Because the international monetary and financial system is a “public good,” all have an interest in improving it, IMF Managing Director Michel Camdessus said during a conference entitled Key Issues in Reform of the International Monetary and Financial System in Washington, hosted by the IMF’s Research Department, on May 28–29. The conference, which was organized by Michael Mussa and Alexander Swoboda, in collaboration with Peter B. Kenen, took a critical look at issues central to the discussion of how to strengthen the system, including coping with capital flows, coordinating exchange rate policies, providing financial assistance to countries facing external payment difficulties, and preventing and resolving financial crises. Participants included academics, senior government officials, members of the press, IMF Executive Directors, and IMF staff. Camdessus and Jacob Frenkel, Governor of the Bank of Israel, delivered keynote addresses, and IMF First Deputy Managing Director Stanley Fischer provided closing remarks.
Highlights of the conference are covered on pages 194–200.
Exchange rates among major currencies
Past attempts to coordinate action among the major currency countries to limit the damage caused by exchange rate instability have met with little success and have even led to questions about the need for such efforts, according to Benoît Coeuré and Jean Pisani-Ferry. However, Pisani-Ferry, who presented the paper, said two recent events have reopened the discussion—the exchange rate crises in emerging economies, which some observers have traced back to the effect of the strong dollar on currencies that were formally or informally pegged to it, and the creation of the euro and its possible impact on the international monetary system.
Exchange rate coordination in the post–Bretton Woods era has been a process of trial and error, Pisani-Ferry said. Attempts have ranged from highly ambitious schemes with internationally agreed targets, such as the Plaza and Louvre accords of 1985 and 1987, to more modest schemes, with ad hoc interventions in the case of extreme misalignments only. Neither approach to coordination was able to secure lasting stability.
Coordination may be more feasible now than in the 1980s, Pisani-Ferry said, because the situation is different and countries are more knowledgeable about the results of misalignments and lack of coordination.
A renewed international arrangement should dissociate the two objectives that target zone schemes closely associate: policy coordination and exchange rate stabilization. There is still a case for monitoring exchange market developments, but not for targeting specific values of nominal exchange rates. Pisani-Ferry and Coeuré proposed a two-pronged approach: a coordinated response to macroeconomic shocks accompanied by a monitoring of foreign exchange developments. The steps they recommend for implementing this arrangement are
• the joint endorsement by the United States, Japan, and Europe of a core set of broad macroeconomic policy principles.
• development of commonly agreed principles for deciding on the fiscal and monetary response of each participant to shocks.
Pisani-Ferry and Coeuré also suggested that estimates of equilibrium exchange rates could be used to structure Group of Seven discussions on exchange rate developments and provide some guidance for market assessment. The IMF could be asked to produce and release such estimates on a regular basis, as part of its surveillance exercise.
Discussion. Most discussants agreed with Pisani-Ferry and Coeuré that excessive exchange rate volatility could be destabilizing and disruptive. They also agreed with many of the authors’ suggestions for policy coordination (except for the suggestion that the IMF produce and release equilibrium exchange rates), although most were skeptical about their practical application.
Alan Blinder wondered if any of the proposed strategies would reduce short-term volatility. Also, domestic policies in the major countries are not always consistent; and the exchange rate—rather than the interest rate—should be allowed to absorb some of the effects of an external shock, he added.
Horst Siebert noted that a multilateral approach to stabilizing exchange rates requires countries to adhere to stability-guaranteeing rules that all relevant policies in the three major regions would be harmonized, thereby relinquishing sovereignty over monetary policy. This is not realistic and may not be desirable.
Ricardo Hausmann said he saw a trend toward fewer currencies, which would make it easier for countries to hedge their currency risk in euros or U.S. dollars. Ronald I. McKinnon argued that the market’s obdurate expectation of trend yen appreciation was a main source of problems for the Japanese and, hence, the world economy. He offered a strategy for dealing with the problem.
Capital flows to emerging markets
The emerging market crises of the 1990s—and in particular the Asian crisis with its global repercussions—have generated perceptions of serious inadequacies in the international financial system and intense debate on global financial reform, particularly regarding capital flows to emerging markets. The aim of the paper by Michael Mussa, Alexander Swoboda, Jeromin Zettelmeyer, and Olivier Jeanne was to focus on the role of international public intervention in forestalling and mitigating future crises, Mussa said.
