volatility; abrupt reversal of private capital flows; persistent and ‘upstream’ external
imbalances (net capital flows moving from emerging to rich countries); asymmetry
in the adjustment mechanisms between borrowing and lending countries; asymmetry
in the adjustment mechanisms between the United States, whose currency lies at the
centre of the current arrangement, and the rest of the world; and excessive accumulation
of foreign reserves by emerging countries. Moreover, some consider this ‘system’ to be
an aggravating factor—or even a trigger—of the financial imbalances at the root of the
recent financial crisis.
Taking a stand on these issues requires a two-step analysis. In the first step, we
examine how the international monetary system functions (or fails to function) during
systemic crises, such as the one recently experienced. Through what mechanisms did
the prevailing system contribute to the weakening of the financial system and global
economy? What role did the system play during the crisis itself? In other words, what
are its systemic inefficiencies? Our answers to these questions reveal an essential
function that the international monetary system must satisfy in times of crisis: the
provision of liquidity. The absence of systematic mechanisms to allow for the sufficient
and coordinated supply of liquidity is a major weakness of the current system. This
deficiency exacerbates individual countries’ self-insurance decisions in the form of
accumulating excess foreign reserves. These decisions are individually optimal but
socially inefficient.
we develop several concrete proposals that aim not only to increase the
coverage of global liquidity necessary when facing individual and systemic crises but
also to reduce demand for foreign reserves.
• Promote the development of alternatives to US Treasuries as a dominant reserve asset
to accelerate the inevitable transition to a multipolar system. From this perspective,
the issue of mutually guaranteed European bonds seems particularly desirable. In a
probably more distant future, necessary steps may include opening of the Chinese
capital account, convertibility of the yuan, and development of a yuan bond market.
• Make permanent the temporary swap agreements that were put in place between
central banks during the crisis. Establish a star-shaped structure of swap lines
centred on the IMF.
• Strengthen and expand such IMF facilities as Flexible Credit Lines (FCLs),
Precautionary Credit Lines (PCLs), and the Global Stabilization Mechanism
(GSM); also, expand the IMF’s existing financing mechanisms—notably, the New
Arrangements to Borrow (NAB)—and allow the IMF to borrow directly on the
markets.
• Establish a foreign exchange reserve pooling mechanism with the IMF that will
provide participating countries with better coverage than self-insurance and,
incidentally, will allow reserves to be recycled in the financing of productive
investments.
These measures, which reinforce the mechanisms that provide the liquidity required
for proper functioning of the global economy, will have to be paired with prudential
monitoring by the IMF of the evolution of financial balance sheets (by currency and
maturity) so that the terms and conditions of access to liquidity can be adjusted in times
of crisis.
It is important to note that, according to our analysis, the global provision of liquidity
need not involve the issuance of SDRs; nor does it require ‘anchoring’ the system
through coordination of foreign exchange policies. Special drawing rights are complex
and poorly adapted to the liquidity needs of the global economy. Their use—which can
be justified under certain limited conditions—would not, in itself, cure the structural
inefficiencies of the international monetary system. And a monetary anchor assumes
that the priorities of monetary policy (economic and financial stability, including stable
prices) can be changed in favour of external objectives. However, such an evolution is
neither feasible nor clearly desirable.
The second step of our analysis concerns the regulation of international capital flows
and of the exchange rate movements that these flows induce. The consensus on these
issues has changed significantly. Institutions such as the IMF now recognise the merits
of targeted capital controls, especially in times of excessive volatility of capital flows.
In addition, the issue of external adjustments must be examined—given that the world
economy remains in a liquidity trap.
We recognise the need, in some specific cases, for temporary controls on capital inflows.
Such controls should be paired with a set of prudential and monetary measures. Finally,
under certain limited circumstances, capital flows may create negative externalities in
the rest of the world and must therefore be subject to mutual monitoring. Towards this
end, we recommend extending the mandate of the IMF to the financial account and
strengthening international cooperation in terms of financial regulation.
Our proposed reforms of the international monetary system are complementary to but in
no way a substitute for the equally necessary reform of the regulatory and supervisory
architecture of the financial system.