Functioning of the International Monetary System

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1.1 What’s the issue?

Login Sign up Search. Subscribe Login Sign up. Foreign Policy. Courtesy Reuters Since the return of convertibility among the currencies of most major industrial countries at the beginning of , a crisis affecting at least one major currency has threatened each year; the U. While the further use and improvement of the present combination of new and old arrangements may well prove fully adequate, the stage has clearly been reached, both in terms of facilities and of mutual understanding, when Loading, please wait Ivan Briscoe.

Hacker and Paul Pierson. Stay informed. In-depth analysis delivered weekly. Related Articles. This list means that, potentially, all the features of an IMS can be at stake in the present discussion, contrary to what happened in the late nineties when the discussion revolved around the functioning of the financial sector and the crisis prevention and resolution in emerging economies.

The debate then was not about the reform of the IMS but rather about a new Global Financial Architecture, meaning the international framework for safeguarding and ensuring the efficient functioning of the global financial system. I will not address this last point. Regarding the second issue on the exchange rate regime, I will only mention that I see no justification to change the floating regime among the major currencies or to modify the recommendation that big emerging economies should also adopt much more flexible rate regimes.

This means that in the conflict characterised by MacKinnon between the international adjustment view of exchange rates and the monetary standard view, I take the side of the former. Also, the present situation of financial globalisation confirms the early "bipolar view" of Alexander Swoboda that with high capital mobility the only stable exchange rate regimes are floating rates or hard pegs, of which monetary unions are an extreme example see Eichengreen, There are many predictions about the gradual addition of other currencies to the dollar as truly international currencies.

What seems to make this unavoidable it is not only the emergence of the euro, the increasing strength of China or the growing vulnerabilities of the US. The growth in importance of emerging countries, that have seen their share in the world GDP augmented by 15 percentage points in the last 20 years, creates a structural increase for the demand of reserves that the developed countries, including the USA, will not be in a position to supply. This question is linked with the problem of the provision of official international liquidity.

As Maurice Obstfeld has recently recalled, there is a fiscal dimension to the supply of official reserves. No single country in the world could indefinitely offer its currency as the reserve asset that could satisfy all the needs of a growing rest of the world.

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In the present circumstances where deficit and debt ratios need to be decreased, the US could not offer its bonds and T-bills as the almost exclusive reserve asset of the world. In this context, Euro assets are necessary. Even if they are clearly seen as an unrealistic prospect, Eurobonds, from the pure perspective of the International Monetary System, would be useful as a reserve asset for the world economy.

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In the future, the system will also need assets in the Chinese currency, when China will have a convertible currency, a flexible exchange rate and a developed bond market. All this implies that one possible scenario is the evolution towards a truly multi-polar IMS , which, as many have recently observed, would produce credible alternatives to dollar-denominated investments, thereby enhancing policy discipline in the core reserve issuer.

Also, a multi-currency world would imply greater monetary policy autonomy in emerging economies such as China, which would thus be in a better position to tackle its own imbalances see e. Bini Smaghi There are five key conditions for a currency to become a major international currency.

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  • The first one is having a very large economy , which engenders network externalities and lowers transaction costs. The second is given by deep, efficient and open financial markets. Third, good political and macroeconomic governance is of course of the essence to preserve the external value of a currency. Fifth, one should not overlook the importance of geopolitical influence and political stability.

    It is therefore not easy for a currency to fill all the conditions necessary for it to have an international role. Consequently, I do not think that we will see a major change in the role of the US dollar over the next years — though the conclusion may well be different over a longer horizon. The euro has established itself as the second most important international currency after the US dollar. At the same time, this role is predominantly regional in nature, since the euro is mainly used by economic agents resident in euro area neighbouring countries with special political and economic ties to the European Union and the euro area.

    More recently, it is known that Asian investors and foreign central banks accounted for a sizable share of the demand for bonds issued by the European Financial Stability Facility EFSF. Looking ahead, the share of the euro in international markets has the potential to rise further once financial stability and market integration is restored in the euro area. The ongoing efforts to improve the governance of the euro area and provide it with a credible crisis resolution mechanism will also indirectly affect the international use of the euro, even if the ECB and the Eurosystem do not take any initiatives to directly promote its use Angeloni, Sapir This neutral stance — neither foster nor hinder — is based on our conviction that the international use of currencies should be a by-product of autonomous market decisions driven by the aforementioned five determinants.

    Turning to the Chinese renminbi , one can observe that the use of the renminbi as an international currency has remained limited although China is now the third largest economy after the United States and the euro area and second largest exporter after the euro area of the world. The Chinese authorities have launched several initiatives since March to promote a wider international use of the renminbi, e.

    Nevertheless, the full potential of the renminbi can ultimately only be achieved with the liberalisation of the capital account, accompanied by the reform of domestic financial markets. Once these will be in place, a major internationalisation of the renminbi will happen as a by-product. For the time being, Chinese authorities seem to be trying to prudently promote financial liberalization via experimenting with market-driven renminbi securities in Hong Kong S.

    The international monetary system: Is it fit for purpose?

