As FY2010 drew to a close,1 the global economy appeared to be emerging from the worst recession in over 60 years. The recovery remained uneven, however, with some economies growing very robustly, while others were experiencing more tepid rebounds, and downside risks were increasing-and continued to do so in early FY2011. Policies are needed to address these risks and set the stage for a return to strong and sustained global growth.
The past year has been a roller coaster for the global economy.4 The severe financial crisis that followed the collapse of Lehman Brothers in September 2008 had a significant negative effect on the world economy, with global output falling by ½ percent in 2009. Advanced economies were the most significantly affected by the financial crisis, having to deal with a serious credit crunch, battered balance sheets, and rising unemployment. In these countries, output fell by 3¼ percent in 2009. The crisis was transmitted swiftly across the globe through a number of channels-including a collapse in trade, a drying up of capital flows, and a drop in remittances. When the dust had settled, it became obvious that several emerging markets and low-income countries had been severely affected by the global crisis, the worst in over 60 years.
The global economy went through a period of unprecedented financial instability in 2008-09, accompanied by the worst global economic downturn and collapse in trade in many decades. The IMF played a leading role in helping its member countries deal with the immediate challenges posed by the crisis and begin to shape a new, stronger global financial system.
At the October 2009 Annual Meetings, the IMFC endorsed the following broad priorities for the IMF for the period ahead: (1) reassessing the institution’s mandate to encompass the full range of macroeconomic and financial sector policies that bear on global stability; (2) continuing to strengthen its financing capacity, to help members cope with balance of payments problems, including financial volatility, and reduce the perceived need for excessive reserve accumulation; (3) sharpening multilateral surveillance and better integrating it into bilateral surveillance, and undertaking further strengthening of cross-country, regional, and multilateral surveillance; and (4) reforming Fund governance, to increase the institution’s legitimacy and effectiveness.
In FY2010, the IMF continued the implementation of internal reforms approved in 2008. Work progressed on restructuring the income and expenditure sides of the IMF accounts. Sales of IMF gold envisioned in the 2008 reforms, with the intention of enabling a move to a new income model for the Fund and supplementing its resources for concessional lending, were approved by the Board and began. On the expenditure side, further progress was made in aligning the Fund’s medium-term budget with revised objectives involving permanent reductions in expenditures and numbers of staff.
The past decade proved to be a period of considerable stress for non-oil developing countries. Throughout most of the 1970s, a combination of events caused the international economic environment to become less conducive to stable growth for this group of countries and made the problem of economic management in general—and of balance of payments adjustment in particular—much more difficult. The substantial fluctuations in the world market prices of primary commodities, the sharp increases in the price of energy products, the slowdown of economic activity in the industrial countries, and the rise in real interest rates toward the end of the period were all major contributors to a serious deterioration in the current account positions of most non-oil developing countries. At the same time, domestic developments in a number of economies also played a significant role in exacerbating payments disequilibrium. In many non-oil developing countries, inflationary demand-management policies—combined with rigid exchange rate policies and restrictions on trade and payments—resulted in domestic demand pressures and cumulative losses in international competitiveness that also gave rise to current account and overall balance of payments difficulties.
The role of exchange rate policy in economic adjustment has been widely studied and is the subject of numerous theoretical and empirical papers produced in the Fund and elsewhere. The Fund staff has reviewed from time to time the effectiveness of adjustment programs incorporating an active exchange rate policy.1 Other issues relating to exchange rate policy, including, in particular, the interaction between the exchange rate and other macroeconomic policy variables, also have received considerable attention.2 However, little detail is available on the methodology of developing and implementing exchange rate policies in the context of adjustment programs. Besides examining general issues related to formulating exchange rate policy in adjustment programs, this paper reviews the experience with development of exchange rate policy in programs supported by the Fund in 1983.
Whenever a country undertakes a program of balance of payments adjustment, it needs to consider whether a change in the exchange rate is required to achieve a viable external position and a reasonable rate of economic growth over the medium term. The ways in which exchange rate policy works to correct balance of payments problems and to improve the allocation of resources are well known and need no repetition here. To provide a setting for the discussion in the remainder of the paper, however, this section briefly considers four conceptual issues: (1) the use of indicators to assess the appropriateness of the exchange rate in adjustment programs; (2) the role of exchange rate policy in relation to other program policies; (3) the extent to which exchange rate stability should in itself be a proximate policy objective in adjustment programs; and (4) the attention given to exchange rate policy when use of Fund resources is involved.