The group of G20: Trials of global governance in times of crisis

In spite of the disappointing outcome of some recent summits, notably the most recent in Cannes, the G20 is and should remain the cornerstone of the global financial architecture. Its record of performance in the last three years, reviewed in this paper, is mixed but not as unambiguously negative as critics have said. However, its effectiveness as a decision-maker has diminished over time. Enhancing the relevance and effectiveness of the G20 will require time and action on several fronts, including greater involvement and stronger commitment on the part of political leaders, better internal organisation and the development of a shared mission. Ignazio Angeloni is the editor of the G20 Monitor.

Testing times for global financial governance

Ignazio Angeloni believes that the increase in financial interdependence in recent decades has not been matched by sufficient progress in the international coordination among regulatory authorities. In fact, the international financial system has suffered from insufficient globalisation of regulatory and supervisory policies, not excessive globalisation of financial markets.

Let's bring our acts together

There is an unequivocal sign that a cooperation mechanism, a policymaking forum, a â??Gâ?? in short, is losing effectiveness; that its agenda is becoming an end in itself rather than a premise for purposeful action. It is when its press communiquées lose focus and turn into long lists of unrelated wishes, none of which entailing a serious commitment by any of the participants. We have seen this in the past, for example in certain phases of the G7/G8 history, and malicious voices suggest this is already happening to the G20, the young and most ambitious global economic cooperation forum ever conceived. Are the critics right? Should we lose hope and start thinking about something else? The ongoing French presidency, that will convene the next summit in Cannes in November, is a tests. Meanwhile, based on our criterion, the ministerial meeting just concluded in Paris gives little ground to contradict the critics. As already noted in this Monitor, the first steps of the G20, after the launch of the new formation at the level of heads of state and government (Washington, 2008), had been promising. Pressed by events, in the Fall of 2008 the leaders swiftly put together a sensible list of priorities and an innovative delegation structure, composed of the G20 summit at the top, supported by ministers and governors, and by the Financial Stability Board and the International Monetary Fund conducting technical work in their areas of expertise. More importanly, concrete actions followed, especially in the area of financial regulation. Then two things happened. To begin with, the crisis ended; or, should we say, its most acute manifestations in the financial markets subsided. As we had expected, the ensuing sense of relaxation weakened the will of policymakers to minimize divergences and agree on concrete actions. Second, the priorities evolved. Faced by the difficulty of agreing on a set of macro-policies to reduce global imbalances, participants turned attention elsewhere: to the reform of the international monetary system (an even more contentious subject, if possible), to the wish of some governments to combat â??speculationâ??, notably in commodity markets, to the implications of rising inflation and the exit strategies, and so on. A good starting point is to recognise that all these issues are linked. All G20 members (even the US now) agree that global imbalances contributed to the crisis, and that something should be done about them now, before new and bigger gaps arise. The state of the international monetary system (IMS) is an angle of the same problem. For surplus and deficit countries alike, global imbalances are a symptom of the inability of the current non-system to define, and enforce, any meaningful notion of â??rules of the gameâ??. The US were allowed, even encouraged, to neglect their rising external deficit by their ability to issue ever increasing volumes of the only universally accepted reserve asset, the US dollar. On the surplus side, China and others were moved by similar (dis)incentives, with reverse sign; they were even forced, by lack of alternatives, to accumulate surpluses in order