In the Wake of the Crisis: Leading Economists Reassess Economic Policy

22. International Monetary System Reform: A Practical Agenda

International Monetary Fund
Published Date:
March 2012
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Charles Collyns

Reform of the international monetary system is always an intellectually stimulating topic, but sometimes it gets lost in abstruse debates that lead nowhere. The turbulent economic developments of the past several years underline that now is a moment when our collective attention needs to focus on a pragmatic policy agenda with real practical consequences.

In this chapter, I address three immediately relevant issues: first, ensuring effective international economic cooperation to achieve a sustained, well-balanced global recovery; second, moving to more consistently flexible exchange-rate management across all the major economies to support rebalancing and reduce the long-prevailing asymmetric bias in the international monetary system; and third, developing a consensus around a coherent framework for emerging economies to manage capital-flow volatility. I conclude by emphasizing the crucial role that the International Monetary Fund (IMF or the Fund) can play to advance this reform agenda by delivering more forceful surveillance.

International economic cooperation proved highly effective in dealing with the aftermath of the 2008 global financial crisis, when all Group of Twenty (G20) economies faced similar problems of grappling with a collapse in demand and confidence. The task now is harder but no less relevant. Recent global growth has been fragile and uneven. Much of the emerging world has grown rapidly but has faced risks of overheating. By contrast, in advanced economies, the recovery has been more gradual and recently has lost steam, output gaps and high unemployment remain serious concerns, and sustained fiscal consolidation will be needed over the medium term. This fragile and uneven recovery raises the specter that external imbalances could again widen, which could destabilize financial markets and threaten a period of weak global economic performance.

At the Pittsburgh Summit in September 2009, the G20 created the Framework for Strong, Sustainable, and Balanced Growth as a central foundation for effective cooperation across the world’s largest economies.1 We need to build on this framework to achieve consensus on joint efforts to identify the root causes of imbalances and agree on policies to address them. Success is imperative for the health of the global recovery and for the G20’s credibility.

In Paris in February 2011, the G20 finance ministers agreed on a set of indicators to focus on large imbalances requiring policy action.2 In Washington in April 2011, we agreed on indicative guidelines, and selected seven countries for more intensive study of the root causes of imbalances.3 The next stage is to develop a concrete action plan and policy deliverables by leaders at the Cannes Summit in November 2011.

Successful rebalancing will require complementary actions across countries. Advanced countries, including the United States, will need to deliver credible multiyear reforms to restore fiscal sustainability. Other nations must play their part by undertaking the difficult reforms required to develop new sources of growth. Most important, major emerging economies with persistent current-account surpluses need to reduce their reliance on export-led growth and shift their economies toward domestic consumption and investment. This will require policy reforms to encourage robust growth of domestic demand and a corresponding shift in the pattern of supply toward domestic markets.

My second theme is the importance of persuading all major economies to allow exchange rates to move flexibly. The current international monetary system is an uneasy hybrid of flexible and heavily managed exchange rates. It is increasingly ill-suited to facilitating global adjustment as rapidly growing emerging economies with heavily managed exchange rates take on rising importance in the global economy. This is a new form of a long-standing asymmetry in the system, by which surplus countries do not face adequate pressure to let their currencies adjust.

The limited degree of currency flexibility in the world’s largest exporter and second-largest economy, China, is of particular concern. China’s currency remains substantially undervalued, notwithstanding some increased flexibility toward the dollar since June 2010. To avoid losing competitiveness relative to China, many of China’s neighbors also intervene heavily and also have undervalued currencies. Such policies undermine the key role of the exchange rate in shifting the pattern of global supply and demand, imposing an undue burden on others and threatening to impede strong and sustainable global growth. All major economies, whether emerging or advanced, should be prepared to allow exchange rates to move to facilitate external adjustment in response to market forces.

My third and final topic is the need for consensus around a coherent policy framework for emerging economies to manage volatile capital flows. To some degree, this issue is receiving increased attention as a consequence of the previous two issues. A world with a multispeed recovery combining flexible and heavily managed currencies is one in which capital flows tend to be volatile, putting pressure on macroeconomic frameworks and threatening to exacerbate financial vulnerabilities.

