Introducing a new eReport: Reforming the international monetary system

by Emmanuel Farhi, Pierre-Olivier Gourinchas & Hélène Rey

Vox
September 19, 2011

Some prominent economists argue that failures in the international monetary system are the root cause of the global crisis. This column introduces a new eReport arguing that, at the very least, the international monetary system is inefficient and destabilising for the global economy. It proposes a number of reforms, the common thread of which is to increase the conditional supply of liquidity and reduce its unconditional demand.

On the face of things, the ad hoc international monetary system seems to be working well enough. The US dollar dominates international financial transactions, and one asset class (US Treasuries) serves as a global reserve or safe asset. This system, however, has its weaknesses.

• When the financial storm erupted in autumn 2008, investors worldwide steered their portfolios towards the safe havens – US dollars and US government debt.
• This surge would have had severe adverse consequences for currency prices, interest rates, and asset markets worldwide, had it not been accompanied by an unprecedented level of cooperation and coordination among major central banks.

This collaboration allowed the large-scale provision of US dollar liquidity to the broader markets via various swap lines the Fed set up with selected central banks (Goldberg et al 2011). The situation was also improved by the broadening of collateral criteria, and a substantial increase in the resources at the disposal of the IMF. This temporary provision of liquidity in a time of severe financial stress restored confidence in markets and helped stop a potentially damaging deleveraging process.

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