- Il SaKong, and Olivier Blanchard
- Published Date:
- July 2010
© International Monetary Fund and Korea Development Institute
Reconstructing the world economy / edited by Olivier Blanchard and Il SaKong. – Washington, D.C. : International Monetary Fund, 2010.
- p. ; cm.
“Papers presented at a joint conference of the Korea Development Institute and the International Monetary Fund.”
Includes bibliographical references.
1. Global Financial Crisis, 2008-2009 – Congresses. 2. Fiscal policy – Congresses. 3. Monetary policy – Congresses. 4. Economic policy – Congresses. 5. International Finance – Congresses. I. Blanchard, Olivier (Olivier J). II. SaKong, Il III. International Monetary Fund. IV. Han’guk Kaebal Yŏn’guwŏn.
Disclaimer: The views expressed in this book are those of the authors and should not be reported as or attributed to the International Monetary Fund, its Executive Board, or the governments of any of its members.
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- About the Authors
- SECTION I EXIT STRATEGIES FOR ANTI-CRISIS MEASURES
- 1. A Strategy for Renormalizing Fiscal and Monetary Policies in Advanced Economies
- Carlo Cottarelli and José Viñals
- SECTION II REDESIGNING THE MACRO FRAMEWORK
- 2. Rethinking Macroeconomic Policy
- Olivier Blanchard, Giovanni Dell’Ariccia, and Paolo Mauro
- 3. “Rethinking Macroeconomic Policy”: Comments
- Yung Chul Park
- 4. Toward a Stability-Oriented Policy Framework
- Jürgen Stark
- SECTION III THE FUTURE FINANCIAL SYSTEM
- 5. Redesigning the Contours of the Future Financial System
- Laura Kodres and Aditya Narain
- 6. Comments on “Redesigning the Contours of the Future Financial System”
- Philip Lowe
- 7. Discussion of “Redesigning the Contours of the Future Financial System”
- Hyun Song Shin
- SECTION IV GLOBAL IMBALANCES: IN MIDSTREAM
- 8. Global Imbalances: In Midstream?
- Olivier Blanchard and Gian Maria Milesi-Ferretti
- 9. Comment on “Global Imbalances: In Midstream?”
- Charles Bean
- 10. Comments on Dealing with Global Imbalances
- Justin Yifu Lin and Mansoor Dailami
- 10.1. Are Global Current Account Imbalances a Threat to the Recovery or to Global Financial Stability?
- 10.2. What Sorts of Policy Actions Are Needed to Reduce Imbalances? How Effective Would These Actions Be in Reducing Imbalances?
- 10.3. From a Global Political Economy Viewpoint, Can Countries Be Convinced to Take These Actions?
- 10.4. References
- SECTION V FUTURE OF THE INTERNATIONAL MONETARY SYSTEM
- 11. The Debate on the International Monetary System
- Isabelle Mateos y Lago, Rupa Duttagupta, and Rishi Goyal
- 12. Remarks on “The Debate on the International Monetary System”
- Changyong Rhee
- Figure 1.1. Government debt in G-7 countries, 1950–2010 (in percent of GDP)
- Figure 1.2. Money multipliers, 2007–09
- Figure 1.3. Key central bank balance sheet items (cumulative changes from August 2007, in percent of GDP)
- Figure 1.4. Advanced economies: Illustrative scenario for fiscal adjustment (in percent of GDP)
- Figure 1.5. Monetary sector heat map
- Figure 7.1. Stylized financial system
- Figure 7.2. Short intermediation chain
- Figure 7.3. Long intermediation chain
- Figure 8.1. Sum of absolute value of world current account balances (ratio of world GDP)
- Figure 8.2. Global imbalances, 1996–2008
- Figure 8.3. Saving and investment trends (in percent of world GDP)
- Figure 8.4. Saving and investment trends (in percent of domestic GDP)
- Figure 8.5. World capital flows, 1996–2008
- Figure 8.6. A. United States current account deficit and capital inflows (ratio of GDP).B. Composition of U.S. portfolio debt inflows (billions US$)
- Figure 8.7. Current account projections (in percent of world GDP)
- Figure 8.8. Net foreign asset projections (in percent of world GDP)
- Figure 8.9. Real effective exchange rates, 1996–2009
- Figure 10.1. U.S. household wealth and disposable income
- Figure 10.2. Structure of China’s national savings
- Figure 10.3. Global current account balances
- Figure 10.4. Exchange rate movements in emerging markets before and after the crisis
- Figure 10.5. Exchange rate movements in China and Asian countries with floating currency regime (nominal)
