10 October 2014

Financial Times: The world needs new tools to tame capital flows

While much has been done to reform the financial system, seven years after the crisis the faultlines in the international monetary system remain more or less as they were. We live with arrangements that lead to persistent international imbalances in the pattern of spending, saving and investment. When trouble hits one country, it quickly spreads abroad.

How can we maintain the benefits of floating exchange rates and cross-border flows of capital without such serious costs? Realistically, there is little we can do about the imbalances. Throughout history there have been nations that saved less than they invested, which resulted in current account deficits. There have been nations that spent less, building up savings and current account surpluses. But the savers have never shown much interest in reducing their surpluses at a pace desired by other countries, seeing that as the duty and need of the debtors.

What can be mitigated is the tendency for crises to spill across borders. The International Monetary Fund’s triennial review of how it monitors economic and financial risks and policies – to which I have contributed, along with my colleague David Li of Tsinghua University – provides an opportunity to do just that.

There was a time when most international capital flows were associated with financing a country’s net trade in goods and services. This meant the size of current account positions was more or less all that mattered; countries that were in balance, exporting about as much as they imported, did not fear turbulence in international markets. But that has not been true for decades, as a string of crises attests. A country can be vulnerable if its borrowers – whether in business, government or the financial sector – have taken too many short-term loans in foreign currencies or from abroad.

© Financial Times