The International Monetary Fund: Its Present Role in Historical Perspective*
Michael D. Bordo
Prepared for the U.S. Congressional International Financial Institution Advisory Commission
* For valuable and timely research assistance we thank Debajyoti Chakrabarty. For helpful comments on an earlier draft we thank Jim Boughton.
Table of Contents
What does the IMF do?
Origins and Original Aims
The IMF’s Role in the Post Bretton Woods Era: Externalities and Public Goods?
The IMF in Search of a Mission
International Politics and the IMF
Conclusion: Some Issues in the Case for Reform
Average Time Spent in IMF Programs by Class of Borrowers
Arrears in the IMF
IMF Quotas as a Share of World Imports
IMF Charges and Commercial Interest Rates
Total Fund Credit Outstanding to Members
Low Interest IMF Lending
Transactions of the International Monetary Fund, 1955 – 1997
After 55 years of existence there are strongly conflicting views on the importance and role of the IMF for today’s international economy, and on its effectiveness. On the one hand there are those who see the Fund as having adapted well to the changing world environment with perhaps the need for some reforms to the International Architecture.1 On the other hand are those who believe that its useful time has passed in the environment of exchange rate flexibility and open capital markets.2 These radically conflicting views require the need for a balanced perspective on the role and performance of the IMF within the context of its historical evolution.
In this paper we describe what the IMF is and what it does. We consider its origins as the guardian of the Bretton Woods adjustable peg exchange rate system and financier of temporary current account deficits for advanced countries, to its present primary roles as development financier and crisis manager for the emerging world. We consider the externalities or market failures that the IMF is believed by many to correct and the public goods that the IMF provides. Critics of the IMF downplay the extent of market failure and the scope of public goods provided. They attach greater importance to market solutions. We consider their views as well.
The reincarnation of the Fund occurred against the backdrop of a series of major economic and political shocks: the oil price shocks of the 1970’s, the debt crisis of the 80’s, the collapse of the Soviet empire in the late 1980’s, and the recent emerging market crises in Mexico and East Asia. These events served as a template for the creation of new Fund responsibilities, facilities and enhanced resources. As we document, the expansion of the Fund served different constituencies: the United States, the other advanced countries, the emerging countries and the very poor LDC’s. Most importantly, the evolution of the IMF has reflected the geopolitics of the international economy, which we discuss in Section 6. We conclude by raising some questions that should be considered in the course of a serious evaluation of the IMF’s role at the beginning of a new millennium.
2. What does the IMF do?
Most people think of the IMF as an institution that provides emergency credits to countries that have found themselves in difficulties, either as a consequence of poor economic policies or through external circumstances, such as a sudden drop in commodity prices, or a financial crisis in a neighboring country. In return the country is obliged to impose painful austerity policies, usually involving reductions of budget deficits, through spending cuts or increased revenue (taxation), a rise in interest rates to reduce inflation, and an alteration of the exchange rate (a devaluation).
This view, while not inaccurate, gives only a partial picture of the reality of the Fund's operations, or of what it is supposed to do. Its mandate, as laid down in the first Article of Agreement in 1944 in Bretton Woods, NH, is very general: to promote international monetary cooperation, facilitate the growth of world trade, promote exchange rate stability, and to help to create a multilateral system of payments. In order to achieve these objectives, the Fund was supposed to provide short term balance of payments support to countries in need of additional international reserves.
It is now an almost universal financial institution, having grown from the 44 states represented at the 1944 Bretton Woods conference to 182 countries today. Now it includes almost every economy of the world. (There are only a few exceptions: Cuba, North Korea, Taiwan.)
Who runs it? The IMF is owned by the governments of its member countries, represented through a Board of Governors. The Governor for each member country is usually the Minister of Finance or sometimes the Central Bank Governor (in the case of the United States, the Secretary of the Treasury). Voting is in accordance with the size of a country's share-holding in the Fund (or "quota"), and many important decisions require special majorities (85% of the vote). There is no attempt to give an equal voice to every country, as there is in the United Nations. Periodically, quotas are recalculated to reflect changing economic size.