- Figure 10.6. Exchange rate movements in China and Asian countries with floating currency regime (real effective)
- Figure 11.1. Evolution of international reserves and the use of U.S. dollars in the international monetary system
- Figure 11.2. Features of alternative international monetary and reserve systems
- Table 1.1. Decomposition of Large Reductions in Government Debt-to-GDP Ratios in Advanced Economies
- Table 1.2. Required Improvement in the Primary Position, 2011–20
- Table 8.1. Average Current Account Balances (in percent of world GDP)
- Table 8.2. Average Current Account Balances (in percent of world GDP)
- Box 11.1. Triffin Revisited
- Box 11.2. Should the IMF Provride Country Capital Insurance?
- Box 11.3. What Would It Take for New International Reserve Currencies to Emerge?
- Box 11.4. A Global Substitution Account?
- Box 11.5. Keynes’s Bancor and How It Might Work in Today’s International Monetary System
As the most severe crisis since the Great Depression appears to wind down, global policymakers face many new challenges. Some are more immediate, such as deciding when to exit from crisis support measures. Others pertain to the medium term and include reevaluating the macroeconomic policy framework, redesigning financial regulation and supervision, and strengthening the international financial architecture.
A workshop was held in Seoul, Korea, on February 25, 2010, to provide a forum for discussing these challenges. The workshop coincided with participation of the Presidential Committee for the G-20 Summit. It was especially appropriate therefore to hold the workshop in Seoul since Korea is scheduled to host and chair the forthcoming Seoul Summit in November 2010 where these issues will be taken up. The papers prepared by IMF staff are intended to serve as a starting point for these discussions. Although they reflect the IMF’s internal debate, they do not represent official IMF positions; they are in some instances appropriately provocative.
While the financial crisis hit economies around the world at more or less the same time, recovery from the crisis is taking place at different speeds across economic regions. In several advanced economies, the recovery remains vulnerable. High and still rising unemployment and weakened household balance sheets are holding back private consumption, while tighter than normal credit conditions are restraining investment. In many emerging economies, by contrast, the recovery is already underway, reflecting buoyant domestic demand and relatively healthy financial sectors. Overall, the IMF has called for supportive policies to be maintained into 2010 for a majority of the world’s economies—though in some emerging economies, the time for stimulus withdrawal has already arrived.
When to exit from macroeconomic stimulus is a difficult challenge: unwinding too early could jeopardize the recovery, while maintaining support for too long could pose risks to price, financial, and fiscal stability. In response to the request by the International Monetary and Financial Committee for the IMF to advise on the timing, and nature, of exit from crisis-related intervention measures, staff have prepared a paper—the first section in this volume—that identifies a number of basic principles to guide an exit strategy—including the need to integrate strategies across different policy-making entities, international coordination to improve the chances of success of some types of fiscal and monetary measures, and a flexible approach that can respond to unforeseen developments. The IMF is playing an important role here. By reporting on the unwinding process through our surveillance mechanisms, additional monitoring, and technical support, we hope to reduce the likelihood of policy inconsistencies across countries. We are also providing analytical support for the G-20’s ongoing mutual assessment process.
International policy coordination will be also critical for promoting a rebalancing in world aggregate demand, which the G-20 has identified as critical for securing strong, sustainable, and balanced growth over the medium term.
