Tag Archives: financial stability

The Costs of the Defragmentation of the Global Economy

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The integration of markets across borders has slowed down, and in some cases, reversed. These changes come in the wake of the global financial crisis, Donald Trump’s embrace of trade restrictions, Great Britain’s withdrawal from the European Union, the disruptions in global supply chains during the pandemic, and the invasion of Ukraine. President Biden has shown a willingness to use trade and financial restrictions in response to what he views as Chinese and Russian threats to U.S. strategic interests, and there are responses to the use of sanctions and other tools of disruption. The fallout from this rift will take years to play out.

A team of IMF economists have written a Discussion Note on Geoeconomic Fragmentation and the Future of Multilateralism. They attribute the reversal of economic integration to national considerations, such as the desire of governments to increase their domestic production capabilities in particular areas. But the authors of the Note point out that while fragmentation may achieve some goals, it also imposes costs. These include: “higher import prices, segmented markets, diminished access to technology and to both skilled and unskilled labor, and ultimately reduced productivity which may result in lower living standards.” Moreover, fragmentation will slow down joint efforts to address global issues such as climate change.

The Discussion Note summarizes the results of several studies of the loss from geoeconomic fragmentation. In all the studies they cite, the costs are greater the larger the degree of fragmentation. Among the reasons for the losses in output are reduced knowledge diffusion due to technological decoupling. Not surprisingly, low income and emerging market countries are most at risk from a separation from the latest technological developments.

Pinelopi K. Goldberg of Yale and Tristan Reed of the World Bank Group (Goldberg is former chief economist of the World Bank) examine the prospects for global trade in their recent NBER Working Paper “Is the Global Economy Deglobalizing? And if so, why? And what is next?” They find that “slowbalization” is a better description of the recent trend in international trade than “deglobalization.” Foreign direct investment and migration have exhibited relatively less slowdowns. But the authors also document changes in U.S. policies and public attitudes that represent a marked shift away from the liberalization of trade. They attribute these reversals to various factors, including the impact of imports on U.S. labor, concerns over the resilience of global supply chains, and national security considerations.

Goldberg and Reed conclude their analysis with some projections of the consequences of deglobalization. They point out that the previous regime of the last three decades led to growth and technological progress They warn that global innovation will be particularly slowed by a decoupling of the U.S. and China  Reconfiguring production supply chains will slow growth as well. These reversals and changes raise the possibility that the recent decline in global inequality will halt, with low-income countries most at risk.

Trade, of course, is not the only component of international commerce that has undergone changes in how it is organized. Chapter 4 of the IMF’s most recent World Economic Outlook analyses the geoeconomic fragmentation of FDI. The authors point to an increase in the “reshoring” and “friend-shoring” of production facilities domestically or to countries with similar political alignments. They estimate a model of the impact of geopolitical alignment on FDI flows, and find that geopolitical factors account for part of the shift in bilateral FDI to countries with governments with similar views to the home country. This could presage a shift to more FDI among advanced economies, rather than emerging markets and developing economies that may differ on political issues.

The Fund’s economists also analyzed the output costs of FDI fragmentation. They utilized different scenarios of geopolitical alignment, such as a world divided into a U.S.-centered block and a China-centered block, with India and Indonesia and Latin America and the Caribbean as nonaligned. In this scenario, the impact of smaller capital stocks and less productivity cumulate with long-term output losses of 2%. Other scenarios allow for the diversion of investment flows to some areas that could offset a decline in global economic activity. However, the chapter’s authors also warn that nonaligned nations may face pressures to choose one side over the other. They conclude from their analysis: “…a fragmented global economy is likely to be a poorer one. While there may be relative—and possibly absolute—winners from diversion, such gains are subject to substantial uncertainty.”

Other forms of capital flows are also subject to fragmentation, and the IMF’s economists examine these trends is a chapter of the latest Global Stability Report. In their analysis, geopolitical tensions can lead to instability through two channels. The first is a financial channel that could respond to increased restrictions on capital flows, greater uncertainty or conflict. The second channel is a real channel, due to disruptions in trade and technology transfers or volatile commodity markets. These two channels can reinforce each other. Restrictions in trade, for example, could discourage cross-border investments.

Geopolitical affinities affect cross-border capital allocation, and the evidence reported in the chapter indicates that recent events have reinforced this impact. The empirical analysis based on a gravity model finds that a rise in geopolitical tensions can trigger sizable portfolio and bank outflows, particularly in developing and emerging market economies. Geopolitical fragmentation can also lead to a loss in international risk diversification, thus leaving countries more vulnerable to adverse shocks and a sizable welfare loss.

All these analyses from multilateral institutions warn of the negative economic consequences arising from the decoupling of trade and financial ties. But the most threatening effects may come from the deepening division of the world into different blocs. As the dividing lines become solidified, the chances of discord extending beyond economic interactions increase. All this friction arising when climate warming already poses a clear threat to our existence only intensifies the dangers we will face.

The IMF’s Position in a Fragmented Global Economy

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Ten years ago Cambridge University Press published my book, The IMF and Global Financial crises: Phoenix Rising? I had written a series of journal papers on the IMF and used the format of a book to summarize what I had learned about the Fund. I also made some evaluations and projections about the IMF and its reputation; a decade later, how has the IMF done?

The book reviewed the history of the IMF from its founding at Bretton Woods through the global financial crisis. One of the theses of the book was that the IMF had paid a high price for its handling of the Asian financial crisis. The Fund had formulated programs for Indonesia, South Korea, and Thailand that proved to be controversial. Among the charges levied against the Fund was:

  • Condemnation for imposing harsh macro policies in the conditions of the programs;
  • Criticism for including inappropriate structural conditions;
  • Blame for indirectly precipitating the crisis through its support of capital decontrol.

In the aftermath of the Asian crisis as well as subsequent crises in Russia, Turkey and Argentina, the global economy entered a period of steady real growth and moderate inflation rates. The demand for the Fund’s assistance declined, and the IMF used the occurrence of relative stability to undertake post-mortem reviews and changes in its recommended policies. These included a retreat from its advocacy of full capital decontrol, and a reassessment of the purposes and scope of conditionality.

When the global financial crisis of 2008-09 occurred, it was an opportunity for the IMF to show that it had learned the lessons of the previous crisis and could adapt its playbook.  The IMF set up 17 Stand-By arrangements during the period of September 2008 through the following summer. The policy conditions attached to these programs were based on an understanding that the contractions in economic activity in the program countries were the result of falling international trade that followed the financial collapse in the advanced economies. Subsequent reviews of the programs found that credit was disbursed more quickly and in larger amounts than in past crises.

