A LEGO approach to international monetary reform

The international monetary arrangement that has prevailed for the last forty years has been a disaster. There have been four waves of banking crises, most of the impacted countries also experienced currency crises at the same time. These crises have led to recessions and to extended periods of slow growth. Every country that experienced a banking crisis had previously had a boom and an increase in investor demand for its securities, which led to an increase in their prices and usually to an increase in the price of their currencies. These booms morphed into banking crises when these investment inflows slowed, which often occurred when one or several of the lenders recognized that the external indebtedness of these countries was increasing at rates that were too rapid to be sustainable. .   

 This pattern in cross border investment inflows is very different from the one that was advanced by proponents of floating currencies in the 1950s and the 1960s. Their articles have become the monetary constitution for the currency arrangement that has prevailed since the early 1970s.  They claimed that if currencies were free to float, the deviations between the market prices of currencies and the long run average prices would be smaller because the changes in the prices of currencies would track the differences in national inflation rates; instead the deviations have been much larger. They claimed there would be fewer currency crises; instead there have been many more and most have occurred with a banking crisis. The proponents claimed that each country would be more fully insulated from shocks in its trading partners, instead countries have been pummeled by the variability in inflows. .

 The primary objective of international monetary reform is to dampen the sharp  cross border investment inflows.    The Lego-approach to reform involves selections from two menus. One involves the institutional innovations or the framework for implementing measures to reduce the sharp variability in cross border investment inflows. The more ambitious institutional innovations involve a new institution like the  International Monetary Fund or a rejuvenation of the IMF. The least ambitious arrangement involve a decision by one or several countries to follow similar policies to dampen the scope for cross border investment inflows.