Even though global imbalances have narrowed considerably since the crisis, they are likely to widen again in the absence of further adjustments. And failure to address the underlying causes of imbalances could result in the world economy getting stuck “in the middle of the stream,” threatening the sustainability of the recovery. The principal recommendations—as outlined in the second section in this volume—are as follows:
- In the United States, saving must increase. A significant adjustment in private saving has already taken place since the crisis. But public saving must be increased, over time, as the recovery gains strength.
- In China, growth should be led more by domestic demand, especially by private consumption. Better social insurance, stronger corporate governance, and increased access to credit for households and small-and medium-sized enterprises are needed. Exchange rate adjustment must play an essential supporting role.
- Many other emerging market economies should and can afford to rely more on domestic than on foreign demand.
- If oil prices remain high, as currently forecast, some oil-exporting countries can boost domestic demand further and spend more on social infrastructure.
The IMF is supporting the rebalancing effort through its policy advice and surveillance activities. Further reform of its lending facilities, such as building on the Flexible Credit Line introduced during the crisis, could also promote rebalancing by reducing the demand for precautionary reserves. Although this conference only covered the rebalancing of global macroeconomic imbalances, Korea, as Chair of the G-20 in 2010, also defines global imbalances in broad terms to include narrowing or eliminating the widening development gap.
Rethinking Macroeconomic Policy
The crisis has revealed flaws in the prevailing macroeconomic policy framework, major gaps in financial sector supervision and regulation, and vulnerabilities in the international monetary system. These issues are at the center of the current debate about the future shape of economic and financial policy and are discussed in the third section in this volume.
Before the crisis, macroeconomists and policymakers generally agreed that all would be well as long as inflation was low and stable and public debt was sustainable. But the crisis showed that vulnerabilities and threats to macrofinancial stability may develop under a seemingly tranquil surface of stable prices, small output gaps, and healthy public finances.
While many tenets of the precrisis consensus—notably low inflation and fiscal discipline—remain valid, others need to be reassessed. In particular, the crisis has reopened the question of whether macroeconomic policy should respond to assetprice and housing bubbles—and if so, how best to respond. In that context, it has been noted that the policy interest rate is a blunt (and possibly ineffective) tool to deal with these problems and that better and more targeted instruments can and should be developed. Regulatory ratios, such as capital ratios for banks or loan-to-value ratios for households, that vary over the cycle could be a promising start. But more work is needed on how to design a new macroprudential framework.
The crisis has also reminded us of lessons we had already learned, such as the importance of building fiscal space in good times. And it has made a strong case for improving automatic stabilizers, in particular those that allow some transfers or taxes to vary based on the state of the economic cycle.
The Future Financial System
It comes as no surprise that the crisis—with its origins in the financial sector—has motivated a profound reevaluation of the global financial system. How policymakers and market participants respond to the recent events will shape the future financial system and its role in the global economy for decades to come.
To limit future crises, we must be better equipped to handle the systemic nature of financial risks in a globalized system. This will require many reforms, including a widening of the perimeter of regulation, and ensuring that the regulatory framework is broadly consistent across countries to address systemic risks and ensure a level playing field. In addition, to limit excessive leverage and risk taking, incentive-compatible regulation will have to be designed. At the same time, we must recognize that efforts to mitigate systemic risks are not costless. Thus, care must be taken to avoid excessive regulation that could stifle innovation and unduly limit the benefits of a more globally integrated financial system, a point stressed in the fourth section in this volume.
Reforming the International Monetary System
The current system, which is based on a dominant country-issued reserve currency, is marked by difficulties. In particular, the global demand for reserve assets can only be satisfied if the reserve issuer runs fiscal and external deficits. And there is no ready mechanism for surplus or reserve-issuing countries to adjust. The problem has been aggravated in recent years as the demand for reserves has risen sharply—reflecting in part the desire of emerging markets to self-insure against costly capital account crises (as discussed in the final section in this volume).
How can these tensions best be addressed? On the demand side, we need to explore alternative insurance arrangements that could mitigate the precautionary demand for reserves. On the supply side, we should consider whether alternative reserve assets could offer greater stability and efficiency.