In addition to providing financial resources, the IMF called for a coordinated response to the crisis and the use of fiscal stimulus to offset its effects. The Fund’s economists completed its turnaround in its position on capital account regulation and acknowledged that capital controls could mitigate financial fragility. The IMF’s activist stance was acknowledged by the newly formed Group of 20, which approved an increase of the IMF’s financial resources, and called upon it to institute surveillance of their economies.

The IMF, therefore, came out of the global financial crisis with its reputation as a crisis manager restored. The whimsical subtitle of my book came from a line in Don Quixote that referred to a phoenix that rose from the ashes of a fure.  How the IMF used its reputation and handled new crises, however, could only be revealed with the passage of time.

The IMF does much more than serve as a crisis lender. The results of its surveillance of the global economy are published in reports such as the World Economic Outlook, and updates to its economic forecasts are widely reported. The IMF’s Managing Director, Kristalina Georgieva, has a high public profile, and speaks out a range of global issues. The research of its economists has grown to include work done on income inequality, gender and climate change.

The next major challenge the IMF faced was the Greek debt crisis, when it joined the “troika” of the European Central Bank and European governments in arranging a resolution. The loans extended to Greece were controversial because of the conditions the Greek government had to implment. As the crisis deepened, the IMF differed from its troika partners in advocating for debt relief. Greece eventually repaid its loans from the IMF two years earlier than planned, but in retrospect the IMF’s inclusion in the troika constrained its ability to set sustainable debt levels.

More recently, during the pandemic the IMF was active in providing financial assistance to its poorest members. Some of its funds were given through new facilities, such as the Rapid Credit Facility and the Rapid Financing Instrument, with (at most) minimal conditionality. Brad Setser of the Council of Foreign Relations pointed out that lending from the IMF and the World Bank to lower middle-income countries rose just as private credit flows fell. Setser observed:

“Such a surge made financial sense, and was a moral imperative as well. The Bank and the IMF, and thus President Malpass and Managing Director Kristalina Georgieva, deserve credit for making it a reality. The system, in a sense, worked. Low income countries had to struggle through the pandemic, but they didn’t lose access to new financing at the same time.”

But not all agree that such lending by the IMF is consistent with its core missions. Kenneth Rogoff of Harvard, who was chief economist at the IMF from 2002 to 2003, points out that the Fund, unlike the World Bank, is not an aid agency. It uses conditionality in part to ensure that it is repaid so that it can continue to lend.  He also argues that “forceful IMF conditionality is essential to establish financial stability and ensure that its resources do not end up financing capital flight, repayments to foreign creditors, or domestic corruption.”

More recently the IMF has become involved with a number of developing nations that can not meet their debt obligations, including Egypt, Sri Lanka and Pakistan. According to The Economist, this work is likely to escalate:

“Debt loads across poorer countries stand at the highest levels in decades. Squeezed by the high cost of food and energy, a slowing global economy and a sharp increase in interest rates around the world, emerging economies are entering an era of intense macroeconomic pain… All told, 53 countries look most vulnerable: they either are judged by the imf to have unsustainable debts (or to be at high risk of having them); have defaulted on some debts already; or have bonds trading at distressed levels.”                                                 The Economist, 7/20/2022

The Fund recently published a Staff Discussion Note on “Geoeconomic Fragmentation and the Future of Multilateralism.” The authors of the Note point out that the pace of globalization slowed notably after the global financial crisis, and geopolitical tensions have led to a reversal of economic integration. They examine the consequences of fragmentation on international trade, the diffusion of technology and the international monetary system.

Could the IMF be replaced? It is difficult to imagine how a new global organization could be organized. On the other hand, regional blocs may become more widespread. For example, the IMF’s Note on fragmentation notes that global liquidity has four sources: central bank reserves, bilateral swap agreements, regional financial arrangements, and the IMF. Bilateral swap lines and regional arrangements have grown rapidly, leaving  the Fund as the only provider of universal coverage. Further growth of regional arrangements based on geopolitical blocs would increase their coverage, but it would be uneven across blocks and could be inadequate to deal with large shocks.

I argued in my book that it is crucial to remember that the IMF is an agent for its 190 principals. Its ability to address global challenges depends on the willingness of the sovereign members to use the IMF to organize responses to the challenges. A world that is divided by U.S.-China frictions gives the IMF limited scope to play the role it seeks to have.

The 2022 Globie: Money and Empire

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Every year we name a book the “Globalization Book of the Year” (aka the “Globie”). The prize is (alas!) strictly honorific and does not come with a monetary award. But announcing the award gives me a chance to draw attention to a recent book—or books—that are particularly insightful about globalization. Previous winners are listed at the bottom of the column (also see here and here).

This year’s recipient is Money and Empire: Charles P. Kindleberger and the Dollar System by Perry Mehrling, Professor of International Political Economy at the Pardee School of Global Studies of Boston University. The book is an intellectual biography of Charles Kindleberger, who came to MIT in 1948 after having served at the U.S. Treasury, the Federal Reserve Board, the Bank of International Settlements and the U.S. Department of State. He was the author of a number of articles and books on international macroeconomics and economic history that have retained their relevance long after their initial publication date. In his work he often focused on the policies needed to achieve international stability in a world of different national currencies and policies. He had a insightful perspective on the circumstances that led to the Great Depression, and what needed to be done to avoid a repeat of that catastrophic occurrence.

Among the topics that Mehrling covers is the evolution of Kindleberger’s views on the global economic role of the dollar. The dollar became the international reserve currency under the Bretton Woods regime, which was designed to avoid a repeat of the relative chaos of the 1930s. Foreign central banks held dollars to stabilize the value of their currencies, while the U.S. stood ready to exchange these dollars for gold. What had been a dollar shortage in the period after World War II became a dollar glut in the 1950s and 1960s, however, and the stability of the link to gold was questioned by Robert Triffin and others.

Kindleberger, on the other hand, believed that the dollar was serving an important international function as a key currency, as the pound had done in the pre-WWI ear. The responsibility of the U.S. was to set monetary policies that took account of the state of the world economy. In 1966, he joined with Walter Salant and Emile Despres in writing an article for The Economist, “The Dollar and World Liquidity: A Minority View,”  which advanced the view that the U.S. served as the “world’s banker,” i.e., as a financial intermediary with respect to Europe that issued short-term deposits and invested long-term capital around the world. The result was an unplanned but functional international monetary system. In that perspective, gold was an unnecessary distraction.

