In the aftermath of the crisis, there seems to be a case for improving the menu of instruments and institutions to protect against global liquidity crunches in a preventive way: multilateral coordination proved that it could respond to the shocks but only belatedly—as a “safety belt” that saves passengers? lives but does not prevent the car crash. Moreover, the recent strengthening of IMF resources and redesigning of instruments, while a move in the right direction, met the demand of only a few countries, and its effectiveness as a protective safety belt remains largely untested. And a new and enhanced menu of facilities offering more complete after-crash protection which the Fund is actively working on—may still face important political obstacles.
It would be myopic to leave unfinished the pending task of establishing an effective global financial safety net simply because capital flows to emerging markets (EMs) have resumed and liquidity is now plentiful. The hope that the next liquidity crisis in emerging markets will summon the same interest from advanced countries is, in our view, naive, particularly if it does not originate in and involve advanced economies. Now that the memory of the latest crisis is still fresh is the time to move towards reliable preventive arrangements that perform well regardless of the nature of the systemic liquidity crisis.
In this piece, we make concrete proposals for a financial safety net to address systemic crises by providing access to a global liquidity facility to countries suffering from exogenous systemic financial shocks, of which the recent global liquidity crunch is a good example. This focus on “liquidity insurance” closely relates to the Global Stabilization Mechanism (GSM) currently under discussion at the IMF. Even within the narrow focus of systemic financial shocks, it is important to recognize that the conditions for activating a global liquidity facility may be not as clear-cut as they were in the recent global crisis.
For example, a systemic liquidity crunch due to disruptions in specialized international credit markets may not rise to the level of a global financial disruption, but the systemic financial crisis it would generate among emerging markets could share many of the same characteristics (e.g., the aftermath of the Russian default in the late 1990s). The proposal is not designed to fight yesterday?s battle but to generally address systemic liquidity crises affecting developing countries, whether or not they engulf advanced countries.