TEXT: Bank of Canada Governor Mark Carney’s speech

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 unrealistic 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 co-operative 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. 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 greater
exchange rate flexibility, and putting in place a series of
structural policies.

G-20 nations have started, but completing the job will
require renewed faith in an open, flexible, and market-based
international monetary system.

TEXT: Bank of Canada Governor Mark Carney’s speech