Mark Carney, Governor of the Bank of Canada talks on international monetary system (IMS) in his recent speech.
The international monetary system consists of (i) exchange rate arrangements; (ii) capital flows; and (iii) a collection of institutions, rules, and conventions that govern its operation. Domestic monetary policy frameworks dovetail, and are essential to, the global system. A well-functioning system promotes economic growth and prosperity through the efficient allocation of resources, increased specialization in production based on comparative advantage, and the diversification of risk. It also encourages macroeconomic and financial stability by adjusting real exchange rates to shifts in trade and capital flows.
Carney then provides a snapshot of 3 IMS we have had – Gold Standard, Bretton Woods and current hybrid system. On th present system he says:
After the breakdown of the Bretton Woods system, the international monetary system reverted to a more decentralized, market-based model. Major countries floated their exchange rates, made their currencies convertible, and gradually liberalized capital flows. In recent years, several major emerging markets adopted similar policies after experiencing the difficulties of managing pegged exchange rate regimes with increasingly open capital accounts. The move to more market-determined exchange rates has increased control of domestic monetary policy and inflation, accelerated the development of financial sectors, and, ultimately, boosted economic growth.
Unfortunately, this trend has been far from universal. In many respects, the recent crisis represents a classic example of asymmetric adjustment. Some major economies have frustrated real exchange rate adjustments by accumulating enormous foreign reserves and sterilizing the inflows. While their initial objective was to self-insure against future crises, reserve accumulation soon outstripped these requirements. some cases, persistent exchange rate intervention has served primarily to maintain undervalued exchange rates and promote export-led growth. Indeed, given the scale of its economic miracle, it is remarkable that China’s real effective exchange rate has not appreciated since 1990.
In each major global crisis we have had to reform our IMS. We cannot continue with the current IMS as well. Changes need to be made as we would end up in similar problems later on as well.
So what is the way forward? He suggests some options:
The first is to reduce overall demand for reserves. Alternatives include regional reserve pooling mechanisms and enhanced lending and insurance facilities at the IMF. While there is merit in exploring IMF reforms, their effect on those systemic countries that already appear substantially overinsured would likely be marginal. As I will touch on in a moment, the G-20 process may have a greater impact.
He explains these in details.
A nice short note on IMS.