National policy failures—especially in banking and financial supervision—and a lack of transparency, as well as adverse shocks, helped pave the way for the international financial crises of the 1990s. But there is little doubt, Mussa said, that systemic fragilities also played an important role. In particular, the vulnerability of several emerging market economies to potential financial crises was increased by a sharp progression in the level of their short-term, foreign-currency-denominated liabilities from the 1980s to the 1990s, due in part to an increase in the overall level of debt but also to a shortening of its maturity.
Reform of the international financial system, Mussa noted, has three key objectives: fostering efficiency and growth by allocating capital to where it can generate the highest returns; reducing the risk of international financial crises; and mitigating the impact, and equitably sharing the burden, of crises when they do hit. However, because of asymmetric information and other distortions that prevent any financial system from operating with absolute efficiency, simultaneous pursuit of these objectives gives rise to fundamental tensions. There is no universally applicable, first-best approach for dealing with these problems, Mussa said, and there are inevitably trade-offs.
• While policies that maintain a relatively closed capital account may provide significant protection against international financial crises, they substantially impair a country’s ability to take advantage of the efficiency gains from broader participation in the global financial system. More needs to be done to contain the risks and damage of financial crises.
• Efforts to divert capital flows, particularly of short-term credit denominated in foreign currency, into forms that pose less danger of systemic risks run counter to the incentives of economic agents on both sides of the bargain. But it is difficult to establish a sharp dividing line for what constitutes too much short-term debt or to say how far it is prudent to go in shortening maturities and taking on foreign currency debt in attempting to avert a crisis. When a country experiences difficulty maintaining external financing flows, shortening maturities and increasing foreign-currency-denominated borrowings can be quite useful in forestalling a financial crisis. Sometimes, Mussa said, this strategy works, but sometimes it fails, and the subsequent crisis and its costs are enlarged.
• Proposals for bailing in the private sector in financial crises, by requiring private creditors under certain conditions to retain or expand their exposures to a country experiencing an actual or potential financial crisis, also entail trade-offs. The application of such mechanisms for one country in, or on the verge of, a crisis might help that country, but would also be a clear signal for creditors to flee from whatever country they believe might be next on the list for trouble, Mussa said.
The historical pattern of boom-and-bust cycles in international capital flows to emerging markets seems likely to persist, Mussa said. As a result, the time will come again when a number of emerging market countries will face severe external financing difficulties. The reforms to the international monetary system now under way or in prospect should help lessen these problems, but will not make them disappear. Accordingly, there will continue to be a need for official assistance—in appropriate circumstances—with as little subsidy as possible, and subject to relevant conditions, to help countries manage their external payments difficulties and especially to help contain the severe economic damage typically associated with situations of national default. Concern about moral hazard is mitigated, to an important degree, by the conditionality associated with international support packages and by broader international efforts to promote improved national policies.
Discussion. Most discussants thought that sound macroeconomic policy was as key as strengthening the international system. David Folkerts-Landau criticized the paper for attaching too much importance to systemic weaknesses. Rather, he said, financial linkages across emerging markets and fundamental failures in policy in the emerging market economies were the real culprit, not the international financial system. Roberto Zahler observed that the extent to which a country is integrated into the international economy is usually linked to the confidence the rest of the world has in the prospects and management of that economy. This creates a dilemma: sound policies attract excessive capital inflows that threaten the soundness of the economy; as a consequence, measures must be taken—including, in some cases, Chilean-type controls—to manage these inflows.
Oldrich Dedek noted that the Czech monetary authorities had found no “silver bullet” for reducing internal and external imbalances and for coping with the ebb and tide of capital flows. The country is seeking entry into the European Union, which requires policy convergence, including of the exchange rate. Eventual participation in the European Economic and Monetary Union would, he said, relieve members of having to use the exchange rate as an adjustment tool.