to secure precautionary buffers against future adverse shocks. The present system lacks self-regulation, not only with regard to bilateral payment positions but, more importantly, with regard to global liquidity creation. Here is where commodity price booms link up. In early 2008, when the financial crisis could still be mistaken as mild and the recession had not yet started, commodity prices reached a historical peak, fuelled by five or more consecutive years of global liquidity expansion. After a short halt we are now seeing something similar happening again. Commodity markets are discounting the fact that the international community has found no better way, to exit the recession an prevent double dips, than to reactivate the same mechanisms of the past, made of new and bigger imbalances and an excessive expansion of global liquidity. â??Speculationâ?? (whatever it means) may add fuel in certain situations, but the new commodity bubble we are now observing (accompanied, not by chance, by stock market indices again well above historical trends) logically follows from the current global policy setting. The French authorities were right to include the reform of the IMS among the key priorities of the presidency. The problem is that none of the realistic alternatives can by itself guarantee greater discipline, in a reasonably near future. A multipolar system, with a somewhat more prominent role for the renbinbi and perhaps the euro, would help balance the composition of international reserves but not necessarily ensure a firmer control over their total creation. The same applies to other proposals under discussion that feature an enhanced role for the SDR, either via regular allocations or some form of â??substitution accountâ??. It is unlikely that a better control of global imbalances can result soon from changes in the IMS. Besides, if effective cooperation is hard to achieve consensually, as we see, it is equally hard to seek it through systemic rules that themselves need consensus to be decided and enforced. A peer review process, based on a shared methodology and indicators to detect which country is out of balance and should adjust, supported by an adequately empowered IMF, still seems the inescapable starting point. The Paris meeting just concluded opened up with a simple suggestion on the table: using 5 indicators (current accounts, international reserves, exchange rates, public deficits and private savings) to preliminarily identify external imbalances, triggering a more detailed review. After 2 days of discussion it agreed on the following formula to define the relevant indicators: â??(i) public debt and fiscal deficits; and private savings rate and private debt (ii) and the external imbalance composed of the trade balance and net investment income flows and transfers, taking due consideration of exchange rate, fiscal, monetary and other policies.â?? One may object to this use of ministerial time, or to the convoluted wording, but this matters little. What is important is to move ahead: complete the agreement with operational guidelines and put the review process to work. This is what the leaders promised in Pittsburgh. Perhaps the parties will end up agreeing on what to do, even if they disagreed on why to do it. Post scriptum. Two final remarks on other subjects: 1.    Financial reform. This is another key topic of the G20 agenda, but was not a majoe focus of the discussion in Paris. Ministers and governors reiterated their mandate to the Financial Stability Board to bring forward its agenda, notably on all aspects of the Basel III framework and on shadow banking systems. All in all, the FSB agenda appears to be on track, though effective implementation in all jurisdictions will be a different matter. 2.    Speculation in commodity markets. After the comments heard on the eve of the meeting, it is surprising to see that the word â??speculationâ?? was not even mentioned the ministersâ?? final statement. This is unfortunate, not because the subject necessarily justifies policy intervention, but because it would be useful to give more substance to the notion of â??potential excessive commodity price volatilityâ??, mentioned in the statement. The IMF has already conducted analyses that could be revisited and updated in light of the recent experience, as a basis for a G20 position on this issue.

