By Mervyn King, Governor, Bank of England.
In 2009, demand in the world’s major economies fell, relative to its pre-crisis trend, by around US$2.5 trillion or 5% of GDP. The ﬁnancial crisis damaged virtually every country. Global imbalances helped to fuel the ﬁnancial crisis. And today they threaten the sustainability of the recovery in global demand. Global imbalances are a reﬂection of today’s decentralised international monetary and ﬁnancial system. All the main players around the world are rationally pursuing their own self interest. But the ﬁnancial crisis has revealed that what makes sense for each player individually does not always make sense in aggregate. These actions had collective consequences. The main lesson from the crisis is the need to ﬁnd better ways of ensuring the right collective outcome. Improved ﬁnancial regulation will help to intermediate the ﬂows associated with global imbalances. But the global economy will remain vulnerable to the risks associated with imbalances if they are not tackled at source. Two principles should underpin the way ahead. First, discussions should focus on the underlying disagreement about the right speed of adjustment to the real pattern of spending and hence the reduction in these imbalances. This discussion should be informed by countries’ ability to follow that path in a sustainable way. Second, many policies, in addition to changes in exchange rates, will be needed to reduce imbalances. If agreement is not reached on these two principles, at best there will be a weak world recovery; at worst, the seeds of the next ﬁnancial crisis will be sown.