The debate over the architecture of the international monetary system seemed to end when Richard Nixon terminated the exchange of gold for dollars in 1971. The U.S. and the European nations also began the transition away from fixed exchange rate regimes, although the Europeans would move to their own “fixed currency” with the euro. But the dollar did not recede into the mix of the international monies. The end of Bretton Woods also meant the end of the acceptance of capital controls, and capital began to flow more freely, first among the advanced economies and then to the emerging market nations. Private capital flows rose in importance in financing corporate and government debt, and in the cases of external finance these debt instruments (particularly of emerging market economies) were denominated in dollars.

By the 2000s the existence of a “global financial cycle”, based on U.S. monetary policy, became widely accepted. The dollar was indeed the international currency, although this was decided by private markets as much as governmental decrees. Pierre-Olivier Gourinchas of UC-Berkeley and Hélène Rey  of the London Business School, in explaining the central role of the U.S., updated the 1966 title given to the dollar by Kindleberger and his associates to the world’s “venture capitalist.”

One of Kindleberger’s most well known contributions came from his analysis of the Great Depression. Previous work usually placed the blame on the outbreak and/or duration of the crisis to misguided national policies. Kindleberger realized that there was an international dimension: the lack of a country that acted as a leader in providing the international public goods needed for stability. These included maintaining an open market for distress goods, providing long-term lending and overseeing a stable system of exchange rates, ensuring the coordination of macro policies among nations and acting as a lender of last resort. In the 1930s Britain was no longer able to act as the global leader, while the U.S. was not willing to accept that roel. Kindleberger’s insight became the basis of a body of work known as “hegemonic stability,” one of the tenets of international political economy.

Kindleberger offered yet another perspective on financial instability in his Manias, Panics and Crashes. As the title implies, the book is an account of financial crises dating back over time and their common elements. The book was first published in 1978. Robert Aliber took over the job of updating the book after Kindleberger’s death, and the latest edition (the eighth) has Robert N. McCauley as the newest co-author.

 In the book Kindleberger extended Hyman Minsky’s model of financial instability, which was a domestic model, to include an international dimension. Minsky had proposed that credit expansion and contraction followed a cycle of initial displacement, boom, euphoria, profit taking, and panic. In a global context, this cycle can be amplified by short-term international capital flows, that increase the amount of credit that is available during the early stages of the cycle. But the money is rapidly withdrawn by foreign investors when doubts arise about the solvency of the projects they have financed. The withdrawal of foreign capital exacerbates the instability of the last stages of the cycle. Kindleberger’s adaptation of Minsky’s work proved to be remarkably prescient during the emerging market economies’ crises of the 1990s, such as the Asian crisis, as well as the global financial crisis.

Mehrling, therefore, has done a valuable service in explaining Kindleberger’s contributions to our understanding of the global economy. Because his analyses were not based on mathematical models or econometric testing, Kindleberger did not receive the same degree of respect as did his colleagues at MIT and elsewhere who used these tools. But the passing of time demonstrates that Kindleberger possessed a keen understanding of how capital and credit flows functioned, and the need for some form of governmental oversight. Any lack of attention to this work at the time when Kindleberger was active tells us more about the blindfolds of economics than it does about Charles Kindlberger.

“Globies”

2016    Branko Milanovic        Global Inequality

2017    Stephen D. King          Grave New World: The End of Globalization, The Return of History

2018    Adam Tooze                Crashed: How a Decade of Financial Crises Changed the World

2019    Branko Milanovic        Capitalism, Alone

2020    Tim Lee, Jamie Lee      The Rise of Carry

             and Kevin Coldiron

2021    Anthony Elson             The Global Currency Power of the Dollar

             Jeff Garten                  Three Days at Camp David

The Restructuring of Sovereign Debt

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The economic repercussions of Russia’s invasion of Ukraine will be devastating for many countries that have yet to recover from the pandemic. Higher prices for commodities, particularly energy and food, will increase inflation rates and widen trade deficits for those nations that import those items. Increases in interest rates will raise the cost of debt financing and hamper the ability of borrowers to meet their obligations or refinance existing debt.

Carmen Reinhart, Chief Economist of the World Bank, warned that the pandemic had exacerbated existing financial weaknesses in her Mundell-Fleming Lecture, “From Health Crisis to Financial Distress,” which has been published in the IMF Economic Review. She points out that economic and financial crises, including banking, currency, debt, etc., often occur together. The resulting “conglomerate crisis” can lead to a severe economic downturn. She warns that initial attempts to arrange a “shallow” restructuring of sovereign debt that does not reduce the intertemporal value of the debt may be followed by one or more subsequent restructurings, exacerbating the impact of the crisis.

Governments that need to restructure debt may be able to lessen the resulting impact if they act early. Tamon Asonuma, Marcos Chamon, Aitor Erce and Akira Sasahara have examined the consequences of debt restructurings in an IMF Working Paper, “Costs of Sovereign Defaults: Restructuring Strategies, Bank Distress and the Capital Inflow-Credit Channel.” The authors looked at 179 restructurings of the sovereign debt held by private holders over the period of 1978-2010. They divided the sample into three categories: “strictly preemptive,” where no payments were missed; “weakly preemptive,” where some payments were missed but only temporarily and only after the start of negotiations with creditors; and “post-default,” which occurred when payments were missed and without agreement with the creditors.

They reported that banking crises and severe declines of credit and net capital inflow occurred more frequently following post-default restructurings. They also found that contractions of GDP and investment spending were substantial in post-default restructurings, less severe in weakly preemptive restructurings and did not occur in the case of strictly preemptive cases. Private credit and capital inflows remained below the pre-crisis levels and interest rates rose after post-default restructurings. Their results indicate that governments that can restructure without missing payments will avoid some of the costs associated with restructurings. The authors acknowledge that large shocks can force a halt in payments, but even in those cases collaboration with creditors is more advantageous than unilateral actions.

The IMF reviewed the institutional mechanisms that address sovereign debt restructurings in 2020 policy paper, The International Architecture for Resolving Sovereign Debt Involving Private-Sector Creditors—Recent Developments, Challenges, And Reform Options. The review found that recent restructurings of sovereign debt had been much smoother than those in previous periods. It attributed this change to several factors, including the increased use of collective action clauses which allow a majority of the creditors to override a minority that oppose a restructuring. The paper’s authors called for more contractual reforms as well as an increase in debt transparency, and also recommended that the international financial institutions support debt restructurings financially when appropriate. But the report  warned that the pandemic could engender a widespread crisis that could overwhelm existing procedures:

“Should a COVID-related systemic sovereign debt crisis requiring multiple deep restructurings materialize, the current resolution toolkit may not be adequate in addressing the crisis effectively and additional instruments may need to be activated at short notice.”