Rudiger Dornbusch said the emerging market crises might have been averted if the growing stock of debt had been restructured earlier, rather than after the crash. The best way to avoid currency crises, he said, was to “outsource monetary policy,” as in a currency board arrangement.
Balance between adjustment and financing
Developed and emerging market economies share many common symptoms of a financial crisis: large capital inflows, asset price and credit booms, currency overvaluation, and large current account deficits. But as Guillermo Calvo and Carmen Reinhart noted, industrial and emerging market economies part company in the developments that usually follow a speculative attack. Unlike their more developed counterparts, emerging market economies routinely lose their access to international capital markets. Furthermore, Reinhart noted, given the common reliance on short-term debt financing, the public and private sectors in these countries are often asked to repay their existing debts on short notice. These large negative swings in capital inflows—or “sudden stops”—are dangerous. The slowdown or reversal could push the country into insolvency or drastically lower the productivity of its existing capital stock.
New answers to old questions
Following is a summary of remarks by Jacob Frenkel, Governor of the Bank of Israel, during the conference.
Policymaking is being carried out in a new globalized environment that requires new answers to old questions, such as how to conduct exchange rate policy and how to manage capital market flows, Frenkel said.
When capital markets were less open, Frenkel said, the authorities decided when to intervene, where to set the rate, and which regime to follow. Markets and the authorities were in an adversarial relationship. Now, we want to work with the markets, recognizing that market discipline helps to ensure good policies. It is no longer a case of “you versus us,” but rather a partnership based on transparency and accountability.
Over the next 10 years, Frenkel said, the trend in exchange rate regimes will probably be toward very fixed or very flexible. In-between regimes will disappear. Countries in intermediate stages should therefore make it clear to the markets that they are in a transitional stage; otherwise, temporary stratagems could be taken as permanent. It was a good idea, he said, to have an exit strategy.
Before making the final jump, countries should make sure they have a parachute, Frenkel said. The exchange rate regime is an important issue, but developing the corresponding markets is essential whatever regime is chosen. Preconditions, such as a functioning exchange rate market and early private sector participation, need to be in place as a condition for fully opening the capital account.
Making their economy attractive to investors in the economic “Miss Universe contest” is the best way for emerging market economies to regain access to capital markets, Frenkel said. Restrictions on capital flows, even in the interests of controlling sudden reversals in market sentiment, will not attract investors. But evidence of a strong economy and credible policy will bring investors back—even those that had bailed out in recent crises. Markets reward good policy, and countries that adopt the right policies will make the markets quickly forget bad memories, Frenkel concluded.
By the time the crisis erupts and a country has lost its access to international capital markets, the range of policy options available to manage the situation has been severely restricted. The evidence suggests that capital controls do appear to influence the composition of flows, diverting them away from short maturities. However, such policies are not likely to be a long-run solution, and this option has little appeal for countries not wishing to reverse the process of financial liberalization.
Many emerging markets may nevertheless rely increasingly on controls because of a fear of floating and because they lack the discipline that underlies fixed exchange rates. Even when fear of floating does not lead to capital controls, floating exchange rates may have significant costs in terms of both the interest rate volatility associated with them and their procyclical nature.
No serious economist will prescribe the same exchange rate regime for every country, Calvo said. But Latin America already lives in a “semi-fixed world” where the U.S. interest rate has been a crucial variable for national policy since the 1970s. The question is, should these countries stay where they are or go all the way? Strong pegs, like dollarization, can help reduce the incidence of external shocks and may be an attractive option for emerging markets in dealing with the problem of recurring sudden stops. Although full dollarization will not eliminate banking problems, it could lessen them if it reduces the problems stemming from currency and maturity mismatches—and it will do away with speculative attacks on the currency.
Discussion. Most discussants agreed that the time for policy response is immediately after a shock but before the crisis hits. Some objected to the “short shrift” Calvo and Reinhart gave to floating. Montek Singh Ahluwalia suggested that the authors might have focused more on other preventive measures, such as banking sector reform. Yoon-Je Cho noted that when the IMF financing package for Korea was put together, no one had expected that the degree of correction would be so high, and the insufficient financing led to massive depreciation.
