THE CHALLENGES facing the IMF as a monetary institution have grown ever more complex since its founding. The IMF’s mandate must evolve to take into account economic policy interdependence, financial market liberalization, and the new predominance of capital flows. Mr. Guitián presents his insights into how the IMF might respond to these challenges by expanding IMF surveillance, enlarging the institution’s oversight to cover capital flows, and substantially increasing its resources.
Half a century has elapsed since the creation of the IMF and the World Bank. In his speech to the Inaugural Meeting of the two institutions, Keynes made many points that are relevant today and will remain so for years to come. Two are particularly important. One is the call for a “perpetual reminder” that the two institutions “belong to the whole world and their sole allegiance is to the general good, without fear or favor to any particular interest.” The other is that for the institutions “to win the full confidence of the suspicious world, it must not only be, but appear, that their approach to every problem is absolutely objective and ecumenical, without prejudice or favor.”
To a large extent, the ability shown by the two institutions over their first five decades to heed Keynes’ reminder is one of the critical forces behind their effectiveness and relevance. The continuation, and possibly the strengthening, of this ability is ever more necessary in view of the challenges the international economy faces as it strides toward the next century.
The IMF’s mandate
The impetus for establishing a formal framework for a world economic order came from the desire to avoid the economic, political, and social turbulence of earlier periods. Within that framework, the IMF was charged with safeguarding and monitoring a most important component—the norms guiding the conduct of exchange and monetary transactions among member countries. The original concept postulated a liberal world monetary system based on a clear rule—the Bretton Woods par value regime. But as the international economy evolved, the concept moved toward a system based on national discretion—the generalized flexible exchange rate arrangements currently in effect. Experience with the two regimes has been evenly divided as each has prevailed for roughly 25 years.
The IMF was conceived as and remains the institution responsible for the surveillance of the code of international monetary and exchange conduct. This responsibility encompasses: jurisdiction over the exchange arrangements of members—the IMF has regulatory functions with regard to these matters; provision of conditional financial support to countries in actual or potential balance of payments difficulties—the IMF acts as a lender of financial resources; and technical assistance—the IMF provides specific advice on economic policy and statistical matters related to its mandate.
The relationship of the IMF with its member countries has always included some or all of these aspects. But the relative emphasis placed by the institution on each of them has varied over time in response to the needs and concerns of its membership as well as to global economic developments. In the early Bretton Woods period, the jurisdictional and regulatory aspects were emphasized to encourage members to liberalize exchange systems and, more generally, to open their economies to free trade in goods and services. Over time, this regulatory activity was increasingly supplemented by the extension of financial assistance, on a conditional basis, to support economic liberalization. As new members joined the institution, the provision of technical assistance gained prominence.
Evolution after 1970. Exercising jurisdiction became more complex when the Bretton Woods par value system was abandoned in the early-1970s in favor of flexible exchange rates. With this change, the international economy moved from a virtually self-enforcing arrangement to one in which judgment was of the essence. The IMF thus entered a period in which surveillance in an ample sense—encompassing the evaluation of members’ macroeconomic policies—became more prominent. This was accompanied by continued institutional support of members’ adjustment efforts through conditional access to IMF resources. Apart from the changes inherent in the adoption of flexible exchange rates, surveillance also became more complex because of the progress made in opening national economies. Openness led to increased economic interdependence, and consultation between the IMF and individual members—bilateral surveillance—had to be supplemented by a review of the policies of all members—multilateral surveillance.
There is no doubt that the IMF has lived up to the challenges it confronted when it was established. Through its monitoring of the international financial code of conduct, the institution has been instrumental in bringing about the substantial opening that has taken place in countries’ external accounts. Experience so far has also shown the resilience of the international financial system, as illustrated by its ability to integrate new members in the 1960s and 1990s, to cope with the turbulence of the 1970s, and to resolve the systemic aspects of the debt crisis of the 1980s.
The serious challenges facing the IMF and the international economic system today are rooted in the very effectiveness of the institution and the success of the postwar world economic order. Economic interdependence has been intensified by the deregulation of financial sectors and the liberalization of capital movements, as well as by the increasing relevance of the free play of market forces in the economic process. The resulting globalization of capital markets—a logical outcome of these developments—has important implications for the design and implementation of national economic policies and, in particular, for the management of monetary and exchange affairs. It also has a bearing on surveillance and the code of international financial conduct entrusted to the IMF.
