Reform of the IMS: Perspectives of East Asia’s Emerging Economies Yung Chul Park Korea University May 2011

I.Lesson of the 2008 Global Financial Crisis - Failures of global financial markets stemming from the information asymmetry, collective action problems and associated overreaction Euphoria, excessive optimism and herding Excessive risk taking and procyclicality in lending High degree of volatility of capital flows. -The overreaction and procyclicality lie behind the boom-bust liquidity cycle and financial crises 2

- Global liquidity, however defined, matters. - Excesses and shortages of global liquidity affect inflation, asset prices, and external imbalances. -In emerging economies, a sudden reversal of capital inflows has been a major cause of a reserve currency liquidity crisis.. This fear of the crisis has led to holding large amounts of reserves for self- insurance, thereby exacerbating the global imbalance. -Yet, there are no global institutions that can control the growth of global liquidity or volatility of capital flows 3

- Creating a Cooperative Arrangement among Major Central Banks: A Proposal Many of these problems could be mitigated or better managed, if a global central bank were to be created. There is no prospect for establishing a global central bank A second best solution is the creation of a cooperative arrangement among major central banks to serve as a quasi global lender of last resort. 4

- Membership :three groups of central banks The core group includes the US Fed, the ECB, the Bank of England, and the Bank of Japan The second group -central banks of the countries whose currencies are internationalized –such as Switzerland, Canada, and Australia The third group-other central banks of emerging economies active in international finance. 5

-Functions Monitor and exchange information on monetary policy of member countries to supply an adequate amount of liquidity to the global economy Provide a liquidity safety net through currency swaps, repurchase transactions and cross-border collateral arrangements Intervene in the foreign exchange market to stabilize major currencies and those of systemically important emerging economies within G-20 framework. 6

- Moral hazard problems if emerging economies are included? Once they have the liquidity backing, they may lose discipline in macroeconomic policy. liquidity support could be offered only to those suffering from a capital account crisis Emerging economies belonging to the network could share the burden by making available some of their reserves for swaps 7

II. Regional Liquidity Support -CMIM-ASEAN+3 Liquidity Support System Has never been activated: how effective is it? Adequacy of the pooled reserves ($120 billion) -More Regional Arrangements? How many more? And where? European Monetary Fund will be operated independent from the IMF? What about others? Without the IMF linkages, the regional arrangements would be prone to moral hazard? 8

III. New Global Role for SDR? -New SDRs are new reserve currencies-dollars, euros, and etc.. Supply is not controlled by any national central bank is its appeal and weakness -US is the only country that can supply liquid short term public debt instruments -Unclear how the elevation of SDR will help global macroeconomic adjustments or improve efficiency of global financial markets. 9