International Financial Crisis: 2007-2010: Tipping Points

The Global Financial Crisis: Lessons Learned and Challenges for Developing Countries

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The broader lesson of this crisis is that globalization of trade in both goods and services, such as tourism , finance in both the availability and cost of credit , and labor in terms of the direct and indirect demand for labor and the flow of remittances had tied countries together to a much greater extent than they had been for about a century, since the early s. This reality was underappreciated.

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The consequence is that in today's world any crisis that affects a major country or group of countries in the global economy or financial system will have some, largely adverse, effects on all other countries. It follows that the citizens and authorities of all countries, large and small, have a common interest in the quality of the economic and financial policies in other countries, in particular in the systemically important countries.

The conventional wisdom is that the global economic and financial crisis began in the United States and essentially was caused by some combination of the economic, financial, regulatory, and supervisory policies in the United States and possibly those in other traditional industrial countries. Conventional wisdom also contrasts this crisis with other international financial crises during the past four decades with their origins in developing and emerging-market economies in Latin America, Asia, or the region dominated by the former Soviet Union. It follows from these two bits of conventional wisdom that the emerging and developing economies should be held blameless for the crisis and that they have been adversely affected by the crisis through no fault of their own policies.

These two elements of the conventional wisdom are respectively incomplete or incorrect. The first bit of conventional wisdom is incomplete because the policies of systemically important countries other than the traditional industrial countries played a role in the crisis, in particular the exchange rate and other policies of countries with very large current account surpluses, such as China and a number of the oil-exporting countries. The second bit of conventional wisdom is incorrect because many international financial crises of the past four decades had their origins in or linkages to developments in the traditional industrial countries, for example, the stock market crash of , the collapse of the Exchange Rate Mechanism in Europe in , and the tightening of financial conditions in In the current context, the most relevant example was the global debt crisis of the s.

That crisis was associated with overly easy macroeconomic policies in the s in the traditional industrial countries, in particular the United States, that contributed to global inflation and the subsequent global recession, after the US authorities learned their painful lesson. The crisis also was associated with inadequate supervision of the lending activities of internationally active banks.

Whatever the merits of the two bits of conventional wisdom, the conclusion that emerging and developing countries should be held blameless also does not follow so neatly. It is true that many countries have been caught up in this global crisis as a consequence of no precipitating policy actions by their own authorities other than endeavoring to participate fully in the global economy and financial system. However, the central lesson of this crisis, as with any crisis of any scale that I have witnessed for the past 40 years, is "be prepared. Being better prepared has two broad consequences.

First, a country will be better off in the face of a global crisis if its own vulnerability is limited, for example, if its fiscal affairs are reasonably stable, if its inflation rate is low, its internal and external debt position is sustainable, and if its exchange rate is flexible. Second, a country will be better off, if it has preserved the room to maneuver to respond to external shocks through the use of domestic policy instruments, primarily fiscal and monetary policies. The good news is that many emerging and developing countries in many regions of the world in found themselves in dramatically better positions to deal with the external shocks associated with this crisis than had been the case in the past.

Ask yourself what would have been the impact on countries, such as Brazil and Mexico, if going into the crisis their economic policy fundamentals had looked more like they were in at the outbreak of the Global Debt Crisis, in at the time of the Tequila crisis, or in at the start of the Asian financial crisis. The impacts on those economies would have been much more severe, following from their greater vulnerability to shocks.

In addition, a number of the countries would not have had the capacity to adopt countercyclical measures. For most emerging-market and developing countries, this capacity was largely absent in other global economic crises in recent decades. The scope to use countercyclical policies has limited not only the direct negative effects of the crisis on these countries, but also the indirect effects on other countries. It should be noted that not all countries were equally prepared for the global financial crisis.

The policies and circumstances of some countries not only made them vulnerable to contagion, but they also had little or no room to cushion the effects of the slowdown in the global economy, the deleveraging of the global financial system, and the increase in risk aversion. Thus, for example, a number of countries in Eastern Europe and elsewhere have found it necessary to turn to the IMF for assistance designed to support strong programs of economic policy reform that in most cases would have been needed eventually in the absence of this crisis. In some cases, these countries probably would have had their own crises without the contribution of the global meltdown.

A second group of countries, including three in Central America, is in a second category. They have been adversely affected by the global crisis, and their ex ante economic and financial policies and circumstances, while generally prudent, were not sufficiently robust to provide absolute assurance that they would be able to withstand the effects of the crisis.

These countries have found it wise to turn to the IMF for precautionary stand-by arrangements, some with high access, that involve adjustments in economic and financial policies, as well as countercyclical measures in some cases, and the possibility of drawing on the Fund if their circumstances worsen. Colombia, Mexico, and Poland. These are countries whose past policy records and current economic circumstances have qualified them for potential financial assistance without the immediate need to make policy adjustments.