The need to integrate economies in transition within the global system has provided a new challenge for the IMF and the world economy. This is a complex endeavor that calls for persistence in the reform efforts by the countries concerned and international support for those efforts, so that the transition to a market-based system can be completed in a manner consistent with a liberal economic order.
Strengthening world economic interdependence also remains a challenge. The larger countries must accept a measure of responsibility for the stability of the system, or what is equivalent, accept the constraint that it imposes on their national economic policies. This responsibility also involves encouraging international resource flows, which provide the best hope for closer and more equitable participation of developing countries in the world system.
“Economic interdependence has been intensified by the deregulation of financial sectors and the liberalization of capital movements, as well as by the increasing relevance of the free play of market forces in the economic process.”
As we look into the next century, the challenge ahead for a monetary institution like the IMF is daunting but stimulating. Is the code of conduct for the current and the prospective world economy still appropriate? How should the IMF’s responsibilities evolve within a setting of progressively falling economic barriers? These questions can be answered in many ways—the focus here is only on those that pertain to the IMF in its essential role as a monetary institution.
Global financial markets
The predominance of large and at times volatile capital movements poses important questions for the observance of the code of conduct—surveillance and its jurisdictional dimension—and also has important implications for the IMF’s financial size and activities.
Relevance of capital flows. The code of conduct permits countries to restrict international capital movements in response to balance of payments pressures. In an environment where, de jure or de facto, those movements have been generally liberalized, the relevance of this provision may be called into question. There has always been an awkward inconsistency between the code of conduct’s advocacy of freedom of current transactions and its acceptance of capital controls. It can be argued that this distinction made sense at the inception of the Bretton Woods regime when the intent was to focus primarily on the liberalization of trade and current payments. But the argument hardly holds today now that current accounts have been broadly opened and capital basically flows freely. Economic logic and reality call for a consistent and uniform approach to all external transactions. In this spirit, the IMF has strengthened its efforts to encourage its membership to shun capital controls and aim toward full currency convertibility. To these ends, the institution is giving increasing attention to capital account developments and their implications for national and international economic policy.
Multilateral surveillance. The importance of capital flows also has other consequences. The original Bretton Woods focus linking exchange rate management to current account flows, thereby stressing the importance of competitiveness, shifted toward the link between exchange rates and monetary policy, and through these linkages, to inflation control. The corollary of these developments has been that the degree of monetary policy autonomy, indeed of the autonomy of domestic economic management generally, has turned out to be more limited than generally thought, even with flexible exchange rates. As a result, the interaction among national economies has become a central aspect of the process of surveillance. In the absence of clear rules, such interaction has increased the complexity of policy evaluation. Not only does surveillance have to adopt a broader-than-bilateral focus, it also must pinpoint the sources of imbalances and assign policy responsibilities for their correction among countries. It is now necessary for all countries to keep their economies on an even keel not just for balance to obtain in each of them, but also to avoid the spillover of disruptions to other countries.
A larger IMF? The growing importance of capital transactions not only calls for the increasing attention of the IMF but it also has potential implications for the institution’s financial size and activities. The need to help countries to deal with temporary balance of payments difficulties, including those that stem from capital flows, would seem to call for a substantial increase in IMF resources. The IMF’s lending potential should increase precisely because global capital flows are so large. Although such enhanced lending potential would and should be rarely called upon, the IMF must be prepared to act if necessary.
Ideas in this direction have been advanced by the IMF’s Managing Director, Michel Camdessus. The Managing Director has advocated the establishment of a fast-disbursing, very short-term lending facility, which would help cushion the reserves of countries suddenly subjected to bursts of speculation in spite of policies that IMF surveillance had found to be appropriate. Such a facility could help countries that were implementing sound economic policies to avoid being pushed off track and would be useful for developed and developing countries alike.
In a world of global capital markets, an IMF of such characteristics would have to continue to be extremely vigilant to protect its monetary character. The institution’s resource base should be sufficient to cope with the balance of payments problems of any of its members, but its financial position should normally be one of ample liquidity. Thus, in sharp contrast to typical financial lenders, in general, the IMF should not be fully loaned up. Ample IMF liquidity would signal the effectiveness of surveillance in averting balance of payments problems. The availability of IMF resources on a scale commensurate with the external payments problems of even its largest members would add to the incentives of the whole membership to seek access to them. This would restore universality to the institution’s financial activities, instead of their being confined to a relatively limited set of countries as has been the tendency so far.
The globalization of capital markets has made economic policy interdependence a definite feature of the international setting. If anything, this evolution has added to the relevance of the IMF mandate, and has created an additional mandate for the institution: that of an international forum for the resolution of the issues related to interdependence.
