By Steven K. Beckner

Prasad proposes that “the level of the premium would depend not
only on the level of insurance desired but also the quality of a
country’s policies. There would be higher premiums for a country that
chose to run large budget deficits or that accumulated large amounts of
debt, increasing its vulnerability to crises.”

“The premiums would increase in a nonlinear fashion with the
persistence and levels of policies that contributed to an economy’s
vulnerability,” he goes on. “A country running large budget deficits or
continuing to accumulate large stocks of external debt in successive
years would pay rising premiums in each of those years.”

What’s more, the pool could “charge higher premiums from countries
with policies that might serve them well individually but could drive up
global risks,” suggests Prasad, who advocates that countries that choose
to go on accumulating a large stock of reserves by preventing currency
appreciation should have to pay a higher premium.

Prasad proposes that the premiums be invested in a mixed portfolio
of government bonds, which could be drawn against as needed. He says the
Fed and other major central banks “would be obliged to backstop
the pool’s lines of credit in the event of a global crisis.”

“This would simply institutionalize ex-ante swap arrangements of
the sort that major central banks opened up ex-post during the crisis to
provide liquidity to other central banks,” he says.

The IMF might jump at the chance to expand its role and take on the
proposed insurance function, but Prasad maintains that would be a
mistake. He lists three problems:

1. “the (much-needed) austerity policies that the IMF foists upon
countries has made any involvement with the IMF toxic for politicians in
emerging markets, especially in Asia.”

2. “IMF programs to pre-qualify countries for emergency assistance
carry their own stigma. Application for prequalification could itself be
seen as a sign of weakness.”

3. “IMF resources are simply not enough.”

Besides, he says, the IMF’s two main current roles — surveillance
and crisis lending — are “incompatible if the objective is to provide
global insurance through the IMF and reduce incentives for the
systemically important emerging market economies to self-insure by
building up huge war chests of reserves. The IMF cannot credibly commit
to maintaining an open credit line and not imposing ex-post
conditionality with its loans if a country that qualifies for the FCL
starts running bad policies.”

Nor can the Fed or the European Central Bank directly provide
credit lines to countries, because it would become too much of “a
political matter,” says Prasad.

So his solution is to have the insurance pool be run by the G20. To
encourage all countries to join the pool, he suggests: “make
participation in this pool a condition for continued membership in a
body such as the Financial Stability Board, where all countries would
like to have a seat as it will have an important role in developing
principles for international financial regulation.”

“This would remove the stigma effect and also have the virtue of
tying together financial and macroeconomic policies, as their
interaction is clearly crucial for global economic outcomes,” he
continues. “Indeed, the FSB or BIS could easily administer this
program.”

Prasad says his insurance pool will be needed because “emerging
markets will be subject to greater policy spillovers and transmission of
shocks from the advanced economies.”

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** Market News International **

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