John Lipsky—Acting Managing Director, International Monetary Fund
Annual Meeting of the Bretton Woods Committee
For nearly three decades, the Bretton Woods Committee has played an invaluable role in supporting the work of the IMF and of other international institutions. With the Bretton Woods institutions adapting to meet new global realities, your efforts to promote understanding of our mandate and our work remain essential for us to be effective. You also provide valued feedback and commentary on how we can better fulfill our unique global role.
Today, I’d like to focus on how we can build a stronger global economy. My principal point is straightforward: The prospective contribution of greater policy cooperation in enhancing systemic stability and in preventing crises—and in containing their costs when they occur—is more important today than ever.
Supporting this cooperation lies at the heart of the IMF’s mandate. In the wake of the crisis, we undertook important reforms to our surveillance and lending tools. But as the world continues to change, we must do so as well.
In particular, I will focus my remarks today on the steps we are taking to enhance the framework for our unique surveillance activities. For example, we are seeking to deepen our understanding of the complex and growing interlinkages across the world, with an emphasis on the drivers of capital flows. We also are looking to sharpen our awareness of the quality of growth within countries—including such considerations as income distribution and unemployment—and its relation to macroeconomic stability.
As part of our efforts to enhance systemic stability, we are examining how the global financial safety net can be made more effective. We’ve made progress since the crisis hit in force in 2008. Nonetheless, we are far from the point where countries can be confident that they will have secure access to international liquidity at times of systemic crises. At the same time, we have to remain alert to the need to create proper incentives in designing safety net tools, in order to insure that the results of our efforts aren’t paradoxical.
Before explaining the strategic changes currently underway at the IMF in greater detail, let me briefly outline the economic backdrop against which they are taking place.
A strengthening, yet fragile recovery
Overall, the global recovery is gaining strength. But it remains fragile and uneven, and beset by uncertainties. So there is no room for complacency in dealing with the challenges that still threaten the recovery. These challenges fall into two camps.
First, countries are still dealing with the aftermath of the crisis.
In the financial sector, substantial progress has been made already to re-build buffers and strengthen regulation. But the work is far from over, especially when it comes to supervision and cross-border resolution. Fiscal reform is another pressing issue. At the end of 2010, government debt was as much as 25-30 percentage points of GDP above the pre-crisis level for several advanced economies—and is projected to continue rising, in the absence of bold measures to rein it in. Credible solutions will be required for the serious fiscal challenges facing many advanced economies, notably in the European periphery, but also in the United States and Japan.
Turning to Europe, several peripheral euro area countries today remain in critical situations. And there is no easy solution. Without any doubt, the primary responsibility for restoring their economic health lies with the peripheral countries themselves. Difficult and demanding measures will be required in order to avoid an even more serious crisis and to restore economic health. At the same time, there are compelling reasons for their European neighbors and the global community—operating through the IMF—to support these countries’ reform efforts. The only viable option for Europe today is a solution that is comprehensive and consistent—and that is also cooperative and shared. Such a solution inevitably will include: (i) strengthening area-wide crisis management frameworks; (ii) accelerating financial sector repair; (iii) improving fiscal and macroeconomic coordination; and (iv) promoting high-quality growth.
For our part, the IMF is supporting our European members as they seek to put their economies back on a sustainable footing. Last week, we agreed on a joint IMF-EU financing package for Portugal worth €78 billion, aimed at reigniting growth and employment. This week, we completed the first and second reviews of Ireland’s program. And in Greece, a mission is currently in the field, working closely with the authorities to identify the policies needed to underpin the adjustment program going forward.
The second challenge to the global recovery reflects its unevenness.
In many advanced economies, we are experiencing a moderate recovery. Unemployment remains stubbornly high in most of these countries, raising the risk of higher structural unemployment. Only in a few advanced economies that have improved their competitiveness through structural reforms, such as Germany, is growth notably above-trend, thus reducing the margin of excess capacity.
In the emerging economies, by contrast, the recovery has been quite robust—and in some, overheating is an increasing concern. That is why we have welcomed recent steps in many of these countries to tighten macroeconomic conditions—though further action likely will be warranted. This strong recovery in the emerging economies has been associated with a run-up in commodity prices and a rise in headline inflation rates. Increasing food prices—that recently eclipsed the highs set in 2008—have particularly difficult implications for low-income countries.
The uneven global recovery also is affecting international policy cooperation. During the crisis, most countries faced similar economic challenges. This made it easy to agree on the policy solutions. Today, countries are at different stages of recovery—thus making cooperation more challenging. But as we learned from the crisis, global problems require global solutions. In our increasingly interconnected world, we need policies that are right for the national interest and right for the global interest.
The IMF—with its near-universal membership of 187 countries—has a vital role to play in promoting international cooperation. Let me explain in more detail how we are changing to achieve this.
A new surveillance for an interconnected world
Modernizing IMF surveillance remains critical to increasing our effectiveness. We have already done a lot since the crisis to strengthen our ability to identify potential vulnerabilities. Let me give just two examples. Since its inception in 2008, the Early Warning Exercise has become firmly established, and provides timely warnings to global policymakers. And last year, the Financial Sector Assessment Program (or FSAP) was made mandatory for countries with systemic financial sectors.
