"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.
Because few countries can offer truly safe assets, and the availability of liquidity in times of crisis is not guaranteed, we argue that there are severe distortions in the demand for safe assets even in normal times, distortions that can accentuate financial fragilities and exacerbate economic volatility.
In short, the main structuring idea that guides our report is that the world economy is characterised by a chronic and severe shortage of reserve assets –or, with some abuse of language, ’safe assets’.
The principal characteristics that determine the reserve potential of a financial asset are its safety and its liquidity; investors must be assured that the asset will not lose its value and that this value can be quickly realised. This is a rare characteristic, since the conditions that lead a country to liquidate part of its reserves are often associated with periods of economic stress and of low liquidity in world markets.
The unmistakable sign of this shortage of safe assets is a persistently low level of world real interest rates, and of the yields of the different classes of safe assets, be they sovereign debt of fiscally responsible countries, highly rated corporate bonds, or highly rated tranches of securitised products.
at http://www.voxeu.org/index.php?q=node/7000
- 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.
Deep fault lines
This success, however, revealed deep fault lines in the system.- What drives the demand for safe assets in more normal times and in stress times?
- Who supplies global reserve assets, and why?
- Could the international monetary system also be, in some indirect way, partly responsible for the financial fragility of the world economy?
Because few countries can offer truly safe assets, and the availability of liquidity in times of crisis is not guaranteed, we argue that there are severe distortions in the demand for safe assets even in normal times, distortions that can accentuate financial fragilities and exacerbate economic volatility.
In short, the main structuring idea that guides our report is that the world economy is characterised by a chronic and severe shortage of reserve assets –or, with some abuse of language, ’safe assets’.
The principal characteristics that determine the reserve potential of a financial asset are its safety and its liquidity; investors must be assured that the asset will not lose its value and that this value can be quickly realised. This is a rare characteristic, since the conditions that lead a country to liquidate part of its reserves are often associated with periods of economic stress and of low liquidity in world markets.
The unmistakable sign of this shortage of safe assets is a persistently low level of world real interest rates, and of the yields of the different classes of safe assets, be they sovereign debt of fiscally responsible countries, highly rated corporate bonds, or highly rated tranches of securitised products.
- Our diagnosis is that the current functioning of the international monetary system is not only inefficient, but that it also has a number of perverse effects that undermine the stability of the world economy.
- We propose a number of reforms. The common thread of these proposals is to increase the conditional supply of liquidity and reduce its unconditional demand.
at http://www.voxeu.org/index.php?q=node/7000
