Remarks by Tiff Macklem
Governor of the Bank of Canada
Council on Foreign Relations
October 7, 2021
Washington, D.C.
(via webcast)
The long and short of it: A balanced
vision for the international monetary
and financial system
Introduction
your kind introduction. I'm very pleased to be here with you,
Thank you for
virtually at least. I look forward to the day when we can meet in person again. But
the need to invest in international cooperation can't wait. And I know we'll have
some thoughtful and engaging conversation despite the virtual format.
My hope is that we can take inspiration from the cooperation among researchers
who developed effective vaccines against COVID-19 in record time. Their efforts
and collaboration are saving lives and livelihoods and are underpinning the
global economic recovery. This is international cooperation at its very best.
there hasn't
Tragically, been nearly as much success in ensuring the equitable
global distribution of vaccines, especially to developing countries. This is the
biggest health and economic risk facing the world, and-as the G20 highlighted
in July-governments and the private sector must work together to make
vaccines available to all.
While global public health is the most urgent challenge for international
cooperation, the international monetary and financial system is one of the most
enduring. August marked the 50th anniversary of the end of the Bretton Woods
system of fixed exchange rates. Canada exited early, moving to a floating
exchange rate in 1970.1 That was a year before the United States suspended
convertibility of the US dollar into gold and most major countries floated their
exchange rates. This anniversary provides a timely occasion to reflect on the
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international monetary and financial system that has emerged-and how well
equipped it is to deal with the challenges ahead.
This global system-the exchange rate and capital accounts as well as the
institutions and rules that govern them-affects everyone and is critical to our
shared prosperity. The investments we have made collectively to strengthen the
system have allowed us to clear some hurdles. But we need a system that better
balances the immediate imperatives of the short run with the important building
That's
blocks for longer-run prosperity. what I want to talk about today.
We aspire to an international monetary and financial system that favours
inclusive and sustainable growth. In the long run, that is best achieved by a
system that promotes economic integration-with free trade, open capital
current system isn't there
markets and flexible exchange rates. But the yet, and
while we aspire to the long run, we live in the short run. For both these reasons,
policy-makers face a delicate balance.
Too much confidence that open markets will always deliver economic and
financial stability increases the risk of volatile episodes that hurt jobs and growth.
But too much focus on managing short-run pressures risks thwarting the
medium- to long-run adjustments that are fundamental to productivity and rising
standards of living. Finding the right balance between managing short-run
pressures and ensuring steady progress toward liberalization is the crucial task
of the international monetary and financial system.
While much progress has been made in the 50 years since the end of Bretton
Woods, achieving this balance remains elusive. And looking ahead, it will not get
easier or less critical. As the recovery from the pandemic progresses, and major
economies begin to remove exceptional monetary stimulus, the system will likely
come under more pressure. Tighter financial conditions globally will suit some
countries better than others. And beyond the pandemic recovery, new and even
bigger challenges are on the horizon, including climate change, the digitalization
of currencies and growing inequality.
I'd like to talk about Canada's place in the global monetary and
In my time today,
financial system. Then I'd like to
highlight some of the challenges the system
I'd like to outline
faces, particularly in the wake of the COVID-19 crisis. Finally,
our vision for the 21st century.
Canada and the global monetary and financial system
Cross-border economic integration has been a critical source of increased
prosperity for Canadians and for citizens the world over. To be effective, the
international system needs to deliver stability in prices and allow exchange rate
movements that reflect fundamentals. At the same time, it must be able to adjust
to shocks and structural changes in a timely way. In Canada, we have
longstanding experience with open capital accounts, inflation targeting and flexible
exchange rates, and they have served us and a growing number of countries
well.
Still, weaknesses in the arrangements and policies that make up the international
monetary and financial system are long-standing. Over the past two decades, the
Bank of Canada has emphasized the need for sound economic and financial
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policy frameworks in advanced and emerging-market economies (EMEs) and
sound governance of our global institutions.2
Progress has made the system better able to prevent and manage crises. The
International Monetary Fund (IMF) has strengthened its surveillance, enhanced
its financing facilities and developed a framework to guide the use of capital
controls. Many EMEs have strengthened their policy frameworks, including the
wider use of inflation targeting and greater exchange rate flexibility.3 Financial
regulation and supervision have been enhanced globally through the
implementation of the Basel III reforms. Swap lines and reserve pooling between
central banks-two elements of the global financial safety net-have expanded.4
And advanced economies have also become more attuned to the spillovers their
policies might cause.
This progress has helped the global economy weather the COVID-19 shock. But
the crisis has also reminded us of the connectedness and fragility that are
inherent in the system. As we all know, massive liquidity interventions by central
banks were needed to restore market functioning and support the provision of
credit. The interconnections in the global financial system-across countries and
between banks and non-bank financial institutions-have brought great benefits.
