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17. Reforming International Monetary System
Kanhaiya Singh The global economy is faced with unprecedented imbalances where huge reserves mostly denominated in US dollar have been accumulated in non-reserve currency countries and income velocity of the global reserves is decreasing with random-walk.
In this paper, global data with respect to world economy and the United States (US) have been analysed in Vector Error Correction and Unconstrained Vector Auto Regression frameworks to understand the changing dynamics of economic relationship between US and other nations through Granger Causality and impulse responses. In particular, the economic relationships between US and groups of other economies of the World has been examined with respect to real GDP, domestic money market rates, and international interest rates respectively to demonstrate the prevailing dichotomy in international economic structure.
The dynamics of analysis indicates that the US does not cause growth in real GDP of other countries (taken in groups of high income, upper middle, lower middle and low income countries) but it continues to affect the money market of major economies. Such possibility is argued to be plausible only because of the dual use of the US dollar, which is both the national currency of the US and major currency of international transaction. A dichotomy of this kind is inherently unsustainable as it creates distortions in conducting monetary and fiscal policies of all nations including the US. We also estimate a simple model of consumer price inflation in the US and demonstrate the prevailing rigidity and supply side dominance. It is then argued in particular how the inflation targeting regime in the US has been misplaced, volatile and destabilising for the entire global economy through linkages provided by dual use currency system while preferred policy regime should be characterised by low level low volatility interest rate.
Under these contradictions the global stability cannot be achieved without making the international currency neutral. The economy of the US would also be better off with a neutral currency of international reserve, which decouples its current account deficits from the holding of international reserve of other countries. Several proposals have been floated to reform international monetary system (IMS). However, world appears to be divided in three very broad groups: (1) Replace the current dual use currency with an international currency, (2) Replace current dominant dual use currencies with a basket of currencies, and (3) Leave the current currency as it is but develop regional currencies to provide completion. We believe, in the long run only first option is sustainable because other option will lead to similar situation as the one being faced today. There is no guarantee that the multi currency System would remain flexible and competitive.
We have attempted a modest proposal as follows. (1) We propose that there should be neutral currency say SDR-Money (SDRM) for international transaction, which can provide stable store of international value by virtue of expanded basket based valuation system and such currency needs to be managed by a banker of last resort say IMF-Bank, where excess reserve can be deposited and lent at pre-decided benchmark rates just like any central bank but with a provision of transaction off the bench mark rate. (2) There should be arrangement of bilateral negotiations between depositor central bank and borrowing central bank to make a deal off the bench mark rate where discounted deposit of surplus country can be transferred to borrower country in the mutual interest of trade. Such benefits can be provided by the surplus country to avoid tariff barriers from deficit countries which in a sense are supporting employment in exporting country. (3) The transition from US dollar-based IMS to SDRM based system should be done in an agreed timeframe with a period of coexistence followed by complete transition to SDRM. (4) With increasing share of other nations in world real economy, the demand for greater participation is legitimate and it would act as stabilising force. Therefore, more and more currencies need to be added to current SDR basket before adopting SDRM; and finally (5) the monolithic monetary fund may be decentralised with an arrangement of central office and several autonomous regional offices looking after surveillance, monitoring, and advisory with respect to the member countries, and management and distribution of fund at the regional level. The central office could concentrate on currency management, Policy making, surveillance of regional offices and fund allocations to regions. Such a system as proposed here would not only bring more confidence among smaller countries but it would be more robust, knowledgeable and effective.
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