Multipolar governance and global imbalances.pdf

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Multipolar governance and

global imbalances

International Aairs 86: 3 (2010) 681–692© 2010 The Author(s). Journal Compilation © 2010 Blackwell Publishing Ltd/The Royal Institute of International Aairs

PAOLO GUERRIERI

The current global economic crisis originated in poor nancial regulation inthe United States. But global macroeconomic imbalances, characterized by

large current account decits in the US and a few other advanced industrialcountries, alongside huge surpluses in China and many other emerging marketeconomies, were facilitating contributory factors. There is a broad consensusthat it is impossible to understand the giant asset bubble that developed, andthe crash that followed its bursting, without considering the role of these globalimbalances.

If future crises similar to that of recent years are to be prevented, therefore, itis necessary to address the problem of global imbalances. Large current accountsurpluses and decits stem from many factors. During the years preceding thiscrisis, persistently increasing US current account decits and substantial under-valuation of major Asian currencies have contributed to global imbalances. The

International Monetary Fund (IMF) has rules on exchange rates and exchange ratemanipulation, creating obligations for individual countries and the membership asa whole, but these rules have seldom been used. More generally, macroeconomicadjustment policies remain for the most part unregulated in the present globalgovernance regime, and there is a complete absence of eective remedies againstexchange rate manipulation.

It is easy to predict that this problem will continue to haunt the internationalnancial and monetary system. In fact, few issues are as central to that system oras much in need of multilateral cooperation. This article argues that the agree-ment reached at the G20 summit in Pittsburgh in September 2009 is a rst step in

the right direction, but did not generate enough in terms of specic action andenforcement mechanisms. This means that we face the risk that a new expan-sionary phase will bring back large and growing external imbalances, which willput world growth on an unsustainable path once more.

This article sets out how multilateral cooperation and international nancialinstitutions can be renewed to provide an eective means for addressing thesenew issues and problems. The next section assesses the role of global imbalancesin the crisis; the third section assesses the impact of exchange rate misalignmentsupon the imbalances; the fourth section claries why there is a role for multilateralaction in dealing with adjustment policies of major countries; the fth points out



Paolo Guerrieri

682International Aairs 86: 3, 2010© 2010 The Author(s). Journal Compilation © 2010 Blackwell Publishing Ltd/The Royal Institute of International Aairs

what the contents of new rules and coordination agreements should be; and thesixth oers some brief concluding remarks.

The contributing role of global imbalances in the crisis

The present global crisis rst originated, as is well known, in poor US nan-cial regulation. Risk management, disclosure, regulation and supervision did notkeep up with rapid nancial innovation, leaving scope for excessive risk-takingand asset price ination. The ‘ecient market paradigm’ provided the intellectualbacking for the deregulation of nancial markets in general and the banking sectorin particular.

The remedial action prescribed as a result of this analysis includes rst of all amore robust set of clear and tighter rules and regulations in the nancial sectorto contain the nancial risk of banks and nancial institutions within manageablebounds. Strict reliance on market discipline has been proved awed in a worldwhere bankers are improperly compensated, where agency problems lead to poormonitoring of lending, where credit risk was transferred to those least able tounderstand it and manage it, and where regulatory arbitrage was widespread andrampant.

Proposals for changes in both regulation and crisis response have come frommany quarters, including international organizations, the United States, theEuropean Union and public and private sector groups.1 It is also clear that nan-cial reforms and supervision cannot be conned to the national level and that amuch stronger degree of international coordination is necessary to avoid a race to

the bottom and to prevent excessive regulatory arbitrage.2

However, the crisis was of such magnitude, and spread so rapidly acrosscountries, that it cannot be attributed solely to failures in the nancial system,dramatic as they are. We need to look at a much broader set of interrelated contrib-uting factors, including the peculiar macroeconomic environment—which hasbeen called Bretton Woods 2—and the global imbalances that have characterizedit over the past 15 years.3

Starting in the latter part of the 1990s, the US current account decit worsenedsteadily, while surpluses expanded rapidly in Asia (particularly in China) and morerecently in the oil-exporting countries (see gure 1). The excess savings in Asia

were translated into current account surpluses, since sterilized foreign exchangeintervention kept exchange rates undervalued, and in turn prompted American

1 The Group of Thirty, Financial reorm: a ramework or fnancial stability (Washington DC: Group of Thirty,2009), http://www.group30.org/pubs/reformreport.pdf; John Lipsky, ‘Don’t forget nancial sector reform’,IMF Direct, 7 Jan. 2010, http://blog-imfdirect.imf.org/2010/01/07/nancial-sector-reform/, both accessed 2April 2010.

