Journal Issue

Review Article: The IMF in A Period of Turbulence: Review Article on Latest Installment of The Fund History

International Monetary Fund. External Relations Dept.
Published Date:
March 1986
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Robert Solomon

The third installment of the International Monetary Fund’s official history covers 1972–78, a period of fundamental change in the world economy and in the international monetary system: the move to floating exchange rates, the several effects of the first oil shock, the onset of stagflation in the industrial countries, and the emergence of newly industrializing countries as heavy borrowers from commercial banks. The IMF had to amend its constitution (the Articles of Agreement), enlarge and revise its lending facilities and the terms on which it made funds available, and adapt its consultation and surveillance procedures to the new circumstances.

The author, Margaret Garritsen de Vries, has produced a valuable history of this period. She, and the management of the Fund, are to be congratulated. Mrs. de Vries has been given, and has used, the freedom to analyze and to exercise independent judgment as well as to narrate. It is not an exaggeration to say that, had one examined this manuscript without knowledge of its source, one would not have identified it as an official history from its style and substance (except, of course, for a few superficial indications such as the acknowledgments in the preface and the third volume of documents).

The two volumes of “narrative and analysis” comprise 1042 pages, excluding appendices, a useful chronology, and the index. That comes to almost 149 pages a year. The previous installment, covering 1966–71, devoted about 109 pages to each year, on average, and the first installment, covering 1945–65, 60 pages to each year. The increasing number of pages a year is an indication of the growing importance of the Fund in the world economy and the greater complexity of its activities. This latest history of the IMF is for all practical purposes a history of the international economy and of international monetary developments and policies in 1972–78.

Robert Solomon is a Guest Scholar at the Brookings Institution. He was formerly an Adviser to the Board of Governors and Director, Division of International Finance, US Federal Reserve System. He has served as Vice Chairman of the Committee of Twenty, 1972–74. He is the author of The International Monetary System, 1945–1981 (Harper & Row, 1982) and numerous journal articles on economics and finance.

Margaret Garritsen de Vries

The International Monetary Fund 1972–1978

Cooperation on Trial

Volumes I and II: Narrative and Analysis; Volume III: Documents. The International Monetary Fund, Washington, DC, 1985, 1809 pp., $60 (set).

As a result, the narrative and analysis cannot and do not proceed in strict chronological order. Instead, the history treats topics seriatim, often spanning the same period, as it traces the origins and development of ideas and situations, and the variety and complexity of issues that the IMF confronted.

Déjà vu

History at its best helps to illuminate the present. The work under review does this in numerous ways. It gives us, for example, a perspective on current proposals for international monetary reform. Dissatisfaction with floating exchange rates—particularly with large medium-term swings in currency values—is being widely expressed nowadays, much more than in the period covered by the Fund history. Specific proposals for maintaining more stable exchange rates, such as the establishment of target zones, are being put forward by some officials and by some private parties. Implementation of these proposals would require that monetary policy be aimed more directly at stabilizing exchange rates, even in the largest industrial countries (a number of small and even medium-sized nations already do so to a significant degree).

Yet, as the Fund history brings out again and again, neither the German nor the US monetary authorities have been willing to sacrifice the domestic objectives of monetary policy in order to preserve exchange rate relationships. In 1972, in the course of IMF consultations with the United States, the US Executive Director “took issue” with the recommendation that US monetary policy be oriented to raising interest rates so as to attract funds from abroad and thereby help preserve the dollar’s par value. He argued that it was “essential that US authorities retain a free hand in formulating monetary policy in order to facilitate the expansion needed in the domestic economy” (p. 15).

In that same year, Germany imposed a cash reserve requirement (Bardepot) on borrowings abroad by residents, who found interest rates higher at home than on foreign markets (pp. 17–18).

Even earlier, in May 1971, German officials had tried to persuade their partners in the European Community to undertake a joint float in order to regain control over their own monetary policy (p. 113). The same motivation led to the decision by the European Community countries in March 1973 to allow their currencies to float against the dollar (p. 113).

Is there any more reason today than in the 1970s to expect the largest economies to devote their monetary policies to the pursuit of exchange rate targets? There might be a greater prospect for this if fiscal policies were more flexible. But the experience of the 1980s shows fiscal policy in both the United States and Germany to be highly inflexible.

