Int’l financial stability must for global peace
Mr Masaaki Shirakawa, Governor of the Bank of Japan addressing at a high-level seminar, co-hosted by the Bank of Japan and the International Monetary Fund said it is a great pleasure for me to welcome you to Tokyo on the occasion of the annual IMF-World Bank Meetings. About two years ago, at the Per Jacobsson Lecture in Basel, my old and respected friend, the late Tommaso Padoa-Schioppa, offered his insights on how to strengthen the governance of the rapidly integrating global economy.1 Since then, the subject has been in a corner of my mind. Today, I am happy to co-host with the International Monetary Fund a high-level seminar devoted to that topic.
Many of you here today probably heard Tommaso forcefully present his case, but for those members of the audience who were not on hand at that time, I would first like to offer you a brief summary. Tommaso observed that one of the causes of the Great Financial Crisis was the failure of national governments to properly rein in market forces, which were fast becoming global in nature.
He saw that the increase in crossborder financial activities required a corresponding increase in the provision of basic facilities or services - supporting or facilitating those activities - including prudent regulation and supervision from a cross-border perspective.
Nevertheless, the supply of such facilities or services was deficient or lacking because national governments inherently could not provide for them. The solution, he argued, was to enhance supranational governance of the global economy. I.
The Great Financial Crisis and the supply of global public goods As Tommaso and many others have pointed out, the Great Financial Crisis has exposed the naïve simplicity of the view that, if the economic policies of individual economies are geared towards domestic economic stability, and private actors are allowed to operate freely in such an environment, the global economy would be all right.
The painful realization is that the self-correcting power of the market goes only so far. Markets must sometimes be nudged, pushed, or even forcefully shoved off their existing trajectory so as to prevent them from running into disasters.
In order to function properly, markets also depend on things that are not provided spontaneously by themselves, such as the rule of law, respect for private property, and the safety and freedom of passage.
"Public goods" is the name ascribed to these facilities or services in economics textbooks, and global public goods are those needed for the global economy to function properly.
So, what are the global public goods that support the functioning of the global financial system? One obvious but only partial answer is the appropriate regulation and supervision of cross- border financial activities.
The Great Financial Crisis has demonstrated that there were many shortcomings in this area, and the international community has taken steps to correct them.
Good regulation and supervision are important, but by themselves are not sufficient. The soundness of individual financial institutions is one building block of financial stability. In this sense, the international public good supporting global financial
1 Padoa-Schioppa, Tommaso, "Markets and Government Before, During, and After the 2007-20XX Crisis," The Per Jacobsson Lecture in Basel, Switzerland, June 27, 2010. By looking at international financial stability as a public good, we can apply a well-established microeconomic analytical framework to it.
A public good is a good that is both non-rivalrous and non-excludable: that is, one's use of a public good does not reduce the availability to others and one cannot effectively prevent the use by others. Consequently, two important features of public goods are that they will not be provided if left solely to the market, and that they tend to be consumed excessively when they are provided at all.
The latter insight allows us to interpret the Great Financial Crisis as being the consequence of overconsumption of a public good - namely, international financial stability. Financial institutions took stability for granted and shouldered excessive risks.
This exaggerated the impact when the risks were manifested; markets could not regain stability by themselves and had to wait for interventions by the public sector, including the coordinated provision of liquidity by central banks.
Providing global governance in a globalized world In a world where globalization is deepening, and where national financial systems are becoming more interconnected, financial stability must increasingly be achieved at the global level.