March 2009The global economic crisis: systemic failures and multilateral remedies
Ensure level playing field – stable real exchange rates:
�� The real exchange rate is kept constant among a group of countries (one region or more). Fundamental and long lasting trade imbalances are prevented since all participating countries maintain their level of competitiveness.
�� Real exchange rates are normally kept constant by way of setting labour market institutions that allow steering nominal wages in a way that reflects productivity increases and the growth rate of inflation in each country.
�� If nominal wages fail to adjust or if inflation targets diverge, nominal exchange rates need to be adjusted to exactly compensate the emerging gap in competitiveness.
Avoid currency speculation – interest rate parity:
�� To avoid large speculation gains in currency markets, nominal exchange rates need to adjust to changes in interest rate levels of countries along the interest parity condition (relative UIP developments).
�� Even if inflation rates do not converge over time, the reflection of relative PPP in exchange rates on a regular basis (monthly or quarterly) will remove most of the incentives for shortterm speculation in currencies.
Enduring symmetric response:
�� As unilaterally pegged exchange rate arrangements and floating are prone to speculative attacks, an international financial system designed to minimize speculative attacks needs to be built on a symmetric responsibility that commits interventions to be carried out by the central banks of both the depreciating and the appreciating currencies if an exchange rate comes under unjustified attack.
�� The country with an appreciating currency has unlimited intervention potential (since the means can be printed and the result of foreign exchange market interventions on the domestic money market can normally be sterilized). In this case the need to hold foreign exchange reserves to “insure” against depreciation pressures is minimal for all individual countries.
�� Symmetric response also means that cost and profits of intervention will be equally shared. For instance, the central bank of the appreciating currency will incur a valuation loss of its foreign exchange reserves in its own currency, while the central bank of the depreciating currency will make a valuation profit of its exchange reserves in its own currency. Likewise, cost of sterilization may incur on one side that need to be shared with the partner central banks.
Multilateral code of conduct:
�� The code of conduct needs to reflect the new sprit of multilateralism in global economic governance based on the need to balance the advantages of one country against the disadvantages of other directly or indirectly affected countries.
�� The code of conduct ends the competition of nations. It is not countries that should compete with each other but companies on a level playing field.
Global organization of the system: (pictured above)�� The present Bretton Woods institutions have to be fundamentally redesigned or a new global institution with supervisory and advisory powers has to be created and has to practically manage the new financial system.
�� Lead currencies have to be found (“planets”); given the economic power shift away from a singular economic leader in the post-war financial system, several lead currencies (existing or artificial) should be envisaged in today’s multi-polar economic system.
�� The lead currencies will be linked with each other through symmetric managed floating systems with exchange rates automatically adjusted by relative price differentials (relative PPP).
�� Regional blocks can be formed (“satellites”) to be linked to one of the “planets” or a group of them. Alternatively, individual countries may choose to be associated as “satellites” with one or more of the “planets”.
�� Entry and exit criteria will need to be defined a priori and include provisions on domestic monetary and fiscal policy.
The authority managing a multilateral exchange rate system needs to assume a series of fundamental responsibilities to ensure its efficient functioning through rules that keep the real exchange rate stable. An international monetary authority would need a mandate to enforce such regulations, including through adjustments to members’ nominal exchange rates.
The surveillance function needs to be complemented by an enforcement capacity so as to be able to implement binding commitments for necessary adjustments within the system. The authority also has to assume the role of a lender of last resort so as to supply liquidity to the system’s members in case of crisis.
A common currency unit could be envisaged under its surveillance, the seignorage of which would be shared among all members. To efficiently face stress in the financial and exchange rate system the managing authority will have to assign tasks and responsibilities in a symmetric fashion, i.e. through the involvement of the depreciating and the appreciating currencies. At the same time, the institution will ensure that costs and profits of symmetric interventions are shared among all parties concerned. Finally, the governing institution of the new exchange rate system would act as the highest authority for the establishment and monitoring of a true global financial multilateralism.
Conclusion
In the second half of 2008 the sharp devaluation of the Icelandic krona (51 per cent against the United States dollar) has been followed by a larger wave of currency depreciations, such as of the Hungarian forint (34 per cent), the South African rand (38 per cent), the Brazilian real (34 per cent),the Turkish lira (33 per cent), the Mexican peso (29 per cent) and the Chilean peso (28 per cent).
