What changes in the international financial system might mitigate global
imbalances in the future?
We see at least two first-order agenda items.
The first is domestic financial development in the poorer economies. In some emerging-market countries, notably China, high saving is promoted by
underdevelopment and inefficiencies in financial markets. Structural shortcomings tend to raise both corporate and household saving rates. For example, if typical Chinese savers had access to relatively safe instruments offering higher rates of return, huge positive income effects would in all likelihood swamp substitution effects, resulting in lower, not higher, household saving. The result would be higher household welfare in China, as well as a reduction in China’s foreign surplus.
The second agenda item is the regulation of internationally integrated financial markets. Now that the fig leaf of constructive ambiguity has been torn away, development of a globally more effective framework for financial regulation is an urgent priority. It is well understood that a rational and politically robust regulatory framework will have to be based on more extensive international cooperation than currently exists –
notwithstanding the considerable progress made since the initiation of the Basel process in the 1970s. Given their significant and growing importance in world trade and finance, the emerging markets will rightly be full partners in any new arrangements.
As the 2009 Pittsburgh G-20 summit illustrated, however, international agreement on further concrete common measures is far away. While this is the case, large global imbalances will remain dangerous as possible manifestations of underlying financial excesses. Macro-prudential regulatory stringency that responds forcefully to financial
booms will be the most important lever for avoiding financial busts in the future. Some observers have suggested that emerging markets use countercyclically intensive regulatory oversight in response to big financial inflows (Mohan and Kapur 2009; Ocampo and Chiappe 2003). Richer countries can usefully apply the same precepts in the face of big current account deficits.