Mr. Caruana argues that liquidity conditions often spill over across borders and can amplify domestic imbalances to the point of instability. In other words, the IMFS not only does not constrain the build-up of financial imbalances, it also does not make it easy for national authorities to see these imbalances coming.
Certainly, some actions have been taken to address this weakness in the system: the regulatory agenda has made significant progress in strengthening the resilience of the financial system. But it is also known that risks and leverage will morph and migrate, and that the regulatory response by itself will not be enough. Other policies also have an important role to play. In particular, Mr. Caruana argues that, in order to address this blind spot, central banks should take international spillovers and feedbacks – or spillbacks, as some may call them – into account, not least out of enlightened self-interest.
The current environment offers a good opportunity to revisit the various issues regarding the IMFS. Addressing the blind spot in the system will require to take a global view. There is need to better anchor domestic policies by taking financial factors into account. There is also need to understand and internalise the international spillovers and interactions of policies. This new approach will pose challenges. It is must yet to develop an analytical framework that allows us to properly integrate financial factors – including international spillovers – into monetary policy. And there is work to be done to enhance international cooperation.
All these elements together would help establish better global rules of the game. The global financial crisis has demonstrated that international cooperation in crisis management can be effective. For instance, the establishment of international central bank swap lines can be seen as an example of enlightened self-interest. However, it is must also to recognise that there are limits to how far and how fast the global safety nets can be extended to mitigate future strains. This puts a premium on crisis prevention. Each country will need to do its part and contribute to making the global financial system more resilient – and Mr. Caruana adds that reinforcing the capacity of the IMF is one element in this regard. And taking international spillovers and financial stability issues into account in setting monetary policy is a useful step in this direction.
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