Jeffrey Frankel agreed with the authors that the crucial period when the adjustment/financing framework is relevant is right before the crisis. The IMF’s recently established Contingent Credit Lines, which could help an otherwise healthy economy defend its exchange rate from speculative pressure, were thus a step in the right direction. Peter Kenen added that steps were needed to limit bank exposure to short-term debt in countries with underdeveloped structures and institutions. Private sector involvement has to be included if the balance between adjustment and financing is to be improved, he said.
Involving the private sector in crisis prevention and resolution
Progress in compelling investors to share the financial burden of a crisis has been slight, Barry Eichengreen noted. Some analysts have questioned whether moral hazard is a sufficiently overwhelming problem to justify actions that may disrupt the operation of the markets and make it more costly for reputable debtors to borrow. Others assert that a solution to the moral hazard issue may not be possible and that financial and policy innovations can have unintended consequences, including precipitating the very crises they are meant to forestall. Nevertheless, finding ways to ensure that private sector creditors bear their share of the burden is a key step in learning to deal with modern financial crises, Eichengreen said.
The IMF has experimented with a variety of methods for involving the private sector, Eichengreen said, including direct pressure on international banks to lengthen their credit lines in Korea, informal pressure for them to maintain credit lines in Brazil, and asking the government of Ukraine to renegotiate its bonds as a precondition for the extension of official assistance. But the success of each of these approaches depended on characteristics specific to the countries involved.
The IMF and the international community have been trying to find ways of bailing in the private sector, according to Eichengreen, including by adopting new provisions in loan contracts to facilitate orderly restructurings, such as collective action clauses in bonds and creating workable alternatives to ever-bigger IMF bailouts. The addition of such clauses to bond contracts, Eichengreen said, is the only practical way of creating an environment conducive to flexible restructuring negotiations.
Efforts to bail in the private sector will have to proceed on a case-by-case rather than a rules basis, Eichengreen concluded. This approach may seem arbitrary and unwieldy, but at least it does not pose a danger of aggravating the crisis problem as would rules specifying the modalities and circumstances in which creditors would be bailed in.
Discussion. Most discussants agreed with Eichengreen that the private sector had to be bailed in on a case-by-case basis. There is a need to restore capital flows to emerging market economies, especially loans and bond credits, and changes in financial architecture should nourish this return, William Cline said. The objective should be to increase, not reduce, flows. Pablo Guidotti thought that proper management of debt, notably lengthening its maturity structure, was key to reducing public sector financing needs and avoiding excessive recourse to international financial assistance—one of the purposes of “involving the private sector.” Innovations in bond contracts are welcome, Guidotti said, if introduced by the private sector to make resolution of future crises more efficient; but IMF policy should not be linked to their introduction.
J.A.H. de Beaufort Wijnholds said the industrial countries should lead the way in bond rescheduling. The IMF should act as a facilitator to ensure that agreements with the private sector are being observed. Voicing a somewhat contrary opinion, Martin Wolf of the Financial Times suggested that since there are such huge difficulties in handling sovereign foreign currency indebtedness, there should be much less of it. Sovereigns should either balance their budgets or borrow in domestic credit markets.
Role of the IMF
During the emerging market crisis, the IMF was asked to take on exceptional responsibilities under uncertain conditions, David Lipton said. Some observers have been harshly critical of the IMF’s performance, while others believe the IMF played a crucial role in helping the world through a difficult and dangerous episode. Maintaining the IMF’s readiness to function in the future may require a refocusing of its role, ensuring that it is assigned appropriate tasks and that its legitimacy and public acceptability are reinforced, lest its effectiveness be impaired.
Lipton offered proposals that might help redraw the limits on the use of IMF financial resources by shifting more of the burden of dealing with economic problems to the markets and private sector participants. To start with, he said, the international community should end large-scale IMF financial assistance for member countries with balance of payments problems.
The crises of 1997 and 1998 were unexpectedly severe and filled with uncertainties about capital flows and contagion and the IMF’s response was key to preserving the system. But the large financing packages provided only a short-term expedient. It is unreasonable to ask the IMF to continue playing this role, nor is it ideal to assume that these resources will always be available. Lipton said that there is a need to “put the genie of large IMF lending operations back into the bottle” and to restore a more rigid adherence to the use of access limits in approving members’ use of its resources.