Capital flows to emerging markets typically reflect strong growth and attractive rates of return and have the potential to help fill substantial investment needs. Particularly in countries with undervalued currencies, capital flows are a natural economic response to perceptions of higher financial returns. A real appreciation is called for in these cases. This is most easily and effectively achieved through a nominal appreciation. Efforts to block nominal appreciation in these cases would eventually result in a real appreciation through inflation, but this adjustment is likely to be delayed and costly. Countries can also use the classic remedy of fiscal tightening and monetary easing to reduce pressures on domestic interest rates and lower incentives for capital inflows, while maintaining domestic demand on a steady course.

The difficulty arises when capital is flowing to a country with an already overvalued exchange rate, with more than adequate levels of reserves, creating a risk that excess growth in credit or asset prices could leave the domestic financial system vulnerable. The challenge here is to contain the short-term risks without undermining the real long-term benefits that capital flows offer, and without distorting the market signals (and needed adjustments) that capital flows reflect.

But even in such extreme instances, measures to deter capital inflows should be seen only as a temporary fix and should be carefully structured to minimize distortionary or discriminatory effects. Experience has taught us that such measures are unlikely to have much lasting effect on aggregate flows, particularly as market participants find ways to evade their impact. There are also significant administrative costs for governments and compliance costs for firms.

At a systemic level, the imposition of capital controls and heavy foreign-exchange intervention in certain emerging-market economies has diverted capital flows to other economies that do not impose such measures, complicating policy management in these countries.

High-growth countries that have moved to more flexible exchange-rate regimes and more open capital accounts seem particularly vulnerable to such spillovers. We need to guard against negative externalities imposed by the proliferation of defensive measures against the free flow of capital. This is why a joint effort to develop a sensible consensus on approaches to be used in responding to surges is important.

Finally, the IMF has a crucial role to play in advancing this reform agenda. Through its surveillance role, the Fund can and should do more to promote more flexible exchange rates, a better balanced global economy, and more coherent management of volatile capital flows.

The IMF has long been an acknowledged center of expertise on international monetary issues. Accordingly, the G20 is relying on the Fund to play a key technical part in the G20 Framework for Strong, Sustainable, and Balanced Growth. Moreover, the Fund is working hard to strengthen its analysis on reserve adequacy and exchange-rate valuations,4 which provide essential underpinnings for rigorous policy assessments. And the Fund is contributing to the task of developing sensible guidelines for managing capital flows based on a careful analytical framework and drawing lessons from cross-country experience.5

But the Fund must do more than provide high-quality technical analysis. It must also provide a stronger voice for globally coherent policies. The United States has long called for the IMF to strengthen its surveillance of exchange rates, and it remains critical for the Fund to follow through and speak more forcefully on exchange-rate issues. For a start, the IMF could increase transparency of surveillance by more widely publishing bilateral and multilateral surveillance products, such as by making publication of Article IV reports mandatory and publishing its exchange-rate assessments. But more than this, the Fund needs to make sure that its voice is forceful and candid. The recent report by the Independent Evaluation Office (IEO) of the IMF’s performance in the run-up to the financial crisis makes clear that there is room for the Fund to do a better job at identifying and communicating risks to the global economy. This is about both sharpening the tools in the toolkit and also applying them more effectively to gain greater influence over policy decisions. This may require broader reforms of the Fund’s governance structure to, in the words of the IEO report, “clarify’ … roles and responsibilities” and “establish a clear accountability framework.”6

I end here by reiterating my central point: reform of the international monetary system is a key issue for today’s global economic policy agenda, but to be most useful it should be directed squarely at delivering practical results to underpin a sustained and well-balanced global expansion.


G20 Leaders’ Statement, The Pittsburgh Summit, September 24-25, 2009,

G20 Communiqué, Meeting of Finance Ministers and Central Bank Governors, Paris, February 18-19, 2011,

G20 Communiqué, Meeting of Finance Ministers and Central Bank Governors, Washington, DC, April 14-15, 2011, 2011/04/G20%20Washington%2014-15%20April%202011%20-%20final% 20communique.pdf.

See International Monetary Fund, “Addressing Reserve Adequacy,” February 14, 2011,

See International Monetary Fund Staff Discussion Note, “Managing Capital Inflows: What Tools to Use,” Jonathan D. Ostry et al., April 5, 2011,

Independent Evaluation Office of the International Monetary Fund, Evaluation Report, “IMF Performance in the Run-Up to the Financial and Economic Crisis IMF Surveillance in 2004-07,” 2011, Signature).pdf.

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