IMF Survey: Ken Rogoff—one of your successors as head of the IMF’s Research Department—recently suggested that the IMF “would serve better if it made no loans.” In his view, the organization has enough resources to create moral hazard problems but too few to deal effectively with a deep global financial crisis. He also termed the IMF “just too politicized to be a consistently effective lender of last resort.” Is he right?
Polak: He is right in one aspect only. The Fund has too few resources to deal effectively with a deep global financial crisis, and that’s a matter that it should be concerned about. On all the rest, he’s wrong. He overlooks the fact that, of the IMF’s approximately 55 financial arrangements, close to 40 are currently with low-income countries that have no access to capital markets. And they borrow from the Fund to deal with current account, not capital account, problems. For them, and for the system, it makes a lot of sense for the Fund to have financial resources that can serve as a carrot to match the stick of its conditionality to improve their policies.
Ken also seems to ignore that there is great merit in having a lender of last resort in the system. I agree with [former IMF First Deputy Managing Director] Stan Fischer—one needs a lender of last resort to mitigate the effects of instability in the system. That is not to say the IMF has always done a good job on that score. It’s also fair to say that, in handling that job, the IMF is, to a considerable extent, politicized, and the result of that has been, on the whole, a willingness to lend in difficult cases for too long and, therefore, to lend too much. The obvious examples are Argentina and Russia. But, in the end, the IMF did say no to both countries, and their creditors suffered very considerable consequences.
IMF Survey: One of the IMF’s key functions—surveillance over its member countries’ economic policies—is to provide confidential advice to member governments. The IMF is increasingly being prodded to take on greater “signaling” duties—that is, alerting markets to potential problems. Do you see any inherent conflicts between these two tasks?
Polak: The IMF, in the normal course of its business, gives quite a few signals to the market. When a member comes to borrow from the IMF, that’s a signal that it has difficulties. The IMF decision to lend conveys some degree of satisfaction with the measures the member is taking to get out of its difficulties. Similarly, the inclusion of a country’s currency among those used in IMF transactions must mean that the IMF has a good opinion of that member’s reserve and balance of payments positions. And, of course, the Fund nowadays releases a lot of its opinions on countries to the public in the form of summaries of Executive Board decisions to lend, Letters of Intent, and so on.
To go beyond that is none of the Fund’s business. It shouldn’t think up special signals just to tell the market what it thinks about a country.
IMF Survey: The IMF’s surveillance over its largest member countries is often perceived as ineffective. Can it do anything to gain greater leverage?
Polak: The accepted doctrine in the Fund is that if its surveillance of the major economies is not effective, we should improve it. In my opinion, we should also contemplate the opposite reaction: curtail it. These countries don’t need the IMF’s advice. They get the same advice from all over the world, and they themselves know very well what needs to be done. Plus, IMF advice is expensive in terms of staff resources. Surveillance could be slimmed down to allow the IMF to shift more resources to other regions that badly need additional high-quality staff.
IMF Survey: The IMF’s founding fathers couldn’t possibly have foreseen the power that financial markets would assume in the international financial system, and their blueprint for the institution doesn’t really spell out the IMF’s relationship with the markets.
Polak: The IMF doesn’t have a relationship with financial markets or, for that matter, with commodity markets. But it has to be fully aware of how these markets function—and, of course, they function much more efficiently and much more broadly than anybody could have predicted 60 years ago. The IMF’s key relationship is with its member countries. So when the IMF advises a country to raise interest rates or to impose restrictions on capital movements, it has to be fully aware of how the markets will respond.
IMF Survey: Presumably, participants at the Bretton Woods conference didn’t foresee a role for the IMF in low-income countries either. How can the organization contribute to the growth and prosperity of its poorest members?
Polak: More than half of the 40 or so countries at the conference were what you would now call low-income countries. Their opinions were taken into account, and the manner in which the IMF could help those countries was also taken into account. There wasn’t, perhaps, full awareness of the fact that industrial countries impoverished by the war and countries in Latin America, Africa, or Asia were poor for different reasons.
Now the situation is clearly different. The IMF has no lending business with the rich countries. But it still has a contribution to make in poor countries in terms of helping them strengthen their overall economic policies, which, as everybody now realizes, is an essential precondition for development and growth.
IMF Survey: Is there a role today for the SDR—the international reserve asset that you had a principal role in creating in 1969?
Polak: A modest role. The original role—to take care of a possible shortage of international liquidity that could curtail the expansion of the world economy—has completely disappeared. Now countries that want more reserves can get them—if they’re willing to pay for them—without depriving other countries of reserves.
At the same time, there is still a potentially important role for the SDR. All countries are required to hold reserves, and the IMF insists on their holding enough reserves to deal with most balance of payments problems, leaving access to the IMF solely for more serious balance of payments problems.
But there is a cost to holding reserves. Rich countries can borrow dollars or euros on the market and hold them in banks at about the same rate of interest. For them, holding reserves is virtually costless. Poor countries that have some access to capital markets can borrow there, too, but at high interest rates. So there’s a big margin between what they have to pay for their reserves and what they can earn if they keep them. For poor countries without access to capital markets, getting reserves is even more costly: it involves forgoing consumption or investment.