Among the changes Lipton suggested is a more widespread reliance on flexible exchange rates. The implicit guarantee of a pegged regime in times of stress puts all the onus on the central bank, whereas a floating rate diffuses the stress through the marketplace, he observed.
Although the IMF has access to borrowing arrangements designed to supplement ordinary resources, the recent crisis made it clear that the potential financial requirements to stem a global crisis are very large and that circumstances could arise in which all of the resources presently available to the IMF could be inadequate to stem the spread of crisis. The international community, Lipton said, should be equipped to react forcefully if some constellation of factors again threatens the international financial system.
Lipton proposed setting up a large pool of resources to equip the IMF to respond if the health and integrity of the international financial system were endangered. A “trust fund” established by a select group of large countries could be used as a last line of defense for the international financial system in time of dire threat. The trust fund would not be an IMF facility, but rather a backstop to the international financial system to be operated in the interests of the international community. The fund would lend freely, and at a penalty rate, as called for in the operation of lenders of last resort. Management of the fund should retain “constructive ambiguity” about the circumstances in which it might be activated.
Discussion. Discussants expressed general skepticism about Lipton’s proposed trust fund, and several were not as sanguine about the merits of a floating exchange rate. Jack Boorman expressed doubts about the efficacy of limiting access levels to IMF financing. It is not always easy, he said, to determine when a crisis begins to unfold, whether it will be systemic. Limits would either not be believed by the markets or would tie the hands of the IMF, which needs to be free to stimulate markets and the flow of official and private finance.
Kwesi Botchwey asked what guarantees would be in place to ensure activities of the proposed trust fund would be carried out in a principled way. Charles Calomiris agreed, observing that access would inevitably be delayed and politicized. “Ambiguity,” he said, “is open to manipulation in the guise of coordination.” Yung Chul Park supported the IMF as crisis manager and lender to emerging market countries, but believed it could provide more information and early warnings to policymakers when it identifies a shift in market perceptions. The IMF should promote closer cooperation between central banks in the Group of Seven and in the emerging market countries.
Tatiana Paramonova said that the Russian experience with stabilization attempts had persuaded her that no single exchange rate regime was optimal for all countries at all levels of development. Relatively clean floating or a currency board would be her choice for emerging markets.
Is international financial and monetary stability a public good?
Following are edited extracts of an address delivered by IMF Managing Director Michel Camdessus at the conference on key issues in reform, hosted by the IMF’s Research Department, in Washington on May 28. The full text is available on the IMF’s website (www.imf.org).
Let me start with the proposition that the international monetary and financial system may be seen as a global public good. It is essentially the same system for everyone. If it works well, all countries have the opportunity to benefit; if it works badly, all are likely to suffer. Hence, all have an interest in reforms that will improve the system for the global public benefit.
Coordinating exchange rate policies
There is no world money controlled by a world monetary authority that performs the essential functions of medium of exchange, store of value, and unit of account at the global level. Rather, the moneys of the largest industrial countries do double duty as the moneys for their respective countries and as the moneys used by most other countries for conducting their international trade and financial transactions.
Reasonable stability of the domestic price level is increasingly recognized as the most basic objective of monetary policy. From the global perspective, this domestic orientation of monetary policies in the major currency areas is generally desirable. As experience has unfortunately taught, economic and financial instability in the dominant economies of the world is bad for them and for the rest of the world as well. Thus, economic policies that promote domestic economic and financial stability in the largest economic areas of the world are not only desirable—they are essential—for economic stability and prosperity elsewhere.
Recent experience suggests rather pointedly that more attention can be paid to international consequences and specifically to exchange rates in the management of economic policies in the largest economies with beneficial results for these economies as well as for the rest of the world.
Last September and October, in the wake of Russia’s default and the near failure of a large hedge fund, a liquidity crisis gripped a wide range of financial markets. Although adverse effects on the U.S. economy were not apparent, the U.S. Federal Reserve, recognizing the danger posed by this crisis, took the lead among major currency area central banks in easing monetary conditions. In this instance, forward-looking monetary policy action in the United States, the euro area, and Japan, which took account of conditions in global financial markets beyond those of immediate domestic concern, clearly helped to forestall important risks of a deeper global economic downturn and, correspondingly, has helped to create the more favorable prospects for global growth we see today.
