Ben Bernanke recently expressed worries that continued large global imbalances could create the conditions for another crisis. Eswar Prasad has a proposal to reduce the danger. The idea is to have individual countries commit to particular objectives with regard to policies that could contribute to global imbalances, and then pay a price if they fail to meet those commitments. The argument is that this would "shift the discussion from contentious arguments about current policies to a focus on outcomes":
Global macroeconomic imbalances: G20 leaders must back up their rhetoric with deeds, by Eswar Prasad, Commentary, Financial Times: The financial crisis has taught us a painful lesson that global macroeconomic imbalances can wreak enormous damage on the world economy. Indeed, the centerpiece of the recent G20 Summit in Pittsburgh was agreement on a framework for balanced and sustainable growth to forestall a resurgence of imbalances as the economic recovery gets underway. ...G20 leaders gave the IMF a mandate to manage this framework by providing hard-nosed evaluations of their countries’ macroeconomic policies.
Experience suggests that grand promises to implement policies that are in the collective global interest can’t be taken seriously without an effective enforcement mechanism. ... The IMF has no real levers when it comes to the leading G20 economies, especially since they are the major shareholders in the institution. Moral suasion and name-to-shame approaches don’t work well as the large economies tend to simply brush off external criticism of their policies.
There is a simple approach that has real consequences, would be straightforward to implement and allows G20 countries to make enforceable policy commitments. It involves Special Drawing Rights, essentially an artificial currency created at the IMF and distributed to countries in rough proportion to their economic size. The total stock of SDRs is now close to $300bn, a sizable chunk of money.
The scheme would work as follows. The G20, in consultation with the IMF, develops a simple and transparent set of rules for governments on policies that could contribute to global imbalances - for instance, that government budget deficits and current account balances (deficits or surpluses) should be kept below 3 per cent of national GDP. Each country posts a commitment bond amounting to a minimum of 25 per cent of its SDR holdings to back up its commitments to those objectives.
Since it is not easy, even with the best of policies, to turn around the factors underlying imbalances within a short period, commitments to policy objectives would be made over a five year horizon. ... Failure to meet the targets would mean a forfeiture of the bond... The actual cost would not be large. China, for instance, now has an allocation of 7bn SDRs and 25 per cent of that would amount to less than $3bn. Still, the symbolic effect of being levied an SDR penalty for running bad economic policies would be huge. ...
This approach would shift the discussion from contentious arguments about current policies to a focus on outcomes. For instance, China has consistently maintained that its current account surplus reflects structural problems in its economy and has nothing to do with its exchange rate policy. Who could quibble with methods so long as China commits to reducing its current account surplus and succeeds in putting its economy on a trajectory to get it below 3 per cent of GDP in the next 5 years...?
What happens to SDRs that get docked if countries don’t hit their targets? These SDRs would be distributed among low income countries. To get incentives right, only those low-income countries that meet minimum standards in terms of their macro policies would be eligible for this redistribution. This way, the IMF could finally offer carrots to poor countries for good policies rather than just sticks for bad policies. Any SDR redistributions to small poor economies ... would be morally justified - instability caused by bad policies in the larger and richer economies tends to hurt these vulnerable and innocent bystanders disproportionately.
The G20 commitment to tackling global macroeconomic imbalances is laudable. G20 leaders must now be ... ready to pay the price for breaking their commitments.
Five years seems too short of a time period given the large adjustment some countries would have to make to get to a 3% target, but I can't imagine this being implemented in any case. They'd never get past the contentious, endless discussions over what the targets should be, how they should be defined, the acceptable range in each case, and so on.
I suppose we could think of this as a tax on excessive contributions to global imbalances (solving an externality problem that is present when individual countries do not consider the effect of their policies might have on other countries except to the extent that it feeds back on them). Maybe we could try a cap-and-trade system instead. Cap global imbalances at some level, and then have countries buy and sell permits in order to deviate from their allotment of the total (the initial permits could be distributed by auction with the proceeds distributed among countries in some way, or simply given away). Yeah, that'll work.
This post has been republished from Mark Thoma's blog, Economist's View.