The United States, the largest member of the IMF, currently has 17.78% of the vote, and thus can veto any major decision of the Fund it feels is unacceptable. Under the terms of its Articles of Agreement, the IMF's headquarters are located in the largest member country: they have always been in Washington D.C..
Meetings of the full Board of Governors are a rather cumbersome annual event; a smaller and more manageable body is the so-called "Interim Committee", of 24 Governors, which meets twice a year and is charged with reporting to the Governors (and in practice making recommendations which stand a good chance of success) on "the management and functioning of the international monetary system and on proposals to amend the Articles of Agreement".
Day to day decisions are made by an Executive Board. Countries are grouped into constituencies to elect 24 Executive Directors as members of the Board, with the exception that the five largest members of the IMF (the United States, Germany, Japan, France and the United Kingdom) have their own Executive Directors. The Executive Board also appoints a Managing Director. The staff of the IMF (currently 2,660) is recruited internationally, but without any quotas as to nationality (as is the practice in the United Nations).
How big is it? Fund quotas for member countries are initially determined by a calculation based on the size of the national economy (GDP, current account transactions in the balance of payments). They are periodically increased, in response to perceived needs for the IMF's operations. The Articles of Agreement provide for a general review of the quotas every five years. There have been a total of 12 such quota reviews, in 4 of which it was decided that no increase was needed. In the other 8, there was a general increase, and some redistribution of quotas to reflect changing positions in the world economy. In the most recent round of increases, the total quota was raised by 45%, from SDR 146 bn. to 212 bn. (approx. $291 - on September 3, 1999, SDR= $1.37494), with the U.S. share being set at SDR 37,149.3. The size of the IMF, measured by the total of IMF quotas, measured as a proportion of world trade fell sharply between 1946 and the mid-1970s; since then this ratio has been stable, and even shown a slight increase.
Figure 1: IMF Quotas as a Share of World Imports
Since borrowing from the Fund (or “drawing” of quotas in IMF parlance) is related to the size of a country’s initial deposit or quota, the IMF is often seen as analogous to a credit union rather than a bank, in which there is no such association between lending and deposits.3
What does it do? The IMF has evolved into a major influence on the development of the world economy. Its functions today include the following, many of which correspond directly with the mandate, and others have been added, with the intent of realizing the original mandate:
1. The IMF still sees its primary purpose in promoting world trade, and in securing the general well-being of the world economy, through analysis and advice. This advice is aimed at avoiding inconsistencies between the policies of its different member states, and policy mistakes by individual members. The IMF tries to influence the policies of its members, in the belief that poor policies have an adverse effect that extends beyond national frontiers. Its Articles of Agreement (Article I, 1) refer to the establishment of a "machinery for consultation and collaboration on international monetary problems". The term used by the IMF for this function is "surveillance".
Surveillance takes two principal forms: the first is multilateral, based on a general overview of the inter-connections and inter-actions between national economic policies and performance, and of forecasts based on a variety of scenarios. The most important practical expression of these calculations is an exercise conducted by the IMF's staff, and then discussed by the Board and presented as a publication, the World Economic Outlook. World Economic Outlook material is also used in G-7/G-8 economic summits and in the meetings of the G-7 Finance Ministers, where the views of the IMF are presented by the Managing Director and by the Director of the Research Department. The IMF staff also prepare published assessments of world capital markets, the International Capital Markets Reports. These focus on market developments, not only in advanced economies, but also in emerging markets (which are dealt with much more fully than in the analogous BIS reports). WEO and capital markets reports material is generally highly regarded, and the econometric model used is state of the art, although analysis of errors in past forecasting in the WEO shows a tendency toward optimism.4 Recently, the IMF has also conducted research on early warning signals that might show the imminence of currency or banking crises: but such research - in common with similar academic research - tends to show the difficulties in finding reliable prior indicators of crisis .5
Secondly, there is a bilateral surveillance, based on regular consultations with member countries (known as Article IV consultations). As a result of a feeling in the 1990’s that some of the problems in the international economy were a consequence of inadequate surveillance, the IMF reverted to a pattern of annual consultations (after a period in which they were less frequent). Sometimes IMF staff reports on member countries are thought to be insufficiently critical (because of the development of a sort of “clientism”, in which good relations with officials and ministers develop).
