The devastating financial crisis that erupted in 2008 continues to occupy front and centre of the global stage. The prospect of another recession is looking increasingly and sadly plausible. The costs of this on-going crisis are enormous in both human and financial terms: unemployment levels are unacceptably high, financial institutions and markets are shattered, and budget deficits the world over threaten to become unmanageable.
The past three years have underlined the fact that the global community has not adequately addressed the fundamental weaknesses of the global economic and financial system. On the surface, it first appeared that these weaknesses were concentrated in the financial sectors of the major advanced economies. But it has become apparent that the problems are fundamental and systemic. As the crisis unfolded, the tide of excess liquidity turned and capital flows either reversed or ceased altogether; investors scrambled to reduce their exposure to risk and de-leveraged. The crisis has made even more obvious how tightly the economies and financial markets of the world are tied together – a shock in one major country rapidly spreads throughout the entire global monetary and financial system.
Beyond the weaknesses of financial institutions are the enduring weaknesses of the international monetary system. Too little attention has been paid to the importance of the international monetary system.
If the problems of the international monetary system are not addressed with a real sense of urgency, they could lead to a fragmentation of our economic system, making it more vulnerable to protectionist pressures. This, in turn, would lead to an unravelling of the system, where national and regional policies are mutually inconsistent. Any progress that has been achieved towards open, competitive markets runs the risk of stalling, possibly even reverting.
The task of reforming the international monetary system is immense. It will not only require a very special spirit of cooperation but will also require time and that initiatives are appropriately sequenced.
In late 2010, together with the late Tommaso Padoa-Schioppa and Alexandre Lamfalussy, I had the pleasure of convening the Palais Royal Group. The Group – made up of former finance ministers, central bank governors, high-ranking officials from international financial institutions and academics – proposed a list of concrete steps for the reform of the international monetary system, now widely known as the “The Palais-Royal Initiative”.
On surveillance, the Group proposed the following six recommendations to initiate the process of reform:
1. IMF member countries should ensure that their policies are conducive to the stability of the global economic, monetary and financial system. We suggest that Article IV of the IMF Articles of Agreement be amended to reflect this strengthened commitment and to ensure that firm surveillance applies not only to exchange rate policies but to all economic and financial policies relevant for both domestic and global macro-financial stability.
2. In support of surveillance over each country’s or group of countries’ compliance with the obligations under the Articles, the IMF should adopt norms for members’ policies. The development of such norms should draw on the advice and experience of all IMF members and other available expertise. Norms should be established in such a way that they function as alarm signals, with appropriate thresholds defined for each of them whenever possible.
3. Persistent breach of a norm would trigger a consultation procedure and, if needed, remedial action. The purpose of the consultation would be to ascertain the underlying causes and potential consequences of the deviation from the norm, both for the country itself and for the good functioning of the international monetary system. If the assessment concludes that a persistent deviation from the “norm” is not justified and seriously disturbs the international monetary system, it should be followed by policy recommendations.
4. For systemically relevant countries whose policies do not appear to meet the norms, compliance with obligations should be explicitly ruled upon by the relevant organ of the IMF. All countries would be subject to the same obligations; and compliance with these obligations would generally be assessed in the context of IMF bilateral surveillance.
5. The IMF should develop positive incentives for countries to remain in full compliance with the requirements of the strengthened surveillance system. Such incentives could include automatic qualification for liquidity facilities and access to a voluntary SDR market (allowing a member to sell SDRs against freely usable currencies without having to demonstrate a balance of payment need and or recourse to the mandatory procedure called designation).
6. Strong consideration should be given to including in the surveillance framework the possibility for the IMF to impose appropriate graduated remedial actions if a country has persistently violated one or more obligations. This might entail a more detailed analysis of what a breach of the norm implies, informal meetings with the country concerned, and ultimately, if no action is taken, a move to the next phase of consequences.
We believe that these recommendations would lead to more effective and fair surveillance of the international monetary system. They would go a long way to ensuring the discipline and stability that are so urgently needed to provide a base for sustainable economic growth and employment creation.
We believe very strongly that time is of the essence. When the G20 meets in November 2011 in Cannes, we will be looking for significant steps toward a multi-polar monetary system that the world needs now.
Adopting an approach whereby we once again somehow ‘muddle through’ is simply no longer adequate.
Michel Camdessus is co-chairman of the Emerging Markets Forum, co-convenor of the Palais Royal Initiative and Governor Emeritus of the Banque de France