With the global economic situation sharply deteriorating in the past six months – the exigency for decisive actions and a coordinated response from each individual country to prevent any further downward revisions of their economies has become more evident. Needless to say, economic activity has declined significantly in the U.S. The European economy has also undergone a sharp contraction, and the Asian economies, far from remaining unharmed by these negative developments, have also been heavily affected. Fortunately, signs in the credit markets that the financial crisis is not deepening are somewhat encouraging. However, as the finance ministers of the G20 countries gather this weekend for their meeting in Horsham, southern England ahead of the London Summit (April 2), finding viable economic solutions – in terms of macroeconomic stability and financial regulation – is at this point essential, if not imperative.
The Centre for Economic Policy Research [CEPR], the leading European research network in economics, has published a new ebook where it analyzes several policy proposals on how the G20 process and the London Summit might bring concrete and implementable results that can restore confidence (a commodity worth noting that disappeared with the collapse of Lehman Brothers in September 2008) and lead the way to economic recovery.
The book, which is designed as an input into the G20 process and starts with the global
perspective and continues all the way to the individual bank, stresses some key issues (listed below) that deserve special attention, while taking economic developments into account.
The first policy proposal that addresses the crisis is directed by CEPR at global imbalances and capital flows. CEPR argues that the dispersion of current account balances, positive and negative, increased greatly over the past decade, prompting gross capital flows to rise more and disproportionaly than the net flows. As a result, global imbalances interacted with the flaws in financial markets and instruments, consequently generating, through specific features of the crisis, an acceleration in the fall in all major financial market volatilities that began in 2004.
The research network stresses the necessity of “creating credible insurance mechanisms for countries that forego further reserve accumulation and stimulate domestic expansion.”
Under the same topic (global imbalances and capital flows) CEPR also suggests “the acceleration and the development of emerging market country financial systems, with particular emphasis on local currency bond markets and on foreign currency hedging instruments.”
Any threat of deflation according to CEPR, should be met promptly, “before it takes hold, with a zero interest rate policy and quantitative easing.”
International coordination of cooperatively designed fiscal stimuli” is seen as necessary “to allow the internalisation of the effective demand externalities of a fiscal stimulus through the trade balance and the real exchange rate.”
On the aspect of ‘market reform’ CEPR’s suggestion consists in “requiring without further delay a centralized clearing counterparty for CDS trades”, and more importantly “CDS be exchange-traded”, with the consideration of “prohibiting CDS that do not insure a holder of the underlying asset (naked CDS).” Also, for structured instruments CEPR proposes “enforcing greater disclosure of information about the underlying pool of securities.”
In terms of controlling financial institutions, CEPR sees effectiveness in the “establishment of a harmonized special bankruptcy regime for banks. This would involve US-style ’prompt corrective action’, giving the (independent and well-staffed) supervisory agency powers to limit the freedom of bank managers (possibly remove them) and shareholders (possibly expropriate them) before the bank is technically insolvent.”
Considerations also ought to be given, notes CEPR, to the “creation of an International Financial Stability Fund that takes equity positions in the financial institutions of participating countries and monitors their activities.” [Via VoxEu]
In this book CEPR has brought together the most important elements to identify the most efficient solutions and integrate them into a coherent analytical and working concept. These elements, while providing important conceptual inputs for the understanding of the financial intermediation and the structure supporting it, also provide potential policies to prevent or alleviate future crises. Furthermore, these policies could be effectively used by the G20 group as a base line for policy decisions to start economic recovery and subsequently, preserve the stability of financial systems. CEPR however stresses, no fiscal policies will work in this depressed environment unless and until blockages in the supply of credit are resolved.
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