The economic basis of staff papers in preparation for these consultations have been published for some years (under the title "Recent Economic Developments"). In April 1999, the IMF launched an experimental program for the release of staff reports subsequent to consultations. The results of the consultations are expressed in a paper, which is now published by the IMF, given the consent of the member country concerned, as a "Public Information Notice" (previously, the outcome of such discussions was regarded as confidential). In 1999, the IMF began to release full staff reports.
Within the general field of surveillance, the IMF has a special mandate with regard to exchange rate policy. This was the original rationale for the IMF's existence (see Section 3), and exchange rate policy remains at the center of advice to member countries. The IMF groups and lists the exchange rate policies of its members, and a great deal of its research is concerned with theoretical as well as practical issues relating to exchange rate policy.
Currently, the surveillance function accounts for 42% of the IMF's budget, if overhead costs are included.
2. The IMF is primarily a financial institution, which provides credits to member countries, known in IMF terminology as "drawings on the Fund". Such credits are extended in relation to the size of the quota. Since the 1950’s, credit has been provided in “tranches”, units corresponding to 25% of a member’s quota. The first tranche is available automatically, without any discussion of policy. The larger the credit is in relation to the quota, in other words, the higher the tranche, the higher is the extent of policy reform required (conditionality). These credits are at a rate of interest calculated by the IMF to correspond with market rates of principal member countries, and to cover the IMF's operating costs.
Figure 2: IMF Charges and Commercial Interest Rates
At the end of April 1999, the IMF had SDR 63.6 bn. credit outstanding (approx. $ 87 bn.). This might look as if it is only a relatively small share of the total of quota resources (it is less than half of the pre-quota increase total of SDR 146 bn.), but in practice not all of the quota IMF's resources can really be used in support operations (using the quotas paid in national currency by a small developing country, or even a larger emerging economy, even though such currencies may nominally be convertible, might provoke a problem for that country; in practice, the IMF is thus usually limited in lending out the quotas paid in by its richer members.) In reality, an assessment of what really constitutes the usable resources of the IMF requires very careful judgment of the current state of international currency markets. A critical measurement of the Fund’s position is the “liquidity ratio”, the proportion of uncommitted usable resources to liquid liabilities. The highest ratio recently was 170%, in January 1995. It fell sharply after the Asian crisis to 45% (April 1998), but has risen to 89% (April 1999), after the most recent quota increase.
Figure 3: Total IMF Credit Outstanding to Members
As shown in Figure 3, IMF credit is given in different forms and on different conditions. The stand-by arrangements assure that a member can make borrowings over a specified period, usually between 1 and 2 years, but sometimes for a shorter period and sometimes for up to 3 years, with repayments scheduled between 3 ¼ and 5 years after the borrowing. The extended facility, introduced in the 1970’s, is available for a longer period, of 4 ½ to 10 years. These facilities carry an interest rate based on an average of rates in the major industrial countries. Thus, inevitably, for each of the IMF’s major net contributors of resources (the industrial countries), depending on the relative state of the business cycle, rates of remuneration on resources (the SDR interest rate) deposited with the IMF are sometimes higher and sometimes lower than prevailing interest rates in the national economy. Thus IMF rates were slightly higher than U.S. interest rates in the early 1990s, and are now slightly lower (see Figure 2).
