2014 International Council Meeting: Decoding Mixed Signals for Global Growth and Financial Stability

On October 9th, 2014, over 200 Bretton Woods Committee members and friends –including leaders within the financial sector and across the international economic policy community of experts – gathered for the Bretton Woods Committee’s 2014 International Council Meeting. Under this year’s program theme of Decoding Mixed Signals for Global Growth and Financial Stability, speakers and participants shared perspectives on the evolving focus of the International Monetary Fund, progress and implications for reforming the international financial system, and the headwinds facing a still lackluster global economic recovery.

The first segment featured IMF Managing Director Christine Lagarde and Bretton Woods Committee Co-Chair Jim Wolfensohn. In light of the Fund turning 70 this year, Lagarde reflected on the Fund’s resilience – as evidenced by its adaptation to global macroeconomic changes, accomplished without resorting to drastic changes of its governance framework – as well as shifts in the IMF’s focus. Sustainable growth, labor markets, and rising inequality are now of great concern. The Fund’s technical assistance arm is as active as it has ever been – the IMF assists 80% of its membership with capacity building.

When asked about particular concerns around the world, Madame Lagarde lauded the progress made by governments in Tunisia, Yemen, Jordan, and Morocco in improving their fiscal positions. However, she painted a less optimistic picture of other countries in the Middle East such as Egypt, which still needs major financing. Relations with the Egyptian government have improved, Lagarde noted, but the IMF must continue to avoid entanglement in domestic politics, which limits the efficacy of Fund policies. Lagarde also expressed great concern about the Ebola outbreak in West Africa, and, given the economic fragility of affected countries, the potential for the health crisis to stymie development in the region. She elaborated on the Fund’s swift provision of financial assistance to affected countries. Regarding Ukraine, Lagarde indicated that IMF assistance would not be sufficient and stressed that more assistance will have to come from multiple sources, as Ukraine has already borrowed in excess of 800% of its quota.

Finally, the Managing Director expressed her continued concern that the United States had not yet ratified the 2010 IMF governance reforms, but she concluded by thanking the Bretton Woods Committee for its valuable efforts in urging Congressional approval of these measures.

In the second segment Jean-Claude Trichet, Honorary Governor of the Banque de France, interviewed Daniel Tarullo, Governor of the Federal Reserve Board about the state of reform within the financial system. While reforms and regulatory initiatives since the 2008 financial crisis have put forth a more stable framework, Tarullo stated, the process is not complete and there are various challenges to their implementation. Many of the key reforms (e.g., capital and liquidity requirements for financial institutions) are still a few years away from coming fully into force. Tarullo pointed out that U.S. regulators are still finalizing work on capital surcharges, resolution mechanisms, and qualifying instruments meant to increase bank loss absorption capacity. “Making it a credible expectation to have a non-disorderly resolution of a large financial system” is one of the biggest remaining challenges for U.S. and international regulators, he noted.

When asked by Trichet what additional work remains to be done, Tarullo listed the following concerns: monitoring the migration of risky practices from regulated institutions to other firms, the importance of strengthening minimum margin requirements in derivatives trading, ensuring that firm funding structures do not incentivize volatile short term funding, and preventing regulatory arbitrage. Trichet and Tarullo also discussed regulatory convergence. Tarullo proceeded to discuss the more stringent requirements, which go beyond the Basel III agreement, for particular firms in the United States. Basel III, he noted, only serves as a minimum requirement. On regulatory segmentation, Tarullo took pains to clarify that complete international regulatory convergence is not desirable, despite the jurisdictional overlap of financial sector regulators.

During audience questions, Tarullo was asked how the regulatory gap between Europe and the U.S. would be closed. After he noted one of the key differences between the U.S. and Europe (i.e., the key role of banks as financial intermediaries in Europe), Tarullo expressed his hope for more international discussion in order to avoid regulatory fragmentation. Similarly, Trichet noted that until European capital markets take on a more prominent role, the gap will endure. Finally, when asked about the shadow banking system, Tarullo pointed out the difficulty in determining the appropriate or desired size of the shadow banking system. Having a shadow banking system is not unhealthy, but caution must be exercised.