2 Maria B. Costa, Diogo Nogueira and Luis G. Mansur Siqueira, ‘The global crisis and the international nancialsystem: reform to recover’, background paper for the 29th G24 Technical Group meeting (Geneva: Intergov-ernmental Group of Twenty-four, 2009).

3 Michael P. Dooley, David Folkerts-Landau and Peter Garber, An essay on the revived Bretton Woods system (Cambridge: National Bureau of Economic Research, Sept. 2003); Richard Portes, ‘Global imbalances’, inMathias Dewatripont, Xavier Freixas and Richard Portes, eds, Macroeconomic stability and fnancial regulation (London: Centre for Economic Policy Research, 2009).



Multipolar governance and global imbalances


cheap-money policies. US interest rates were cut from 6 per cent to 1 per cent andremained exceptionally low for three years. This contributed to low real interestrates worldwide, which in turn induced considerable risk-taking and fed fast creditgrowth. The extraordinary levels of nancial leverage that developed in parts of the world during this period can only be understood against this backdrop.

So the accumulation of large global imbalances was another very signicantdetermining factor in the global nancial crisis, as many authors have recognized.4 It is true that global imbalances did not lead to a crisis in the form and via themechanisms that many observers feared would occur: namely, a sharp, disrup-tive decline in the foreign exchange value of the United States dollar and soaringdollar interest rates as a consequence of a strike by foreign and domestic investorsagainst accumulating additional dollar-denominated assets. But it is also true thatglobal current account imbalances amplied problems in the US nancial system.Excess savings in Asian and other emerging markets were recycled into US nan-cial markets, producing low interest rates and incentives for nancial excess in

the United States. This, together with an accommodative US monetary policy,contributed to low real interest rates worldwide, which in turn induced consider-able risk-taking and fed fast credit growth. In the United States, the credit marketdebt of households and non-nancial businesses grew from 118 per cent to 173 percent of GDP between 1994 and 2007. The growth of the credit debt of householdsaccelerated even more after 2000, jumping in seven years from 98 per cent to 136per cent of disposable personal income. During the same period, similar ratiosgrew from about 120 per cent to 180 per cent in the United Kingdom and from

4 Maurice Obstfeld and Kenneth Rogo, ‘Global imbalances and the nancial crisis: products of commoncauses’, discussion paper (Santa Barbara, CA: CEPR, Oct. 2009).

Figure 1: Current account balances, 1990–2014

Source: IMF, World Economic Outlook, Oct. 2009.



Paolo Guerrieri


72 per cent to 91 per cent in the euro area. At the same time, an unprecedentedincrease in house prices in the United States was accompanied by similar boomsin many developed economies.

Decient nancial regulation and the presence of large macroeconomic imbal-ances should thus be considered complementary causes of the global crisis. It iscorrespondingly dicult to understand the asset bubble and the crash withoutconsidering the role of global imbalances.5 Indebtedness and leverage would nothave reached such extremes in the world in the absence of international macro-economic imbalances; on the other hand, the macroeconomic imbalances wouldnot have been so deep and persistent without the extraordinary development of the nancial market.

It follows that to sustain the recovery of the world economy in the future wehave to nd a way to reverse the international macroeconomic imbalances. Thisis as important as redesigning the nancial regulatory framework. The central

question today, then, is this: what macroeconomic framework, based on factorsdierent from those that led to the imbalances of the past two decades, would becapable of guaranteeing a sustainable dynamism in the world economy?