The international economy has seen national financial sectors develop into a sharply competitive world industry. Besides promoting economic integration, this process also led to financial innovation and technological advances, bringing with it new financial techniques and instruments that have altered definitively the nature of world capital markets. A major immediate consequence of these developments is that it has intimately linked exchange rates and exchange market developments—areas of direct importance to the IMF—to national monetary policies and conditions, which are the natural spheres of interest of central banks. A consequence of this relationship is that national monetary policies have become more closely connected.
This evolution has a variety of implications for the IMF, particularly for its surveillance role. One is to underscore the institutional aim of promoting monetary and economic policy consistency. With national economic openness, the ability of monetary policies to attain domestic objectives has been substantially reduced. An important task for the IMF will be to help ensure that national monetary policies remain compatible with global financial stability. Another implication is that the IMF must examine, in close consultation with member governments, the consequences of financial market innovation for national monetary and exchange policies and for the international financial system. Yet another issue is the role that should be played by the IMF when pressures develop in international monetary and exchange relationships.
“The need to help countries to deal with temporary balance of payments difficulties, including those that stem from capital flows, would seem to call for a substantial increase in IMF resources.”
Balancing objectives. On the first issue, financial stability, there is consensus that the primary objective of national monetary policies should be monetary stability, generally interpreted as stability in the domestic price level. Together with this consensus has come the agreement that the pursuit of this objective must be insulated from day-to-day policy requirements and, more broadly, from political compromise. This view is well-illustrated by the importance given to ensuring central bank independence in a growing number of countries. These trends can and should be supplemented at the international level in a variety of ways.
Concentration on the attainment of domestic price stability must not be at the expense of preserving a viable balance of payments position—a primary responsibility for the IMF. One area where surveillance can complement national policy implementation is in making sure that domestic economic objectives conform to international constraints. But monetary stability is not always assured by a stable domestic price level, important though such an aim is. It also requires exchange rate stability, yet another subject of fundamental importance for the IMF and its members.
The essential task is to ensure that the objectives of internal monetary (domestic price level) stability and of external monetary (exchange rate) stability do not compete with one another. While conflicts are inevitable in a world with unanticipated economic disturbances, they cannot be sustained and, therefore, it would be futile to pursue one of these aims at the expense of the other. The often heard argument that the objective of a stable price level should be sought over the medium run and not be made subject to short-run policy compromises applies to the aim of exchange rate stability just as well. This observation carries obvious implications for the concept of the independence of central banks, concerned as they are with inflation control and monetary stability.
Lender of last resort. The second issue—the implications of the rapid evolution of international financial transactions—brings to the forefront an important aspect of monetary and central banking policy on which there is less consensus, though there is agreement on its importance for monetary and economic management. A traditional central bank function has been the discharge of lender-of-last-resort responsibilities, which brings with it concern over the soundness of the banking sector. The developments in international capital markets—their globalization, growth and increased complexity—put these subjects in a new light and on an unprecedented scale.
There are many aspects to consider: the impact of capital market globalization on the activities of banks; and the emergence of new actors in the international capital flow scene, such as institutional investors. These developments raise the question of the appropriateness of prevailing national prudential supervision norms, that is, do they help ensure a level playing field across all economic agents? Finally, there is the role of the emergence of new instruments and financial techniques in blurring the traditional separation between bank and nonbank financial intermediaries.
All these developments add to the complexity of monetary policy, which must be extended beyond the conventional macroeconomic objective of monetary stability. They underscore that the attainment of this aim goes beyond the search for domestic price or exchange rate stability. The effectiveness of monetary policy requires the existence of a competitive and sound financial sector, thereby bringing supervision and prudential regulation squarely into the domain of central banking. Indeed, it can be argued that, despite the importance of these issues for effective monetary management, focus on domestic price stability has relegated them to a neglected dimension of monetary policy.
Discipline and governance. It is in the interplay between market forces and monetary policy that the role of the IMF lies. This role is based on the issues of market discipline and governance. Although governments have increasingly favored market forces, they have been generally reluctant to accept the full force of market-imposed discipline. This reluctance is even more apparent in banking and finance, where important spillover effects can arise. Because of these spillover effects, financial deregulation must be accompanied by an appropriate framework of supervisory norms to guide market forces.
It will be important to harmonize this framework across countries. The IMF has a role to play in this process both systemically and on a country-specific basis: systemically, because of its institutional interest in and responsibility for the prevention of macroprudential policy problems (such as those that were posed during the 1980s by the debt crisis); and from a country-specific perspective, because of the IMF’s mandate with regard to advice and consultation on domestic economic policymaking.
