Henrique Meirelles: Bretton Woods II - on its way out?
Speech by Mr Henrique Meirelles, Governor of the Central Bank of Brazil, at the 18th
Frankfurt European Banking Congress, Frankfurt am Main, 21 November 2008.
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In the last few weeks, much was talked about "Bretton Woods II" and even about "Bretton
Woods III", as we heard here this morning. To many, "Bretton Woods II" represents a new
era of cooperation between economic and financial authorities worldwide, aimed at fighting
the current global crisis, enhancing cross-border regulation and possibly reform the financial
system at some extent. To many others, it is a full redesign of the global financial
architecture and of the role of the multilateral institutions. To a few, it implies a sort of
arrangement to stabilize major exchange rates - or at least to reduce their fluctuation, not to
say a new global exchange rate system, maybe as the one established in the aftermath of
the Second World War.
Yet, five quarters after the beginning of the financial turmoil in the US, few people would
envisage that we would go that far in terms of international cooperation and proposals, as
indicated by the communiqué of the summit of head of states of the G20, held in Washington
on Nov 15. The communiqué put forward not only a series of ambitious recommendations,
but also a plan of action for the near future that may reshape the global regulatory
framework. Even controversial issues that were long blocking international negotiations, as
the Doha agenda, received a new momentum in the G20 communiqué.
So far, as you all know, significant progress has been achieved in terms of recognition of the
causes of the crises, including development of unsound risk management practices and
excessive leverage, in a time regulators in many jurisdictions failed to perceive the build up
of unbalances in individual institutions and financial markets in general.
At the same time, each country in one way or another has taken actions to provide liquidity
and unfreeze credit markets, and when necessary - particularly in mature economies - to
stimulate the economy, strengthen the capital basis of financial institutions and tackle
regulatory deficiencies.
That said, authorities in Washington committed to implement reforms that will strengthen
financial markets and regulatory regimes. An important novelty is the recognition that
financial markets are global in scope, so that enhanced international cooperation among
regulators is needed in a globalized world.
Commitment to reform the multilateral institutions to increase their legitimacy and
effectiveness has also progressed, granting a larger weight in their decision bodies to
emerging economies, as well as expanding the representativeness of the Financial Stability
Forum and of the Basel Committee on Banking Supervision. The IMF and the expanded
Financial Stability Forum are called to increase efforts in crisis prevention and responses.
The G20 communiqué backed the calls for a broader international cooperation in several
fronts, but let me remind you that the international community of central bankers and
financial regulators have already developed strong cooperation ties. Institutions as the BIS
with its regular meetings or governors and of senior central bank officials and experts or
forums like the Basel Committees and the Financial Stability Forum have been providing for
years the necessary dialogue, exchange of ideas and information between us. I understand
that other forums of economic authorities can replicate our own model of cooperation.
Regarding the IMF, the discussion currently concentrates around its role and legitimacy. Its
role should focus on three main topics. The first is surveillance. It is very important that the
IMF becomes a key and integral part of the financial early warning system. The IMF is vital
not only in terms of forecasting, which is already regularly performed and published, but also
in terms of surveillance of each country's policies and specific warning indicators, aimed at
detecting its growing unbalances. One of the points that, in my personal opinion, have
complicated efforts to deal with the current financial crisis is that the whole focus of the IMF
during decades was to prevent crises in emerging markets. There is a different picture now,
and is paramount that the surveillance done by the IMF focus on every relevant economy
and really works as an early warning system.
The second topic, evidently, is international cooperation. And international cooperation
requires that the IMF and the Financial Stability Forum work together to propose a new set of
regulations - some of them were already discussed here today, and particularly regulation
and supervision of cross-border transactions, which are not directly restricted to one national
supervisory authority. The Basel Committee will most likely continue to be the focal point of
conducting the implementation of the process.
The third topic is the IMF role in supporting emerging and developing countries, which have
no financial conditions to address the effects of the financial turmoil on their economies.
Traditionally, the IMF has focused on crisis generated in one specific economy or group of
economies and in proposing policies to restore that country's soundness. The problem that
we are facing today is that some countries might have a sound policy but were affected by
the global systemic crisis. How to react to that? If the crisis is "imported" and the country
cannot meet its financing needs, the IMF should provide liquidity and contribute to any kind
of anti-cyclical adjustment. In that regard, the authorities of leading economies should
usefully consider to allow the IMF to issue bonds. In a moment of de-leveraging, when we
are talking about re-leveraging, a leveraged IMF would have increased ability to meet its
rising challenges.
In regard to the World Bank, it should focus on poor countries, the ones that not only require
liquidity or loans, but effectively need financial support. And for both the IMF and the World
Bank, a critical question today is legitimacy. And the way emerging market economies are
playing a more important role in the global economy - not only they are representing a larger
share of world output as compared to before, but also represent at this point a solution for
the crisis - it is imperative that these countries have a proportional weight in the governance
structure of the two Bretton Woods institutions.
Another fundamental development these days is the increasing role played by the G20, for
the very same reason of the growing participation of emerging markets economies in global
output. It is clear today that the G7 alone or even the G10 are not able to address all relevant
issues that affect the world economy, which are better dealt by a larger group as the G20.
Evidently there is always a trade-off, the larger the group, the more difficult its effectiveness.
But that is a challenge that we have to face. The first meeting of heads of states of the G20
was an essential step towards making the G20 a more effective decision-making forum.
The next topic is a global supervisory authority. The G20 suggested the creation of a college
of supervisors, following a Financial Stability Forum recommendation. President Köhler
raised here the idea of having the IMF playing this role. We are in the very preliminary phase
of this discussion and many challenges lay ahead in that regard, particularly deciding what
should be subject to international supervision and what should be subject to national or
regional supervisory entities.
Much of the discussion today evolves around crisis prevention. In terms of crisis resolution,
the recommendation is for every country to take all the necessary actions to restore the
regular working of its financial system, consumer and investor confidence and the level of
economic activity. But every country must act according to its needs and resources.
Countries were financial institutions faced severe losses require capital injections, while
some countries have to boost domestic demand to compensate for too much dependency on
exports. The important point here is to draw a clear difference between fiscal stimulus,
liquidity management and monetary policy.
The difference between liquidity management and monetary policy is not clear for many
observers nowadays, but it is nonetheless fundamental. In moments of market disfuntionality,
for instance, monetary easing sometimes does not work. It is important to mention that in
some circumstances liquidity management is the critical issue. Of course, we should not
forget the need for price stability in order to have the basis to restore growth.
In this regard and despite recent criticism, inflation targeting continues to be the most
appropriate monetary regime to coordinate inflation expectations in both mature and
emerging economies, not only providing transparency but also taking due consideration of
time lags and uncertainties in the process of monetary policy implementation. In fact, the
combination of short-term flexibility with the permanent commitment to price stability
embedded in the framework makes it particularly suitable to the current environment.
While disinflation will possibly be fast in mature economies, creating adequate conditions for
monetary counter-cyclical actions in different countries, in emerging economies disinflation
will probably be slower, particularly where the authorities have not prevented inflation from
escalating recently, or where they did not retain a vigilant attitude. In any case, inflation
targeting is the most suited framework to coordinate the public's inflation expectations,
particularly in an environment marked by growing uncertainty.