Global imbalances and exchange rate misalignments

Large current account surpluses and decits stem from many factors. Thereare a number of views on the causes of the imbalances that emerged from themid-1990s, with quite dierent implications for corrective policy measures anddierent predictions about the directions and costs of adjustment.

A rst view attributes the persistent US current account imbalances to struc-tural factors and policies lowering United States national savings, in particularvery expansionary monetary policy and nancial innovation.6 It is easy to showthese conditions of abundant liquidity in terms of the Taylor rule, revealing ahuge and persistent gap relative to historical standards. While the US monetarystance was progressively tightened in 2005, long-term interest rates remainedlow for a protracted period during the rst years of the decade, favouring asustained growth in household consumption and a severe contraction in thesaving rate.

Given the zero-sum game of trade balances at the global level, the US decit hasto be matched by trade surpluses in the rest of the world. The Asian countries inparticular, and among them China especially, have been saving and consuming lessthan they have been producing, and have been accumulating dollar claims againstthe United States as a result.

A second view, which strongly complements the analysis of excess spendingand insucient saving in the United States, focuses on China’s current accountsurplus and exchange rate policy and its strong inuence on the policies pursuedby the other emerging markets in Asia. This explanation emphasizes the deliberate

5 Portes, ‘Global imbalances’.6 Obstfeld and Rogo, ‘Global imbalances and the nancial crisis’.





maintenance by China and much of developing Asia of undervalued exchange ratespegged to the US dollar as part of these countries’ export-led growth strategies.7 Undervaluation of the renminbi in real terms creates a cost advantage to Chineseexporters but also keeps Chinese terms of trade abnormally low and distorts theinternal relative prices of traded and non-traded goods. Overall, a strategy of

export-led rapid industrialization appears to be accompanied by policies discour-aging domestic (consumer) demand.8

According to these two complementary views,9 the macroeconomic arrange-ment benets both the United States and Asia, and was self-reinforcing. A key

7 Most estimates of the equilibrium exchange rates between China and the rest of the world for the last 15 yearsindicate an undervaluation of 20–40 per cent: see William C. Cline and John Williamson, 2009 estimates of fundamental equilibrium exchange rate (Washington DC: Peterson Institute for International Economics Policy,2009). Eliminating this undervaluation is estimated to reduce China’s current account surplus by between 6and 12 percentage points of GDP, or between $150 billion and $300 billion (Morris Goldstein and NicholasLardy, ‘China’s exchange rate policies: an overview of key issues’, paper presented at conference on ‘Debat-ing China’s exchange rate policy’, 19 Oct. 2007, Peterson Institute for International Economics, WashingtonDC). Formally, China abandoned its inexible peg against the US dollar in July 2005, when it switched to

a managed oat, allowing the renminbi to uctuate within a small band around dollar parity. Then, duringthe recent crisis, China reintroduced a pegged exchange rate policy against the US dollar (see gure 2).

8 The dollar peg regime is an important element in the Chinese (and wider Asian) strategy to achieve rapidindustrialization, which also includes strict capital controls, delinking the domestic nancial and bankingsector from the rest of the world and thus allowing state authorities to pursue country-specic credit policiesand retain some control over domestic monetary policy.

9 There is a third view about global imbalances—the so-called ‘saving glut’ (Ben S. Bernanke, ‘The global savingglut and the US current account decit’, Homer Jones Lecture, St Louis, Missouri, 14 April 2005). Accordingto this, the US decit depends largely on the fact that excess world savings are channelled preferentially to theUS, because it has a comparative advantage on a global scale in terms of supplying safe, high-quality nancialassets and in a rapidly integrating world attracts demand from high-growth industrializing economies. Amajor problem with this view is that it cannot explain the increasing disaection of private investors towardsUS equities after the dot com bubble in 2000, when ocial ows replaced private capital ows in nancingthe US decit.

Figure 2: Nominal efective exchange rates, 1999–2010

Source: Ignazio Visco, ‘Global imbalances in the nancial crisis and the internationalmonetary system’, BIS Review, no. 161, Dec. 2009, p. 8.