The ongoing Trilateral Surveillance Review—which should be completed this fall—will provide an important opportunity to take stock of recent initiatives and recommend further steps. In particular, it will consider how well the Fund is positioned to detect and warn about risks, and the effectiveness, candor, and evenhandedness of our surveillance. But we are already moving forward in a number of areas. I’ll focus on three in particular: spillovers, capital flows, and the quality of growth.
The first is the issue of spillovers. Over the last decades, we have witnessed a tremendous increase in the interlinkages among countries—of trade but especially of finance. These interlinkages have provided great opportunities for investment and growth. But rising interlinkages also make each country more exposed to spillovers from policy decisions and economic developments in other countries.
With this in mind, we are now focusing on how an improved understanding of interlinkages can support better policy collaboration. This year, we are undertaking in-depth analysis of the outward spillovers from the five largest economies in the world—China, the Euro Area, Japan, the United Kingdom, and the United States. The results of our experimental work will be presented in a series of Spillover Reports, to be discussed by our Board, alongside each country’s Article IV report, this July. By shedding light on the impact of one country—or region’s—polices on others, we hope to facilitate the process of finding policies that serve both the national and the global interest.
We also are supporting the G-20’s efforts to increase policy collaboration, with the goal of securing strong, sustainable and balanced global growth. The G-20’s Mutual Assessment Process—or MAP—already has made substantial progress in creating a forum for productive policy dialogue. During the current phase, the MAP is focusing on the internal and external imbalances that are most problematic for global growth and stability. With analytical support from the IMF, the G-20 is analyzing impediments to adjustment, and the measures that might address them.
As we all know, capital flows have grown to dominate international transactions for many countries. While capital flows confer many benefits, their size and volatility can exacerbate macroeconomic and financial stability risks. Understanding these risks is especially important, given that it is only reasonable to expect cross-border capital flows to increase in size for years to come, reflecting the emerging economies’ impressive growth potential. Recipient country authorities typically are concerned with coping with the volatility of net capital flows. Our analysis suggests that the first line of defense in dealing with surging capital inflows should be macroeconomic policies, though capital flow management measures could be useful in certain circumstances. More generally, countries are advised to adopt structural reforms—including the deepening of domestic financial markets—that increase their capacity to absorb capital inflows efficiently, and prudential measures that strengthen their financial system’s resilience.
In the period ahead, we will be working to gain a better understanding of the drivers behind capital flows—in supplier and recipient countries. We also are exploring how a voluntary and cooperative approach to global capital flows—perhaps through an agreed reference framework for individual country policies—could help make them less volatile, and hence less costly. By bringing together the views of both importers and exporters of capital, the Fund can play a constructive role in the discussion.
A third issue is the quality of growth, and its impact on macroeconomic sustainability. Recent developments in the Middle East and North Africa show that we must deepen our understanding of the broader factors that may affect macroeconomic stability. This applies to many advanced economies as well, where high unemployment remains a serious threat to the recovery. At the Fund, we are working to gain a better appreciation of the social factors that affect macroeconomic stability, drawing on outside experts in this field. These factors must play a bigger role in our analysis and in our policy advice.
A strengthened global financial safety net
Turning briefly to the developments regarding the global financial safety net, we’ve already taken significant steps to enhance the provision of liquidity in times of extreme volatility. The IMF’s financial resources have been increased notably, and we have created insurance-like instruments intended for crisis prevention, rather than crisis resolution. These include the Flexible Credit Line for members whose policies already are deemed to be appropriate, and the Precautionary Credit Line for members implementing policy adjustments. However, doubts remain about whether the global financial safety net adequately reflects potential risks, in view of rising trade and financial linkages
Ensuring that we have the right tools can help to prevent future crises, and to reduce their costs when they do occur. To gain a better appreciation of the need for global liquidity at times of stress, we are now looking more carefully at the causes of systemic crises—drawing in particular on our work on cross-border linkages across different types of economies, and on analysis of past systemic crises and policy responses.
We also continue discussing possible ways to provide short-term liquidity at times of systemic stress, including via collaboration with institutions such as major central banks, systemic risk boards, and regional financial arrangements. In the recent crisis, emergency short-term liquidity was provided through ad hoc arrangements deployed on a one-off basis by central banks. Clearly, there are lessons to be learned from this experience. Ongoing work on the role and composition of the SDR also holds the potential to improve mechanisms to provide global liquidity.
As the global recovery strengthens, it might be expected that policymakers will focus more on domestic priorities, and worry less about global issues. But in our increasingly interconnected world, the two cannot be separated. The recent crisis demonstrated that even the largest economies cannot effectively set their policies in a vacuum, and that effective international cooperation can improve economic prospects for all.
How best to sustain collaboration? For our part, the IMF can:
– Increase our understanding about global economic interlinkages;
– Demonstrate analytically the benefits of enhanced policy collaboration; and
– Facilitate the international dialogue needed to find global solutions.
And you, the Bretton Woods Committee, also play an important part in summoning the will of policymakers to act. By advocating for international cooperation, you remind leaders that by acting in the global interest, they are acting most directly in their national interest.
John Lipsky—Acting Managing Director, International Monetary Fund