THE SEOUL PAPERS

Post-crisis Rethink at Asia Conference

IMF Survey online
February 25, 2010

  • High-level meeting ponders how to reconstruct the world economy
  • Five papers explore key finance, macroeconomic issues
  • Traditional orthodoxies questioned, new solutions proposed

Top policymakers and academics from around Asia and G-20 countries have been meeting in Seoul to
debate some of the most pressing issues to emerge from the worst economic slump since the Great
Depression.

The one-day conference, organized by the Korea Development Institute (KDI) and International
Monetary Fund (IMF) and entitled “How to reconstruct the world economy,” is centered around five
papers prepared by IMF economists.

The “Seoul papers” represent a rethink of some traditional orthodoxies and are part of a larger
reexamination of key macro and financial issues being undertaken by the IMF in response to the
global economic crisis. The papers range from how to exit stimulus policies, through a reevaluation of
macroeconomic policy, to proposals on strengthening the international financial architecture.

In an opening speech, the First Deputy Managing Director of the IMF, John Lipsky, said the papers
did not represent the official IMF position, but reflected internal debate in the Fund.

“They are intended, in part, to be provocative,” he said.

Revisiting inflation

Included among the proposals is a suggestion by the IMF chief economist, Olivier Blanchard, and his
coauthors, that central banks might consider setting their target inflation rate at 4 percent, rather than
the long-held ideal of 2 percent.

“Higher average inflation, and thus higher nominal interest rates to start with, would have made it
possible to cut interest rates more, thereby probably reducing the drop in output and the deterioration
of fiscal positions,” they write.

The proposal has already provoked considerable lively debate in the public arena and was warmly
endorsed by the liberal economist, Paul Krugman.

The Seoul papers

Exit Strategies
The paper’s authors suggest it is too early to withdraw from crisis-response policies, but they propose
five basic principles to guide an exit from macroeconomic stimulus. These include the need for
consistency across policy instruments, flexibility, clear communication, ensuring strategies rely on
market-based incentives, and the need for cross-country consultation and coordination.

Advanced economies face a daunting challenge to bring fiscal and monetary policy back to normalcy,
suggest the authors, who then present elements of a strategy to restore economies back to health.

“Addressing the fiscal problem will require clarity of intent and firm political resolve: health and
pension entitlement reforms, cuts in the ratio between other spending and GDP, and tax increases will
be necessary.“

Global Imbalances

This paper addresses future sources of growth and asks how the world’s economies can avoid the
global imbalances that precipitated the current crisis.

It warns that a failure to address remaining domestic and international distortions “could result in the
world economy being stuck in midstream.”

If global growth is to be put on a more sustainable footing, it says, the United States will need to save
more, whereas major surplus countries such as China will need to consume more domestically.

Similarly, oil-exporting countries will be able to boost domestic demand, if oil prices remain stable or
higher in the medium term.

Rethinking Macroeconomic Policy

As well as a rethink by the IMF chief economist about the ideal target inflation rate, this paper also
questions whether financial stability—including asset price performance—should be an explicit goal
of policy, and if so, how that should be achieved.

It notes that monetary policy is a blunt tool and suggests that better and more targeted instruments
should be developed.

The Future Financial System

The economic crisis, with its origins in the financial sector, has sparked a deep reevaluation of the
global financial system. This paper proposes a number of reforms, including widening the scope of
regulation to include all systemically significant financial institutions and limiting excessive leverage
and risk-taking, but warns against stifling innovation.

The international linkages highlighted by the crisis have underscored the importance of creating a
new regulatory framework that is consistent across countries, say the authors.

Reforming the International Monetary System

This paper addresses the question of how a new international financial architecture, and in particular a
strengthened international monetary system, can help address some of the current challenges.

It discusses how the monetary system could be structured to dissuade economies from building up
reserves to insure against capital account crisis—an issue that has long preoccupied the Fund (see:
Exchange Rate Regimes and the Stability of the International Monetary System, March 2010)The
paper proposes alternative insurance arrangements to mitigate this precautionary demand for reserves,
while exploring a menu of alternative reserve assets which, the authors suggest, “could offer
sustained stability and efficiency.”