A global financial safety net
What’s at stake: South Korean President Lee Myung-bak, whose country is chairing the G20 this year, proposed building a "global financial safety net" to insure against risky capital flows and help mitigate global imbalances in trade and development. Lee used the special address to hundreds of top policy makers, business leaders and civil society representatives at […]
What’s at stake: South Korean President Lee Myung-bak, whose country is chairing the G20 this year, proposed building a "global financial safety net" to insure against risky capital flows and help mitigate global imbalances in trade and development. Lee used the special address to hundreds of top policy makers, business leaders and civil society representatives at the World Economic Forum in Davos to outline Korea’s plan for the G20 summit to be held in Seoul in November. As a key theme of the G20 summit, he proposed the establishment of a global financial safety net to address sudden reversals of international capital flows on emerging and developing economies. A total of ten G-20 meetings will be held this year the first planned for February 27th and 28th in Incheon west of Seoul with vice finance ministers and deputy governors of central banks in attendance. G20 deputies will informally discuss the Korean proposals and other policy options to mitigate risks in the international financial system at a conference on the eve of the meeting.
Reza Moghadam, director of the IMF’s Strategy, Policy, and Review Department, argues that the Fund has been modernizing its lending and conditionality framework to deploy its resources more effectively. While the IMF tripled its lending resources from $250 billion to $750 at the G20 London Summit in April 2009, some academics have called for the Fund’s resources to be expanded even more, arguing that the availability of large resources would forestall the actual need for the IMF to intervene, and also prevent sudden stops in capital flows. For example, Simon Johnson has suggested that at least $1 trillion is needed, while Guillermo Calvo has underscored the important lender-of-last-resort role played by the IMF.
Ricardo Caballero advocated in the past an insurance arrangement for emerging markets where they would pay a premium during normal times in exchange for an insurance transfer during the times of external financial turmoil that typically trigger sudden stops in these economies. To prevent a host of incentive problems, this insurance would not be a function of country-specific variables. According to him, the IMF should play a dual role of monitor (a sort of public rating agency) and as a facilitator of the insurance mechanism. The reason that such mechanism is superior to a standard reserves-accumulation strategy is that this is an insurance problem. The reserves-accumulation strategy amounts to self-insurance, and as such, it generates too much redundancy and too large a waste of scarce resources. This is even more so when a critical factor behind these crises is investors’ panic, for in that case there is really no need to hoard or inject resources at all, as long as there is a credible insurance in place.
Eswar Prasad proposes that each country pays an entry fee of between $10 –25bn dependent on economic size and an annual premium for coverage. Premiums would depend on the level of insurance a country desired and on the countries economic policies. Countries would face higher premiums if they run large budget deficits/accumulate large debts and adopt policies that drive up global risks (accumulate reserves for self-protection). The premiums would be invested in a portfolio of US, euro area and Japanese government bonds. These central banks would be obliged to top up the pools credit lines in the event of a global crisis.
Ricardo Caballero also argued a few years ago for the creation of hedging instruments contingent on factors that are (largely) not controlled by the individual country. Chile, for example, could swap its entire public and private external debt for bonds with embedded options on the price of copper (Chile’s influence on this price is not enough to hamper insurance contracts) — that is, for debt that automatically transfers resources back to the country when the price of copper falls below critical levels. These markets need to be developed. There are currently too many free-rider problems for them to emerge without a concerted effort.
John Williamson makes the case for regular SDR issues. Special Drawing Rights holdings are part of IMF members’ reserve assets a SDRs are a means for members to obtain freely usable currencies from other members. Williamson argues that the world would be a better place if a substantial portion of the demand for holding additional international liquidity were to be met by creation of more SDRs instead of exclusively by expanding reserve currency holdings, as in the recent past. By a "substantial portion" he mean perhaps half, which – to judge by the additions to reserves in the period 2002–06 – would imply SDR allocations of over $400 million per year. For Williamson, this offers the surest way of reducing the inconsistency in payments objectives that currently looks to be the biggest obstacle to a strong recovery in the global economy in the post-Lehman world.
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