But these interconnections can also propagate and amplify stress. The test we
faced together during the COVID-19 shock as well as the challenges that lie
ahead underline the need to refocus our attention on where the system should be
headed and how we get there. The fallout from the pandemic and the inevitable
adjustments ahead as major regions recover at different speeds make dealing
with these issues more urgent.
Challenges and issues facing the system
The current challenges facing our global system can be grouped into two
categories: short-run pressures and longer-run challenges. Let me first talk about
those short-run issues.
EMEs have continued to experience volatility in their financial conditions, despite
improvements in fundamentals that have resulted in fewer full-fledged crises. In
the last dozen years, episodes of global stress have been all too frequent: the
global financial crisis in 2008-09, the taper tantrum in 2013, the sell-off in China
2
T. Macklem,
See, for example, "Renewing the IMF: Some Lessons from Modern Central
(speech to the Global Interdependence
Banking" Center, Philadelphia, March 9, 2006); D. Dodge,
"Making Global Economic Institutions Work-What the World Needs Now" (speech to the
Chicago Council on Global Affairs, Chicago, May 21, 2007); and M. Carney, "The Paradigm
Shifts: Global Imbalances, Policy and Latin America" (speech to the Inter-American Development
Bank, Calgary, March 26, 2011).
3
Countries that attempted to fix their exchange rate in the 1990s, and paid the price when their
"iPhones, iCrises and iTargets:
regimes collapsed, have adopted inflation targeting. See A. Rose,
Inflation Targeting Is Eradicating International Financial Crises in the iPhone Era," CEPR Policy
Insight No. 100 (May 2020).
4
Swap lines are agreements between two central banks to exchange currencies, with one of
them being a reserve-currency country. Reserve pooling involves access to a shared pool of
reserves that countries contribute to.
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in 2015 and the sell-off in emerging markets in 2018. The COVID-19 shock
dwarfs these in global scale and reach. In March 2020, capital flew out of EMEs
at a historic pace (Chart 1).
Chart 1: Portfolio flows to emerging-market economies declined sharply during
COVID-19 compared with previous shocks
Cumulative daily non-resident portfolio flows to emerging-market economies
US$ billion
20
0
-20
-40
-60
-80
-100
-120
t t + 1 t + 2 t + 3 t + 4 t + 5 t + 6 t + 7 t + 8 t + 9 t + 10
Number of weeks since start of episode
Global financial crisis (2008) Taper tantrum (2013)
China sell-off (2015) Emerging-market economy sell-off (2018)
COVID-19 (2020)
Sources: Institute of International Finance and Bank of Canada calculations Last observation: April 3, 2020
While the situation has since stabilized, capital outflows could happen again
when the largest economies start reducing the extraordinary stimulus put in place
to deal with the pandemic.
To address similar circumstances, EME policy-makers have used a variety of
measures, including restricting capital flows and intervening in foreign exchange
markets. These policies have gained increased acceptance, and there are
circumstances in which they are justified and can be effective in managing
shortrun pressures. At the same time, these policy interventions can thwart or delay
necessary adjustment in their economies and stunt the development of domestic
financial markets and products. For example, the use of capital controls and
foreign-exchange interventions-particularly the repeated use of them-can
undermine the longer-run development of deep and liquid domestic financial
markets. Appropriate guardrails are required to ensure that short-run actions do
not get in the way of needed development. Otherwise the short run can become
the long run.
There is another knock-on effect. Faced with elevated volatility, EMEs are taking
out more insurance by accumulating reserves (Chart 2).
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Chart 2: Reserve holdings by emerging-market economies remain high
Official reserve assets (including gold)
US$ billion
9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
0
China Emerging-market economies, excluding China
Source: International Monetary Fund International Financial Statistics Last observation: July 31, 2021
At a minimum, this self insurance looks globally inefficient. And this demand for
reserves is contributing to a shortage of reserve assets, which may be reinforcing
the decline in the neutral rate of interest. This in turn raises the risk of liquidity
traps and can lead to the buildup of financial vulnerabilities everywhere.
Turning to longer-run challenges, there are several. The first involves the
welcome evolution of countries from frontier to emerging to advanced
economies. As these economies grow and increase in importance, their
integration into the international monetary and financial system will become more
pressing. Early on, they may not have a well regulated and stable domestic
financial sector, or open trade and capital markets that promote economic
integration. The international community needs to develop and invest in a clear
long-run strategy to assist with the smooth integration of these countries into the
global system and to encourage them to adopt the rules that guide this system.
