PUBLIC LECTURE, SOUTH AFRICAN RESERVE BANK, PRETORIA,TUESDAY, 28 NOVEMBER 2000  World Capital market can be treacherous sea World now different from Bretton Woods in one crucial respect - free capital mobility Official sector wasted opportunity of 50th anniversary of BW in 1994 Crises:MexicoAsiaBrazilArgentina94-9597-9898-992000  Impossible trinity:Domestic monetary autonomyStable exchange ratesFree capital mobilityRecent years: sacrifice either first (MUs or currency boards, - EUII, Argentina)Or second (floating x-rates with inflation targets - South Africa, Canada, UK, Brazil) BW: Keynes preferred to give up third.Much of BW conference devoted to problems of convertibility Capital mobility:Needed to finance investmentBW idea of WB: finance post-war reconstructionSoon, private flows dominated official flowsOverall, great benefits, but(i) s-t capital flows exhibit sudden and large reversals.Result: crises(ii) frequency and scale of crises threatens support for open market-led international economy 1996-98 : reversal of flows to 5 Asian countries (Korea, Thailand, Indonesia, Malaysia, Philippines) was £125 billion.In Korea unemployment tripled, others: years of growth wiped out.Recession: real GDP fell by 6% in Korea, more in most othersNo crisis: India or ChinaMost reversals were s-t debt finance (80% was change in bank finance).Key Lesson: structure of national balance sheet: maturity and currency mismatches.Liquidity runs key issue: What would we do if another Korea or Brazil occurred? Coordination or Collective Action ProblemWhat does economics have to say?Two solutions to problem of liquidity crisesLOLRTemporary Payments suspension or standstills ("timeout")Both reduce incentives to run, support efficient equilibrium, and are good for creditors ILOLR In long run may come, but no prospect now of political support or money.Major problem: moral hazard *lenders): difficult to use supervision to limit. Lending to risky countries (capital requirements) or to demand changes in policy.So, despite Fischer, not on agenda ("lend freely, at penal rate, against good collateral" too demanding)Therefore, we need a mechanism for "timeouts" to reschedule payments. SOLUTIONS1. Crisis prevention2 .Crisis resolution3. Governance of IFS Crisis PreventionSix Lessons:1 Pursue policies that make equity investment more attractive 2 Self-insurance or DIY LOLRlarge forex reservesChina about $160bn,Korea $7bn to over $90bnContingent credit lines (private or IMF)3 Monitor and Manage national balance sheets simple guidelines, eg forex reserves > liabilities over next year, av maturity ext liabs >3 yearsEliminate incentives to s-t flows - both in emerging markets and industrialised countries 4 TransparencyForex reserves: SDDS, 66 standards and codesTransparency about transparency (ROSCs)Feed into Article IV assessments 5 Relations with creditorsCreditors committeesCACs6 Avoid fixed but adjustable exchange rate pegs (central to BW) Crisis ResolutionTwo key principles: 1. Limits to official finance: no ILOLRTherefore, "timeouts" needed to reschedule payments. Orderly, not disorderly, process needed for PSI 2. Greater clarity for private sector about what principles will guide international community in how crises are managedThese are key principles: need stating clearly. Recent Progress1 Before Prague:(a) ad hoc, case by case, constructive ambiguity, say nothing(b) Mouth PSI over and over2 Prague: coming together, prompted by UKconstrained discretion (used by Kohler) Clear objectives:(i) limits to official finance. No rigid formulae, but exceptions must be justified: systemic, contagion. Official money linked to PSI(ii) Greater clarity to PS about timeout mechanism NOW - MAKE OPERATIONAL1 Ex ante criterion for exceptional lending. Presumptions on IMF facilities. Ex post audit of exceptions.2 Spell out more clearly, "timeout" mechanism, including temporary standstills.3 Constrained discretion Finally, Governance of IFSQuestion: Do we need a new Bretton Woods agreement?Answer found in files - Bank and Keynes papers - see separate quote.Problems on who