Successful coordination in fiscal and monetary affairs would enable the region to manage external shocks successfully.

The first concerns the growing imbalances in the monetary and financial systems that expose the global economy to shocks that are beyond any national capacity to control.

But this overlooked a crucial feature of monetary unions free capital mobility and elimination of currency risk indispensable attributes of a currency area could be (and were) the source of asymmetric shocks. Currency unions, in other words, must worry about endogenous as much as exogenous shocks.

They are facing the argument that the United States monetary union works much better because there is a large federal budget to smooth the impact of asymmetric shocks that is, shocks to individual states. The eurozone, it is claimed, should have its own budget to provide similarly automatic insurance to its members.

Germany s Five Shocks

Finally, once the crisis hit, leading to a re pricing of risks in financial markets, the need to avoid an economic and financial meltdown compelled governments to support aggregate demand and make private liabilities whole. But the disconnection between centralized monetary and decentralized fiscal powers de facto impeded the full use of monetary instruments to meet monetary and financial shocks.

Most notably, eurozone countries have faced powerful asymmetric shocks, to which their lack of independent monetary policy instruments made it virtually impossible to respond. As a result, they have struggled with recurring economic crisis.

Second, exchange rates need to reflect economic fundamentals. But while theory suggests that flexible exchange rates should blunt foreign monetary or financial shocks, in practice, such a currency regime rarely works on its own.

The US will normalize its interest rate policy sooner or later according to its need. For other countries, it is important to focus on policies that can strengthen resilience to foreign financial or monetary shocks.

18. Also notes the initial discussion in the International Monetary Fund on a new liquidity instrument that would enable high access financial support to developing countries that have market access and strong economic policies but nonetheless remain vulnerable to shocks

A single monetary policy focused on price stability in the euro area cannot react to shocks that affect only one country or region. So, to avoid prolonged local slumps, it is critical that national fiscal policies can perform their stabilization role.

Adjustment, support to trade and trade related shocks

These shocks were naturally beyond the ECB s control. The policy response, however, required preventing these shocks from becoming entrenched in medium to long term inflation expectations.

So it was a series of five painful shocks.

And they gave them a series of painful electric shocks.

Debt sustainability is also affected by vulnerability to external shocks.

Half of them are told that they're being given the shocks by somebody in another room, but the person in the other room doesn't know they're giving them shocks.

This external dependence increases their vulnerability to external economic threats and shocks.

Formidable challenges lie ahead, however, since the impact of past internal and external disequilibria and the vulnerability of the countries of the region to external shocks are expected to carry over into the future, thus reducing their manoeuvering room for the implementation of countercyclical fiscal and monetary policies.

That Committee rightly considered lack of economic diversification as an indicator of the exposure to shocks and recognized that small countries tended to be more vulnerable to external shocks than large ones (E 2005 33, paras.

The factors leading to the deep debt crisis culminating in the 2005 debt restructuring were characterized by the conjunction of policies (constraints on monetary, exchange rate and public borrowing policies imposed by the currency board) and external shocks (devaluation of the Brazilian currency in 1999, Asian and Russian financial crises in 1998).

Monetary Mystification

Globalization has increased the vulnerability of the developing and transition economies to adverse external shocks.

My Berkeley colleagues David and Christina Romer, for example, faced an analogous problem when seeking to determine whether monetary policy shocks affect economic growth. They used careful historical analysis to identify and focus on cases in which the policy stance changed for reasons not having to do with the current state of the economy.

These capital flows created a boom and a loss of long term competitiveness in some regions, which was followed by an all too predictable bust. To the extent that monetary and fiscal arrangements fail to reduce or eliminate moral hazard, the risk that capital flows create these endogenous asymmetric shocks will remain commensurately high.

Moreover, energy and food price shocks can be both large and largely unpredictable, while the speed of price changes tends to increase with big shocks. Most forecasting models used by central banks therefore put a large weight on recent inflation.

The Monetary Cosmopolitans

China s Monetary Sterilization

International Monetary Fund

International Monetary Fund

A fully functioning monetary union also requires a central bank that is free to act as required to confront liquidity and confidence shocks, some mutualization of government debts, and centralized control over fiscal policy. Moreover, it must have centralized banking supervisory policies, with strong powers to manage bank crises and to liquidate banks that cannot be rescued.

As a result, some observers may find the notion of increased monetary integration even the establishment of a fixed exchange rate regime based on, say, the Chinese renminbi or the Japanese yen highly appealing. But I would argue that the flexible exchange rates that prevail today remain Asia s best bet for boosting prosperity and protecting it from shocks.

Of course, Germany fails to recognize that successful monetary unions like the United States have a full banking union with significant risk sharing elements, and a fiscal union whereby idiosyncratic shocks to specific states output are absorbed by the federal budget. The US is also a large transfer union, in which richer states permanently subsidize the poorer ones.

It also helps to shield them from shocks and volatilities in the global economic and financial environment.

Asian economies deepening trade and financial integration has left them increasingly vulnerable to growth shocks from China, with exporters of commodities and capital goods especially vulnerable. In fact, a study by the Asian Development Bank shows that Chinese shocks have larger and more persistent effects on individual Asian economies output than do global shocks, as a 1 increase in China s GDP raised GDP in emerging East Asia by about 0.6 .

China s Monetary Policy Surprise

China s Monetary Policy Choice

The New Monetary Disorder

IMF International Monetary Fund

International Monetary Fund (IMF)

However, economic growth and expectations are constantly threatened by inappropriate macroeconomic policies, poor economic management and external shocks.

The current shocks to GDP have led to falling levels of per capita income and brought widespread poverty.

Why is Monetary Policy Underrated?

Shinzo Abe s Monetary Policy Delusions

12. Notes that it is important for the International Monetary Fund and the World Bank to continue their efforts to strengthen the transparency and integrity of debt sustainability analysis and to consider any fundamental changes in countries' debt sustainability caused by natural catastrophes, severe terms of trade shocks or conflict when making policy recommendations, including for debt relief, as appropriate