We've
A second longer-run challenge is the choice of exchange rate regime.
seen how a freely floating exchange rate may lead to excess volatility in
response to short-run disturbances. But to accommodate longer-run structural
changes that are essential for sustained development, some margin of flexibility
is needed. If nominal exchange rates remain fixed, then domestic prices and
wages have to adjust, and this can be protracted and painful. In particular, if
domestic prices and wages need to fall, this is likely to require an extended
period of weak demand and high unemployment. In the medium run, the real
exchange rate moves and the system adjusts, but the cost of forcing the
adjustment through all wages and prices can be steep. Worse still, if that
adjustment is also hampered by capital controls, external imbalances are likely to
persist and build. And if, as a result, the currency peg becomes unsustainable,
the country is likely to face an abrupt adjustment, and the effects are often felt by
the entire system.
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Vision and agenda for the 21st century
As we consider these challenges together, the right balance is crucial. We need
a vision for the international monetary and financial system of the 21st century in
which EMEs will form an increasing share of the global economy, while gradually
developing their financial systems. This vision for the long run cannot merely
focus on a utopian system where all participants have mature, well-regulated
financial systems, fully open capital accounts and exchange rates that are freely
floating. We must also be mindful that some are closer to the destination than
others. In discussing this vision, I want to focus on three priorities: the need to
find balance between short-run policies and long-run progress, the value of a
framework for currency intervention, and the need for global cooperation and
resources.
Over the past decade, the focus has been on widening the set of policies
countries use to deal with temporary external shocks. This is welcome and is
Institutional
reflected in the IMF's View. But there has not been enough attention
to ensuring that these policies do not impede longer-run progress. Many EMEs
seem to be settling for intermediate exchange rate regimes with more or less
regular foreign exchange interventions. This risks slowing needed structural
adjustments in the real economy. It also risks exacerbating the very pressures
these short-run tools seek to manage. By thwarting adjustment, they can cause
pressures to build up, leading to greater volatility.
Finding balance means allowing countries to respond to excess volatility or
disruptions in the short run while making the system flexible enough to adjust in
the long run. Progress has been made in the IMF's Institutional View, which
supports the use of macroprudential policy to manage financial stability risks.
And only if macroprudential measures are insufficient, should capital flow
management be considered. But more work is required to understand the
implication of short-run policies for longer-run financial development.
Currency intervention needs attention as well. A freely floating currency may not
provide as much benefit to some EMEs as once thought. Dominant currency
pricing reduces the benefits of exchange rate adjustment for some countries, and
currency mismatches on balance sheets increase the costs.5 But the system
needs guardrails to make sure currency intervention does not get in the way of
needed relative price adjustments. At the Bank, we would like to see the
development of a framework for exchange rate management similar to that in the
IMF's Institutional View for capital flow management. Such an agreed-upon
framework could guide managed floating exchange rate regimes to make sure
they do not stall adjustment in the medium to long run. The focus here should be
on a coherence between the choice of exchange rate regime and other policies.
In the end, policy-makers need to recognize that capital account and currency
interventions should be targeted to address specific concerns, and these
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interventions should be temporary. Over the longer run, countries should plan to
rely less on these policies as their financial systems mature. In the shorter run,
every time these interventions are used, a clear exit plan should be in place. And
the circumstances under which interventions may occur should be well defined,
so that an exit can be facilitated when conditions are no longer met.
Global cooperation and resources are also required to agree on a long-run vision
for the international system. Considerable resources have been devoted to the
management of short-term liquidity and volatility issues, and that has been
necessary and important. Global policy-makers need to balance this effort with
greater focus and resources to promote longer-term economic and financial
development. The IMF's multilateral role in surveillance is
essential-the global
system needs to be managed as a system. And the Financial Stability Board is
doing valuable work with peer review and assessments to strengthen adherence
to international standards. My hope is that we can build on these elements to
deepen the engagement of systemically important economies on an international
monetary and financial system that maximizes the benefits of economic and
financial integration.
In Canada's experience, the destination is one with open capital markets, robust
and transparent policy frameworks-including monetary, fiscal and
macroprudential policies-and enough exchange rate flexibility to promote the
timely and symmetric adjustment to shocks. Effective and legitimate multilateral
institutions are essential to this destination. To this end, continuing efforts to
improve the governance of these institutions are important. This includes
ensuring that IMF members are properly represented in their quota shares and
there are transparent and clear roles and responsibilities for each level of
decision-maker at the IMF.
Conclusion
Let me conclude here, so that we have enough time for a good discussion. I want
to leave you with a sense of urgency and purpose. The pandemic and the
looming challenges ahead, including climate change and digital currencies, make
it more important than ever that the international monetary and financial system
evolves. We need a clear long-run destination that everyone is committed to and
challenges in a way that doesn't
a framework to manage short-run derail us from
that ultimate destination. What we need is an international monetary and financial
system that can handle-even facilitate-the transitions to come, including the
exit from exceptional monetary policy, the transition to net zero emissions and
the potential digitalization of the international monetary system.
I look forward to discussing all of these issues with you. Thank you.