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component of these trends is the role of undervalued exchange rates. Exchangerate competitiveness in turn is seen as being supported by systematic interventionby China and other Asian developing countries in the foreign exchange market to

purchase US dollars, thus providing the external nancing required by the UnitedStates to purchase Asian exports.

This arrangement was seen as a positive-sum game for all the countriesinvolved. But in the light of the recent dramatic global crisis one could now saythat it oered only a short-run return. In the medium to long run the macro-system—the so-called Bretton Woods 2—was clearly unsustainable. Somethingwent wrong largely because the world became far too dependent on the demandgenerated by huge US current account decits. What resulted was the worst nan-cial crisis since the Great Depression—a crisis that, because of securitization, hasbeen extended to the rest of the world.

How multilateral action can help

Given the major role played by global imbalances in the current global nancialeconomic crisis, there is cause for concern about their future prevalence. TimGeithner has indicated that he shares this concern, as well as expressing his viewthat the IMF must play a role in this area: ‘The IMF needs to ensure going forwardthat the distribution of global demand is far better balanced’, and that there is noreturn to a global economy ‘characterized by large global imbalances and relianceon a single or a few engines of growth’.10

To a certain extent, the recent global downturn has itself led to a natural

rebalancing of economies. America’s current account decit and China’s currentaccount surplus have both halved from their peaks as a result of the crisis, toaround 3 per cent and 6 per cent of GDP respectively. Indebted US consumers canno longer aord to buy as many imported goods as before, and China’s exportshave plunged as a result of weaker demand both in the US and in other developedcountry markets. Some forecast that weaker export demand will substantiallyreduce China’s (and Germany’s) surpluses in the next four or ve years.

But this natural rebalancing alone is not enough, since most of it is due tocyclical and not structural factors.11 Other things being equal, we can thus expectto see global imbalances re-emerge once the recession is over,12 perpetuating

macroeconomic problems in the major economies and possibly setting the stagefor the global economy to take another tumble in the future. If we consider theUS and China, for example, the recovery from the crisis is likely, paradoxically, to

10 Tim Geithner, statement at International Monetary and Financial Committee (IMFC), IMF, 19th meeting,Washington DC, 25 April 2009.

11 Ashoka Mody and Franziska Ohnsorge, ‘G7 consumption growth: implications for recovery and globalimbalances’, VoxEu.org, 17 Feb. 2010, accessed 2 April 2010.

12 Olivier Blanchard and Gian Maria Milesi-Ferretti, ‘Global imbalances: in midstream?’, sta position note(Washington DC: IMF, 22 Dec. 2009), http://www.imf.org/external/pubs/ft/spn/2009/spn0929.pdf, accessed2 April 2010.





intensify the linkage between the two economies.13 China needs export growth inorder to maintain job growth and preserve social stability; the United States needswilling buyers for the treasury bonds issued to nance its budget decit, which has

dramatically increased as a result of the bailout and the scal stimulus.Additional measures to achieve a sound, eective rebalancing are thus neces-

sary if a global recovery is to be sustainable over the medium term. Achieving thisdepends on establishing a dierent pattern of global demand. Imbalances will onlystay low as the recovery consolidates if decit countries such as the United Statescut their budget decits and save and export more, while surplus economies,notably China but also countries like Germany and Japan, do the opposite and relymore on domestic demand. Greater exibility in Asia’s exchange rates should be animportant part of the adjustment. The real exchange rates of emerging countriesin Asia should appreciate substantially and domestic wages and incomes shouldrise more quickly throughout the region. Therefore countries like China should

be encouraged to allow greater exibility in their exchange rates. This wouldmake China’s exports relatively more expensive overseas, encouraging Chineseconsumers to buy more imports, and could also encourage rms in China to focusmore on selling to domestic consumers.

