Policy recommendations

While briefly shrinking during the global crisis, global imbalances in trade and financial flows and their underlying systemic causes have not gone away. The current monetary non-order causes developing countries to adopt defensive strategies against fickle markets and allows developed countries to engage in beggar-thy-neighbour strategies, with a reliance on exports serving to offset their failure to manage domestic demand. Global imbalances are a symptom of existing systemic governance shortcomings. They can only be properly addressed by global governance reform and proper international policy coordination.

At the peak of the global crisis, G20 G20 The Group of Twenty is a forum for international cooperation between the world's major advanced and emerging economies (19 countries members plus the European Union) on the most important aspects of the international economic and financial agenda.
moremembers managed to see eye to eye on the need for coordinated measures to generate a strong demand stimulus. Policymakers mostly agreed that deflation presented the greatest threat. That moment of unanimity in policy views has since passed. However, nothing is gained if cooperating countries agree on strategies for their respective countries that do not represent any departure from the policies that had led to the global imbalances in the first place. Significant policy adjustments have been made in developing countries, to the extent that some have again been pushed into precarious positions by speculative capital flows. Major obstacles to global rebalancing and sustained recovery reside in key developed countries or regions.

Persisting global imbalances indicate a failure of the G20 process of international cooperation. So far that process has fallen short of launching serious reforms of the international monetary and financial system.

Essentially, the world is missing an international monetary order allowing for both reasonable exchange rate stability as well as symmetric adjustment pressures on creditor and debtor countries alike. The lack of coherence between the multilateral trading system and the international monetary system has led to persistent current account imbalances. Combined with far-reaching financial deregulation and unfettered global finance, a highly unstable and hazardous global economic environment is nourished, in which democratic national governments are subject to market whim. Given systemic asymmetries in economic and political power, developing countries are particularly vulnerable.

UNCTAD’s proposal of a multilateral agreement centred on a constant real exchange rate rule would directly address the systemic causes behind global imbalances. The proposed multilateral system of rules-based managed floating exchange rates aims at stabilizing real exchange rates at sustainable levels, so as to facilitate international trade and decision-making on fixed investment in the tradable sector, while forestalling destabilizing currency speculation. The proposed system requires symmetric obligations for currency market interventions by members and amounts to a dynamic version of the earlier Bretton Woods system of pegged but adjustable exchange rates. Instead of allowing discrete adjustments in the face of fundamental balance-of-payments disequilibrium, this alternative system aims at avoiding such disequilibria from arising in the first place, namely through continuous rules-based adjustments.

Rules-based adjustments of nominal exchange rates could follow either of two principles: adjustment according to changes in purchasing power parity; or adjustment according to uncovered interest parity. The first principle addresses more directly the need to avoid imbalances in trade flows, while the second is more directly related to avoiding imbalances in financial flows (i.e. destabilizing carry trade speculation). To the extent that differentials in official interest rates reflect differences in national inflation rates, which is largely the case (while inflation differentials, in turn, very closely correlated with trends in unit-labour costs), the two approaches lead to the same result.

It may seem paradoxical at first that the proposed monetary system should take the traditional theories of purchasing power parity and uncovered interest parity as its key guiding rules, given that these theories were found contradicted by the facts in the era of non-orderly floating exchange rates. Unfettered markets cannot be trusted to determine exchange rates that reflect fundamentals and allow balanced trade. Left to their own devices, currency markets lack an anchor, and exchange rates are rendered inherently restless, inviting destabilizing speculation. Policy intervention following the proposed rule would provide the needed anchor. Intervention by governments and central banks should not be seen as an exception to the rule of free markets, but rather, as a means of making the market function more efficiently.

Establishing a multilateral system of rules-based managed floating exchange rates should go hand in hand with re-regulating global finance, including financialized commodities markets, with a view of safety and stability.

• Lack of coherence between the multilateral trading system and the international monetary system has led to persistent current account imbalances;
• International monetary non-order, financial deregulation and unfettered global finance make for an unstable and hazardous global economy – highly asymmetric for its lack of proper global governance;
• Crisis has accelerated the shift in economic balance toward emerging market economies while global rebalancing remains unresolved;
• Global financial reform and national re-regulatory initiatives remain unfinished business;
• The G20 process of international policy cooperation has failed to produce satisfactory results;
• UNCTAD’s proposal of a multilateral agreement on exchange rates provides a solution to a pressing lack of global governance.