The IMF sought to establish new instruments in 2020 when it joined the Group of 20 nations to create an institutional mechanism for low-income countries with unsustainable debt loads called the “Common Framework” (see here). The initiative sought to bring together official creditors, including the traditional lenders such as the U.S. and France, with more recent lenders, such as China and India, to coordinate debt relief efforts. Private creditors were to use comparable terms in their negotiations.

But the Framework has not been widely adopted because of reluctance by some lenders and borrowers. Chinese lending has been funneled through several institutions, and they are not always willing to join other creditors. The governments of the nations with the debt loads have been reluctant to signal that they may need relief, in part because of a negative signaling effect. The IMF has called for reorganizing and expanding the Common Framework.

A wave of restructuring may be triggered by a Russian default on its dollar-denominated bonds. The credit rating agencies have downgraded the Russian bonds to junk bond status (“C” in the case of Fitch’s rating). President Putin has stated that the bond payments will be paid in rubles, but the Russian currency has lost its international value. A default would hasten the collapse of the Russian economy. It would also lead to a reassessment of the solvency of other governments and their ability to fulfill their debt obligations. Foreign bondholders could decide to cut their losses by selling the bonds of the emerging markets and developing economies. A wave of such selling that occurs at the same time as the Federal Reserve raises interest rates will almost certainly lead to a new debt crisis for many countries. The IMF and World Bank will be hard-pressed to coordinate relief efforts across so many borrowers and lenders.

2020 “Globie”: The Carry Trade

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It is time to announce the recipient of this year’s “Globie”, i.e., the Globalization Book of the Year. The award gives me a chance to draw attention to a book that is particularly insightful about some aspect of globalization. This year’s winner is The Rise of Carry: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Decaying Growth and Recurring Crisis by Tim Lee, Jamie Lee and Kevin Coldiron. The prize lacks any monetary reward, but no doubt the distinction of having won has value in itself. Previous winners are listed at the bottom.

The classic carry trade involves borrowing and investing in different currencies. For many years the Japanese yen served as the source of cheap loans that could then be exchanged for Australian dollars that yielded a higher return. At the end of the period the dollars would be exchanged for yen, and the loan repaid. As long as the funding currency had not appreciated in value, the trader would profit from the difference in returns. A profitable carry trade, however, violates uncovered interest rate parity, which stipulates that any difference in returns should be offset by an expected appreciation of the funding currency. At times the currencies would realign, and purchasing the originating currency to repay the loan could eliminate any previous gains.

The authors extend the concept of carry trades to include all those transactions that provide a stream of income but are subject to the risk of “…a sudden loss when a particular event occurs or when underlying asset values change substantially.”  Since carry transactions are based on borrowing, leverage is a key component. Buying stock on margin, for example, is another form of carry trade, as is a private equity leveraged buyout.

The trader benefits only as long as asset prices remain close to their current levels. Volatility can wipe out a position, and the financial losses can spill over to the economy. Those negative consequences bring central banks into the financial markets. Their intervention may reestablish stability, but it allows those who would have suffered a loss to transfer that loss to the public sector. Central bankers acting as lenders of last resort, the authors write, “…underwrite some of the losses associated with carry. This encourages further growth of carry, and a self-reinforcing cycle develops.”

The authors investigate the spread of carry trade and its broad scope, including the transformation of global financial markets. Firms in emerging markets use capital markets to obtain finance from cheaper foreign sources. Changes in the VIX measure of volatility have international reverberations and engender global financial cycles.The Federal Reserve’s use of swap facilities to help their counterparts in other countries assist domestic institutions that face a dollar liquidity squeeze demonstrates that carry crashes require global responses.

The authors also claim that the carry trade increases income and wealth inequality, as only those with sufficient assets engage in carry and profit from central bank intervention.  The continuing returns from these transactions flow to those who know how the system works and how to exploit it. These rewards act as an incentive to draw more people to finance, contributing to the growth of the financial sector.

The book was written before the events of this year, but the analysis is very relevant. In March, financial markets crashed as the global extent of the pandemic became evident. Stock prices plunged and foreign capital fled emerging markets. This outbreak of volatility engendered a massive response by the Federal Reserve that dwarfed their actions in the 2008-09 crisis (see here and here for overviews of central bank policies). The markets responded by regaining lost ground, and the Standard & Poor’s 500 has set new highs.

After the latest meeting of the Federal Open Market Committee, the Federal Reserve reiterated its pledge to keep  the target range for the Federal Funds Rate at 0 to ¼% “…until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.” The Fed’s commitment to low interest rates provides an incentive for more carry trade activities, and these are appearing. Special Purpose Acquisition Company (SPACS), for example, are pools of money that are established to purchase privately-held firms and take them public, profiting from the IPO price. The SPACS investors do not know which company will be acquired or when, and they may not realize a return for years. But they are providing liquidity, and at minimal cost due to the Federal Reserve’s interest rate policy.

Lee, Lee and Coldiron convincingly demonstrate that the carry trade has contributed to the financialization of the economy, which has grave and disturbing implications. As the subtitle of the book indicates, the suppression of volatility leads to lower growth and recurring crises. When a vaccine for the coronavirus is available, there will undoubtedly be a burst of financial activity that will prepare the way for the next crisis. We will not be able to say that we were never warned.

An interview with the authors is available on the podcast Hidden Forces.

2019    Branko Milanovic, Capitalism Alone: the Future of the System That Rules the World

2018    Adam Tooze,  Crashed: How a Decade of Financial Crises Changed the World

2017    Stephen D. King, Grave New World: The End of Globalization, the Return of History

2016    Branko Milanovic, Global Inequality

2015    Benjamin J. Cohen. Currency Power: Understanding Monetary Rivalry

The Guardians of the Financial Galaxy

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The rapid expansion of the pandemic and the ensuing economic and financial collapses brought about responses by policymakers, including actions undertaken on an international basis. The Federal Reserve acted together with other central banks to ensure that an adequate supply of dollars was available to support dollar-based financing outside the U.S. Similarly, the IMF moved rapidly to provide financial support to its members. These national and international institutions constitute a “two tier” system in international finance that occupies the role of lender of last resort.