The problem is that these virtuous policies cannot be left to the autonomousand self-enforced strategies of major individual countries, as this past decadehas so clearly demonstrated. National governments were unwilling to let othercountries’ agendas dictate the pace and scope of change, and individual countries’economic sovereignty and self-interest continued to take precedence over interna-tional cooperation. This tendency was exacerbated by a world economy operating

under a ‘market-led international monetary system’ which incorporated no incen-tives to correct the imbalances.14 In the words of Paul Volcker: ‘The present stateof world aairs has made clear that our international monetary arrangementshave not provided a needed element of discipline either for surplus or decitcountries.’15 In this system the United States could nance persistent currentaccount decits by exploiting the role of the US dollar as the international reservecurrency; surplus countries could avoid any adjustment by pegging their curren-cies to the dollar. In eect, exchange rate manipulation remained mostly unregu-lated in the international monetary regime and there was a complete absence of eective remedies against it.

It follows that in the current international system macroeconomic adjustmentcannot be assured either by market self-regulation mechanisms or by individual

13 Richard Baldwin and Daria Tagliana, ‘The illusion of improving global imbalances’, VoxEu.org, 14 Nov.2009, http://www.voxeu.org/index.php?q=node/4209, accessed 2 April 2010.

14 Fabrizio Saccomanni, ‘Managing international nancial stability’, edited text of remarks at a meeting at thePeterson Institute for International Economics, Washington DC, 11 Dec. 2008.

15 Paul Volcker was the principal author of a 1972 US proposal to use international reserves to trigger balanceof payments adjustment (Council of Economic Advisers 1973). That proposal put forward the possibility of IMF enforcement actions—formal regulation with teeth—against countries with surpluses in the form of general import taxes or surcharges, loss of scheduled special drawing right (SDR) allocations or taxes on thecountry’s excess reserve holdings. Barry Eichengreen, in ‘The nancial crisis and global policy reforms’, paperpresented to Federal Reserve Bank of San Francisco conference on ‘Asia and the nancial crisis’, Santa Barbara,CA, 2009, also mentions that last possibility.



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countries’ initiatives since it is a sort of public good requiring eective cooperationamong the major economies. There is a classic ‘collective action’ problem.

In this respect there is a fundamental dierence with regard to the past macro-

economic regime. Over the past two decades mercantilistic policies have beenfollowed by many countries, to the extent of widely characterizing the functioningof the international macroeconomic system. In particular, as we have seen, manydeveloping countries in Asia, and especially China, have been supporting export-led growth by pegging exchange rates and widening trade surpluses. But thesestrategies did not hold down growth rates in the world economy since the UnitedStates played the n.th role in the system by widening its current account decitsto accommodate the external surpluses and decits of other n-1 countries in thezero-sum game of all countries balance of payments at world level.16 ExpansionaryUS policies had a signicant positive impact on world demand (and growth),while the United States obtained cheap external nancing from developing Asian

surplus countries.This resulted in a very peculiar equilibrium which became increasingly unten-

able and fed the global economic crisis. Similar macroeconomic imbalances cannotbe supported today since there is no single country able to play the n.th role in thecurrent international macro-regime. The United States is hampered by its hugeaccumulated debt and can no longer be the consumer of ‘last resort’, running largecurrent account decits. This means that there will be no mitigating eect againstthe mercantilistic policies of the surplus countries (such as China, Japan, Germany,most of Asia and most emerging markets), resulting in a deationary bias in theworld economy.

In other words, surplus economies will be able to restore their potential growthrates only if their domestic demand—especially private domestic demand—risesfaster than GDP. But if that demand does not grow fast enough, the resultinglack of global aggregate demand relative to supply—or, equivalently, the excessof global savings relative to investment spending—will lead to a weaker recoveryat global level over the medium term, with most economies growing at much lessthan their potential growth rates.

This is why there is a classical ‘collective action’ problem at international level,since export-led growth (neo-mercantilism) is justied at individual country levelwhile at systemic level in the current multipolar economy it generates a worlddeationary bias. Current macro-imbalances could thus have punitively negativeeects upon world demand and growth, fuelling trade tensions among majorcountries. Unless a long-term solution is jointly worked out, trade conict willworsen and it will become increasingly hard to reverse the oending policies. Inan interview at the 2010 World Economic Forum in Davos, Dominique Strauss-Kahn, the Managing Director of the IMF, warned that ‘national and global growthwould be slower than many countries hoped because too many were relying on

16 Ignazio Visco, ‘Global imbalances in the nancial crisis and the international monetary system’, BIS Review,no. 161, Dec. 2009.





exports to underpin expansion’.17 To solve this collective action problem andfoster world economic growth, multilateral cooperative agreement is needed.