The international monetary system is changing: what opportunities and risks for the euro?

After a thirty-year pause, discussions on the future of the international monetary system (IMS) have restarted. This is partly due to the fact that the IMS has facilitated, or at least not prevented, the economic and financial imbalances that led to the recent crisis. This paper argues that the international position of the US dollar is likely to erode in the coming years, though the speed of the process is uncertain. This will create a demand for other currencies to be used internationally as means of payment and store of value. The most likely candidates for filling the partial vacuum created by the dollarâ??s decline are the euro and the Chinese renminbi. The probability that the renminbi will eventually become one of the worldâ??s key currencies is very high, but the speed of the process is uncertain. As far as the euro is concerned, much will depend on if and how the sovereign debt crisis is resolved. Our view is that the crisis will be dealt with and that it will result in radical steps towards fiscal and financial integration. If such steps are taken, the euro will secure both internal stabilisation and a growing international role.

Monetary policy transmission in the euro area: any changes after EMU?

We examine the euro area monetary policy transmission process using post-1999 data, with two main questions in mind: has it changed after ­ and because of ­ EMU and, if so, is it becoming homogeneous across countries. Given the data limitations, we concentrate on three blocks of transmission: the banking, interest-rate and asset-market channels. We find evidence that the transmission through banks has become more potent and homogeneous across countries because of EMU. On the financial-market channels, our evidence is somewhat weaker but suggestive. The interest-rate channel appears to have changed even before EMU, and to now affect national economies in a broadly similar way. The asset-market channel (proxied by the stock-market effects of monetary policy) also seems to work rather homogeneously across national markets (no comparison with pre-EMU is available here). A positive answer to both questions raised above represents, in our view, the best working hypothesis under current knowledge. JEL Classification: E43, E52, G21bank and financial integration, euro, Monetary policy transmission

Euro area inflation differentials

We build a stylised 12-country model of the euro area and use it to analyse why differences in national inflation and growth rates arise within the European monetary union. We find that inflation persistence is a key potential explanatory factor. Other more frequently mentioned reasons, like country-specific shocks or differences in the monetary transmission mechanism across countries, count less. We also look at how a monetary policy geared to area-wide average inflation affects these differentials. Our model suggests that area-wide inflation stability and low inflation differentials are complementary. JEL Classification: E31, E32, E52, F42Currency union, euro area, inflation differentials, Inflation persistence

From the ERM to the euro: new evidence on economic and policy convergence among EU countries

Skeptic views on EMU are usually cast around three arguments. First, the EU does not satisfy 'Optimum Currency Area' (OCA) conditions. Second, heterogeneous economic and financial structures will produce differences in monetary transmission. Third, the shift from domestic to area-wide considerations may give rise to conflicts in the decision making of the European Central Bank (ECB). JEL Classification: E52, F02, E32economic and policy convergence

Wanted: a stronger and better G20 for the global economy

The G20 acted as a crisis manager when global financial markets were under threat in 2008 and 2009, and contributed to a positive outcome. However since then, in the more routine work of crisis prevention, its performance has been less convincing at best, and criticism of its effectiveness has increased. Nevertheless, a global governance forum such as the G20 is necessary. Allowing the G20 to slide slowly into irrelevance would be unfortunate because a global crisis manager is once again needed, this time to deal with the European sovereign-debt crisis The first priority is to promptly finalise the macro-coordination framework still under construction, and strengthen it by bringing intra-regional imbalances explicitly to the fore. These should be treated as global imbalances under G20 responsibility if they have global implications, as the euro crisis certainly does. Second, decisions should be taken on how the emerging country bloc represented in the G20 could contribute to provide financial-market support in conditions of stress. The 3-4 November Cannes G20 summit is an opportunity to strengthen the G20â??s role. This paper is a contribution to a Think Tank 20 volume to be published by The Brookings Institution.

Exit strategies

We study alternative scenarios for exiting the post-crisis fiscal and monetary accommodation using the model of Angeloni and Faia (2010), that combines a standard DSGE framework with a fragile banking sector, suitably modified and calibrated for the euro area. Credibly announced and fast fiscal consolidations dominate – based on simple criteria – alternative strategies incorporating various degrees of gradualism and surprise. The fiscal adjustment should be based on spending cuts or else be relatively skewed towards consumption taxes. The phasing out of monetary accommodation should be simultaneous or slightly delayed. We also find that, contrary to widespread belief, Basel III may well have an expansionary macroeconomic effect. Keywords: Exit Strategies , Debt Consolidation , Fiscal Policy , Monetary Policy , Capital Requirements , Bank Runs JEL Classification: G01, E63, H1

Monetary Policy and Risk Taking

In this paper Bruegel Visiting Scholar Ignazio Angeloni (European Central Bank), Ester Faia (Goethe University Frankfurt, Kiel IfW and CEPREMAP)  and Marco Lo Duca (European Central Bank) examine the links between monetary policy, financial risk and the business cycle, combining data evidence and a new DSGE model with banks. The model includes banks (modeled as in Diamond and Rajan, JF 2000 and JPE 2001) and a financial accelerator (Bernanke et al., 1999 Handbook). A monetary expansion increases the propensity of banks to assume risks. In turn, financial risks affect economic activity and prices. This "risk-taking" channel of monetary transmission, absent in pure financial accelerator models, operates via the leverage decisions of banks. The model results match certain features of the data, as emerged in recent panel data studies and in our own time series estimates for the US and the euro area.