusion would have been much more convincing if TPS had shown that the ECB will be able to avoid the Japanese pitfalls.

No analysis of the euro can avoid mentioning the lack of political union. This is the point where the central banker TPS meets the citizen TPS. His description is as usual elegant: Europe is a “polity in the making.” But is it really only a “challenge”? Couldn’t the lack of political union also be an opportunity to move toward a more “perfect” central bank? The coexistence of many different polities in Europe has the advantage of making it less likely that policy mistakes or fads will determine economic policy. In a national polity, one party—even sometimes a single person—can make a mistake or become the follower of a fad. TPS defends the eclectic approach used by the Eurosystem with the Hayekian argument that one can never be totally certain what model is the best. But this argument also implies that the dispersion of decision making across many centers, coupled with a strong dose of policy competition, might actually constitute an advantage. The lack of political union might thus in the long run render the euro area economy—and the euro itself—stronger and more stable than many expect today.

Daniel Gros
Director, Centre for European Policy Studies (CEPS)
Brussels, Belgium