In the next segment, moderated by former Federal Reserve Board Vice Chair Don Kohn, several discussants provided their diverse perspectives on global financial reforms. First, Stefan Ingves, Governor of the Sveriges Riksbank, updated audience members on the progress made by the Basel Committee on Banking Supervision. He stated that much of the new framework (capital and liquidity requirements) is complete; agreement was reached on a definition of the leverage ratio, although an actual number has not been agreed on; and supervision and assessment of compliance is now relatively easier than before. Ingves indicated work remains to be done on securitization, establishing constraints on risk weighted assets, sovereign risk, and assessing implementation based on feedback from key stakeholders.

Next, Barbara Novick, Vice Chairman of BlackRock, repeatedly stressed the need to ensure horizontal regulation of the industry. She pointed to the danger in regulators going after only the most visible firms, as size is not a sufficient indicator of potential systemic risk. Some categories of concern include: counterproductive rules for money market funds, reduced liquidity in the corporate bond market, increasing the robustness of central clearing houses, and avoiding exaggerated measures to rein in high frequency trading.

Following Novick, Colm Kelleher, Chairman of Morgan Stanley International, stressed the importance of considering the unintended consequences of new regulations. New regulations, he emphasized, need to be transparent and standardized. Kelleher noted that regulatory barriers and the need for securitization are part of what is holding back the recovery in Europe.

Finally, UBS Chairman Axel Weber commented on some of the positive developments of regulatory reform, and offered his analysis as to why advanced economies have failed to achieve ‘escape velocity.’ Weber welcomed the increased in capital requirements, and he pointed to the considerable progress made by banks in restructuring their balance sheets. He also expressed support for greater utilization of central clearing. Then, he stated that policy makers should not be surprised that the recovery is slow. Weber stressed that systemic stability, through the channel of stricter regulations, curbs growth. The trend toward booking risks locally is transforming the banking business and will ultimately have a bigger impact on banks than capital and liquidity regulation, he surmised.

In the last segment,moderated by Gillian Tett of the Financial Times, Lawrence Summers, Jean-Claude Trichet, and William Rhodes held a spirited debate on global economic growth, markets and risks. Summers spoke about the threat of secular stagnation as the greatest single risk to global economic growth. In his view, economies are suffering from a serious deficiency of demand, and given the lack of traction for monetary policy, which he believes is being asked to do a disproportionate amount of work, governments in advanced economies should be providing stimulus through infrastructure investment. Summers also pointed to a recent IMF analysis that found that infrastructure investment, in addition to being highly effective at stimulating the economy, can potentially decrease a sovereign’s debt burden.

Trichet and Rhodes agreed that secular stagnation is a serious threat that must be addressed. However, Trichet brought up the fact that many advanced economies are running current account surpluses. Consequently, infrastructure investment would require external funding, and this places a constraint on deficit financed investment. Rhodes also expressed concern that central banks cannot stimulate the economy on their own, and countries must proceed with needed structural reforms. Summers added that structural reforms were not a panacea for depressed growth. He pointed to the relatively poor performance of the U.S. labor market, as measured by labor force participation, and urged investment as the key. Trichet agreed with his assessment about the U.S. labor market and the need for more lending, but also urged the need for more equity finance in Europe.

Panelists also discussed the threats facing emerging markets. Rhodes pointed to several headwinds: the end of the commodity super-cycle; the slowing of the Chinese economy, the reversal of monetary easing by some central banks, geopolitical uncertainty in Europe and the Middle East, and investors’ search for yield. He did point out that certain countries have pushed through necessary structural reforms, with Mexico being singled out as an example. Summers spoke about positive trends in Africa, and, despite the Ebola crisis, there is great reason for optimism.

During audience questions, the three speakers shared perspectives on deficit financed investment expenditures, the digitalization of the economy, and inequality. Summers stressed that debt finance expenditures, often derided as placing an unacceptable burden on future generations, are not counterproductive in today’s economic environment of low borrowing costs for most sovereigns. He spoke about the danger of leaving future generations worse off because of the aversion to investment. While all three participants agreed on the need to counter economic stagnation, they brought attention the benefits and drawbacks of different tools for boosting growth.

The Committee is grateful to the following organizations for their generous support of this event:
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Audio for segment 1 can be found here.

Audio for segment 2 can be found here.

Audio for segment 3 can be found here.

Audio for segment 4 can be found here.