Mrs. de Vries’ judgment that independent monetary policy under floating rates has proved to be “illusory” strikes me as not quite correct. She derives this conclusion from the observation that pursuit of independent monetary policy, especially in Germany and the United States, led to exchange rate movements that had some undesired effects (p. 834). This is certainly true, but those effects—“distress” for German exporters and some worsening of inflation in the United States when the dollar depreciated against the mark in 1977–78—did not prevent monetary policies from achieving their primary domestic aims. Restrictive monetary policy is bound to distress some elements in the economy; if it had not been German exporters by way of appreciation of the deutsche mark, it would presumably have been the construction industry or other industries sensitive to interest rates. In the same way, the mix of fiscal and monetary policies in the United States in 1981–84, instead of crowding out domestic investment, distressed US exporters and producers that compete with imports. When exchange rates are flexible, monetary policy does not become less effective. On the contrary, it has a wider reach across the economy.

Committee of Twenty

With international monetary reform in the air once again, it is germane to ask whether the Committee of Twenty (C-20) exercise has relevance today. Mrs. de Vries provides a thorough and basically fair review of that unsuccessful effort to create a more satisfactory international monetary system. The C-20 began its work in September 1972, when the exchange rates of industrial countries were pegged at the values negotiated in the Smithsonian agreement (except for the pound sterling, which began to float in June 1972). But the dollar was no longer convertible into gold or SDRs for monetary authorities, as it had been up to August 15, 1971. The US balance of payments had been weak for some time and had not yet shown improvement in response to the exchange rate realignment, while many other industrial countries were in surplus.

In the circumstances, the main interest of US officials in the C-20 negotiations was to establish conditions under which nations in “large and persistent” balance of payments surplus were required to adopt policies aimed at reducing their surpluses. This aim inspired the comprehensive proposal that US officials put on the C-20 agenda. Changes in countries’ reserves would establish a presumption for the adoption of balance of payments adjustment measures. Incidentally, that proposal did not, contrary to what Mrs. de Vries has concluded, provide for “virtually automatic” exchange rate adjustments (p. 231). The proposal explicitly stated that exchange rate changes “are not seen as the only, or necessarily as the most desirable, means of adjustment in all cases” (Economic Report of the President, January 1973).

The main interest of officials of European Community countries, as Mrs. de Vries points out, was in convertibility or asset settlement, since they were “convinced that the US payments deficits were caused by relatively easy US money policies and the resulting inflation and that the special role of the dollar in international payments encouraged these deficits since the United States did not need primary assets or borrowed credits to finance them….” Europeans were unwilling to accumulate inconvertible dollars indefinitely and they “resented the transformation of the gold-exchange standard into a dollar standard” (pp. 164–5).

Not all of this is unfamiliar today. Although the dollar is far from weak, the United States is once again in current account deficit and the other industrial countries in current account surplus. A large part of those current account imbalances is attributable to the appreciation of the dollar in 1981–84.

Suppose that the system adumbrated in the C-20 Outline of Reform had been in force in the 1980s. But assume also that the United States had adopted the same budget and monetary policies that have prevailed in recent years. With exchange rates pegged at, say, their 1980 values, the flow of funds to the United States would have led to decreasing reserves in Europe, Japan, and elsewhere and to increasing reserves in the United States. Europe and Japan would have been expected to adopt restrictive monetary policies and, if the reserve losses were substantial, to move their exchange rates lower relative to the dollar. American policies would have been expected to shift the other way. Thus, exchange rates would have moved in the same direction as they actually did in the 1980s. But the macroeconomic policies dictated by the C-20 principles would have been perverse. The United States, which was already growing faster than other industrial countries, would have been expected to adopt still more expansionary policies, since its reserves would have been increasing. Europe and Japan would have been expected to pursue more restrictive policies, despite the sluggishness of their economies.

The point is that the C-20 Outline of Reform did not anticipate a situation such as that which prevailed in 1981–84, when the United States had a weak balance of payments on current account but a strong currency. Therefore the provisions in the C-20 Outline for overriding the reserve indicators would probably have been invoked. This could also have led to the activation of the provision for floating in “particular situations.” And that takes us back to where we are today.