What the new arrangements and rules should prescribeThe fundamental lesson to be drawn from the crisis is that to assure sustainableglobal economic growth we should look for more formal international agreement torestrain macro-level current account imbalances. The crisis has been generated rstand foremost by international macroeconomic arrangements, which have permittedexplosive expansion of balance of payments decits and surpluses and the unsus-tainable accumulation of assets and liabilities. Therefore we should try to restore aneective supranational mechanism to promote stability-oriented macroeconomicpolicies at the national level, especially by systemically signicant countries.

The establishment of a macroeconomic cooperation regime does not neces-

sarily imply that key countries have to agree for each dened period on a short-term coordination of their macroeconomic policies. Short-term coordinationis quite costly and rarely successful, as in the short run perceived benets fromcooperation are generally inferior to perceived costs. An eective macroeconomiccooperation regime requires that rules of the game for adjustments and growthbe established that will apply over the medium term. This dicult task is relatedto the traditional problem of asymmetries between surplus and decit countries,which in turn is rooted in the mercantilistic attitudes of key major countries.Keynes worried about the potentially damaging eects of global current accountimbalances and the fact that market forces were not very strong in compelling

surplus countries to adjust. Keynes’s own idea for this problem was the so-called‘scarce currency clause’ and eventual trade sanctions against a country runningpersistent surpluses.18

The global adjustment process should thus involve the avoidance of policiesthat promote or sustain international and domestic imbalances both in the realeconomy and in the nancial sector. What is needed is an eective coordinationof macroeconomic adjustments of the major countries based, for example, on a peer pressure mechanism, grounded in formalized criteria. Such a mechanism shouldbe implemented by an international nancial institution endowed with eectivemultilateral surveillance powers, such as the IMF.19

The global adjustment process is strongly bound up with the formal obligations

of IMF members. In some policy areas members have formal commitments underthe IMF’s articles of agreement. The IMF is thus the right platform around which

17 See references in www.nfacts.ie/irishnancenews/article_1018935.shtml, accessed 2 April 2010.18 The scarce currency clause (SSC) in the IMF’s articles of agreement addresses this problem of asymmetric pres-

sure to adjust felt by decit and surplus countries. However, authorizing other members to invoke the SCCagainst a country running chronic surpluses and to impose taris on its exports would be politically dicult,and so the IMF executive board has never invoked the application of the SCC. Aditya Mattoo and ArvindSubramanian proposed to rehabilitate the SCC idea by adapting it to the WTO’s powerful sanctioning role:see ‘From Doha to the next Bretton Woods: a new multilateral trade agenda’, Foreign Aairs 88: 1, 2009, pp.15–26.

19 Jack Boorman, An agenda or reorm o the International Monetary Fund (IMF) (New York: Friedrich Ebert Stif-tung, Jan. 2008).



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to build a structure of more eective policy coordination (in addition to its standardrole of lender of last resort for countries with balance of payments diculties).

In this perspective the agreement reached at the G20 summit in Pittsburgh in

September 2009 is a rst step in the right direction; but it appears rather weakin terms of its likely eectiveness. It stresses countries’ shared responsibility toensure that their policies support ‘strong, sustainable and balanced growth’. Underthe framework it sets out, members have agreed to a mutual assessment of theirmonetary, exchange rate, scal and nancial policies, with the assistance of theIMF and other international nancial institutions.20 But the agreement comprisesmany broad principles and very few specic measures or enforcement mecha-nisms, and there will certainly be no penalties for non-compliance. There is sometalk of peer reviews of economic policies, overseen by the IMF, but how suchrules could be enforced is far from clear.

