Christian Noyer: G20 roadmap - how finance can help rebalance the
world economy
Introductory speech by Mr Christian Noyer, Governor of the Bank of France and Chairman of
the Board of Directors of the Bank for International Settlements, at the Paris Europlace
Financial Forum, Paris, 6 July 2010.
* * *
Before I start let me thank the organizers for inviting me to this conference: they have
managed to put together an outstanding program and it is a great pleasure for me to
exchange views with the other participants in this round table.
I was asked to introduce the discussion on "G20 Roadmap: How Finance Can Help
Rebalance the World Economy". The title of this session contains some of the most
important concepts on the current policy agenda: "finance", "rebalancing the world economy"
and "the G20 Roadmap". Let me take them in turn.
"Finance", first. Since 2008, the world is going through the deepest financial crisis since the
second World War, and hence never before has the word finance been so crucial in the
policy agenda. This financial crisis has had very high real costs: real output, industrial
production, trade flows, to name just a few key variables, have contracted markedly during
the crisis. In addition, the fiscal positions and the public debt of many countries have also
deteriorated markedly in the past two years. Yet, it is important to recall that these real and
fiscal problems largely stem from the financial issues that plagued our economies in the past
decade. Indeed the financial sector, with the help of financial innovation and loose regulation
fostered unsustainable growth and asset price bubbles, and if trade linkages have
contributed to spread the crisis across countries, financial integration has fostered the
contagion. So, yes finance matters and is the heart of the real economy.
the world
"Rebalancing economy", next. In the years leading to the crisis, the global economy
was growing at unprecedented speed: above 5% per annum in 2006 and 2007, far above the
average recorded in the decade from 1992 to 2001, at 3.1%. Yet, this growth was
unbalanced, both internally and across countries, such that it was, as it turned out,
unsustainable. In fact, the global policy agenda in the mid- to late 2000s was dominated by
the issue of global imbalances: current account positions widened to unprecedented
amounts (at least by modern standards), reflecting strong saving-investment gaps: to many
observers, household saving was strikingly low in the United States, while emerging Asia
was characterized by a "global saving glut", in the words of Chairman Bernanke. These
global imbalances have adjusted markedly in the wake of the financial crisis, but this
rebalancing has been mostly cyclical and the issue remains.
Let me now turn to the third important keyword of this session, the G20 Road map.
With the intensification of the crisis, it has become obvious that the G20 was the right, -
because the most legitimate - forum to prepare the policy response. And the G20 fulfilled the
most optimistic anticipations as it reacted promptly and strongly to the crisis. Beyond this, the
G20 has also agreed on an ambitious policy agenda, aiming for the long run. The
G20 Roadmap does not only aim at one particular aspect of the global economy; it is very
encompassing. One aspect of it is macrorebalancing, another is on financial regulation and
global financial safety nets. The G20 agenda is focused on crisis prevention by coordination
in order to avoid, or at least dampen overheating and boom/bust cycles.
How are these issues related? First I will briefly tackle the important question of the link
between the financial crisis and global imbalances. Second, I will go through the main
implications of this link and outline the key features of the policy agenda of the G20. In this
second part I will mostly focus on the so-called "G20 Framework for a Strong, Sustainable
and Balanced Growth" and on financial safety nets. In the last section I will focus on financial
regulation issues more specifically.
Why and how do the financial crisis and global imbalances interact?
An overwhelming body of research has established the clear relation between global
imbalances and financial issues, some of which were behind the financial crisis. Indeed,
global imbalances were not just the result of cyclical factors, such as business cycle
fluctuations, changes in oil and other commodity prices, etc. They were also, and to a large
extent, the result of deeper, structural factors, as illustrated by the link between global
imbalances and asymmetries in financial development. Ricardo Caballero focuses for
instance on the notion of asset shortage: as safe financial assets were not readily available
in some regions of the world (emerging Asia noticeably), net savings in these regions were
channeled to the United States, which, in lowering financial constraints, amplified the current
account deficit of this country. One may actually wonder whether this also partly contributed
to the development of a financial bubble in the United States. The key idea I would like to
take from this literature is that finance most certainly played a key role in the emergence of
global imbalances.
How and why may the G20 Roadmap help financial soundness and global rebalancing
As the global economy is recovering from the crisis, the G20 roadmap aims first at ensuring
the transition to a strong, sustainable and balanced growth. By "strong", we mean that growth
should converge to the growth rate of potential output over the medium term whereas that
potential is enhanced by the implementation of more effective structural policies.
"Sustainable" growth should be consistent with public finance sustainability, price and
financial stability, along with social and environmental policy goals. Finally, "balanced" growth
implies a growth that is broadly based across all G20 countries and all regions in the world,
and as I said earlier, that should not generate persistent and destabilizing internal or external
imbalances. "Balanced" growth also implies to facilitate the catching up of developing
countries (and the taking off of the poorest). Drawing the lessons from the crisis, growth
cannot be strong without being sustainable and cannot be sustainable if it is not balanced.
The so-called "Framework for Strong, Sustainable and Balanced Growth" is the key
mechanism by which G20 countries work together to achieve these objectives. With support
from the IMF, G20 countries are going through a mutual assessment process by sharing their
policy frameworks, programs and projections and assessing their consistency with the
common objectives. This process will lead the G20 to recommend policy options to its
members. Policy options obviously depend on national circumstances. Countries facing
serious fiscal challenges need in particular to accelerate the pace of fiscal consolidation,
while countries that have the capacity should expand domestic sources of growth and help
cushion a decline in demand from other countries. Reforms of social safety nets will be
essential in both cases and structural reforms of the product and labor markets will be key to
foster stronger growth in the medium and long run. Policy options may also entail exchange
rate adjustments consistent with smooth rebalancing.
