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Economic Co-operation: Summitry, Institutions, and Structural Change

by John Kirton

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Institutional Development for Monetary and Financial Cooperation

In the realm of monetary and financial co-operation, the G7 in the 1990's has made three major contributions, but faces two major challenges as it looks ahead. It has maintained the “globalization” consensus in favour of barrier free transborder monetary flows and freely floating exchange rates, despite the concerns of some about the volatility, misalignments and social instability the regime has caused. Secondly, its members acted with adequate effectiveness in the Mexican peso crisis to contain the threat of contagious panic. And thirdly, it translated the fiftieth anniversary sentiment in favour of international financial institution reform into an action agenda sufficient to meet the new challenges of the present era. It has yet fully to address the future regionalization of finance in the form of the EMU and the emergence of regional forums (in APEC or through the A6(22) across the Asia- Pacific region (or within NAFTA).

The restricted role of the G7 in exchange rate and monetary-financial management in the 1990's, relative to its active concerted intervention in the Plaza and Louvre regimes of the 1980's reflects less a consensus among G7 members that they are impotent in the face of globalized financial markets demanding autonomous central bankers than a shared view that the degree of ad hoc co-ordinated intervention they have undertaken is appropriate to the degree of volatility they have faced, to manage exchange rate re-alignments that have largely reflected underlying economic conditions, and to maintain a desired process and pace of a financial globalization that has been economically and politically sustainable among members.(23) Relative to earlier periods, and with the exception of European regional instability in 1992, there has been little volatility among G7 currencies, with the major moments of concern caused by President Clinton's public comments about the US dollar on the eve of the 1994 Naples Summit, and the decline of the Canadian dollar amidst the national unity referendum of 1995. (Bergsten and Henning 1996: 50). Only recently have changes in exchange rates among the big three currencies approached the magnitude of the shifts experienced with the soaring superdollar in the 1980's. Such realignments remain consistent with a US economy in the sixth year of a vibrant non-inflationary expansion, and a Japan and Germany experiencing much slower growth. Although French President Jacques Chirac, as host of the G7 in 1996 displayed some sympathy for a “Tobin tax” like instrument to impede international financial flows, and received some initial support from Canadian Prime Minister Jean Chretien, there was little support for such a move on the part of the big three (of the US, Japan and Germany), and Chirac's determination proved no stronger nor effective than that his predecessors traditionally displayed for greater fixity in exchange rates. Nor were Chirac's anxieties about globalization reflected in dominant fashion in the Lyon communiqué.(24) There has thus been little real or perceived need and thus enthusiasm to move toward fixed exchange rates, arrangements for targets and indicators, or Plaza-Louvre-like regimes (Bretton Woods Commission 1994, Williamson and Miller 1987, Bergsten and Henning 1996). The one real threat to the financial system - the Mexican peso crisis of December 20, 1994 and the ensuing collapse of Barings Bank - showed the effectiveness of a US-led ad hoc response, reinforced by a NAFTA, APEC and G7-bred sense of solidarity that contained the immediate crisis and catalysed a preventative, and hitherto successful, G7-led process of international institutional reform.(25)

The resulting program of international financial institutional reform, defined at the G7 Finance Ministers meeting on February 1995, dealt with the capacity of the system to respond to shocks, resource allocation and adequacy, policy direction and conditionality, and organizational management and governance. Due largely to G7 dominance of the international financial system and the IMF, this reform program was largely accomplished within the ensuing two years. A new process of surveillance, early warning and frank dialogue succeeded in the timely deterrence of several smaller countries. The creation, through a flexible formula, of the New Arrangements to Borrow effectively doubled the financial resources that could speedily be deployed in a crisis, and brought the emerging financial powers, largely into Asia, into the regime.(26) IMF procedures have been adjusted to ensure enhanced respect for the practice of sustainable development. And issues of inter- institutional communication and cooperation, as well as overlap and duplication, have begun to be addressed.

At present, the largest challenge to the international financial system, and the institutions that manage it, flows from the deepening regionalization of monetary integration, by far most prominently in Europe, but in nascent form in the Asia- Pacific and NAFTA regions as well. The advent of the EMU, and resulting attempt by three and perhaps all of the European big four to meet their Maastrict targets, reduces any flexibility they might have to engage in any outward-looking, systemically-oriented G7 efforts at policy co-ordination in the coming years. Institutionally, the prospect of EMU as an accomplished reality with a European Central Bank suggests the G7 may be replaced by a G3 (with Canada and perhaps Britain excluded), or at least face the added demand of macroeconomic co- ordination in a world where responsibility for monetary policy resides uncertainly within three or four members of the G7's eight members (with the EU), and that for fiscal policy continues to reside within seven (de Dilguay 1997) .(27) Across the Pacific, the APEC Finance ministers forum, and most recently an A6, with the potential to serve as a mechanism for managing the US-Japanese exchange rate and monetary relationship, while within North American, the ministerial level North American Financial Group provides a forum to deal with the financial dimensions of the United States other two largest trading partners. Together these developments may lead to a process of competitive regionalization, with no connecting power involved in all, that could both threaten the stability of the global financial system, and underscore the potential role of the G7 as a transregional connector.

The A6 is a group of six Asia Pacific countries assembled under US leadership in 1997 to address financial and economic issues within the Asia Pacific region.

This non-interventionist fostering of globalization has brought low interest rates across the G7. In December 1996 short term rates (in %) stood at: US 5.3; Japan 0.6; Germany 3.1; France 3.3; Italy 7.6, Britain 6.1; and Canada 3.0, while long term rates stood at US 6.5; Japan 3.1; Germany 6.1, France 6.1, Italy 7.7, Britain 7.4, and Canada 6.8. (Source: OECD, December 1996). In both cases, correcting for inflation and growth rates (and allowing for the politics of the OECD process), the interest rate differentials provide a strong incentive for the rapid appreciation of the US dollar against most G7 currencies, as experienced over the past year. The real short of the US dollar in 1996 and 1997. For example, the OECD's 1997 projected real short term interest rate for the US was 2.4% and for Japan -0.7.

The Economic Communique was entitled “Making a success of globalization for the benefit of all.”

In taking up international financial institution reform as the centrepiece of the 1995 Halifax Summit the G7 displayed a preventative as well as reactive capacity as the issue was identified at the Naples 1994 Summit, and promoted by Halifax host Jean Chretien, well before the peso devaluation added impetus to the process (Kirton 1995a).

While the GAB-NAB is not enough to handle another Mexico and a Russia at the same time , the G7, through the IMF, is handling Russia through regular relaxations of IMF conditions for the provision of financial assistance. There is thus no need for a major new allocation of SDR's. Indeed, the need had disappeared well before the apparent repudiation of the G7's proposal at the Madrid meetings of the IMF.

The more likely institutional evolution, based on the precedent of the trade ministers Quadrilateral, is the creation of a G4 or G5, with Canada and Britain included.

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