How much attention do we need to pay to the global economic 'Plan B'? This question was the subject of a G20 high-level seminar on the international financial architecture in Paris last week and is sure to occupy the attention of policymakers at the 2016 IMF and World Bank Group Spring meetings — and the concurrent meetings of G20 Finance Ministers and Central Bank Governors — in Washington next week.
First of all, what is Plan B?
The global financial safety net is the world's Plan B. It consists of a range of arrangements that are global (the IMF), regional (regional financing arrangements), bilateral (swaps among central banks) and national (international reserves and private market-based hedging instruments) in scope. Together, these arrangements act to minimise risks of economic and financial crises occurring, reduce the spread of contagion when a crisis occurs and provide support to help countries hit by a crisis. In short, it acts as insurance for sovereigns.
So why do we need a Plan B, anyway? What is Plan A and why is it not working?
The macroeconomic backdrop that will underpin the 2016 IMF-World Bank Spring meetings makes for an unfortunately familiar story. The global economy ambles through the same sluggish recovery following the global financial crisis, with growth too low and unemployment too high. Financial markets may have settled in the month since G20 Finance Ministers and Central Bank Governors met in Shanghai, but it seems likely that the IMF will take the opportunity to downgrade its 2016 forecasts when it publishes the updated World Economic Outlook. And as Larry Summers recently highlighted, we remain as close as one major negative shock away from a global recession.
The best part of the policy toolkit, in the recent words of Australian Treasury Deputy Secretary and Australian G20 Finance Deputy Nigel Ray, remains strong economic frameworks and policies – that's Plan A. But the February G20 Finance Ministers meeting in Shanghai gave little confidence that policymakers are acting strongly to restore their credibility and address economic vulnerabilities and risks. They will get another chance next week to express stronger collective will to address near-term economic challenges. But life will continue to difficult for would-be reformers, given the policy preconditions of public debt at heightened levels, monetary policy rates near the lower bound, and a lack of political support for difficult, but necessary, structural reforms.
The more challenging the path for Plan A, the more attention needs to be paid to the Plan B. And we should be genuinely worried that the IMF thinks that the global financial safety net is not adequate. Global financial defences haven't kept up with the growth of external debt, and a negative global shock has the potential to overwhelm the safety buffers. Current safety net arrangements are costly, not structured to provide the right incentives for countries to pursue sound macroeconomic policies on their own accord, and newer regional elements such as the BRICS Contingent Reserve Arrangement, are of doubtful effectiveness.
The Plan B does work for a small subset of very rich countries. These are the countries that issue reserve currencies and can get foreign currency liquidity when needed through unlimited and permanent central bank swap lines. Think the US, UK, Switzerland, the broader euro area and Japan. In the financial safety net, there is no substitute for a swap from the US Federal Reserve in terms of its ability to provide liquidity quickly and at a relatively low cost.
But not every country can access a US Fed swap line, as rejected requests from Turkey, Peru, Indonesia, India and other countries attest. Those not in such a favourable position have to make do with what they can access. Such support has political and economic costs. For example, help from the IMF carries a political stigma and holding excess reserves is financially costly.
To make it a bit clearer as to which countries are best and worst served by current safety net arrangements, the IMF split countries into two groups. First are 'systemic' countries, those that make significant contributions to both global trade and financial networks, and second are 'gatekeeper' countries which are interconnected and can act as transmitters of shocks. Together, based on what appear generous thresholds, it amounts to a list of 25 countries making up most of the G20, excluding Argentina, Indonesia and Saudi Arabia but including non-G20 members Singapore, Switzerland and Panama:
The IMF's assessment is that the emerging market economies in this combined group — the BRICS countries plus Mexico and Turkey —face inadequate predictability and reliability in accessing bilateral swaps and regional financing arrangements, and high costs from accessing the IMF. Therefore, these countries have an incentive to over-insure through reserves. All that said, it is actually countries which are not designated as systemic or gatekeeper, in particular emerging market economies, that are worst served by the current system.
It has been five years since the last serious discussion of the safety net, and the IMF's analysis will likely launch a meaningful discussion on how best to improve it. Several principles will be important:
- Prevention remains better than cure – solid macroeconomic frameworks should continue to be the primary focus of policy.
- Central banks will continue to make decisions on how they extend swaps, consistent with their domestic mandate, and will face serious political resistance in acting beyond this remit.
- For remaining countries, the core focus within the safety net should be on continuing the ongoing process of strengthening IMF decision-making, ensuring the Fund is adequately resourced, and reducing the political stigma of Fund lending. I discussed some of the challenges of IMF reform in the latest G20 Monitor.
- Regional financing alternatives face serious design limitations that make them more costly and less effective than the IMF.
- Further, self-insurance options, such as reserves and market-based instruments, remain the largest part of the safety net but impose serious financial costs.
Policymakers should continue to focus on Plan A. But in light of global vulnerabilities and given the political reticence among finance ministries and constraints on structural reform, we need to make a priority of fixing the inadequacies regarding Plan B.
Photo courtesy of Flickr user Chad.