During the Asian crisis, a new facility (the Supplemental Reserve Facility) was introduced, that resembled more closely the traditional notion of an emergency lender of last resort, as envisaged by Walter Bagehot in his classic work Lombard Street (1873). This facility is aimed at dealing with abrupt reversals of confidence. The amounts lent are higher, but charged at a penalty rate of 300 to 500 basis points above the IMF’s regular rate of charge. In making such loans, the IMF inevitably has to consider its own liquidity position, and is obviously not capable of extending infinite credit in a manner analogous to the monetary authority in a national setting.6
There are further possibilities of lending in response to natural disasters, in post-conflict situations (such as Albania, Bosnia, Rwanda, Tajikistan), and special facilities: the Compensatory and Contingency Financing Facility, for unexpected and temporary falls in export prices, export volumes, or for increases in the cost of cereal supplies; and the Systemic Transformation Facility, which was used between 1993 and 1995 to support economies in transition from plan to market.
In addition, there is also a possibility for the Fund to borrow resources outside its quotas. Since the 1960’s the IMF has been able to borrow additional sums from 11 large industrial countries (under the so-called "General Arrangements to Borrow", or GAB), which may be lent "to forestall or cope with an impairment of the international monetary system" (it was intended to deal primarily with potential problems in the major reserve centers, the United Kingdom and the United States). This new potential source of IMF credit broke with the previous IMF principle of operating on the lines of a credit union, and turned the institution toward a role as a bank. After the end of the par value system, the GAB was rarely needed as a support for reserve currencies; and the provision had in fact been inactive for twenty years, until it was resuscitated in July 1998 to provide resources for Russia. It was last enlarged in 1983, to an amount of SDR 17 bn. There is also an additional amount available under a separate, but analogous, agreement with Saudi Arabia.
The GAB has recently (1997) also been supplemented by an as yet unused mechanism for borrowing SDR 34 bn. from a wider group of 25 members of the IMF (the "New Arrangements to Borrow"), as a response to the Asian crisis and in order to provide additional facilities in the event of systemic problems in emerging markets..
3. In some circumstances, the IMF is a provider of subsidized credit. Since the 1970’s, the IMF has given low interest credits to poor countries, who at that time were especially vulnerable because of the increased cost of imported fuel. The interest subsidy was paid through a Trust Fund, financed in part in the 1970’s by the sale of parts of the IMF's gold reserves. Currently, the IMF’s facilities for low-income members, defined principally on a basis of per capita income and eligibility for the concessional lending of the World Bank Group under IDA (International Development Association), are known as the Enhanced Structural Adjustment Facility. The loans are made available in three installments over a three year period, carry an interest of 0.5%, and are repaid over a period from 5 ½ to 10 years after the loan disbursement. At the end of July 1999, the IMF had SDR 6.5 bn. in credit outstanding under this subsidized credit arrangement (or 10.2% of its total outstanding credit). The subsidy is paid in part from interest from the Trust Fund created in the 1970’s, and in part from donations and loans from member countries .
The provision of low-interest credit developed in the following way:
Figure 4: Low Interest IMF Lending
Such credit brought the Fund into development work. It is a task that lay outside the traditional areas of IMF responsibilities.
4. The IMF also has the task of creating supplementary reserves, in the form of the SDR (Special Drawing Right). The issue of SDRs is linked, according to the first Amendment of the Articles of Agreement), to a general need for liquidity. In a world of liquid capital markets it is hard to see a case for such a general requirement, short of a general world deflation, and there has been no issue of SDRs since the 1970’s. The consequence is that more recent members have received no allocation of SDRs, and in general the SDR plays a relatively minor role in world monetary policy.