International cooperation has occurred before, and Michael Bordo of Rutgers University gives an account of these efforts in a new NBER working paper, “Monetary Policy Coordination an Global Financial Crises in Historical Perspective.” During the Bretton Woods era, central banks cooperated to sustain the fixed exchange rate system. In 1962, the U.S. established bilateral currency swaps with foreign central banks, which provided dollars to be used in support of their exchange rates.

The swaps continued in the 1970s after the termination of the Bretton Woods regime as policymakers sought to control the volatility of exchange rates. During the early and mid-1980s there were episodes of coordination of foreign exchange market intervention by central banks as governments in the advanced economies sought to stabilize the value of the dollar. But these occurred less frequently in the late 1980s as inflation fell in most of these countries and foreign exchange market intervention became less common.

The outbreak of crises in emerging markets in the 1990s required a joint response, and the IMF took on the role of crisis manager. During the Asian crisis of 1997-98, for example, the Fund provided credit to the governments of the countries in crisis. Their programs included conditions that required included cutbacks in government spending and credit creation, and frequently a currency devaluation. However, the IMF’s policies came under immediate criticism as inappropriate and overly severe. These were not crises based on excessive government spending, but rather financial collapses. The IMF paid a high price in its reputation for its handling of the Asian crisis, but learned a valuable lesson: financial instability can impose a serious cost.

The financial crisis of 2007-09 provided another major challenge to global financial stability and the need for a coordinated response. Banks in Europe and Japan had borrowed dollars to acquire dollar-denominated assets, such as mortgage-based securities. Their access to dollar funding was threatened as the interbank markets for dollars came under strain. In December of 2007, the Federal Reserve announced that it was establishing swap lines with the European Central Bank and the Swiss National Bank. At the crisis escalated in 2008, the Federal Reserve set up similar arrangements with the central banks of Australia, Canada, Denmark, England, Japan, New Zealand, Norway, and Sweden. It also arranged swap arrangements with the central banks of Brazil, Mexico, Korea and Singapore, emerging market economies with substantial exposure to dollar-based financing. The Federal Reserve and the foreign central banks exchanged currencies, and the foreign central banks lent the dollars to its domestic banks that needed them. At the conclusion of the swap period, the currency exchanges were reversed using the same exchange rate, and the central banks would pay the Fed a fee based on what it had charged their own banks.

These arrangements differed from previous efforts in that they were designed to address financial instability, not exchange rate values. The dollar had become the primary global funding currency, so a decrease in dollar liquidity would have had widespread effects. The joint activities of the Federal Reserve and its partner central banks were successful in bringing down the cost of dollar lending in the foreign markets and avoiding the collapse of foreign institutions with dollar liabilities.

The IMF was also active during the crisis. Not all central banks were able to exchange currencies with the Federal Reserve, and the IMF served as an alternative source of financing. During the period from September 2008 through the following summer, the IMF instituted 17 Stand-By Arrangements. The economic policies that were part of these programs reflected an awareness of the origin and severity of the global downturn. Credit was disbursed more quickly and in larger amounts than had occurred in the past and there were fewer conditions attached to the programs. Consequently, the IMF’s record during the great recession was very different from that of the Asian financial crisis.

During the current crisis, central banks and the IMF have built upon and expanded the policies they undertook in 2008-09. Once again, global dollar financing came under strain. In March the Federal Reserve renewed or set up swap facilities with the central banks of 14 countries. In addition, it established a repurchase facility for foreign and international monetary authorities (FIMA) that would allow them to temporarily exchange their holdings of U.S. Treasury securities for dollars.

These efforts were successful in preventing a collapse of dollar financing. Nicola Cetorelli, Linda S. Goldberg and Fabiola Ravazzolo of the Federal Reserve Bank of New York investigated the impact of the Federal Reserve’s facilities by comparing the foreign exchange swap basis spreads of currencies covered by the agreements with those on other currencies. They found that  ”… the swap lines have been an important factor helping to improve market conditions and expand access to dollar liquidity during the period of peak strains in global U.S. dollar funding markets.” They added that the Federal Reserve was engaging in a wide range of other actions that could also have impacted this market.

The central banks that obtained the dollars were able to use them to support banks that provided dollars to other parties in their countries. For example, Gianluca Persi of the European Central Bank showed that the Eurosystems’s use of the swap lines”…not only helped banks to satisfy their immediate U.S. dollar funding needs but also supported market activity.” He concludes that “The swap lines between central banks therefore helped to mitigate the effects of the strains in the U.S. dollar funding market.”

The IMF has also been active in meeting the needs of its members. The IMF has used its rapid financial assistance programs (Rapid Financing Instrument, Rapid Credit Facility) to make loans to 76 countries. These loans do not require full programs or reviews, and carry little conditionality. The IMF is also adjusting existing programs to meet the need for health-related expenditures.

The IMF is making special efforts for its low-income members. It is providing grants to its poorest members to cover the IMF debt obligations. In March the IMF and World Bank called on official bilateral creditors to suspend debt service payments from low-income countries. The Group of 20 governments responded by agreeing to suspend repayment of official bilateral credit from these nations until the end of 2020. The IMF, the World Bank and the G20 also called for private sector creditors to participate in similar debt relief on comparable terms.

IMF Managing Director Kristalina Georgieva at the opening of this spring’s meeting pledged to use the Fund’s  $1 trillion lending capacity to support its members. She also urged governments to be active in addressing the needs of their citizens. In a speech at the London School of Economics on October 6, she pointed out that “flexible and forward-leaning fiscal policy will be critical for the recovery to take hold.” She also called for measures to deal with the debt of low-income countries, including “access to more grants, concessional credit and debt relief, combined with better debt management and transparency.”

A division of labor, therefore, has evolved between the Federal Reserve and the IMF during periods of widespread instability. The Federal Reserve provides dollars to other central banks in upper-income countries and selected emerging market economies to preserve stability in the global financial markets. Since the Federal Reserve lends to central banks, there is little concern about insolvency. In many ways it assumes the traditional role of lender of last resort as conceived by Bagehot and other nineteenth century economists.

In normal times the IMF lends to governments in middle- and low-income countries with balance of payments crises and possible insolvency. The Fund disburses credit in programs that operate over a time horizon at least a year and sometimes longer. However, during the global financial crisis and now the current crisis, the IMF ramps up its lending. It provides credit quickly at little if any cost, and its programs seek to stabilize economic activity. Moreover, the IMF takes public positions to advocate fiscal stimulus and debt relief.