Indeed, recent history already oers a negative experience in this area. In the

spring of 2006 the management of the IMF initiated a ‘multilateral consultationon global imbalances’ involving China, the euro area, Japan, Saudi Arabia and theUnited States. However, the results were disappointing to many observers. TheFund could not exert eective pressure on the participants to make new, specicpolicy commitments. The participants’ resulting statements of their policy inten-tions oered nothing fresh. This is an instance where peer pressure did not produceresults, and the mutual consent to engaging in the process resulted in minimizingdierences.

To get results, therefore, the G20 leaders should endorse a strengthened surveil-lance regime for the IMF, with mechanisms capable of inducing countries to

pursue the virtuous macroeconomic policies described above. For example, excessChinese savings without a pegged exchange rate that supported a trade surpluswould have produced a recession in China, perhaps triggering a Chinese policyresponse that would have expanded domestic demand. Likewise, overspendingin the United States without the huge trade decit would have produced anoverheated economy and a demand-dampening US policy response.

The surveillance role for the Fund should be extended to several key areas suchas monitoring the rise of global imbalances, policing IMF exchange rate obliga-tions, and assessing the stability of national nancial systems.21 Each of theseactivities is central to the Fund’s relevance in the future. The IMF, drawing alsoon the expertise of the Financial Stability Board and other relevant internationalinstitutions and standard-setting bodies, must be allowed to formulate specicpolicy advice to the relevant member countries to promote monetary and nancialstability. It should also have at its disposal some kind of enforcement mechanismsand incentives that can be applied if no corrective policy actions are undertaken.

20 John Lipsky, ‘Changing times: global governance reform and the IMF’, IMF Direct, 11 Jan. 2010, http://blog-imfdirect.imf.org/2010/01/11/global-governance-reform/, accessed 2 April 2010.

21 Steven Dunaway, Global imbalances and the fnancial c risis, CFR special report 44 (New York: Council on ForeignRelations, March 2009); Stanley Fischer, Trevor Manuel, Jean Pisani-Ferry and Raghuram Rajan, ‘The roleand governance of the IMF: further reections on reform’, Jacobsson Foundation Lecture, Washington DC,Oct. 2008; Edwin M. Truman, ‘The G20 and international nancial institution reform: unnished IMFreform’, VoxEu.org, 28 Jan. 2009, http://www.voxeu.org/index.php?q=node/2896, accessed 2 April 2010.





These rules must include symmetrical external discipline on domestic policiesfor all countries—including the United States, which has dramatically abusedits status as the main reserve currency country.22 They must also include appro-

priate arrangements to let exchange rates move to help correct current paymentimbalances, under strengthened collective surveillance.23 However, this is not toadvocate either a return to a xed exchange rate system or excessive condencein a system of freely oating exchange rates—which, it must be admitted, havenot really helped the adjustment of global imbalances. As the case of Icelandillustrates, oating exchange rates can exacerbate nancial fragility. Even insti-tutions like the European Central Bank, the Bank of England and the Bank of

Japan beneted from the Federal Reserve’s currency swaps, which would haveno role if their respective currencies were freely oating against the US dollar. Inaddition, coordination of nancial regulation and supervision, which is likely tobe a prominent feature of the future nancial architecture, can become extremely

complex under freely oating exchange rates. Currencies have now become nan-cial assets that are traded for prot motives with very little relation to the balanceof payments of the issuing country.

It should be noted, however, that in the exchange rates area the record of theIMF and its members has been quite disappointing, to say the least. Though theIMF has rules on exchange rates and exchange rate manipulation, creating obliga-tions for individual countries and the membership as a whole, these rules haveseldom been used. So issues regarding members’ exchange rates and exchange ratepolicy, and their relationship to trade imbalances, have received scant attentiondespite their contributory role in the lead-up to the present global crisis.24

In this respect the new mandate of surveillance of exchange rates adoptedby the IMF in 2007 is a step in the right direction. Even so, it was not soundlyrooted in powerful surveillance tools so as to avoid major countries manipulatingexchange rates. What is needed is an eective rule in the international economicregime prohibiting undervalued exchange rates that are clearly attributable togovernment action.