Many others are likely to follow in 2009, for instance in Eastern Europe, where the pressure on currency markets has been ever-increasing over recent months. Countries like Estonia, Lithuania,Rumania and Bulgaria are under rising distress and the region as a whole is now under serious dangerof economic meltdown.
But the combination of huge current-account and budget deficits, devaluation pressures, sometimes pegged exchange rates and diminishing foreign exchange reserves lead to the same oldpolicy prescriptions of austerity again and again. It is high time to act and break this vicious cycle. Countercyclical macroeconomic policies – enabled and supported by a global multilateral financial framework – are urgently needed.
The bold departure proposed here is needed not only to counter the adverse effects of the current global financial crisis, but also to prevent similar crises in the future. It is clear that vulnerable countries in crisis do not need assistance packages that oblige them to fiscal austerity and restrictivemonetary policy measures. Just as the advanced economies need expansive monetary policy and fiscalstimulus to break the negative feedback of the financial crisis on economic activity, so do developing countries, transition economies and emerging markets.
They all need a combination of financial stabilization with expansive monetary and fiscal polices. In the absence of such a policy mix more and more countries will quickly end up on the verge of collapse.
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Huge gyrations of exchange rates exacerbate the financial crisis and have a severe economic impact around the world, study says
Geneva, 19 March 2009
Exchange-rate adjustments cannot be left to the market and must be subject to multilateral oversight, an UNCTAD report on the global financial crisis says. Changes in nominal exchange rates should reflect differences in rates of inflation between trading countries, the study recommends. That way, real exchange rates will be kept constant, allowing fair competition between producers from different countries and preventing potentially damaging speculation.
The report, titled The Global Economic Crisis: Systemic Failures and Multilateral Remedies (1) , was released today. It was written by economists serving on UNCTAD´s Secretariat Task Force on Systemic Issues and Economic Cooperation in advance of upcoming international conferences on the global economic crisis.
The report notes that the fallout from short-term currency speculation has contributed to sharp collapses in the values of some national currencies as the global economic crisis has intensified. That has made the economic damage of the crisis much more severe for some countries.
The Icelandic krona declined by 51% (against the US dollar) in the second half of 2008, for example. And a subsequent wave of devaluations -- reflecting the de-leveraging of speculators´ positions and also the shocks hitting the global financial sector at large -- have included declines of the Hungarian forint (34% against the dollar), the South African rand (38%), the Brazilian real (34%), the Turkish lira (33%), the Mexican peso (29%) and the Chilean peso (28%).
Currency speculation in recent years contributed independently to the build-up of the crisis, the report finds. It says speculative international capital flows are an important source of exchange-rate misalignment and the crisis has exposed the flaws in conventional wisdom about managing exchange rates. Neither steps by individual countries to peg rates firmly against other currencies or to let them float freely prevents potential abuse, and the only solution is a global framework.
Over the past two decades, short-sighted domestic policies and an unregulated international financial system attracted financial investors to leverage the short-term opportunities provided by divergent monetary policies in different countries, the study notes. Under the "carry trade," billions were borrowed from countries where interest rates were low and invested in countries where interest rates were high, generating large short-term profits for investors and artificially inflating the value of the currencies of the capital-receiving countries. As the financial crisis hit, the highly leveraged exchange-rate "bubble" burst.
The first step in stemming such destabilizing effects is to remove most of the incentives for short-term speculation in currencies. In a broader response to the economic crisis, developed and developing countries need a combination of currency stabilization with expansionary monetary and fiscal polices, the report contends. In the absence of such a balanced policy mix, more and more countries will quickly end up on the verge of collapse.
Coordinated "countercyclical" macroeconomic policies -- that is, policies to stimulate economic demand during a downturn when demand is falling -- have to be implemented without delay, and these policies should be supported by a global multilateral financial framework. UNCTAD proposes a new multilateral exchange-rate management system that links lead and satellite currencies (either globally or regionally) in a way that would maintain effective real exchange rates at relatively constant levels. (See fig.1)
If every country and every government acknowledges that the global crisis is foremost a systemic crisis -- due to the failure of the global community to govern the globalized economy properly -- then broad solutions, such a global bond that can be used at fixed exchange rates to bail out any needy country may be possible, the report says. It points out that in the current crisis, no country is too big or too small to be allowed to fail.
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