We must not, of course, overplay our hand. When domestic considerations relevant for monetary policy in the major countries run counter to external considerations, it will often be a mistake, domestically and internationally, to give much weight to external considerations. Moreover, even when exchange rates may seem to have moved too far, it is not always wise to adjust macroeconomic policies even marginally to try to affect exchange rates.
Concerning intervention, we know it is not a very powerful tool for influencing markets, especially when it is not supported by other policies. However, markets do not always get exchange rates right. Under the influence of bandwagon effects, panics, and other anomalies, markets sometimes take exchange rates a considerable distance away from levels consistent with economic fundamentals in circumstances where this is detrimental to global economic performance. The official sector can and should press further to resist unwarranted movements in major currency exchange rates.
External payments difficulties
The purposes of the IMF’s activities in this area are clearly defined in its Articles of Agreement: “To give confidence to members by making the general resources of the IMF temporarily available to them under adequate safeguards....” The objective of “giving confidence to members” applies not only to times of difficulty. More generally, because open policies toward international trade bring public goods benefits to the global economy, it is desirable to persuade members to adopt such policies by offering some assurance of assistance in the event that they encounter external payments difficulties. This argument applies as well to open and prudent policies toward international capital movements, and it is high time for the IMF’s Articles to be amended to reflect this.
The constraint that use of the IMF’s general resources should be “temporary” and subject to “adequate safeguards” reflects the policy of the international community to be prepared to provide interest-bearing loans, but not grants, to assist countries that are themselves acting constructively, from an international as well as a domestic perspective, to address their own problems. Thus, promotion of the global public good, not merely the correction of disequilibrium in the assisted country, is the clear purpose of the IMF’s financial assistance.
Because the IMF provides loans with firm expectations of repayment, it is not absorbing losses that should be borne by members or their creditors and is thus not contributing directly to problems of moral hazard. Furthermore, through the safeguards built into the IMF’s conditionality, members receiving IMF assistance are pressed to reform their policies not only to correct current problems but also to reduce the risk of future payments difficulties. With these reforms, and the continuing efforts to improve the architecture of the international monetary system and involve constructively the private sector in both lessening the risks and ameliorating the effects of financial crises, I am convinced that the problem of moral hazard can be adequately contained.
On the scale of some recent support packages, the IMF has not been alone; important additional support has come from the World Bank, the Asian Development Bank, the Inter-American Development Bank, and from national governments and central banks. Clearly, in these cases, the responsible judgment of the international community was that financial support beyond the substantial amounts provided by the IMF was necessary and appropriate.
On conditionality, initial economic assumptions in several recent programs proved substantially too optimistic, and it was appropriate to exploit the flexibility of program revisions to better adapt economic policies to unforeseen circumstances—in some cases leading from a prescribed initial tightening to a subsequent substantial easing of fiscal policies. For monetary policies, initial tightenings were, in my view, not only the right policies, but absolutely essential to resist what were already excessive exchange rate depreciations with threatening domestic and international implications.
It is a grave mistake to think that there is an easy way out when a country and its government have lost the confidence of financial markets. Countries that have pressed vigorously ahead are beginning to see the fruits of their efforts even earlier than expected. To generate the greatest possible global public good out of the difficulties of the past two years, it is essential to keep the reform process moving forward.
An increasingly open system of world trade and an increasingly and prudently liberalized system of world finance are the two great global public goods that have been produced by the international community in the postwar era. The effort to reform the system is fundamentally the effort to sustain and enhance these public goods.
The currency crises in Asia have raised questions about the effectiveness and appropriateness of the conditionality the IMF imposed on crisis countries, Takatoshi Ito noted. It has been alleged that IMF-supported programs did not prevent overshooting of currencies or contagion to neighboring countries. With the failure of official financial assistance to restore market confidence, the crises turned into prolonged recessions in many of the affected countries. Ito found merit in much of the criticism of IMF conditionality, especially at the start of the programs.
