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European Commissioner for Economic and Monetary Affairs
We need to address the shortcomings of the international monetary system
European Commission workshop "Towards a new International Monetary System"
Brussels, 19 May 2011
Ladies and Gentlemen,
It is a pleasure to welcome you to this workshop “Towards a New International Monetary System”. I thank the French G20 Presidency for its support for this workshop, which brings together a distinguished group of policy-makers, academics and other experts.
The current international monetary system, despite many imperfections, has enabled remarkable progress in global economic and financial integration. But as said, the system is not perfect. There is scope for improvement and reform.
Looking back over the past 40 years, even with floating or semi-floating exchange rates in the 1980s, authorities had to intervene to reduce global economic imbalances, like the Plaza and Louvre agreements. Today, we still face an adjustment process that is structurally flawed.
The core features of the current system, such as floating exchange rates among advanced countries or open capital accounts, are fundamentally sound. However, the system needs to encompass a larger set of countries and in particular the large emerging market economies.
We need to develop a common understanding on the strengths and weaknesses of the current system and address the shortcomings. This work is ongoing in the G20, and this is why we are here today.
Ladies and Gentlemen,
The debate on the international monetary system is not new and has been going on since the setting up of the Bretton Woods system.
After the Bretton Woods, an informal and mostly market-led system evolved. This system was initially centred on three floating currencies: the US dollar, the Japanese yen, and the Deutsche Mark (the so-called “G3”). There was another new ingredient: the gradual liberalisation of cross-border capital movements.
One major innovation in the International Monetary System was the creation of the euro in 1999. It marked a major step forward in European economic integration and strengthened the multicurrency dimension of the system. The gradually increasing role of the euro in the international monetary system underlines the evolutionary nature of the system.
The basic features of the hybrid system that evolved after Bretton Woods – the combination of free-floating currencies and free capital flows – are still with us today.
But the system has not always functioned smoothly. There have been episodes of excessive volatility among the major currencies – and even episodes when these currencies were clearly misaligned. This prompted unilateral and/or concerted central bank interventions in the 1980s and 1990s.
Equally important, it has become apparent that exchange rate adjustment, while necessary, cannot by itself lead to the complete adjustment of global imbalances.
This is largely related to three features of the current system.
First, to the policy choices of some countries to heavily manage their exchange rates with different combinations of capital mobility and monetary policy independence. The correcting mechanisms have proved insufficient to bring the system back to a sustainable and balanced path.
Second, to the pursuit of country-specific growth models that seek to maximise non-inflationary domestic growth over the short run while paying insufficient regard to international spillovers.
Third, the role of the US dollar as the global reserve currency, which has enabled the US to run large and unsustainable current account deficits. This is why the G20 has set up the Mutual Assessment Process. With this tool, we aim to address the issue in a balanced and cooperative way.
The current adjustment mechanisms are thus structurally flawed and lack enforcement. Actually, John Maynard Keynes already in 1944 recognised the lack of an "international stabilising mechanism" and pointed to the role of exchange rates in the adjustment mechanism. This calls for more cooperative and lasting solutions in a number of areas.
Ladies and Gentlemen,
Let me point to three main challenges the G20 is currently addressing:
First, economic policies, including exchange rates and multilateral surveillance, should ensure effective adjustment and restrain the emergence of unsustainable imbalances. I regard more market-determined exchange rates that reflect economic fundamentals as crucial to improve the global adjustment mechanism.
In addition, we need to focus on sound and sustainable macroeconomic policies to strengthen the international monetary system. We also need adequate macroprudential and regulatory policies, with a main focus on cross-country linkages and spillovers, both in the IMF and the G20.
Second, we are advancing our discussions on how to manage capital flows in the context of the G20 and the IMF. Our aim is to maximise the benefits of free capital flows and minimise the potentially destabilising effects. We need to come to coherent conclusions on the management of capital flows to ensure best practices, as well as maximum benefits and minimum costs for both recipient and source countries.
The overall objective should be for countries to aim at a carefully sequenced liberalisation of their capital accounts. This, however, needs to be done against the background of the necessary macroeconomic and prudential policies and institutional frameworks.
Third, global liquidity management should ensure appropriate levels of liquidity in times of crisis. This requires a further strengthening of global and regional financial safety nets and cooperation between them; the development of local capital markets; a better assessment of the adequate level of reserves; and, an improved reflection of the new economic powers in the international monetary system.
Several emerging market economies are implementing strategies to internationalise their currencies via trade settlement arrangements, offering bilateral swap lines or issuing international bonds. Over time, this is likely to lead to a more multipolar currency system, which consists of several currencies instead of only one main currency.
Take, for instance, the euro. It has increased its share in global foreign exchange and capital markets constantly since its introduction. Its share in the stock of global foreign exchange reserves increased from 18 per cent in 1999 to over 27 percent in 2009.
One further step in the direction of greater multipolarity, where progress seems possible, could be the definition of a criteria-based path to broaden the composition of the SDR-basket.
Ladies and Gentlemen,
To conclude, John Adams, the second President of the United States, noted in a letter to Thomas Jefferson that "All the perplexities, confusion and distresses (…) arise (…) from downright ignorance of the nature of coin, credit, and circulation."
Despite the progress we have made over the last two centuries, it is true that we need to further deepen our understanding of the complex nature of the international monetary system. We need to address the shortcomings to ensure a more robust system in the future.
We live now in a more diverse world, with a greater role for the emerging economies. This workshop is a chance to deepen our understanding and it serves as a basis for finding appropriate solutions in the G20.
Thank you and a warm welcome to this workshop.