The clear be-better-prepared lessons from the crisis are two: First, those countries that were better prepared in advance of the crisis have been better able to deal with its effects. Second, going forward, more countries should endeavor to adjust their policies so that they are prepared, or better prepared, to deal with the inevitable global crises of the future, including through the adoption of countercyclical measures. Should countries seek to self-insure against future crises by building up their foreign exchange reserves in order to prepare better for future crises?

In my view, this is the wrong lesson to learn from this global crisis. Countries should self-insure against future crises by putting in place as best as they can robust economic and financial policy frameworks. One element of that type of self-insurance should be adequate holdings of foreign exchange reserves, but alone that is insufficient. Large holdings of foreign exchange reserves provide an expensive buffer against a global financial crisis. They also can lull the authorities and economic agents into a false sense of security while potentially distorting the functioning of the global economy and financial system.

Take the case of South Korea. This country is now classified by the IMF as an "advanced country. Net capital inflows accounted for the rest of the increase in reserves. However, these developments were insufficient to protect the Korean economy from a sharp growth slowdown in to an IMF-estimated 2. From the start of the global financial crisis in August through February of this year, the Korean won depreciated on a real effective basis by 36 percent, according to the BIS data. The depreciation was 24 percent from July Although the won has since recovered by about 10 percent, the central lesson is that Korea's massive build-up of foreign exchange holdings did not self-insure that country against severe economic and financial strains as a consequence of the global financial crisis.

The Korean experience points to a second lesson: Gross financial flows are more relevant than net financial flows. Korea's current account surpluses in did not stop it from going into deficit in as global trade collapsed and prices of imported commodities soared. As the global financial crisis evolved, those inflows reversed, putting pressure on Korea's exchange rate, reserves, and economy.

These reversals have given rise to huge refinancing needs. Thus, it was the gross inflows that mattered, not the net surplus on the current account or the net accumulation of international reserves. Of course, Korea would have suffered more if it had had large current account deficits in the period before the crisis, or if it had held negligible foreign exchange reserves when the crisis hit, but its huge reserve holdings alone were inadequate to self-insure Korea from the crisis. It was the gross financial inflows not the net surpluses that were the warning sign.

A year ago, the International Monetary Fund was on the sidelines of the global financial crisis. Some observers bemoaned that fact. Other observers saw it as proof of the Fund's irrelevance in the 21st century. As the crisis developed, those of us who had been pressing for years for meaningful IMF reform to reestablish its legitimacy and relevance saw opportunity in crisis Truman The global financial crisis has produced three major lessons on the role of the IMF for its members, including the developing countries: On IMF financing, the clear lesson from the crisis for members of the Fund is that the IMF has an important, continuing role in providing potential financing to member governments in precrisis, incipient-crisis, and actual-crisis situations.

The lesson is that in today's global economy and financial system, financial crises are inevitable. We can hope that efforts to improve the global adjustment process and to implement financial reforms at the national and international level will be successful in limiting the virulence of future financial crises, but that is the most we can expect.

Meanwhile, the IMF must have adequate resources to assist its members when crises occur. The days of starving the IMF for financial resources should be behind us. Fortunately, the G countries and the general membership of the Fund through the International Monetary and Financial Committee have signaled that they have learned this lesson.

International Financial Crisis: 2007 - 2010 TIPPING POINTS

However, if the members of the IMF stop at this point, they will not have fully learned the lesson from this crisis. Unfortunately, I expect that, as the economic and financial effects of this crisis wane, IMF skeptics and critics will reemerge and once again renew their campaign to starve the IMF of the financial resources needed to allow the Fund to deal with financial crisis. The challenge for all IMF members and, in particular, for emerging and developing countries will be to overcome this resistance in the context of the accelerated review of IMF quotas and governance arrangements that is to be completed by January The resulting agreement should contain three major financial elements: If the IMF's financial role can be solidified for the future in an agreement reached 18 months from now, the benefit to emerging and developing countries as well as all members of the IMF will be substantial.

However, in order to achieve this agreement, another lesson from the crisis for the role of the IMF must be learned and applied by its members: Achieving an improvement in the global adjustment process must start with a global economic recovery and expansion over the next decade that is better balanced than was the case over the past ten years in which, to cite the usual example, there was too much reliance on demand from the US consumer.

The major advanced economies must follow more-responsible fiscal and monetary policies than was the case over the ten years prior to the outbreak of the global financial crisis. However, improved policies of the major advanced countries the G-7 countries will be insufficient by themselves to achieve the necessary balance in an expanding global economy unless other systemically important countries, including the large emerging-market economies, also follow responsible fiscal, monetary, and exchange rate policies. In particular, the latter group of countries must eschew policies directed at building up large foreign exchange holdings via the competitive nonappreciation of their currencies.

