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Message from ADB's President Contributors Acknowledgements Executive Summary and Recommendations Jeffrey D. Sachs, Masahiro Kawai, Jong-Wha Lee, and Wing Thye Woo Paper Summaries (full papers downloadable) International Monetary Advisory Group Global Financial Crisis, its Impact on India and the Policy Response Nirupam Bajpai To What Extent Should Capital Flows be Regulated? Maria Socorro Gochoco-Bautista The Case for a Further Global Coordinated Fiscal Stimulus Willem Buiter Managing a Multiple Reserve Currency World Barry Eichengreen From the Chiang Mai Initiative to an Asian Monetary Fund Masahiro Kawai An Asian Currency Unit for Asian Monetary Integration Masahiro Kawai The International Monetary System at a Crossroad Felipe Larrain B. Towards a New Global Reserve System Joseph Stiglitz A Realistic Vision of Asian Economic Integration Wing Thye Woo An Asian Monetary Unit? Charles Wyplosz Will US fiscal Deficits Undermine the Role of the Dollar as Global Reserve Currency? If So, Should US Fiscal Policy be geared to Preserving the International Role of the Dollar? Yongding Yu International Monetary Working Group International Reserves and Swap Lines: the Recent Experience Joshua Aizenman, Donghyun Park and Yothin Jinjarak The Future of the Global Reserve System Daniel Gros, Cinzia Alcidi, Anton Brender, and Florence Pisani Renminbi Policy and the Global Currency System Yiping Huang Will the Renminbi Emerge as an International Reserve Currency? Jong-Wha Lee Asia's Sovereign Wealth Funds and Reform of the Global Reserve System Donghyun Park and Andrew Rozanov Reforming International Monetary System Kanhaiya Singh Designing a Regional Surveillance Mechanism for East Asia: Lessons from IMF Surveillance Shinji Takagi

Executive Summary and Recommendations

Jeffrey D. Sachs, Masahiro Kawai, Jong-Wha Lee, and Wing Thye Woo

The financial crash of 2008 and subsequent global economic downturn has led to a major reassessment of the global monetary and financial system. When the crisis broke, both advanced and emerging economies resorted to frenetic macroeconomic measures to avert financial catastrophe and assure global confidence in the international financial system could return. These globally coordinated policies may have contributed to the ensuing worldwide recovery. But what is needed now is a better regulatory environment that reduces the probability it could happen again.

The crisis was rooted in lax monetary policies and inadequate financial oversight. This was most prominent in the United States (US) and led to serious financial excess. It helped create an over-abundance of global liquidity, partly an off-shoot of widening global imbalances. These originated from both excessive consumption in the US and an unprecedented accumulation of foreign reserves by emerging economies, especially in Asia. Partly a response to the 1997–1998 Asian financial crisis, foreign reserve accumulation was “insurance” against another crisis—when borrowing costs sky-rocket just when emergency financing is needed the most. Yet, hoarding international reserves can be extremely costly and inefficient when effective external debt management is lacking.

Thus, the global crisis ignited a well-timed debate among academics and policy makers about the current global reserve system.

Is the current system unstable and inefficient? Did the dollar-dominated regime contribute to the global crisis? And how should we manage the evolution of the current reserve system? An effective global reserve system supplies the international liquidity needed by a growing global economy, facilitates balance-of-payments adjustments, and provides an international framework for sound national economic policies. Unfortunately, the current system has fallen short of fulfilling its promise.

Reforming the global reserve system has huge implications for developing Asia. The region holds close to half of the world's total foreign exchange reserves and is highly dependent on international trade and capital flows for its growing prosperity.

The Asian Development Bank, in partnership with the Earth Institute at Columbia University, initiated a joint research project on "The Future Global Reserve System—An Asian Perspective.” The project aims to enrich the current debate by examining the issue from an Asian perspective, empowering Asia's policy makers to better deal with the issue and participate in the global dialogue, while informing the public on its importance.

