Valpy FitzGerald, Oxford
Cambridge Trust for New Thinking in Economics
Conference “International Economic Policies,
Governance and the New Economics”
St Catherine’s College, 12 April 2012

• Failures at core of financial system caused major global recession; yet little traction for international financial reform. Why not?
• At first sight, a combination of (i) ideological belief in rational markets; and (ii) intractable global macro-imbalances.
• Yet real obstacles may well be (a) distinct
national models of macro-prudential regulation, and (b) inadequate fiscal base for active policy

• Financial asset demand is inherently unstable; due to suddenly changing risk aversion and mutually contingent asset values (leverage, derivatives etc)
• Balance sheets drive banks; credit flows result from stock adjustment; but asset values are inherently uncertain; and credit markets fail systemically .
• Social function of banks is to convert liquid liabilities to illiquid assets; yet profit objectives and regulatory prudential regulation currently work against this.

• Socialisation of private bank ‘toxic assets’ generated by real estate speculation and unregulated derivatives (US, UK and EU)
• Existing debt levels; political pressure on welfare spend and tax pressure; and capital market risk aversion; mean active fiscal stance short-lived.
• New regulatory initiatives (US, UK and EU) limited to protection of systemically important banks
(SIBs) and payments systems - at national level

• Strengthened bank balance sheets but less productive lending (higher risk aversion); reinforced by previous trend towards origination to distribute rather than hold (less monitoring)
• Abandonment of active fiscal policy (though monetary “easing” continues to support banks) and superficial attraction of “expansionary austerity” despite lack of empirical evidence
• Growth and employment depressed by lack of aggregate demand, low investment levels (public and private) and depressive wealth effects; reinforced by deteriorating income distribution

• Hard lessons drawn from 1990s; so in 2000s debt run down (esp. IMF), reserves accumulated and fiscal surpluses; thus creating ‘policy space’
• New forms of capital controls (particularly through financial levies and bank prudential regulation) instituted and maintained
• Active public management of national external balance sheets as a form of self-insurance; geared to stability and productive investment

• Continued higher levels of growth; and ability to extend universal welfare benefits (political stability); increasing self-confidence
• However, still dependent on commodity prices
(though cycles now better managed through sovereign funds); and Chinese domestic demand
• But national financial protection (like Noth); lack of regional (let alone international) coordination despite potential leverage through G20

•
Financial reform protective of nation states; a parallel with 1930s absent WTO. Basle III framework designed to strengthen SIBs by reducing risk taking and increasing equity. International bailout bank asset levies stalled.
•
No appetite to stabilise capital flows; or halt speculative
NBFIs. International financial regulation requires action on OFCs: both to reveal asset holdings to regulators and to allow effective tax gathering on capital incomes.
• But G20 debate focusses on “global current account imbalances” particularly EM surpluses held to (a) reflect currency undervaluation; and (b) drive credit boom in
US/EU with low interest rates and ‘excess saving’.

•
Regulatory protection in 2010s instead of trade protection in 1930s (WTO); though current account imbalances still conflictive, focus now on exchange and interest rates.
•
But this is empirically and theoretically incorrect:
– cross-border financing not reflected in net capital flows
(X – Y) but gross flows and balance sheet positions;
– market interest rates are determined by monetary policies, not the saving-investment (= X - Y) balance.
• BIS: “monetary and financial regimes failed to restrain the build-up of unsustainable credit and asset price booms”.

• Uncertainty affects asset/liability balances, whose adjustment causes instability. Institutions exist to reduce uncertainty by public goods provision and compensate market failure. A Keynesian not a neoclassical concept.
• Prudential macro-regulation (including bailouts and reserve management) requires bank balance sheet socialisation as Keynes foresaw; yet South is more aware of this than North. An epistemic issue?
• Progress likely not through “world central bank” (IMF or otherwise) – Keynes unhelpful - but central bank coordination (BIS); regional regulatory coordination
(ECB); shared information on (taxable) foreign assets.

Basel Committee on Banking Supervision (2012) Progress report on Basel III implementation Basle:
Bank of International Settlements
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Dow, S. and J. Hilliard eds (2002) Keynes, Uncertainty and the Global Economy (Beyond Keynes,
Volume Two) Cheltenham: Edward Elgar
FitzGerald, V (2007) ‘International risk tolerance, capital market failure and capital flows to emerging markets’ in Mavrotas, G. and A. Shorrocks eds.
Advancing Development: core themes in global economics Basingstoke: Palgrave Macmillan for UNU/WIDER
FitzGerald, V (2012) Global capital markets, direct taxation and the redistribution of income
International Review of Applied Economics 26 (2) pp 241-252
Gallagher,K S. Griffith-Jones, and J-A Ocampo (2012) Regulating Global Capital Flows for Long-run
Development Boston MA: Frederick S. Pardee Center for the Study of the Longer-Range Future. Boston
University
ICB (“Vickers Report”) (2012)
Final Report and Recommendations London: Independent Commission on Banking
IMF (2010) A Fair and Substantial Contribution by the Financial Sector: final report for the G-20
Washington DC: International Monetary Fund
IMF (2011) Global Financial Stability Report
: Chapter 2 “ Long term investors and their asset allocations – where are they now?” Washington DC: International Monetary Fund
IMF (2012) Global Financial Stability Report Washington DC: International Monetary Fund
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Montoro C. and L. Rojas-Suarez (2012) Credit at times of stress: Latin American lessons from the global financial crisis BIS Working Paper 370 Basel: Bank of International Settlements
Perotti, R. (2011) The “Austerity Myth”: Gain Without Pain? BIS Working Paper No 362 Basle: Bank of
International Settlements