Stanley Fischer, who served as First Deputy Managing Director of the IMF from 1994 to 2001, saw the need for an international lender of last resort for countries facing an external financial crisis, and claimed that the IMF had played that role in the 1980s and 1990s. In subsequent years it became clear that central bankers in advanced economies preferred to deal with each other and organize their own programs. There have been periodic calls for the IMF to become more involved in swap networks, but the central banks have shown no interest in involving the IMF in their networks. The two-tier system functioned relatively well in 2008-09 and to date has stabilized financial markets. But the number of coronavirus cases are surging, and there are concerns about another recession in the U.S. and Europe. The current system to back stop financial markets and institutions will be tested in new ways that may show its limitations.

Capital Flows in a World of Low Interest Rates

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Interest rates in advanced economies continue to persist at historically low levels. This trend is due not only to the response of central banks to slow growth, but also fundamental factors. If these interest rates continue close to their current levels, what are the consequences for international capital flows?

The decline in rates in the advanced economies has been widely documented and studied. Lukasz Rachel and Thomas D. Smith of the Bank of England have investigated the determinants of the fall in global real interest rates. They attribute the decline in part to increased savings due to demographic forces, higher inequality and a glut of precautionary savings in emerging markets. Investment spending, which has fallen due to the falling price of capital and lower public investment, also contributes to low interest rates. Most of these factors, they claim, will continue to prevail.

Lukasz Rachel and Larry Summers of Harvard have also looked at falling real rates in the advanced economies, which they attribute to secular stagnation. They point out that since the current rates reflect higher levels of government debt, the interest rate that we would observe if there was only a private sector would be even lower. They urge policymakers to tolerate fiscal deficits and also to engage in policies to increase private investment.

The low rates have been an incentive to potential borrowers, and consequently debt levels have risen. The IMF has updated its Global Debt Database,  which includes private and public debt for 190 countries dating back to the 1950s. The data show that the three currently most indebted countries are China, Japan and the U.S., accounting for more than half of global debt. The increase in the debt of China and other emerging markets is due to increases in private debt. Corporate borrowing in these countries has soared, and much of it is denominated in dollars. Public debt has risen in the advanced economies, and more recently in the emerging market and low-income countries as well.

Last spring IMF Managing Director Christine Lagarde warned of unsustainable debt burdens in some of the low income countries. In recent years, the borrowers have included governments with relatively low risk ratings that may fall lower. In some cases, the increased debt reflects loans from China that are part of that country’s Belt and Road Initiative. IMF officials are concerned that some of these countries will turn to the IMF for assistance of they cannot meet their debt obligations.

The Federal Reserve has indicated that it will not raise its policy rates in the near future.  Consequently, the incentive to search for yield will continue to contribute to the pro-cyclical nature of capital flows in the emerging markets. But the current situation is sustainable for only as long as the existing environment continues.

Martin Wolf of the Financial Times has warned that it is only a matter of time until the next financial crisis erupts. He cites four factors that contribute to the outbreak of such crises. First, over time risk moves out of the most regulated parts of the economy to the least regulated. This makes it more difficult for regulators to assess the fragility of the financial sector. Second, an ideological belief that unregulated markets work best contributes to the proliferation of risky lending. Third, the financial sector is a major contributor to election campaigns. This gives them access to lawmakers who are drafting the laws that govern the operations of the financial sector. Finally, there is the human tendency to forget or ignore past events. This allows the financial sector to engage in risky but profitable activities that enrich those conducting them while the public enjoys access to relatively cheap credit.

Continuing low interest rates, therefore, may alleviate some of the pressure on those borrowers with high debt loads. But they are susceptible to other shocks such as slowing economic growth or the breakdown of trade negotiations between the U.S. and China. If such a shock occurs, we may once again witness a flight to safety that leaves borrowers in emerging markets vulnerable to “sudden stops” of capital that, combined with depreciating exchange rates, will disrupt their economies.

 

 

Global Networks and Financial Instability

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The ten-year anniversary of the global financial crisis has brought a range of analyses of the current stability of the financial system (see, for example, here). Most agree that the banking sector is more robust now due to increased capital, less leverage, more prudent balance sheets and better regulation. But systemic risk is an inherent feature of finance, and a disturbance in one area can quickly spread to others through global networks.

The growth of financial markets and institutions during the 1990s and 2000s benefitted many, including those in emerging market economies that became integrated with world markets during this period. But the large-scale extension of credit to the housing sector led to property bubbles in the U.S., as well as in Ireland and Spain. The development of financial instruments such as mortgage backed securities (MBS), collateralized debt obligations (CDOs), and credit default swaps (CDS) were supposed to spread the risk of lenders in order to mitigate the impact of a negative price shock. However, these instruments and the extension of credit to subprime borrowers increased the vulnerability of financial institutions to reversals in the housing markets. Risk increased in a non-linear fashion as balance sheets became highly leveraged, and national regulators simply did not understand the nature and scale of these risks.

The holdings of assets across borders amplified the impact of the disruption of the U.S. financial markets once housing prices fell. European banks that had borrowed dollars in order to participate in the U.S. MBS markets found themselves exposed when dollar funding was no longer available. The gross flows of money between the U.S. and Europe increased the ties between their institutions and increased the fragility of their financial markets. It took the the establishment of swap networks between the Federal Reserve and European central banks to provide the necessary dollar funding.

John Kay has written about the inability to recognize and minimize systemic risk in financial systems in Other People’s Money: The Real Business of Finance. He draws from engineers the lesson that “…stability and resilience requires conscious and systematic simplification, modularity, which enables failures to be contained, and redundancy, which allows failed elements to be by-passed. None of these features—simplification, modularity, redundancy—characterized the financial system as is had developed in 2008.”

Similarly, Ian Goldin of Oxford University and Chris Kutarna examined the impact of rising financial complexity on the stability of financial systems in the period leading up to the crisis: “Cumulative connective and developmental forces produced a global financial system that was suddenly far bigger and more complex than just a decade before. This made the new hazards harder to see and simultaneously spread the dangers more widely—to workers, pensioners, and companies worldwide.”

Goldin and Mike Marithasan of KU Leuven also looked at the impact of increasing complexity on financial systems in The Butterfly Defect: How Globalization Creates Systemic Risks, and What to Do About It. They use Iceland as an example of how complex financial relationships were constructed with virtually no understanding of the consequences if they unraveled. They draw several lessons for dealing with a more complex financial networks. These include global oversight by regulators using systemic analysis, and the use of simple rules such as leverage ratios rather than complex regulations.