In search of global financial safety nets
There is another side to rebalancing where finance matters.
Starting with the Asian crisis of 1997-1998 and up until the global shortage of liquidity that
took place in 2008, many emerging countries have experienced sudden stops of capital
inflows on a recurrent basis. The international financial architecture as it was before the crisis
lacked appropriate tools to deal with volatility in global capital flows and to prevent crisis
contagion. This was an incentive for emerging countries to self-insure against global liquidity
shocks by accumulating international reserves or protect themselves through capital flows
control, both distortive types of protection.
Reserve accumulation is costly to emerging economies as they have to restrain consumption
and forego profitable investment opportunities in order to buy the low-yield assets that
usually constitute reserves. It also has global consequences. For those emerging market
economies that ran a current account surplus to accumulate reserves, the process has
contributed to current account imbalances. This is why finance has an important role to play
to help these economies effectively deal with capital volatility. A lot has already been done by
G20 countries and international institutions since the beginning of the crisis. Central banks of
large advanced countries have set up swap arrangements with some emerging countries.
The International Monetary Fund has created a precautionary lending facility: the Flexible
Credit Line. A general SDR allocation of USD 250 bn has been agreed in the London summit
of April 2009 and out in place.
However, there is still scope for improvement and further work is currently being done to
improve global financial safety nets. In their meeting in Busan earlier this month, Finance
Ministers and Central Bank Governors of the G20 have "acknowledged a need for national,
regional and multilateral efforts to deal with capital volatility". A Financial Safety Net Experts
Group has been set up to work on the issue.
The reform of financial regulation
The financial crisis as taught us some very hard lessons. While there are many causes to the
crisis, it is clear that it forces us to reconsider the way we regulate and supervise the financial
system. That is what we have been doing since the November 2008 G20 meeting.
We entered this crisis with many unregulated entities playing a major role in the financial
system. There were, therefore, huge "black holes", including what has been called a "shadow
banking system" where most of the excesses of securitisation took place. The G20 has
fostered coordinated efforts by industrialized and emerging countries alike to bring most
important financial actors under the umbrella of supervision, with rating agencies and hedge
funds receiving a larger degree of attention. Beyond these actors, the G20 and the Financial
Stability Board (FSB) in particular have been instrumental in efforts aimed at enlarging the
scope of financial regulation to make sure that the systemic importance and
interconnectedness of institutions, markets, instruments no longer escape our vigilance.
Naturally, the necessary reform of OTC derivatives markets has gained traction and the
G20 has set a very clear roadmap on these matters. Efforts aimed at integrating these
markets into regulated and supervised market infrastructures are indeed an essential policy
response to risks accumulated in these markets.
However, the crisis has not just shown us that we should expand the scope of regulation and
supervision. In fact, two clear trends have emerged and are greatly affecting the very nature
of regulation. The first observable trend is that we must complement micro-supervision with
macrofinancial supervision: this macroprudential approach has in fact developed in many
countries. The second trend is that regulation needs to become more global in response to
the globalization of finance. In that respect, the commitment by all G20 jurisdictions to
implement Basel II by 2011 and to finalize this year a new package aimed at strengthening
bank capital and liquidity standards is a great achievement.
We are confident that making tangible progress on each of these fronts is an essential
response from policy makers to the roots of the global financial crisis. To some extent, the
ultimate aim of financial regulation has to do with financing the real economy. Sound
regulation should enable the stable provision of financial services to economic agents as
they strive to finance their productive investments and consumption, which constitute the fuel
for growth. Banks are central to the financing of economic activity because they perform
maturity and liquidity transformation as well as a credit risk screening function. This is
especially true in continental Europe, where they are responsible for more than 80% of
financial intermediation. This is why the current focus on enhancing banking regulation is
right and progress on key reforms to strengthen bank capital and liquidity standards remains
a top priority. The recent reform package of the Basel Committee will lead to a much more
robust and resilient banking system in the future, with both a stronger capital and liquidity
base than before the crisis. The challenge, now, is to calibrate and phase in the new
framework in a way that does not impede the recovery and does not contradict our
macroeconomic objectives. The macroeconomic assessment of the reforms underway will
help us strike the optimal balance.
We must also reduce procyclicality. Some of the procyclicality can be trimmed through
prudential regulation but I strongly believe that our first line of defense against procyclicality
should be the accounting framework. I therefore support the current focus on reducing the
scope of the mark-to-market approach and moving from an incurred loss model to a
forward-looking model for provisioning.
Conclusions
To conclude, the main challenge ahead of us is to find the right balance between all these
measures and the short-run effects of the rebalancing. If the rebalancing process happens
too fast, it might weaken the recovery; but if reforms are delayed too much, the longer-run
growth prospects will be affected negatively. One very important issue to focus on while
analyzing this trade-off is that policy decisions need to be perfectly coordinated across
countries. The crisis has demonstrated that it was necessary, and that it was possible. I am
confident that the G20 Roadmap is the right approach to this coordination problem. We will,
under the French leadership of the 2011 G20, pay due attention to the smooth
implementation of this process.