A Modest Proposal for the G-20

BEIJING – In March, at a meeting in Beijing organized by Columbia University’s Initiative for Policy Dialogue and China’s Central University of Finance and Economics, scholars and policymakers discussed how to reform the international monetary system. After all, even if the system did not directly cause the recent imbalances and instability in the global economy, it proved ineffective in addressing them.

Reform will, of course, require extensive discussion and deliberation. But the consensus in Beijing was that the G-20 should adopt a modest proposal this year: a limited expansion of the International Monetary Fund’s current system of Special Drawing Rights (SDRs). This proposal, while limited in scope, could play an important role in initiating discussion of deeper reforms while helping to restore the fragile world economy to health and achieve the aim expressed in the G-20’s Pittsburgh declaration: strong, sustainable, and balanced growth.

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We suggest that SDRs’ role be expanded through new issues and by increasing their use in IMF lending. Doing so would build on the enlightened suggestion made at the G-20’s London meeting in April 2009 to issue SDRs equivalent to $250 billion, which was then quickly implemented. The G-20 could suggest that the IMF issue a significant volume of SDRs over the next three years. We would suggest, for example, an issue of SDR150-250 billion annually (approximately $240-390 billion at current exchange rates).

Such a measure would have several positive effects. First, it would reduce the recessionary bias in the world economy, especially during crises and in their aftermath. Many countries continue to accumulate high levels of precautionary reserves, especially to avoid future crises stemming from reversals on their capital and trade accounts. Recent financial crises have taught countries that those with large reserves are better able to weather the vicissitudes of international financial markets.

While such reserve accumulations help protect countries, in certain periods they reduce global aggregate demand. Given its relatively small scale, the annual issue of SDRs would only partly offset these deficiencies, but it would nonetheless help sustain and accelerate global recovery without causing inflationary pressure. Moreover, reducing the need for countries to set aside funds for reserves would also facilitate some reduction of global imbalances.

Ideally, additional issuance of SDRs would be accompanied by further measures to increase their effectiveness. For example, countries’ unused SDRs could be held as “deposits” by the IMF, which the Fund could then use to finance its lending programs. This should be understood as the first step toward integrating “general resource” and “SDR” accounts into a single IMF account, and to increase the SDR’s role in IMF transactions so that it eventually becomes the main – or even only – mechanism for IMF financing. During a declared crisis, IMF lending should be financed entirely by new SDR issues in unlimited amounts.

A working group could be established to study other reforms that would enhance global financial stability further and address other global economic and financial objectives. For example, alternative systems of SDR allocation, with a greater proportion of SDRs given to countries actually demanding the reserves (mainly developing countries), might contribute to global growth and stability. One advantage of this modest proposal is that it would not prejudice the outcomes of the working group on broader reforms, like new distribution formulas for SDRs. The issuance of additional SDRs, while contributing to global stability today, would not alter in any fundamental way existing monetary arrangements.

We suggest that this proposal be discussed at forthcoming meetings of the G20.

The G-20 showed its effectiveness in responding to the crisis that erupted in 2008. The question today is whether, with the moment of crisis passing and countries’ circumstances and perspectives diverging, the G-20 can demonstrate the leadership the world needs in addressing its ongoing critical problems. A failure to take concrete action would risk breeding disillusionment. Our proposal would reaffirm the G-20’s continued leadership in ensuring greater stability and sustained growth in the world economy.