The Basel III regulatory regime follows this advice in a number of areas. But the basic vulnerability of financial networks remains. Yevgeniya Korniyenko, Manasa Patnam, Rita Maria del Rio-Chanon and Mason A. Porter have analyzed the interconnectedness of the global financial system in an IMF working paper, “Evolution of the Global Financial Network and Contagion: A New Approach.” They use a multilayer network framework with data on foreign direct investment, portfolio equity and debt and bank loans over the period 2008-15 to analyze the global financial network.

The authors compare the networks for the years 2009 and 2015, and report which countries are systematically important in the networks. They find that the U.S. and the U.K. appear at the top of these rankings in both of the selected years, although the cross-border holdings of U.S. financial institutions has increased over time while those of the U.K.’s institutions fell. China has moved up in the rankings, as have other Asian countries such as Singapore and South Korea. The authors conclude that “The global financial network remains most susceptible to shocks coming from large central countries…and countries with large financial systems (namely, the USA and the UK)…”

A decade after the global crisis, the possibility of the rapid propagation of a financial shock remains. There is more resiliency in those parts of the financial system that failed in 2008, but the current most vulnerable areas may not be identified until there is a new crisis. Policymakers who ignore this reality will be tripped up when the next shock occurs, and they will learn that  “The past is not dead. It’s not even past.”

A Guide to the (Financial) Universe: Part III

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Parts I and II of this Guide appear here and here.

4.      Stability and Growth

Is the global financial system safer a decade after the last crisis? The response to the crisis by central banks, regulatory agencies and international financial institutions has increased the resiliency of the system and lowered the chances of a repetition. Banks have deleveraged and possess larger capital bases. The replacement of debt by equity financing should provide a more stable source of finance.

Indicators of financial volatility, such as the St. Louis Fed Financial Stress Index, currently show no signs of sudden shifts in market conditions. The credit-to-GDP gap, developed by the Bank of International Settlements (BIS) as an early warning indicator of systemic banking crises, exhibits little evidence of excessive credit booms. One exception is China, although its gap has come down.

But increases in U.S. interest rates combined with an appreciating dollar could change these conditions. Since the financial crisis, financial flows have appeared to be driven in part by a global financial cycle that is governed by U.S. interest rates as well as asset market volatility. This has led Hélène Rey of the London Business School to claim that the Mundell-Fleming trilemma has been replaced by a dilemma, where the only choice policymakers face is whether or not they should use capital controls to preserve monetary control. Eugenio Cerutti of the IMF, Stijn Claessens of the BIS and Andrew Rose of UC-Berkeley, on the other hand ,have offered evidence that the empirical importance of any such cycle is limited. Moreover, Michael W. Klein of Tufts University and Jay C. Shambaugh of George Washington University in one study and Joshua Aizenman of the University of Southern California, Menzie Chinn of the University of Wisconsin and Hiro Ito of Portland State University in another have found that flexible exchange rates can affect the sensitivity of an economy to foreign policy changes and afford some degree of policy autonomy.

A rise in U.S. rates, however, will increase the cost of borrowing in dollars. The volume of credit flows denominated in dollars reflects the continuing predominance of the dollar in international financial markets. Dollar-denominated credit to emerging market economies, for example, rose by 10% in 2017, driven primarily by a rise in the issuance of debt securities. Higher interest rates, a depreciating currency and a deteriorating international trade environment can quickly downgrade the creditworthiness of emerging market borrowers.

Other potential sources of stress remain. One of these is the lack of adequate “safe assets,” which serve as collateral for lending. U.S. Treasury bonds are utilized for this purpose, but in the run-up to the global crisis mortgage-based securities (MBS) with the highest ratings also served that function. Their disappearance leaves a need for other privately-provided safe assets, or alternatives issued by the international public agencies. Moreover, doubts about U.S. fiscal solvency could lead to doubts about the creditworthiness of the U.S. government securities.

Claudio Borio of the BIS perceives another flaw in the international monetary system: “excess financial elasticity” that contributes to financial imbalances. The procyclicality of finance is heightened during boom periods by capital inflows, and the spread of easy monetary conditions in core countries to the rest of the world is facilitated through monetary regimes. The impact of the regimes includes the decision of policymakers to resist currency appreciation which affects their interest rates, and the role of dominant currencies such as the dollar. Borio calls for greater international cooperation to mitigate the volatility of the financial cycle.

Dirk Schoenmaker of the Duisenberg School of Finance and VU University Amsterdam has drawn attention to a fundamental tension within the international system. He suggests that there is a financial trilemma, with only two of these three characteristics of a financial system as feasible: International financial integration, national financial policies and financial stability. A nation that wants to enjoy the benefits of cross-border capital flows needs to coordinate its regulatory activities with those of other countries. Otherwise, banks and other institutions will take advantage of discrepancies across borders in the rules governing their activities to find the least onerous regulations and greatest room for expansion.

These concerns about stability could be accepted if financial development had a positive impact on economic growth. But Boris Cournède, Oliver Denk and Peter Hoeller of the OECD,  in a review of the literature on the relationship of the financial sector and economic growth, report that above a threshold of financial development the linkage with growth is negative (see also here). Their results indicate that this reversal occurs when the financial expansion is based on credit rather than equity markets. Similarly, Stephen G. Cecchetti and Enisse Kharroubi of the BIS (see also here) report that financial development can lower productivity growth.

In addition, it has long been acknowledged that there is little evidence linking international financial flows to growth (see, for example, the summary of this work by Maurice Obstfeld of the IMF (and formerly of UC-Berkeley)).  More recently, Joshua Aizenman of the University of Southern California, Yothin Jinjarik of the University of Wellington and Donghyun Park of the Asian Development Bank have shown that the relationship of capital flows and growth depends on the form of capital. FDI flows possess a robust relationship with growth, while the linkage with other equity is smaller and less stable. The impact of FDI may depend on the development of the domestic financial sector. Debt flows in normal times do not reinforce growth, but can contribute to the probability of a financial crisis.

The impact of international financial flows on income inequality is also a subject of concern. Davide Furceri and Prakash Loungani of the IMF found that capital account liberalization reforms increase inequality and reduce the labor share of income. Furceri, Loungani and Jonathan Ostry also report that policies to promote financial globalization have led on average to limited output gains while contributing to significant increases in inequality. Distributional effects are more pronounced in those countries with low financial depth and inclusion, and where liberalization is followed by a crisis. A similar result was reported by Silke Bumann of the Max Planck Institute for Evolutionary Biology and Robert Lensink of the University of Groningen.

