Fragmentation Risks

• Author: Christine Lagarde
• Position: the IMF’s Managing Director.

Straight Talk

After the strife of the past five years and the depth and breadth of the crisis—brought about in part through deep global interconnections of economies and financial markets—it could be easy to lose sight of the benefits of integration. We must not.

There is much to be gained from a more integrated and interconnected global economy. Trade and financial integration over the past few decades have underpinned strong growth and job creation in many places. This globalization has helped poorer economies narrow somewhat the income gap with richer ones. It has also helped to bring societies closer together and make them more open.

But new and unfamiliar risks can also arise. These risks must be kept at bay if we are to reap the rewards of integration.

A risk cascade

As the crisis has shown repeatedly, risks can cascade through the system very quickly, sometimes in unexpected ways. Small shocks—defaults on mortgages in the United States, uncertainty about Greek government bonds, bank stress in Spain—can become global issues. In today’s interconnected world, crises do not recognize borders.

With fragilities and limited policy buffers in the advanced economies that are the “core” of the global financial system, it is no surprise that systemic volatility is high. Risk sentiment switches rapidly between “on” and “off.” Things are unlikely to change soon—working through the fragilities and rebuilding buffers may take several years. How can we help preserve and enhance the gains from integration, rather than see them reversed by those who prefer to retreat inward?

In a nutshell, the problem is that the architecture for stability of the international financial system has not caught up with the rapid pace of integration. Finance is global, but the architecture for ensuring systemic stability has remained predominantly national. That means that the capacity of policymakers to cope with shocks can be easily overwhelmed, and policymakers may find themselves rapidly running out of policy “bullets.”

A spotlight on cooperation

No part of our interconnected world is immune. The crisis is global, and the way out must also be global. By working together, we can make the whole of our policy actions more than the sum of their parts.

For example, the coordinated fiscal stimulus in the immediate wake of the crisis helped avert a far greater economic calamity. Recently, the global community pledged more than $450 billion to increase IMF resources and help...