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Managing the Global Factor Better

The IMF is the body best suited to serve as a trusted adviser and an effective conductor of the global policy orchestra. If it is to fulfill that role, however, it must strengthen its credibility as a responsive and effective leader. That means listening to its members, then guiding them toward more harmonious policies.

SEATTLE – Imagine a world in which the annual meetings of the International Monetary Fund were more client-driven. Ahead of the gathering – this year’s will take place in Indonesia in October – the IMF would solicit from its 189 member countries three key policy issues on which to focus, not only in official discussions, but also in the numerous seminars that are held in parallel. The result would be an agenda that responded better to the continued anxiety that a growing number of policymakers – and populations – are feeling.

For much of the decade since the global financial crisis erupted, countries worldwide have been subject to what London Business School’s Hélène Rey and others have called “the global factor”: a set of external influences that countries cannot manage or control, but that play an important role in determining key domestic variables. This has generated economic and financial volatility that has complicated internal policy management, fueled political polarization, and exacerbated social divisions.

US President Donald Trump’s “America First” approach has tended to amplify international feelings of uncertainty and insecurity, especially in Asia. Now, beyond having to cope with big changes in capital flows, interest rates, and currency movements, these countries must adjust to the reality that they may not even be able to count on some of their basic, long-standing assumptions about international trade.

But this is not just an emerging-economy problem. Despite attempts to boost resilience, including through both micro- and macro-prudential measures, much of the world remains vulnerable to the global factor.

Of course, countries with existing domestic economic and financial vulnerabilities are generally the first to face disruptions. But even in better-managed economies, external factors are affecting local financial conditions in ways that can have little to do with domestic fundamentals.

In Switzerland, for example, the major economic-management challenges of the last few years have had more to do with spillovers from the eurozone than homegrown problems. In confronting these challenges, the authorities have been forced to implement some distortionary measures – most notably, highly negative interest rates.

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Some of these destabilizing dynamics could well intensify over the next few months, for two reasons. First, central banks will remain on the path toward monetary-policy normalization – albeit at different speeds – after many years of ultra-loose measures focused on repressing financial volatility. As a result, financial conditions for much of the emerging world are likely to become tighter and more unpredictable.

Second, advanced economies’ performance is diverging, with growth in the United States accelerating, and Europe and Japan losing economic momentum. This will place even greater pressure on interest-rate differentials, already at historical highs, and fuel exchange-rate volatility.

Beyond their economic consequences, these trends are likely to exacerbate political and social tensions. After all, the effects of both trends can be difficult to grasp without a decent understanding of quite complicated market structure and technical factors. This will make the monumental challenges ahead difficult to communicate to the public, leaving many feeling confused, insecure, and frustrated.

The IMF can and should help its members address these challenges by assuming a larger role in providing analysis and leading more effectively discussion in pivotal areas. In such a world, the Fund’s agenda would emphasize bolder action in three areas.

First, at the country level, in addition to focusing on general questions of economic resilience, the IMF would examine the scope for effective “sand-in-the-gears” measures to be implemented during the more extreme stages of global liquidity cycles, including to counter disruptive technical forces. Such an approach would be a natural extension of the work that has been done on micro- (institution-focused) and macro- (system-focused) prudential measures.

Second, at the institutional level, the IMF would continue to push hard for measures to track and address spillovers and spillbacks, including the incorporation and expansion of financial linkages that are superior in terms of monitoring, program design, and early-warning mechanisms. This would prevent the tail of obscure financial instabilities from wagging the dog of the real economy. The importance of such measures was highlighted earlier this year in Argentina, where a traditionally well-designed program was effectively derailed in just weeks by unanticipated technical developments.

Third, at the multilateral level, there is a need for more frank, genuine, and cooperative discussion about the cross-border effects of individual countries’ policies. Such discussion must acknowledge the failure of past efforts to address the issue, as well as the costs of deepening fragmentation of the international monetary system. This will inevitably raise issues of fair representation and governance in multilateral institutions, as well as the persistent bias in the system’s response to large imbalances and to divergence in economic and policy performance.

Without progress in these three areas, the unsettling puzzles and disruptive policy challenges facing many countries around the world will remain largely unresolved. This will raise the risk that countries will implement policies that not only conflict with those of their neighbors, but that may also end up being sub-optimal at home.

The IMF is the body best suited to serve as a trusted adviser and an effective conductor of the global policy orchestra. If it is to fulfill that role, however, it must strengthen its credibility as a responsive and effective leader. That means listening better to its members and then helping them more effectively to iterate more harmonious policies.

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