The change in the international financial system that may be the least understood is the evolution of FDI, which has grown in recent decades while the use of bank credit has fallen. FDI flows are increasingly routed thought countries such as Luxembourg and Ireland for the purpose of tax minimization. Moreover, the profits generated by foreign subsidiaries can be reinvested and form the basis of further FDI. Quyen T. K. Nguyen of the University of Reading asserts that such financing may be particularly important for operations in emerging market economies where domestic finance is limited. FDI flows also include intra-firm financing, a form of debt, and therefore FDI may be more risky than commonly understood.

5.     Conclusions

As a result of the substantial capital flows of the 1990s and early 2000s, the scope of financial markets and institutions now transcends national borders, and this expansion is likely to continue. While financial openness as measured by external assets and liabilities has not risen since the global crisis, this measurement is misleading. Emerging market economies with growing GDPs but less financial openness are becoming a larger component of the global aggregate. But financial openness and GDP per capita are correlated, and the populations of those countries will engage in more financial activity as their incomes increase.

A stable international financial system that promotes inclusive growth is a global public good. Global public goods face the same challenge as domestic public goods, i.e., a failure of markets to provide them. In the case of a global public good, the failure is compounded by the lack of an incentive for any one government to supply it.

The central banks of the advanced economies did coordinate their activities during the crisis, and since then international financial regulation has responded to the growth of global systematically important banks. But the growth of multinational firms that manage global supply chains and international financial institutions that move funds across borders poses a continuing challenge to stability. In addition, while the United Kingdom and the U.S. served as a financial hegemons in the past, today we have nations with small economies but extremely large financial sectors that reroute financial flows across border, and their activities are often opaque.

The global financial crisis demonstrates how little was understood of the fragility of the financial system that had built up around mortgage-backed securities. Regulators need to understand and monitor the assets and liabilities that have replaced them if they are not to be caught by surprise by the outcome of the next round of financial engineering. If “eternal vigilance is the price of liberty,” it is also a necessary condition for a stable financial universe.

Trilemmas and Financial Instability

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Whether or not the international monetary trilemma (the choice facing policymakers among monetary autonomy, capital mobility and a fixed exchange rate) allows policymakers the scope for policy autonomy has been the subject of a number of recent analyses (see here for a summary). Hélène Rey of the London Business School has claimed that the global financial cycle constrains the ability of policymakers to affect domestic conditions regardless of the exchange rate regime. Michael Klein of the Fletcher School at Tufts and Jay Shambaugh of George Washington University, on the other hand, have found that exchange rate flexibility does provide a degree of monetary autonomy. But is monetary policy sufficient to avoid financial instability if accompanied by unregulated capital flows ?

A recent paper by Maurice Obstfeld, Jonathan D. Ostry and Mahvash S. Qureshi of the IMF’s Research Department examines the impact of the trilemma in 40 emerging market countries over the period of 1986-2013. They report that the choice of exchange rate regime does affect the sensitivity of domestic financial variables, such as domestic credit, house prices and bank leverage, to global conditions. Economies with fixed exchange rate regimes are more impacted by changes in global market volatility than those with flexible exchange rate regimes. They also find that capital inflows are sensitive to the choice of exchange rate regime.

However, the insulation properties of flexible exchange rates are not sufficient to protect a country from financial instability. Maurice Obstfeld of the IMF and Alan M. Taylor of UC-Davis in a new paper point out that while floating rates and capital mobility allow policy makers to focus on domestic objectives, “…monetary policy alone may be a relatively ineffective tool for addressing potential financial stability problems….exposure to global financial shocks and cycles, perhaps the result of monetary or other developments in industrial-country financial markets, may overwhelm countries even when their exchange rates are flexible.”

Global capital flows can adversely affect a country through multiple channels. The Asian financial crisis of 1998 demonstrated the impact of sudden stops, when inflows of foreign capital turn to outflows. The withdrawal forces adjustments in the current account and disrupts domestic financial markets, and can trigger a devaluation of the exchange rate. The fall in the value of the currency worsens a country’s situation when there are liabilities denominated in foreign currencies, and this balance sheet effect can overwhelm the expansionary impact of the devaluation on the trade balance.

The global financial crisis of 2008-09 showed that gross inflows and outflows as well as net flows can lead to increased financial risk. Before the crisis there was a tremendous buildup of external assets and liabilities in the advanced economies. Once the crisis began, the volatility in their financial markets was reinforced as residents liquidated their foreign assets in response to their need for liquidity (see Obstfeld here or here).

International financial integration can also raise financial fragility before a crisis emerges. Capital flows can be highly procyclical, fluctuating in response to business cycles (see here and here). Many studies have shown that the inflows result in increases in domestic credit that foster more economic activity (see here for a summary of recent papers). Moritz Schularick of the Free University of Berlin and Alan Taylor of UC-Davis (2012)  have demonstrated that these credit booms can result in financial crises.

What can governments do to forestall international financial instability?  Dirk Schoenmaker of VU University Amsterdam and the Duisenberg School of Finance has offered another trilemma, the financial trilemma, that addresses this question (see also here). In this framework, a government can choose two of the following three financial objectives: national financial regulatory policies, international banking with international regulation, and/or financial stability. For example, financial stability can occur when national financial systems are isolated, such as occurred under the Bretton Woods system. Governments imposed barriers on capital integration and effectively controlled their financial systems, and Obstfeld and Taylor point out that the Bretton Woods era was relatively free of financial crises. But once countries began to remove capital controls and deregulated their financial sectors in the post-Bretton Woods era, financial crises reappeared.

International financial integration combined with regulatory cooperation could lessen the consequences of regulation-shopping by global financial institutions seeking the lowest burden. But while the Financial Stability Board and other forums may help regulators monitor cross-border financial activities and design crisis resolution schemes, such coordination may be necessary but not sufficient to avoid volatility. Macroprudential policies to minimize systemic risk in the financial markets are a relatively new phenomenon, and largely planned and implemented on the national level. The global implications are still to be worked out, as Stephen G. Cecchetti of the Brandeis International Business School and Paul M. W. Tucker of the Systemic Risk Council and a Fellow at Harvard’s Kennedy School of Government have shown. A truly stable global system requires a degree of financial regulation and coordination that current national governments are not willing to accept.