It must be added that it will be impossible to get agreement on a major role forthe IMF of the kind described here unless the Fund inspires trust and condence.25 Without a greater acceptance of the IMF’s legitimacy, members will be reluctantto embrace the mutual consent to peer review processes that is necessary if theFund is to be able to meet its regulatory challenges in the future, including withrespect to the global adjustment process. To achieve that robust legitimacy, the

22 As is the case in respect of some formal thresholds for trade or current account balances—perhaps similarin some ways to the EU’ s scal rules—beyond which countries should come under pressure to adjust theirtrade policies. See Barry Eichengreen, ‘Out of the box thoughts about the international nancial architecture’,working paper WP/09/116 (Washington DC: IMF, 2009).

23 Stanley Fischer, ‘Exchange rate systems, surveillance, and advice’, Mundell–Fleming Lecture at the 8th JacquesPolak Annual Research Conference, Washington DC, IMF, Nov. 2007.

24 Michael Mussa, ‘IMF surveillance over China’s exchange rate policy’, in Morris Goldstein and Nicholas R.Lardy, eds, Debating China’s exchange rate policy (Washington DC: Peterson Institute for International Econom-ics, 2008).

25 Domenico Lombardi, Report on the civil society (Fourth Pillar) consultations with the International Monetary Fund onreorm o IMF governance (Washington DC: IMF, 2009).



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IMF will need to undertake a root-and-branch reform of its governance structureto reect the changing realities of the balance of economic power in the world.26 This is particularly relevant in the case of China and other Asian countries, in that

an increase in these countries’ IMF voting rights to a level more consistent withtheir importance in the global economy could make governments in Beijing andelsewhere more receptive to global coordination agreements.27

Concluding remarks

The current crisis has been generated by a combination of poor nancial regula-tion and international macroeconomic arrangements that have permitted explosivebalance of payments gaps and the unsustainable accumulation of assets and liabili-ties. Consideration of the role of global imbalances is thus key to understandingboth the bubble that formed and the subsequent crash. While such surpluses and

decits can sometimes be justied, prolonged imbalances fuel leverage and areunsustainable.

In the current environment, macro-imbalances could thus spur tensions andprotectionism, both in trade and in nance. In the end, the negative consequencesfor the global economy would be huge, and all nations would suer.

At the level of the international system there is a classical ‘collective action’problem to address, since if mercantilistic strategies are pursued by all majorcountries they will generate a deationary bias in world demand. Macroeconomicadjustment cannot be assured either by market self-regulation mechanisms orindividual countries’ initiatives, since it is a type of public good requiring eec-

tive cooperation among the major economies.The lesson to be drawn from the crisis is that we should try to restore some

shared rules of the game for international macroeconomic adjustment. Fundamen-tally, this means adopting coherent, mutually compatible macroeconomic policiesand allowing real exchange rates to adjust to achieve external balance over time.All countries should accept their responsibilities for promoting these policies andrecognizing spillover eects between economies. This in turn means submittingtheir policies to peer review and endorsing a strengthened surveillance regime forthe IMF to encourage and maintain more compatible macroeconomic policies. Tofull this role, the IMF should have incentives and enforcement mechanisms at itsdisposal; past experience has shown that peer pressure alone is unlikely to producesignicant results. If the major economies of the coming decades are to accept theIMF’s exercise of such a major role, it will need to undertake a root-and-branchreform of its governance structure to reect the changing realities of the worldbalance of economic power.

26 Carlo Cottarelli, ‘Eciency and legitimacy: trade-os in IMF governance’, working paper (Washington DC:IMF, Jun. 2005); Lorenzo Bini Smaghi, ‘IMF governance and the political economy of a consolidated EU seat’,in Reorming the IMF or the 21st century (Washington DC: E. Truman, 2006), pp. 233–55.

27 Ngaire Woods and Domenico Lombardi, ‘Uneven patterns of governance: how developing countries arerepresented in the IMF’, Review o International Political Economy 13: 3, Aug. 2006, pp. 480–515.

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