Looking at the IMF’s crisis management in Thailand, Indonesia, and Korea, Ito suggested that “typical IMF prescriptions” did not always have their intended effect and, in fact, may have worsened the situation. A tight fiscal policy may be warranted to enhance confidence and pay for financial reforms. But, Ito said, critics contend, that since Asian countries have a record of sound fiscal policy, such surpluses are not necessary.
The IMF typically recommends tightening monetary policy to prevent further depreciation and inflation. But, Ito noted, critics contend that a sustained high interest rate policy can also lead to a credit crunch or a domestic liquidity crisis.
The emphasis on structural reform in the midst of a crisis was one of the IMF’s more controversial conditions, Ito said. For instance, the announcement of the October 1997 program with Indonesia coincided with the forced closure of 16 banks, which caused a run on banks and created an atmosphere of general distrust. Although it is important to identify and close insolvent banks during a crisis, weak but viable banks should be strengthened with government money, if possible, he suggested.
The IMF’s position on structural policies, according to Ito, is that they enhance efficiency and equity and avoid inefficient investment that is subject to political influence. A crisis provides a window of opportunity to impose a long-overdue agenda.
Although the IMF’s critics have not disputed the long-run benefits of structural policy reform, Ito said, they have questioned whether a crisis is the best time to introduce reforms that are not specifically related to the balance of payments, even though it may be politically more difficult to implement such reforms during periods of relative calm. When a reform agenda is too long and too tough, investors may react negatively if they suspect that the government will not follow through on implementation.
Discussion. Most discussants were less critical of the IMF’s role as crisis manager. Mohsin S. Khan observed that without any IMF action or assistance, the outcome of the crises could have been immeasurably worse. He noted that crisis prediction is difficult in its early stages. Even an accurate early warning system could have little effect if policymakers ignored warnings and markets heeded them.
Mario Draghi said contagion among the southeast Asian countries would have been hard to avoid, since many of them had trade links and competed among themselves. He agreed with the IMF position that interest rates have to be kept high until market confidence returns, and they cannot come down until the right policies are implemented. Reform of the financial sector, he said, was crucial for a country’s recovery.
Kiettisak Meecharoen said that the unexpected severity and spread of the Thai currency crisis had washed over the IMF’s support and financial assistance. Also, problems in the financial sector were worse than originally thought; the crisis provided an opportunity for the authorities to make sweeping reforms not possible in normal times.
John Williamson was more critical of the IMF’s policy advice. The emphasis on excessive fiscal austerity was a mistake, although he acknowledged that the IMF recognized its error and adjusted reasonably quickly. High interest rates, however, might make people question the solvency of the country’s institutions and might be interpreted as a panic signal that would do more harm than good. Guillermo Ortiz Martinez said that the relatively quick resolution of the Mexican financial crisis of 1994—95 benefited from early diagnosis and a quickly implemented program. The denial stage, he said, did not last as long in Mexico as it did in Asia. In both cases, strong measures were needed to counter the overreaction of markets.
In his concluding remarks, Stanley Fischer focused on three issues:
• Martin Wolf’s suggestion that governments should limit their foreign exchange exposure in capital markets. Borrowing in the capital markets is healthy for a country, Fischer said; it provides for competition for the domestic economy and for technology transfers. If a country stays closed, its financial system remains underdeveloped. There are problems, of course, but even after suffering serious financial crises, virtually all emerging market economies have opted for openness over capital market autarky. The challenge is to make the world safer in spite of capital market exposure, through, for example, better supervision, transparency, and possibly in some cases controls on short-term inflows.
• Appropriate exchange rate regime. Among countries facing currency crises, those that had fixed or pegged rates tended to get hit the hardest when they tried to defend their rate or maintain the peg, Fischer noted. Countries with floating rates that have suffered speculative attacks in the past—Israel, South Africa, Turkey—seemed to have suffered less serious hits. The move toward floating, with prudential controls, will likely continue, although hard currency pegs would also be favored among some countries, such as Argentina.
