This is for my inr2002 class How important is a stable international monetary sy

Question

This is for my inr2002 class
How important is a stable international monetary system to cooperation among countries trade relations? Why would this be considered a collective good?
This is for my inr2002 class
How important is a stable international monetary system to cooperation among countries trade relations? Why would this be considered a collective good?

How important is a stable international monetary system to cooperation among countries trade relations? Why would this be considered a collective good?
How important is a stable international monetary system to cooperation among countries trade relations? Why would this be considered a collective good?

Explanation / Answer

Importance and cooperation with stable international Fincece system

The international monetary system is a topic that encompasses a wide range of issues—reserve currencies, exchange rates, capital flows, and the global financial safety net, to name a few. It is one of the key issues on the G-20’s work agenda for 2011, and a topic that is eliciting lively discussion—witness for instance the recent, insightful report of the “Palais Royal Initiative” (or “Camdessus group”).

Some are of the view that the current system works well enough. While not perfect, they point to its resilience during the crisis, citing in particular the fact that the U.S. dollar served as a safe haven asset. And now that the global recovery is underway, they see little reason to worry about the international monetary system. In other words, “if it ain’t broke, don’t fix it”.

I take a less sanguine view. While the world as we know it did not end in 2008, it was only through extraordinary international policy cooperation that a far worse outcome was averted. Moreover, the recovery underway today is not the recovery we wanted. Unemployment remains at record highs, with widening income inequality adding to social strains.

And global imbalances are back, with issues that worried us before the crisis—large and volatile capital flows, exchange rate pressures, rapidly growing excess reserves—on the front burner once again. Left unresolved, these problems could even sow the seeds of the next crisis.

In my opinion, reforms to the international monetary system that help us get to the root of these imbalances could both bolster the recovery and strengthen the system’s ability to prevent future crises.

Let me set out three of the key questions that are guiding the IMF’s work in this area, and on which I look forward to hearing your views. I will start from the premise that when we worry about the deficiencies of the international monetary system, we are mostly worrying about volatility: a sense that money sometimes flows around the globe in too volatile a fashion, and that countries need a more stable, more predictable external environment in order to prosper.

First, how can we strengthen policy cooperation?

Clearly, one driver of volatility is economic policies, especially when they are not consistent across countries. The crisis marked a watershed moment for international policy cooperation—leaders took the actions necessary to overcome domestic and global economic challenges. Now that the worst of the crisis has passed, how can this cooperation be sustained—so that countries adopt policies consistent with sustainable global growth?

The G-20’s Mutual Assessment Process has been an important first step towards creating a more permanent framework for global policy cooperation. IMF surveillance is a critical complement to the MAP—and also lies at the core of our mandate. Through this activity, the IMF seeks to identify the country-level policies that can deliver more stable global growth.

We have already taken a number of significant steps to strengthen Fund surveillance—for example, the early warning and vulnerability exercises. We are now increasing our focus on the impact of countries’ policies across their borders, particularly for the five most systemic economies—for which we have new dedicated “spillover reports” in preparation.

We are also delving deeper into macro-financial linkages. Here, we will be helped by the fact that countries representing the world’s 25 most systemic financial systems have agreed to mandatory Financial Sector Assessment Programs (FSAPs). This tool will facilitate our efforts to catch dangerous build-ups of systemic risk in the financial sector—which is precisely what preceded the recent crisis. Even beyond this, we should explore whether even more ambitious changes to our surveillance are needed—and we are conducting a major review to that effect.

International stable monitory system as collective good

Inevitably, there is an important public goods aspect to monetary policy at the national level--there is only one monetary policy that affects everyone. When non-residents use a national money, as is extensively the case for the world's major national monies, national monetary policies acquire aspects of global public goods. Exchange rates always, to some extent, involve issues of international public goods as an exchange rate is the relative price of two national monies and is affected by the corresponding national monetary policies. This international public goods aspect rises to global significance for exchange rates among the world's major currencies as use of these currencies is global and movements in their exchange rates have widespread effects.

Quite understandably, the monetary policies of the major currency countries (including the Euro area) are directed at domestic economic objectives, which may be broadly described as promoting domestic economic and financial stability. Reasonable stability of the domestic price level is increasingly recognized as the most basic objective of monetary policy. Given this objective, monetary policy also typically seeks to support maximum sustainable growth and to promote general stability in financial markets. The behavior of exchange rates may sometimes influence the monetary policies of the major currency areas, but usually only to the extent that exchange rates affect the more basic objectives of monetary policy.

From the global perspective, this domestic orientation of monetary policies in the major currency areas is generally desirable. As experience has unfortunately taught us on several occasions, economic and financial instability in the dominant economies of the world is bad for them and for the rest of the world as well. Thus economic policies that promote domestic economic and financial stability in the largest economic areas of the world are not only desirable--they are essential--for economic stability and prosperity elsewhere.

That said, it may still be asked whether it might be desirable for economic policies in the largest currency areas to pay somewhat more attention to their international consequences, particularly in the area of promoting greater exchange rate stability? My answer, I suspect, will not entirely surprise you. I am, after all, the Managing Director of the International Monetary Fund. I have a job to do. I try to do it with enthusiasm.

Beyond that, I believe that recent experience suggests--suggests rather pointedly--that somewhat more attention can be paid to international consequences and specifically to exchange rates in the management of economic policies in the largest economies with beneficial results for these economies as well as for the rest of the world. In early 1995, the U.S. dollar plunged below 80 yen and below 1.35 deutsche marks. This sharp weakening of the dollar tended to undermine recovery in the weak Japanese economy and, arguably, was a factor in the slowing of growth in Europe. Also, the instability of the dollar/yen exchange rate that began in early 1995 contributed to the problems that led up to the Asian crisis.

Consistent with advice given by the IMF, in 1995, official actions did seek to forestall and reverse the excessive weakness of the dollar. In the late winter and spring, official interest rates were cut in both continental Europe and Japan and were cut further in Japan during the summer. Coordinated intervention by Japan and the United States was used to send signals to the market. These official actions were, in my judgment, both successful and important in helping to reverse the dollar's unwarranted weakness; and they provide an example that shows the potential usefulness of official efforts to counteract excessive and unwarranted movements of exchange rates among the major currencies.

Last September and October, in the wake of Russia's default and the near failure of the hedge fund, LTCM, a liquidity crisis gripped a wide range of financial markets. The markets most affected were the second tier markets for lower rated and unrated credits of both industrial and developing country issuers. Indeed, yields on the highest rated U.S. Treasury and German government bonds fell sharply, while spreads widened dramatically and new issue activity dried up for virtually all emerging market issuers. Although adverse effects on the U.S. economy were not apparent, recognizing the danger posed by this crisis, the U.S. Federal Reserve took the lead among major currency area central banks in easing monetary conditions. In this instance, forward looking monetary policy action, in the United States, the Euro area, and Japan, which took account of conditions in global financial markets beyond those of immediate domestic concern, clearly helped to forestall important risks of a deeper global economic downturn and, correspondingly, has helped to create the more favorable prospects for global growth that we see today.

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