Slide1: Global Instabilities & Banking Crises A.G. Malliaris Loyola University Chicago Athens University of Economics & Business


Key Roles of Banking Systems: Key Roles of Banking Systems Financial Intermediaries - Allocation of Funds Bank Financing & Economic Growth Mechanisms of Transmission of Monetary Policies Payment System Facilitators


Why are Banks Special?: Why are Banks Special? Low Capital & Cash to Assets Ratios Highly Leveraged Asymmetric Information Banks Are Closely Intertwined


Causes of Banking Crises: Causes of Banking Crises Macroeconomic Instability Global Instability Microeconomic Factors


Key Question: Key Question Are Banking Crises Inevitable? Prevention vs Crises Management


Solutions to Banking Crises: Solutions to Banking Crises Sound Macroeconomic Policies Stable Global Monetary System: The Role of the IMF Efficient Markets Bank Regulation


Efficient Markets: Efficient Markets Appropriate laws for corporate governance & bankruptcies A uniform set of transparent accounting standards Facilities for auditing & external examinations Rules for public disclosure of financial information


Starting Point: Starting Point Mundell, Robert (2000) “A Reconsideration of the Twentieth Century” The American Economic Review 90, 327-340 Volcker, Paul (1999) “The Quest for Exchange Rate Stability: Realistic or Quixotic?” in Gray P. and Scheherazade S. (eds) - The Quest for Exchange Rate Stability in the Next Millennium, Stamford: JAI Press The 20th Century closed with a global monetary system “inferior” to that with which it began Flexible Exchange Rates are an unnecessary evil in a world where each country has achieved price stability


What is the Global Monetary System?: What is the Global Monetary System? Fischer, Stanley (2001) “Exchange Rate Regimes: Is it Bipolar View Correct?” Journal of Economic Perspectives, 15, 3-24


What is the Global Monetary System?: What is the Global Monetary System? Hard Pegs: Currency boards No national Currency (Currency Union or dollarized) Floating: Independently or managed Intermediate or soft pegs: Conventional fixed Crawling pegs Exchange rate band Crawling band


How has the Global Monetary System Performed?: How has the Global Monetary System Performed? Cost of crises in lost output relative to trend (1975 – 97) Source: IMF, 1999, World Economic Outlook: May 1998, p.79


Financial Instability: Financial Instability Mishkin, Frederick (1999) “Global Financial Instability: Framework, Events, Issues” Journal of Economic Perspectives, 13, pp 3-20 Financial Instability occurs when shocks to the financial system interfere with information flows so that the financial system can no longer do its job of channeling funds to those with productive investment opportunities Brock, W. & Malliaris, A.G. (1989) “Differential Equations, Stability & Chaos in Dynamic Economics” North Holland


Our Goal: Our Goal Problem: Global Instability Goal: Stabilize Global Monetary System Possible Solutions: Strengthen Global Financial Architecture – The Role of the IMF Lessons from EMU Will NAFTA move towards a Monetary Union? Coordination of global policies among EU, US and Japan


Lessons Learned from Asian Crisis: Lessons Learned from Asian Crisis Export oriented growth Fixed exchange rates Heavy indebtedness to foreign banks Over-investment / moral hazard The unpredictability of the crisis Currency crisis Banking crisis Financial crisis Economic crises


IMF Initiatives: IMF Initiatives Prevent an outright default on foreign obligations Preserve confidence and creditworthiness Limit the magnitude of currency depreciation Preserve a fiscal balance Control inflation Rebuild foreign exchange reserves Restructure & reform the banking sector Reform the domestic non-financial economy Avoid an economic recession


IMF Policies / Tools: IMF Policies / Tools Fiscal policy Tight domestic monetary and credit policies Capital adequacy standards Bank closures Debt repayment Non-financial structure changes: emphasis on private sector


Criticisms of IMF: Criticisms of IMF Has IMF underestimated global financial contagion? Have the IMF macroeconomic recommendations been misguided? Has IMF created moral hazard with its lending policies? Is IMF reactive or proactive?


Possible Reforms: Possible Reforms Would the global economy be better off without IMF? Currency crises: the role of flexible exchange rates Banking crises: equity requirements and the hedging of foreign currency risk The role of government and the macroeconomy A proactive IMF: financial and economic guidelines


IMF Guidelines for Strengthening the Architecture of the International Financial System: IMF Guidelines for Strengthening the Architecture of the International Financial System Transparency, global standards and vulnerability assessment Strengthening financial systems Involving the private sector in the prevention and resolution of financial crises Systemic aspects


Financial Instability: Financial Instability Joseph Stiglitz asks: “Reforming the Global Economic Architecture: lessons from recent crises” , Journal of Finance, August 1999, pp. 1508-1521 “Are minor modifications (such as slight changes in the governance of the international financial institutions, increased transparency, or surveillance) all that is required or are more fundamental changes necessary?


Trilemma of the Global Monetary System: Trilemma of the Global Monetary System Fixed Exchange Rates Independent Monetary Policy Free Capital Movement Milton Friedman James Tobin Paul Krugman Joseph Stiglitz EMU Robert Mundell Paul Volcker


Evaluation of Tobin’s proposal: Evaluation of Tobin’s proposal Goal: Reduce Currency Volatility Preserve Independence of Monetary Policy Instrument: A transactions tax proposed by Tobin in 1974 and 1978


Issues Related to Currency Volatility: Issues Related to Currency Volatility Foreign Exchange Market Sources of volatility: Fundamental vs. Technical factors Short-term Vs Long-term volatility: Overshooting Stabilizing Vs Destabilizing: speculation/speculative attacks Currency, Banking & Financial crises


EMU lesson: EMU lesson Use monetary & fiscal criteria to achieve convergence The experiment appears to have succeeded Will NAFTA follow the EMU example? With EMU and a Monetary Union in NAFTA will coordination with Japan become easier?


Final Questions: Final Questions Will the vision of one, world currency be materialized? Recall 1944: John Maynard Keynes and his BANCOR Harry Dexter White and his UNITAS