Publication - Articles The layers of the global financial safety net: taking stock
Copyright 2016, European Central Bank
Introduction
The global financial safety net (GFSN) can be defined as a diverse set of institutions and mechanisms which can contribute to preventing and mitigating the effects of economic and financial crises. In debates about global financial stability, policymakers and academics often refer to the global financial safety net, understood as a set of institutions and mechanisms which provide financial support to prevent a crisis and financial support to countries hit by a crisis, both facilitating adjustment at the country level and preventing the crisis from spreading further. A crisis can be of domestic or external origin and it can take many different forms.
A balance of payments crisis occurs when a nation is unable to pay for essential imports or service its external debt. In some cases, balance of payments problems can be compounded by a sharp exchange rate depreciation and a currency crisis. Financial crises stem from insolvent or illiquid financial institutions, and fiscal crises are caused by excessive fiscal deficits and debt levels. The GFSN can contribute to preventing and mitigating the effects of such crises. However, the GFSN has not been established in one single process and does not have a coherent design. The elements of the GFSN are diverse, have different origins, follow different rules and incentives, and help in addressing different types of crises. Foreign exchange reserves, central bank swap and repo lines, funding by regional financing arrangements (RFAs) and international financial institutions are considered the key elements of the GFSN.
An effective and efficient interaction of the different elements of the GFSN is a requirement for a well-functioning international monetary system. Owing to high levels of economic and financial interconnectedness, contagion is a regular characteristic of crisis episodes. Challenges in one country often do not stay confined within that country’s borders, but tend to spread through various channels across countries. Therefore, by providing a country with “financial breathing space”, the GFSN not only limits the economic slowdown and provides a window of opportunity to implement reforms needed for a quick return to economic stability and growth, but also limits spillovers to other economies and thereby contributes to global financial stability, in turn supporting financial integration and globalisation. 33
The GFSN in its current form is the result of the historical accumulation and stratification of different forms of financial support provision. The design of some of its elements has been influenced by domestic or regional rather than global concerns and is, hence, not the result of an ex ante widely shared consensus at the international level.
With the growing financial and economic integration of emerging market economies (EMEs) into the global economy, the GFSN has become increasingly important. The global financial crisis has also highlighted the continued relevance of the GFSN for advanced economies. One of the most important challenges for both EMEs and advanced economies is capital flow volatility, which has remained elevated since the onset of the global financial crisis (IMF, 2016a34). At the same time, the GFSN had not kept up with financial globalisation and the increasing size of capital flows, and the expansion of its elements has not been even (IMF, 2016b35).
These developments have brought the size and coverage of the GFSN back onto the agenda of the G20 and the International Monetary Fund (IMF). Emerging markets remain concerned about persistent financial market volatility given that monetary policies in advanced economies may diverge for some time in the future.36 While there is overall agreement on the need for sound domestic policies and frameworks as a first line of defence, views differ on the need for better coverage of the GFSN and the appropriate size of the GFSN both in terms of the types of instruments available to specific countries and in terms of the amount of resources available to address crises.
This article focuses on the role of domestic policies, the complementary support provided by the four key layers of the GFSN and the interaction between these layers. Section 2 of this article recalls the key role played by domestic policies, Section 3 then reviews the elements of the GFSN, Section 4 discusses the scope for interaction between them and the final section draws some conclusions.
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