##istic to rely on the federal reserve to act permanently as an international lender of last resort. the imf can enhance its role as a contingent supplier of liquidity. in recent weeks, it has made tangible and sensible improvements to its lending programs by refining its flexible credit line, and adopting new a crisis - prevention instrument, the precautionary credit line. however, there are limits to this approach. as with lender of last resort to private entities, there can be moral hazard when lending to sovereigns. why extend credit to countries that have already bought expensive insurance in the form of foreign - exchange reserves that they do not use? how do you “ lend freely against good collateral ” at the sovereign level? countries can do most of the work themselves. private currency mismatches can be reduced through effective supervision, and measures to enhance the liquidity of local currency funding markets are essential. ultimately, sound monetary policy, sustainable fiscal policy, and robust financial supervision and regulation are the best defences against crises and contagion. conclusion the world ’ s economic centre of gravity is shifting. the effectiveness of the international monetary and financial systems will determine how rapidly this change will occur and how sustainable it will be. the current outlook is for continuation of a modest global recovery, balancing stronger activity in emerging market economies with weaker growth in some advanced economies. however, there are non - negligible risks on the downside. in particular, the current functioning of the international monetary and financial systems is beginning to force a wrenching real adjustment across major economies. renewed weakness in the united states could have important implications for the canadian outlook. in this environment, the bank will have to chart a careful course for canadian monetary policy. any further reduction in monetary policy stimulus would need to be carefully considered in light of the unusual uncertainty surrounding the outlook. a few months ago, the bank of canada analysed the potential difference between a cooperative path for the global economy based on the g - 20 framework and one in which markets forced fiscal adjustment and little else is changed. we estimated a possible shortfall in global economic output of $ 7 trillion by 2015 ( chart 5 ). since then, the toronto summit secured agreement on many of the right measures to make up this shortfall. however, the only measures that have actually been implemented have been consistent with the deflation path. while the other right promises have been made, conviction is required. adjusting to the current forces in the global economy requires finishing financial reforms, implementing

- sharing arrangement among its members would have to be agreed upon. a substitution account would create considerable moral hazard, since reserve holders would be tempted to engage in further accumulation. in addition, a substitution account would not address the fundamental asymmetry of the adjustment process. thus, it would appear essential that a substitution account mark the transition from the current hybrid system to an international system characterized by more flexible exchange rates for all systemic countries. given the scale of international asset positions, progress on financial reforms is essential. these are also proceeding with a focus on three core issues : improving the resiliency of institutions ( raising the quality and level of capital ) ; building robust markets ( improving infrastructure and enhancing transparency ) ; and, reducing interconnectedness between institutions ( macroprudential management of systemic risk ). in each regard, interim measures have already been taken. most notably, china ’ s recent decision to enhance the flexibility of its exchange rate is welcome and its full implementation would contribute to strong, sustainable, and balanced global economic growth. european countries have taken measures to consolidate their fiscal positions and have conducted stress tests on their banks. the oversight board of the basel committee has released a broad detailed agreement on new definitions of bank capital and liquidity. with the macro analysis of tightening standards pointing to large net benefits, the calibration of these proposals will be decided shortly. successful implementation of the g - 20 financial reform agenda, when combined with the peer review process of the financial stability board ( fsb ) and external reviews by the imf, should increase actual and perceived systemic stability and thereby reduce incentives for reserve accumulation. this is a necessary condition for a more open, flexible, and resilient international financial system. the g - 20 framework will be buttressed by institutional changes currently underway. the g - 20 is now the premier forum for international economic cooperation. imf governance reforms will further enhance the fund ’ s legitimacy and effectiveness. over time, the fsb has the potential to become the fourth pillar of the bretton woods system. its expertise and broad membership should yield comprehensive and integrated global financial regulations. this will be essential to ensure ongoing cross border flows and to limit regulatory arbitrage and associated leverage. the final piece of the puzzle is the role of the imf itself. the crisis exposed enormous strains caused by currency mismatches and large international gross asset positions. these are not best addressed by further building international reserve positions concentrated in the same currencies. it is also unreal