    But this comes at the expense of increasing exposure to capital flows which poses challenges for the macro-prudential set-up, especially given the current undervaluation of the renminbi. Hence, Chinese authorities may also slow down the use of the renminbi abroad should tensions for domestic policy makers mount. All in all, the potential for the renminbi to upgrade as an international currency is clearly huge, but the timing is difficult to predict. The build up of increasingly large current account surpluses in some export-oriented economies, which rely on a growth-model based on over-savings, was, in conjunction with accumulating deficits in a number of consumption-driven economies, a major source of concern in the years which preceded the global financial crisis.

    Even the global financial crisis and the policy responses have reduced the imbalances only partly and temporarily over the most recent years. The fact that these imbalances have persisted for so long exposes a key weakness of the system, namely the inadequacy of the adjustment mechanisms. Let me explain this in more detail by looking at the various stakeholders:. National authorities in deficit and surplus countries had little incentives to depart from their growth model and policy course.

    Indeed, prior to the crisis the economies with the largest external imbalances were often outperforming their peers in terms of GDP growth: the larger the imbalance, the higher was the growth rate over the short run. Moreover, the deficit and surplus countries, rather than exerting policy discipline on each other, in fact accommodated the other in the pursuit of their respective growth models see Dooley et al.

    Firstly, markets frequently do not function in line with fundamentals as expected, leading to mispricing and undue volatility in, for example, exchange rates and credit risk premia. This may be explained in part by factors such as herding behaviour, but also the lack of a shared view on the relevant fundamentals.

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    • Secondly, market behaviour has also been constrained by structural factors and policy regimes. The insatiable demand for such debt instruments puts strong pressure on the US financial system and its incentives Caballero The demand for US assets constrains the growth in credit and exchange rate risk premia charged by markets on rising US debt.

      What can we expect from a good-quality international monetary system?

      This effectively limits the increase in external borrowing costs, thus removing an incentive to curb borrowing. On the surplus side , the semi-fixed exchange rate regimes and the semi-closed capital account of some major surplus countries prevent markets from exerting excessive pressure on capital flows or the exchange rate of such countries. Thirdly, accommodated by a trend towards self-regulation, financial markets encouraged rather than tamed excessive borrowing.

      Income constraints on debt accumulation were circumvented through innovative debt instruments, which were insufficiently checked by quality credit analysis and internal controls. The international community has a role to play in exerting pressure on countries to adjust, primarily the International Monetary Fund IMF and the G Although helpful policy recommendations have been put forward at the global level, the traction gained by the international community has often not been as strong as it needed to be.

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      The existing rules were designed for the pre-globalisation era and the enforcement mechanisms are not sufficiently effective. Regarding the rules , these were agreed in an era of fixed exchange rates, closed capital accounts and highly regulated financial markets when the financial sector was the handmaiden of the real economy. This was well before the widespread liberalisation of trade, financial markets and capital accounts that defines globalisation. For example, under the IMF Articles of Agreement, members are free to pursue capital account regimes and exchange rate regimes of their choice, with only limited constraints.

      The outcome is a global constellation of exchange rate regimes that does not ensure sustained economic, financial and monetary stability. The peg of currencies of a number of emerging economies to the US dollar creates a symbiosis that fosters ever larger imbalances and hence risks of disorderly adjustment.

      Particularly when one of the emerging economies is very large, the pegging of its currency to another risks limiting the flexibility of adjustment in both, which in turn threatens to distort the exchange rate of other major currency pairs, with implications for global economic performance. Turning to the enforcement mechanisms , surveillance and peer policy review have an essential role to play in identifying risks and encouraging remedial policy action.

      But international pressure — including via the IMF and the G20 — still suffers from lack of grip. This remains the weakest aspect of the surveillance process. The crisis has led to increased efforts to improve surveillance, e. There is a general recognition of the need to strengthen the multilateral angle of surveillance, to better encompass interlinkages and spillover effects, and to better integrate macroeconomic and financial sector.

      More work needs to be done, however, to further strengthen the effectiveness of surveillance. By contrast, we can observe a lot of mutual finger-pointing, mainly between advanced and emerging economies, but to some extent also within the two groups. It follows that EMEs push for an inclusion of global liquidity and its drivers into multilateral surveillance, whereas advanced countries see a need for more scrutiny of reserve accumulation practices, exchange rate policies and capital controls. What can be done in such circumstances? I think that first of all we need to work even harder to achieve a better understanding of interlinkages and spillover effects.

      This implies the need for more and better analysis. The new pilot spillover reports that the IMF started this year with a handful of systemically important countries are one welcome step in that direction.

      Functioning of the International Monetary System Functioning of the International Monetary System
      Functioning of the International Monetary System Functioning of the International Monetary System
      Functioning of the International Monetary System Functioning of the International Monetary System
      Functioning of the International Monetary System Functioning of the International Monetary System
      Functioning of the International Monetary System Functioning of the International Monetary System
      Functioning of the International Monetary System Functioning of the International Monetary System
      Functioning of the International Monetary System Functioning of the International Monetary System
      Functioning of the International Monetary System Functioning of the International Monetary System
      Functioning of the International Monetary System Functioning of the International Monetary System

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