Research Topics

An Assessment in the Context of the IMF Rulings for Greece

Developing countries, led by China and other BRICS members (Brazil, Russia, India, and South Africa), have been successfully organizing alternative sources of credit flows, aiming for financial stability, growth, and development. With their goals of avoiding International Monetary Fund loan conditionality and the dominance of the US dollar in global finance, these new BRICS-led institutions represent a much-needed renovation of the global financial architecture. The nascent institutions will provide an alternative to the prevailing Bretton Woods institutions, loans from which are usually laden with prescriptions for austerity—with often disastrous consequences for output and employment. We refer here to the most recent example in Europe, with Greece currently facing the diktat of the troika to accept austerity as a precondition for further financial assistance.

It is rather disappointing that Western financial institutions and the EU are in no mood to provide Greece with any options short of complying with these disciplinary measures. Limitations, such as the above, in the prevailing global financial architecture bring to the fore the need for new institutions as alternative sources of funds. The launch of financial institutions by the BRICS—when combined with the BRICS clearing arrangement in local currencies proposed in this policy note—may chart a course for achieving an improved global financial order. Avoiding the use of the dollar as a currency to settle payments would help mitigate the impact of exchange rate fluctuations on transactions within the BRICS. Moreover, using the proposed clearing account arrangement to settle trade imbalances would help in generating additional demand within the BRICS, which would have an overall expansionary impact on the world economy as a whole.

International financial flows are the propagation mechanism for transmitting financial instability across borders; they are also the source of unsustainable external debt. Managing volatility thus requires institutions that promote domestic financial stability, ensure that domestic instability is contained, and guarantee that international institutions and rules of the game are not themselves a cause of volatility. This paper analyzes proposals to increase stability in domestic markets, in international markets, and in the structure of the international financial system from the point of view of Hyman P. Minsky’s financial instability hypothesis, and outlines how each of these three channels can produce financial fragility that lays the system open to financial instability and financial crisis.

The argument put forward in this paper is twofold. First, the financial crisis of 2007–08 was made global by the current account deficit in the United States; and second, there is global dependence on the United States trade deficit as a means of maintaining liquidity in financial markets. The outflow of dollars from the United States was invested in US capital markets, causing inflation in asset markets and leading to a bubble and bust in the subprime mortgage sector. Since the US dollar is the international reserve currency, international debt is mostly denominated in dollars. Because there is a high degree of global financial integration, any reduction in the US balance of trade will have negative effects on many countries throughout the world—for example, those countries dependent on exporting to the United States in order to finance their debt.