Restoring Global Financial Stability

Recent crises reflect fundamental weaknesses in the operation of the present global financial system and the need for wide-ranging reform. Public debate has been mainly limited to the issues of prudential regulation with little discussion of the basic problems of volatile capital movements, and asset price and exchange rate instability. The degree of leverage now available to financial institutions through the development of derivatives is excessive and should be reduced. The pressure to abolish control over capital movements in developing countries needs to be reconsidered. A central feature of any “new financial architecture†must be a more stable exchange rate system. There are major drawbacks with both “fixed†and free floating rates. We need to devise workable systems of managed rates with stated parities and bands. Changes in parities should be relatively small and frequent to minimise the potential gains for speculators. Such systems are only workable by mutual agreement between limited numbers of countries and currencies. This suggests the need for a two-tier approach with both regional and global arrangements.