An annual, regular allocation of SDRs to all members, or perhaps only to those members that would really benefit from them, would help solve that problem or at least make it less serious. And it wouldn’t cost anything. The world is willing to hold more SDRs in its reserves than the SDR 20 billion now outstanding, a mere 1 percent of the SDR 2 trillion or so of total reserves. It would be perfectly possible to put SDR 10-15 billion a year more into circulation, perhaps even two to three times as much, without any risk or cost.
IMF Survey: How should the changing balance of economic power in the world best be accommodated in the IMF? Should there be, for example, new procedures for selecting the managing director?
Polak: The way the managing director was selected on this occasion was a whole lot better than the time before. When the French and the Germans tried to quickly move their own man in place, the effort was blocked. Ultimately, of course, the decision on the managing director cannot but be a political one, but it’s important that all members of the IMF have a real feeling that they’ve participated. In that respect, things were handled better this time.
IMF Survey: On the broader question of shifting political and economic power in the world, are you optimistic that these changes will be reflected, in a timely fashion, in the Executive Board and the IMF’s decision making?
Polak: No, I am not. The steadily increasing role of the G-7 [Group of Seven] prevents any such shift. The G-7 countries hold almost half the votes on the IMF’s Executive Board, and they can, if they agree, push or block just about anything.
IMF Survey: After you left the staff of the IMF, you served as the Executive Director for a constituency of small European countries. Do you support the idea of a single chair for the European Union?
Polak: From a European point of view, I think it would be an effective solution. Europe now speaks with eight voices. A single Executive Director for Europe would be sort of the equivalent of the single executive director for the 50 United States. And it would, in a sense, end the awkward hegemony of the G-7.
IMF Survey: Could this also allow some of the rising economies—China, perhaps India soon—to have a growing influence in the IMF?
Polak: Not necessarily. The voting power in terms of numbers isn’t all that important in the IMF. But the IMF’s preference for consensus doesn’t hide the fact that some have more power than others. If the European vote were to be reduced from the present approximately 30 percent to approximately 17 percent—which is what the United States has now—there would be room to distribute additional votes among a whole raft of countries. But while, paradoxically, that might strengthen the position of Europe, I don’t see it as necessarily raising the influence of, say, the Asian countries.
The accepted doctrine in the Fund is that if its surveillance of the major economies is not effective, we should improve it. In my opinion, we should also contemplate the opposite reaction: curtail it.
IMF Survey: Is there still a role for the IMF’s staff and management in proactively addressing major economic and financial issues? The creation of the SDR was, by all accounts, an idea that had its origins in the work of the IMF’s staff.
Polak: I have been retired from the staff for 25 years and left the Board nearly 20 year ago. But having said that, I think that the staff is less able to generate new ideas and get them adopted than it was in the high days of the IMF. And it’s not only a question of staff and management and their relationship to the Board. There is no longer the international political cohesion among member governments that makes it possible to negotiate difficult arrangements.
If the Bretton Woods conference were to be held now, it would not succeed. If the SDR discussions were to take place now, they wouldn’t get anywhere. If one tried to introduce IDA [International Development Association] now, it wouldn’t work. The general agreement at Monterrey to do something more in terms of foreign aid isn’t anywhere comparable to the creation of IDA 44 years ago. And we haven’t been able to negotiate comprehensive arrangements to deal with countries that can no longer service their international debt.
IMF Survey: Are the idealism and the dynamism that came out of the post-World War II era now diminishing?
Polak: Oh, they have diminished. Definitely. The ability in the early years after the war—and I would include the Marshall Plan in that—to create really fundamental improvements in the system has declined. Big projects mean heavy commitments of money and political capital by member countries.
IMF Survey: Is there a lack of generosity? Of vision?
Polak: A sort of isolationism has emerged, and not only on the part of the United States. When countries gathered in 1944 for the Bretton Woods conference, there was a realization that financial matters had been grossly mishandled over the previous 20 years and had to be different from now on. The conferees were so convinced of this that they were willing to make considerable concessions on how things would be done to create a body for this purpose. That kind of commitment isn’t here anymore.
IMF Survey: As it looks forward to the next decade or two, what should the IMF be most concerned about?
Polak: Since the crises of the second half of the 1990s, the Fund has done much to reduce the probability of new crises, with better data and, for emerging markets, floating exchange rates—perhaps the two most important improvements it has pushed for in the world financial architecture.
But we must remain alert to the fact that the IMF is not particularly good at foreseeing crises. We didn’t foresee the debt crisis in the 1980s and its implications. We didn’t know that the Berlin Wall would fall and that we’d get 25 new members. We didn’t foresee the size and speed of the capital account crises. Thus, while we keep working on improving the system, we cannot forget that we’re also the firemen of the system.
IMF Survey: Can we be better firemen?
Polak: Yes. We talked in the beginning about Rogoff saying that we were too politicized as firemen and we could be better. There is a very important question of governance. Will the large members—and that’s a euphemism for the largest member—be willing to consider the IMF in a long-run perspective? That will mean, for the short run, a willingness to be overruled on certain issues because the United States is very keen on the organization’s becoming strong. That was the strength of Frank Southard—first as U.S. Executive Director [1949-62] and later as the IMF’s Deputy Managing Director [1962-74]. To make sure that the IMF is strong, it is important that the United States not attempt to micromanage it.
To make sure that the IMF is strong, it is important that the United States not attempt to micromanage it.