The study was led by the International Monetary Advisory Group (IMAG), assisted by a Technical Working Group. Eleven internationally renowned monetary experts are members of the advisory group, chaired by Earth Institute Director Jeffrey Sachs. Each member contributed a paper on the future of the international monetary system and worked on finalizing a set of recommendations. The technical working group included 3 ADB staff and 6 technical experts from academia and the private sector, chaired by ADB Chief Economist Jong-Wha Lee. They prepared seven technical background papers on research topics identified by the advisory group. These reports and essays were the substance of two international workshops—in New York City in September 2009 and in Tokyo in March 2010.

The 11 IMAG papers discuss the future of the global reserve system; the optimal path for recovery following the global financial crisis; ways to rebalance the world economy; the need to create medium–term macroeconomic frameworks nationally and regionally; how to better manage global capital flows; and the future of Asian integration given the rapid growth of the region’s two economic powerhouses—the People's Republic of China and India.

Nirupam Bajpai discusses India’s response to the global crisis. He argues that the process of fiscal consolidation needs to be accelerated more through qualitative adjustments to reduce government dis-savings and ameliorate price pressures. Maria Socorro Gochoco-Bautista points out that capital flows need to be regulated because unfettered trade in financial assets in the presence of distortions does not improve social welfare. Willem Buiter considers what needs to be done to better coordinate fiscal stimulus globally, and argues the case for future fiscal tightening. Barry Eichengreen argues that the world is headed to a multiple reserve currency system and calls for sound and stable policies on the part of the reserve-issuing countries to ensure a stable system.

Masahiro Kawai suggests that given the difficulty of a global agreement, deepening regional reserve pooling, strengthening formal institutions, and creating a regional currency basket—or an Asian currency unit—in Asia is a practical alternative. Felipe Larrain B. argues that the US dollar will remain the main reserve currency but will face competition from other major currencies, including the euro, BRIC currencies, and a supranational currency such as the IMF’s special drawing rights (SDR). Joseph Stiglitz argues for a wider use of a supranational currency such as the SDR as a reserve currency. And Wing Thye Woo argues that a feasible architecture for an Asian Economic Union would be a free trade and open investment zone with a regional financial facility and its own surveillance mechanism.

Charles Wyplosz suggested that if exchange rate cooperation and limited intra-regional fluctuations are desirable, pegging to external currencies is more coherent than limiting deviations from an Asian monetary unit based on a regional currency basket. Yongding Yu indicates that US budget deficits would undermine the dollar’s role as global reserve currency, and argues that the US government will likely be unwilling to sacrifice domestic objectives to preserve the global sanctity of the dollar.

The Technical Working Group produced seven papers. Joshua Aizenman and his co-authors suggest that Asia may benefit by deepening international reserve pooling and advancing regional swap arrangements. Daniel Gros and his co-authors argue that reform of the current de facto reserve system should aim to better make use of savings accumulated in emerging market economies.

Yiping Huang suggests that the People's Republic of China can facilitate a smooth and orderly adjustment of the global currency system by gradually increasing its exchange rate flexibility and diversifying foreign reserve investments. Jong-Wha Lee argues that an eventual move to a multi-currency system is desirable and that the renminbi would gradually emerge as an alternative international reserve currency.

Donghyun Park and Andrew Rozanov argue that sovereign wealth funds could play a crucial role in reforming the global reserve system. Kanhaiya Singh argues that the international monetary system has undergone substantial change and a fresh approach is needed—one more neutral and encompassing. Shinji Takagi analyzes the surveillance mechanism of the IMF and emphasizes the importance of effective regional surveillance in the Chiang Mai Initiative Multilateralization.

Recommendations

The Asian Development Bank and the Earth Institute at Columbia University jointly convened the International Monetary Advisory Group (IMAG) to create a comprehensive reform agenda for the global reserve system. The IMAG reform agenda is pragmatic, bolstered by concrete proposals on how best to implement policy.