The IMF at the center. The third issue—the role to be played by the IMF in the presence of systemic pressures and tensions—leads directly into a discussion of the desirable evolution of the institution. The main lines of such an evolution flow from the arguments made so far and they include: the eventual extension of IMF jurisdiction to capital transactions, scaling the institution’s resources accordingly, and emphasis on surveillance as well as growing participation in the efforts to protect the soundness of the international financial system.
Given its global scope, the IMF should be able and ready to come to the assistance of any one of its member countries under certain conditions and in certain circumstances, just as a national central bank stands ready to help its banking system. This role would require member governments to place a significant portion of their international reserves in the IMF, just as banks do in their national central bank. But for this scheme to function properly, member country claims on the institution—their quotas—must be kept unequivocally liquid, which means that use of IMF resources by member countries must remain temporary and of short duration. The attention of the IMF must be focused on its contribution, through surveillance, to exchange rate stability, balance of payments viability and more generally, macroeconomic balance in members’ economies and financial stability in the system at large. Its lending activities are only an instrument to support those aims, that is, a means of exercising policy surveillance at a second remove.
The missing feature—and a remaining challenge—for the IMF as a supranational monetary authority, relates to the issuance of its own liability. Quite early in its evolution the IMF took steps in that direction with the creation of Special Drawing Rights (SDRs). But the SDR has yet to acquire the full set of characteristics of an international money, which include its becoming the numeraire as well as providing the central anchor of the international monetary system. If this challenge were met—and this may represent a distant goal—it would be possible to equate the aim of stability of the value of money with the achievement of price level stability on a global scale. In such circumstances, it would be true that global price stability would ensure the maintenance of the value of international money. But this will require a substantial strengthening of the consensus on the supranational role of the IMF and on the future of the SDR along the lines just described.
The road ahead
In the years to come, the IMF will have to function in an environment that differs fundamentally from that which prevailed at its inception. The world economy is no longer characterized by components separated by national economic boundaries, by optimism concerning the efficiency of governments to guide economies and by a belief in the effectiveness of demand management policies to influence economic performance. Instead, the setting at present and—barring major crises—in prospect for the coming century is one of closely integrated national economies, indeed a single global economy for all practical purposes; awareness of the limitations of economic policies to attain real economic objectives (but also of their strength to thwart the achievement of these objectives); a general consensus on the importance of market forces as the key instrument for efficient resource allocation; and more realism regarding the role of government as the driver of the economic process.
The presence of a global economic setting and the predominance of market forces have constrained the effectiveness of national economic policies as well as the margin available for policy inconsistencies across countries. A world market and freedom of market forces will in the end eliminate inconsistent policies, and will do so rapidly and not always in an orderly fashion. Well-designed, consistent national policies foster orderly conditions in the world market, whereas, policy inconsistencies promote market disorder.
The IMF can and should provide the means to bring about an orderly resolution of national policy inconsistencies—but in a way that conforms to fundamental market forces. To this end, it would be helpful to reestablish clear rules to guide the interactions of national economies, or failing that, to reach reasonable understandings to allocate primary policy adjustment responsibilities among countries. The IMF should be helped by the membership in its attempts to strengthen the process and the means of economic policy coordination. In the absence of such a joint effort, the prospect is essentially for policy coordination by force, that is, coordination brought about by market reactions, which on occasion may prove disruptive.
An outstanding contribution that the Bretton Woods conference made to international economic relations, particularly in the monetary and exchange areas, was the establishment of a set of principles—embodied in the IMF’s Articles of Agreement—that provided a basis for economic governance at the international level. Such international governance was a real breakthrough because it provided the basis for the distribution and adjudication of rights and obligations among countries as well as the forum for the resolution of conflicts of interest.
International economic governance must be founded inevitably on openness. It is not surprising, therefore, that an international regime based on and aimed at a liberal world economic order, despite its move from rules to discretion, has been effective in integrating national economies into a global market. The governance requirements of the system that has now been established are far more complex than those that had to be met at the outset. At that time, the challenge was to free basic economic forces. Now, this process has been virtually completed. The challenge now is to channel market forces and, when misguided, reorient them in the direction of sound world economic performance. The importance of monetary stability for the efficiency of market forces is well established at the national level. A similar proposition applies at the international level. A multilateral institution like the IMF described in this article, with a universal mandate for global monetary stability, can make a unique contribution toward its attainment.