The pursuit of such policies would distort the global adjustment process and undermine the sustainability of the global expansion. Thus, the lesson from the financial crisis for the role of the IMF in adjustment is that the members of the Fund must allow the management and staff of the IMF to aggressively promote policies supporting balanced global economic expansion and police the adherence of all members of the IMF to their exchange rate obligations.

Moreover, unless all members of the IMF commit themselves to learn this lesson, it will be difficult to reach international agreement to apply the first IMF lesson and ensure the IMF has sufficient financial resources for the future. This points to the need for a grand bargain. Turning to the global financial system, the overarching lesson for the IMF members is that the financial system is global.

As a global institution, the IMF has a major role to play here as well, in cooperation with other institutions such as the Financial Stability Board and the World Bank. Developing countries have a strong interest in the Fund's success in this area.

Global financial crisis: five key stages 2007-2011

That is one of their challenges. All developing countries have been affected indirectly by the financial tsunami that has swept the global financial system. In addition, a number of developing countries have been directly affected by failures of national and global financial supervision and regulation. For example, the IMF a, has detailed the "unwelcome surprises of the global financial crisis" for Brazil, Mexico, and other emerging-market economies with respect to corporate losses on foreign-currency derivative contacts.

Financial supervision and regulation will remain for the foreseeable future predominantly a national responsibility, but with international consequences as we have seen. Successful coordination of those efforts via the Financial Stability Board will benefit all countries. Moreover, the IMF has a major role in monitoring the adherence of member countries large and small to agreed international standards and in exercising surveillance over the stability of national financial systems.

That is a major lesson from the global crisis. These issues include the monitoring of international capital flows gross and net, establishing a better understanding of the role and effectiveness of restrictions on capital movements, and examining the possibility of amending the IMF Articles of Agreement to update the role of the IMF in this area, which currently is somewhere between obscure and ambiguous.

An underappreciated and dangerous area of lessons from the global financial crisis involves the future of globalization. Don't turn back on globalization. I have no doubt that the progress, and I use that word deliberately, of globalization was an important contributor to the scope and scale of the global financial crisis. The growing integration of the world economy via trade, financial, and other channels guaranteed that any economic and financial crisis on the scale that the United States and other advanced countries have experienced would become global in scope. What lessons are being learned about globalization, in contrast with lessons about the economic and financial policies of the major advanced countries?

And are the right lessons being learned?

Statements of global political leaders, for example at the Washington and London G summits, have explicitly rejected rolling back the globalization trends over the course of the sixty years following World War II. By agreeing to new measures to support and enhance the roles of the international financial institutions, such as the IMF, the World Bank, regional development banks, and the Financial Stability Board, the leaders have given substance to their good intentions, though they have not yet delivered on all their promises. In addition, in G meetings and other forums leaders and ministers have pledged to resist protectionist pressures in trade and finance.

Financial crisis of 2007–2008

In this regard, actions have fallen substantially short of pledges, but the situation could be worse given the collapse of world trade and financial flows and the wrenching effects of the overall crisis on national economies and financial systems around the world. Many of the lessons that I have outlined in these remarks, if I am correct and if those lessons are learned, would be consistent with a continuation of the globalization trends of recent decades albeit with the application of a substantial amount of mid-course correction. However, there is no assurance that these lessons will be learned.

If these lessons are not learned, then I fear that the course of globalization could well go into reverse. The risk is that the globalization trend will be replaced with inward-focused regionalism, selfish nationalism, and disguised and overt protectionism. Learning the right lessons from the global financial crisis of is a challenge not only for the leaders of the advanced economies and the larger emerging economies whose policies individually and collectively will determine the evolution of the global economy and financial system over the next several decades.

Learning and applying the right lessons is a challenge for the leaders of smaller emerging and developing economies that will have to live with the consequences. Their own words should be clear, and their policies should be examples for all of us. This is the most difficult lesson. Financial Stability Report , no. World Economic Outlook April.

Recommendations of the Issing Committee Preparing the G Peterson Institute for International Economics. See, for example, IMF for a broader treatment of recent housing booms. The Bank of England and Issing et al. Decoupling is again fashionable in describing prospects for the global recovery.

I think we should have learned our lesson. It is natural that some countries will emerge from recession before others, but that is not quite the same. The latest estimate is that global growth, on a purchasing power parity PPP basis, was 5. This requires you to provide the URL for each allegedly infringing result, document or item. I have a good faith belief that use of the copyrighted materials described above as allegedly infringing is not authorized by the copyright owner, its agent, or the law.

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Global financial crisis: five key stages | Business | The Guardian

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