• Moral hazard. This question informs the design of every institution, Fischer said. A safety net was part of the architecture set up in 1945 to enable the IMF to provide comfort to member countries. There will always be moral hazard in an equilibrium. The question that needs to be asked is: How much moral hazard can be contained in a sustainable equilibrium? A crisis is obviously not a sustainable equilibrium, so measures need to be adopted to keep moral hazard within permissible limits. The advanced economies should take the lead in implementing changes, such as “majority clauses” in new bond contracts, which would make it harder for individual bond holders to sue a sovereign borrower.
Fischer concluded by noting that, as the worst effects of the Asian crisis fade, the international community is not relaxing its efforts to find new and effective means to deal with future crises, as some critics claimed happened after the Mexican crisis.
The IMF will publish the proceedings of this conference later in the year.
Key Issues in Reform of the Monetary and Financial System
Alexander Swoboda, Senior Policy Advisor and Resident Scholar, IMF Research Department
Michel Camdessus, IMF Managing Director
Jacob A. Frenkel, Governor, Bank of Israel
Session I: The Exchange Rate Regime Among Major
Chairman: Fred Bergsten, Director, Institute for International Economics
Benoît Coeuré, Head, Exchange Market and Economic Policy Division, French Ministry of Economy, Finance, and Industry
Jean Pisani-Ferry, Senior Economic Advisor, French Ministry of Economy, Finance, and Industry
Alan Blinder, Professor of Economics, Princeton University
Ricardo Hausmann, Chief Economist, Inter-American Development Bank Ronald
I. McKinnon, Professor, Stanford University
Horst Siebert, President, Kiel Institute
Session II: Moderating Fluctuations in Capital Flows to Emerging Market Economies
Chairman: Ernest Stern, Managing Director, J.P. Morgan
Michael Mussa, Economic Counsellor and Director, IMF Research Department
Jeromin Zettelmeyer, Economist, IMF Research Department
Olivier Jeanne, Economist, IMF Research Department
Oldrich Dedek, Vice Governor, Bank Board, Czech National Bank
Rudiger Dornbusch, Professor, Massachusetts Institute of Technology
David Folkerts-Landau, Chief Economist and Managing Director, Deutsche Bank
Robert Zahler, President, Zahler and Company
Session III: The Balance Between Adjustment and Financing
Chairman: J.J. Polak, former Economic Counsellor, IMF
Guillermo Calvo, Professor of Economics, University of Maryland
Carmen Reinhart, Associate Professor, University of Maryland
Montek Singh Ahluwalia, Distinguished Visitor, Stanford University
Yoon-Je Cho, Professor, Sogang University, Korea
Jeffrey Frankel, New Century Chair, The Brookings Institution
Peter B. Kenen, Professor of Economics and International Finance, Princeton University
Session IV: Involving the Private Sector in Crisis Prevention and Resolution
Chairman: Sylvia Ostry, Distinguished Research Fellow, University of Toronto
Barry Eichengreen, Professor of Economics and Political Science, University of California, Berkeley
William Cline, Deputy Managing Director, Institute of International Finance
Pablo Guidotti, Secretary of Finance, Argentina
J.A.H. de Beaufort Wijnholds, Executive Director, IMF
Martin Wolf, Associate Editor and Economics Commentator, Financial Times
Session V: The Financial Role of the IMF
Chairman: Arjun Sengupta, Professor, School of International Studies, New Delhi
David Lipton, Senior Associate, Carnegie Endowment for International Peace
Jack Boorman, Director, IMF Policy Development and Review Department
Kwesi Botchwey, Director, African Development Group, Harvard Institute for International Development
Charles Calomiris, Professor, Finance and Economics, Columbia University
Yung Chul Park, Professor, Korea University
Tatiana Paramonova, First Deputy Chairman, Central Bank of the Russian Federation
The Role of IMF Advice
Chairman: Guillermo Ortiz Martinez, Governor, Bank of Mexico
Takatoshi Ito, Professor, Hitotsubashi University
Mohsin S. Khan, Director, IMF Institute
Mario Draghi, Director General, Ministry of the Treasury, Italy
Kiettisak Meecharoen, Assistant Governor, Bank of Thailand
Guillermo Ortiz Martinez
Stanley Fischer, IMF First Deputy Managing Director