5. In the course of surveillance, the IMF collects a great amount of data, which it has presented in a standardized and systematized way in such publications as International Financial Statistics. There has developed an increasing awareness that surveillance can be more effective if its results are made available to a wider public, that is market participants. The World Economic Outlook material is also published. Recently, in 1996, in response to the Mexico crisis of 1994-5, it provided a systematic standard for the presentation of national data relevant to the operation of capital markets, the "Special Data Dissemination Standard". Information supplied is displayed on an electronic bulletin board, and the IMF monitors compliance. The IMF also publishes regular reports on international capital markets.
6. The IMF provides training and technical assistance through the IMF Institute to member countries on matters such as the operation of central banks, Finance Ministries, tax regulation etc.. This educational function accounted for 22.5% of the IMF's operating budget in 1997/8.
How much does it cost? Unfortunately a breakdown of its expenditures between categories has only been available since 1995. For the latest year for which we have data, 1998, we have broken down the IMF’s activities into three categories: surveillance was $218.2 million and represented 42% of the budget; the use of IMF resources (the IMF’s role as a financial institution) was $184.2 million and 35.5% of the budget; technical assistance was $117.1 million and 22.5% of the budget. The data to extend these calculations backward is unavailable. General overhead costs are allocated to each of these three activities in accordance with their proportionate importance. The costs of the IMF Research Department are not shown separately. Research is directed toward these three categories, and the costs allocated accordingly.
3. Origins and original aims
The best way of thinking of the IMF and its functions during the period of the so-called Bretton Woods regime (1945-1973) is not so much as an institution, but as the institutional embodiment of a system of rules (the IMF's Articles of Agreement). The construction of the postwar international monetary system, built around the IMF, came as a result of a general agreement that a repetition of the economic and political nationalism of the 1930’s could and should be avoided.
The IMF was established in the aftermath of the disasters of the Great Depression to overcome perceived market failures of the 1930’s, including destabilizing short-term capital flows (hot money movements), then the breakdown of capital markets, the consequent inability to finance payments deficits in a time of depression, the widespread imposition of exchange controls, competitive devaluations (‘beggar thy neighbor’), and a turn to trade protection.
The Articles of Agreement drafted at Bretton Woods, NH in July 1944 represented a compromise between the plans of the U.S. and U.K., the leading Allied economic powers during the war. For the U.S., restoration of a multilateral payments system based on convertible currencies was paramount. The British wanted the freedom from the external constraint to pursue full employment policies. In the end the American Plan proposed by Harry Dexter White for a Stabilization Fund modeled in part on the U.S. Exchange Stabilization Fund was dominant. The par value adjustable peg system was based on the nominal anchor of gold with the U.S. as the reserve center country. The IMF was designated as the umpire of the system with an initial Fund of 8.8 billion dollars to lend to members when balance of payments pressure threatened adherence to the par values.7,8
In the vision that lay behind the Bretton Woods conference of July 1944, the IMF's major functions were to:
1. facilitate an end of exchange controls and transition to current account convertibility (countries maintaining controls were obliged to hold regular consultations with the IMF referred to as Article XIV consultations).
2. deal with the fear of competitive devaluations (which may have been an instrument of trade warfare in the 1930’s) in response to the belief, based on the experiences of the 1920’s, that flexible exchange rates were destabilizing. It instituted pegged, but adjustable, exchange rates based on the stable nominal rate of the U.S. dollar or on a specific gold value. Adjustment beyond a certain margin (10%) required the concurrence of the IMF.
3. provide short term finance to deal with temporary balance of payments disequilibria (such problems were assumed to arise from the current account, since it was believed that capital flows in the post war would be minimal and moreover the Articles encouraged capital controls). The pursuit of inappropriate demand management policies by a member country would lead to danger signals, in the form of balance of payments imbalances. If the imbalance reflected a fundamental disequilibrium (never explicitly defined but generally meaning an unsustainable payments imbalance), the exchange rate would be altered with the approval of the Fund. If the problem was perceived to be temporary, the IMF would provide financial assistance. Through the quota mechanism, the IMF de facto created an additional pool of reserves (it functioned analogously to a credit union).9
4. constitute an economic equivalent of the United Nations (the five largest quota holders as calculated at the time of Bretton Woods, United States, USSR, UK, China, France, with an automatic right to seats on the IMF's Executive Board, correspond to permanent members of Security Council).