The recent reform in the IMF’s lending instruments—the introduction of the Flexible Credit Line and the mainstreaming of high-access precautionary arrangements—is a significant step forward in bolstering the IMF’s insurance facilities. However, these instruments cannot serve as full substitutes for reserves, given that countries must qualify for these facilities.
Recent work by IMF staff, including the papers in this volume and a paper presented to its Executive Board last summer on “Exchange Rate Regimes and the Stability of the International Monetary System,” presents a number of proposals to improve the stability of the international monetary systems in light of recent challenges. These proposals may well gain traction and practical relevance, over time, if more incremental efforts aimed at strengthening the current system prove insufficient. It is our belief that the G-20’s effort to strengthen the global financial safety net by working together with the IMF is timely and appropriate.
Director and Economic Counsellor
International Monetary Fund
Dr. Il SaKong
Presidential Committee for G-20 Summit
The efforts of many went into organizing the high-level conference “Reconstructing the World Economy,” and producing this publication. The involvement of the Korea Development Institute and the Ministry of Strategy and Economy, Korea, as well as the Financial Services Commission and Bank of Korea are gratefully acknowledged. Special thanks must go to Dr. Oh-Seok Hyun, President of the KDI, and Dr. Hyeon-wook Kim, Director of Macroeconomics, KDI, for coordinating with the IMF and Korea’s Presidential Committee for the G-20 Summit in preparations for the conference.
At the IMF, staff of the Research and External Relations Departments were involved at every stage, and helped to make the conference a stimulating event for all the participants.
We would particularly like to acknowledge the contributions of Jonathan D. Ostry, Deputy Director of the Research Department, who led the organizational team on the IMF side, and Gilles Bauche, Advisor in the External Relations Department. Contributions from Sheila Tomilloso Igcasenza and Tracey Lookadoo are gratefully acknowledged, both in organizing the conference and coordinating the publication of the volume. Colleagues in the External Relations Department also contributed to the success of the conference and creating the conference web page (http://www.imf.org/external/ks5101/kdi/). We also thank Sean M. Culhane and Joanne Blake of the External Relations Department, who managed the editing of the papers and production of this volume.
Director and Economic Counsellor
International Monetary Fund
Dr. Il SaKong
Presidential Committee for G-20 Summit
About the Authors
Olivier Blanchard is economic counselor and director of the Research Department of the International Monetary Fund.
Il SaKong is chairman of the Presidential Committee for the G-20 Summit.
Charles Bean is deputy governor of the Bank of England.
Carlo Cottarelli is director of the Fiscal Affairs Department of the International Monetary Fund.
Mansoor Dailami is manager of international finance in the Development Economics Vice Presidency of the World Bank.
Giovanni Dell’Ariccia is an advisor in the Research Department of the International Monetary Fund.
Rupa Duttagupta is a senior economist in the Strategy, Policy, and Review Department of the International Monetary Fund.
Rishi Goyal is a senior economist in the Strategy, Policy, and Review Department of the International Monetary Fund.
Laura Kodres is a division chief in the Monetary and Capital Markets Department of the International Monetary Fund.
Justin Yifu Lin is a senior vice president and chief economist at the World Bank.
Philip Lowe is assistant governor of the Reserve Bank of Australia.
Isabelle Mateos y Lago is an advisor in the Strategy, Policy, and Review Department of the International Monetary Fund.
Paulo Mauro is a division chief in the Fiscal Affairs Department of the International Monetary Fund.
Gian Maria Milesi-Ferretti is an assistant director in the Research Department of the International Monetary Fund.
Aditya Narain is an advisor in the Monetary and Capital Markets Department of the International Monetary Fund.
Yung Chul Park is a professor of economics at Korea University.
Changyong Rhee is secretary general and sherpa of the Presidential Committee for the G-20 Summit.
Hyun Song Shin is presidential advisor on international finance, Korea.
Jürgen Stark is a member of the Executive Board of the European Central Bank.
José Viñals is financial counselor and director of the Monetary and Capital Markets Department of the International Monetary Fund.