1. Regional-level recommendations

With the quick rise of new, rapidly growing, economic powers, the Advisory Group sees the global reserve system evolving into a multi-currency reserve system. Regional initiatives that increase economic integration and policy coordination will help facilitate this process. Given Asia’s growing economic clout, it is therefore natural to strengthen efforts to establish a coordinating mechanism—at an existing or new regional institution—to help the region’s leaders better understand the complexities of this challenge, and identify new mechanisms to enhance policy cooperation.

1.1. Ensuring global liquidity. The past two decades have shown clearly the severity of economic damage when liquidity abruptly freezes. New arrangements must be made to enable the region’s reserves to play a more central role in stabilizing the global financial system. This includes allowing greater access to swap lines, SDRs, or other types of borrowing. It includes reform of the IMF and increased cooperation among the regional monetary funds.

1.2. Exchange rate coordination and cooperation. Asia is home to a plethora of exchange rate regimes. And the complicated dynamics of cross-rates has likely reduced the benefits of the production chains that have been the backbone of integrating Asia. Most statistical analyses show that currency-basket pegs by Asian currencies can increase stability in intra-regional cross-rates than pegs to the dollar. In practice, country-specific currency-baskets appear to provide as much bilateral stability as a common pan-Asian basket.

1.3. The use of monetary policy and the extent of monetary cooperation. Regions, especially East Asia, should embrace regional monetary coordination more seriously. However, due to great differences in economic size and structure, the wide diversity in stages of economic development, and the general reluctance to permit free movement of labor within Asia, a common Asian currency is currently not a realistic target. Moreover, regional monetary coordination in general should stop short of efforts to peg currencies within the region—Europe’s crisis in 1992 and the 1997 Asian financial crisis are reminders that weak pegs are a recipe for disaster.

1.4. Unilateral and multilateral capital controls—their use and effectiveness. Short–term, volatile capital movements can clearly destabilize the global economy. Well-designed temporary capital controls—as opposed to permanent capital controls—are tools that can strengthen growth-oriented macroeconomic management. These controls on the flow of capital tend to be more effective when done on a coordinated basis across countries that are targets of rapid capital movements, rather than individual countries reacting unilaterally.

1.5. Internationalization of the renminbi and the Chinese economy. One of the biggest changes in the world economy has been the rise of the Chinese economy, now a dominant economic and political power in East Asia. However, the renminbi has yet to become an international currency. It could become one much more quickly than many anticipate. The internationalization of the renminbi has the potential to become an alternative to the US dollar—as did the euro—and help nudge the global reserve system toward a multi-currency reserve structure. Asian countries may also consider to develop a basket of Asian currencies as the region’s anchor currency.

1.6. Surveillance and conditionality. In a multi-polar world with strong and effective regional economic institutions, country-specific economic surveillance and adjustment conditionality must inevitably evolve. Formal mechanisms for consultation between regional and global institutions will be needed to define the menu of policy choices—to prevent a race-to-the-bottom in conditionality-based lending.

1.7. Sharing seignorage. Given the failure of the international community to develop globally-binding agreements on climate change, the Group feels that, potentially, a portion of the revenue a country receives through seignorage could be shared regionally to tackle the climate change as a regional public good. As this is an ethically contentious issue as well as a technically complicated one, international working groups should be convened by the G20 and the United Nations to draw up policy options.

2. International-level Recommendations

2.1. Strengthening prudential capital market regulations. Given the obvious failure of the financial system to effectively police itself—the slew of financial derivatives as an example—and the gross inadequacies of current regulatory standards. The IMF, BIS, and new regional economic institutions can play an important role in helping standardize regulatory frameworks across regions and countries.

2.2. Convening a brain trust of independent international monetary experts. Chronic current account imbalances and varying exchange rate regimes, for example, can cause unnecessary friction between and across countries. Independent, expert analysis could provide a useful tool in ameliorating any disputes over alleged exchange rate manipulation.