It is close to a decade since the start of the global financial crisis that raised many critical questions. Among these are how the international monetary system monitors, regulates, and manages the volatility of global liquidity and the consequent risks for international financial stability. The International Monetary Fund (IMF) is also now discussing a road map for strengthening the international monetary system and better managing liquidity shocks.
Today’s urgency of this consideration is reinforced by a number of factors that could have multiple effects on global liquidity:
- Most important among them is the ongoing historic rise of emerging markets, and the growing likelihood that tomorrow’s key financial players—official and private—will come from emerging markets. This historic shift of global activity and finance from advanced economies to emerging and developing economies and their rising financial integration will impact global liquidity.
- In the near term, the prospects and timing of the Federal Reserve’s further “lift-off” are immediate factors. Coupled with renewed concerns about retrenchment in global markets already affected by ongoing regulatory reforms, they have increased financial market uncertainties.
These factors underline the importance of managing global liquidity as a global public good. In the absence of a mechanism to gain better control over the volatility of global liquidity, the world will continue to be vulnerable to the sudden drying up of liquidity or of disorderly acceleration in capital flows. This risk has become a major flaw in the current international monetary situation.
But is such liquidity management feasible given that private capital movements have become fundamental determinants of the stability of the global system? And is it necessary given the role played by central banks today?
Indeed, central banks do play a key role in monitoring liquidity developments and, as much as possible, in ensuring liquidity is provided sufficiently to international markets. They have recently increased significantly the number of swap agreements, but they have stopped well short of developing an institutionalized global swap network that some have favored to meet the needs of the system in all circumstances. Further, the global discussion of the external spillovers from their national monetary policies remains inadequate.
Addressing these issues could be best done through a global monetary institution, centered in a transformed IMF—with the mandate and instruments that would allow it to regulate global liquidity in addition to all of its other current functions. Michel Camdessus and I have looked at how the IMF can be equipped to be the institution that does this.
First, to do this sustainably, the IMF needs to be assigned monitoring responsibility over movements in capital account balances, like it has over current account balances. This will need an amendment to the IMF’s Articles of Agreement, but consensus on an amendment has not been reached.
Second, a high-level group should be established and charged with overseeing global liquidity. Perhaps this could be a group of central bank governors that would report periodically to the IMF’s International Monetary and Financial Committee.
Third, how can the IMF be equipped with a fully-fledged monetary asset instrument to deal with changing global liquidity? Indeed, making the special drawing rights (SDR) the principal reserve asset in the international monetary system was originally envisaged in the IMF’s Articles of Agreement. To restore the potential of the SDR, a number of specific measures would need to be taken that would give the IMF the power to use it much more flexibly and as needed by the global liquidity situation:
- These measures include steps to give the SDR much more visibility in the operations of the IMF and other institutions in the official sector, thereby building its potential to become competitive with other internationally used currencies.
- And, fundamentally, reforming the irrational present regime of allocations, which consists of providing supplementary SDRs to countries less in need of them than others.
Such a transformed IMF could be charged in cooperation with national or international central banks with continuously monitoring global liquidity flows, and preparing the regulatory decisions that would need to be taken to manage it. This would not be far removed from the mechanism outlined by John Maynard Keynes at the start of the 1930s, when he wrote:
“The ideal system would surely be in the foundation of a supranational bank that would have similar relations with the national central banks to those that exist between each central bank and its subordinate banks.”
How to move in this direction? It would need to be carefully sequenced, giving the IMF a stronger governance framework, the mandate for effective surveillance, stabilization of global liquidity and exchange rates, mechanisms for reducing the risk of disorderly spillovers, and for dealing with debt restructuring.
It will take time to build the necessary global consensus. Toward this, international public opinion needs to become much more aware of the ongoing risks of instability inherent in the current system, leading possibly to a new, large-scale crisis, and then of the need for a new global mechanism properly equipped to prevent it or to face it in credible fashion. In the current climate, it would be highly desirable for major stakeholders to take this initiative forward and convene a new Bretton Woods II conference mandated to propose the needed changes in the Articles of Agreement of the IMF.