The successes and failures of the original vision
World trade expanded quickly from the 1950’s. There was no worldwide depression immediately after the Second World War as had occurred after World War I. The absence of such an economic catastrophe had little to do with the IMF, which actually undertook little activity in the first ten years of its existence, but was rather due to the Marshall Plan, the Pax Americana and the institution of stabilization policies across the advanced world. Implementing the Bretton Woods Articles - in particular the attainment of current account convertibility (Article VIII) - took a long time for the advanced countries of Western Europe. Other parts of the original vision ran into increasing problems.
1. Current account convertibility in the advanced countries of Western Europe took much longer than had initially been envisaged, until December 1958. It was achieved through the efforts of the European Payments Union funded partially by the Marshall Plan. The attainment of convertibility was preceded by a surge of IMF credit in 1956-7, and by 1958 most European countries had accepted the relevant article (Article VIII) of the Articles of Agreement. Japan did so in 1964. Most developing countries however retained current account restrictions until the 1980’s or 1990’s. In 1960, 13% of the IMF’s members had accepted current account convertibility under Article VIII, in 1970 30%, and by 1990 45%. By 1998, however, of the IMF’s 182 members, 142 (or 79%) had accepted Article VIII.
2. The strains on the par value system increased in the 1960’s. Strains included a continuous tension between countries in chronic deficit like the UK, which was prevented by external constraints from expansion and was under continuous pressure to devalue. The UK, at that time the issuer of the world's second most important reserve currency, thus faced almost continual crisis. The surplus countries, Germany and Japan, who found it difficult or impossible to revalue. In addition, the system itself faced considerable strain as the center country the U.S., ran almost continuous balance of payments deficits and persistent gold drains. Numerous efforts to prevent the inevitable collapse of the system included U.S. drawings from the IMF, and the system eventually broke down in a series of currency crises between 1971 and 1973. After the breakdown, the threat of trade wars increased.
3. After 1978 no major industrial countries drew on the IMF for short term finance, because the international capital markets now provided such funds. The growth of capital markets, which had contributed to the breakdown of the fixed exchange rate regime in 1971-3, surprised everyone.
4. The IMF was not initially a global institution, as had been envisaged at the time of Bretton Woods, but became a part of Cold War politics. The USSR had refused to join in 1945, and the IMF became an institution of the non-communist (free) world.
4. The IMF’s Role in the Post Bretton Woods era: externalities and public goods?
The decades following the breakdown of the par value system in 1973 witnessed a sea change in the international environment from that envisioned by the architects of the Bretton Woods system.10 The par value system was gone and with it the IMF’s main function as the umpire of the rules of the game of that system. In the new environment, member countries could freely choose their exchange rate arrangements—pegged exchange rates to secure the benefits of a nominal anchor and monetary and fiscal discipline, or floating rates for policy independence and insulation from external shocks. The move by most advanced countries towards floating, which in theory at least provided policy independence and a reduced need for international reserves, meant that the only role seemingly left for the Fund was surveillance designed to achieve responsible exchange rate policies under the amended Article IV. The IMF provided information and policy advice, and acted as a medium for policy coordination.
A second development that had profound implications for the IMF was the increasing integration of the world economy. This reflected a reduction in trade and transportation costs and especially financial integration.11 The dramatic opening up of private international capital markets, which had been suppressed through the Bretton Woods years by IMF sanctioned capital controls, implied that private capital could substitute for official financing of payments imbalances. This indeed became the case for the advanced countries. The final change in the environment facing the IMF was a dramatic growth in membership with the collapse of colonialism in the 1960’s to 1980’s and the dissolution of the former socialist bloc in the late 1980’s.