…and the situation today

Critics of the present system might argue that under the more structured C-20 system the United States would have been induced to alter its fiscal policy sooner, reducing its budget deficit. That is a matter of political judgment. I find it unlikely that the Reagan administration would have changed its budget policy under the influence of an international monetary system of the C-20 type.

All in all, we have to conclude that the C-20 system, if it had been in effect in the 1980s, could have produced some perverse policies but probably would have led to exchange rate changes in the same direction, and conceivably of the same magnitude, as those that were actually experienced. It is hard to avoid the judgment that, given the macroeconomic policies being pursued in the United States and other industrial countries in the 1980s, the world was better off with an appreciating dollar.

The central problem, it is now being recognized, arises less from the nature of the exchange rate regime than from the interaction of macroeconomic policies of industrial countries and the consequent effect on the world economy. This gives the Fund’s consultation and surveillance processes a potential role of very great importance.

The exchange rate agreement negotiated by J. de Larosière, the Directeur du Trésor in the French Finance Ministry, and E.H. Yeo, then Under-Secretary for Monetary Affairs in the US Tr asur, recognized that exchange rate stability is dependent on “orderly underlying economic and financial conditions.” That agreement, as embodied in the Fund’s new Article IV, calls on the IMF to exercise “firm surveillance over the exch ge rate policies of members” (pp 743–9).

As the Fund’s Executive Directors began to take on this responsibility, they realized, as Mrs. de Vries puts it, that “in judging an exchange rate Fund officials could not concentrate solely on the use a member had made of reserves or on its policies of intervention in exchange markets or even only on its domestic monetary and other macroeconomic policies. The Fund would have to review a member’s entire economic situation” (p. 840).

Today even this formulation appears inadequate, since it contains no reference to the interaction of policies among nations. Until 1978, when the present history ends, the Fund seems to have been too much concerned with “exchange rate policies.” From the vantage point of 1985, what is needed is to broaden IMF surveillance to encompass the fact that a better performance of the world economy depends significantly on the economic objectives and economic policies of the larger industrial countries. How to make those objectives and policies mutually compatible and at the same time conducive to noninflationary and vigorous growth of the world economy is a major challenge. That challenge requires cooperation among nations—sometimes referred to as “coordination” of policies. The IMF, in addition to its function as a lending institution and a creator of reserves (SDRs and reserve tranches), is a forum in which such cooperative policy making could be implemented.

The Fund did make one significant contribution to this process. In 1978, under the leadership of its then Managing Director, H. Johannes Witteveen, the Fund proposed a “coordinated economic growth scenario” (pp. 393–4). These proposals for policy changes in the larger industrial countries helped to influence the decisions taken at the economic summit meeting in Bonn in June 1978. Those decisions have been unfairly criticized, but not in this history; their failing is that they did not do the impossible by anticipating the fall of the Shah of Iran and the second oil shock. The World Economic Outlook exercise, described carefully by Mrs. de Vries, would be an important input to a regular multilateral consultation process in the Fund on macroeconomic aims and policies.

In its capacity as a lending institution, the Fund was active in 1972–78, creating two oil facilities to assist in the recycling of OPEC surpluses, a supplementary financing facility, and enlarged access to its resources. Borrowings (“drawings” in the IMF jargon) were made by 76 non-oil developing countries, 2 oil exporters, 11 so-called “more developed primary producing” members (including Australia, New Zealand, Portugal, and Spain), and Italy and the United Kingdom, in addition to five other industrial countries, including the United States, that drew on their reserve tranches.

In the early 1980s, under Mr. de Larosière as Managing Director, the Fund became not only a still larger lender but, more generally, a manager of the debt problem. That experience will be a major topic for the next installment of the Fund history, which will have to deal even more fully with the controversial subject of IMF conditionality. Whatever one’s views on this conditionality, an observation from the present installment is relevant. It may have been forgotten by now that the stand-by arrangements with Italy and the United Kingdom in the 1970s involved tough conditions on the economic and financial policies of those countries. As Mrs. de Vries says, these arrangements “contradict the criticism sometimes leveled at the Fund that the conditions attached to stand-by arrangements for industrial members are less stringent than those for developing members” (p. 441).

Controversy about Fund conditionality is nevertheless acute. That it is so testifies to the crucial role that the IMF has come to play in the world. Its history merits the splendid treatment given it in these volumes.

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