INFLATION is primarily a matter of national policy. And in a closed economy the International Monetary Fund would have no role to play. But, as we all know, national economies are linked to one another by their exchange rates and by the complex of international transactions in goods, services, transfers, and financial claims which are carried on at those rates of exchange. Since national economies are bound together in this way, they must broadly keep abreast of each other in their price experience. Or rather they would have to do so were it not for such impediments to international competition as quotas, tariffs, and exchange restrictions; and also were it not for the fact that exchange rates can themselves be altered to compensate for differential rates of inflation.
The International Monetary Fund has as one of its major objectives the elimination of exchange restrictions that are due to balance of payments reasons. It carries on extensive annual consultations with its members toward that end; and, once the postwar transition is at an end, these members cannot impose exchange restrictions on current transactions without the approval of the Fund. Similarly, members must seek the concurrence of the Fund for any shifts in their exchange rates. While a shift designed to correct a fundamental disequilibrium that cannot be handled effectively by domestic measures will be welcomed by the Fund, the Fund is constantly working with its members to help them avoid the need for such adjustments. Its objective is a world of relatively stable currencies in which payments for current transactions are, with few exceptions, unrestricted. The GATT, working in the field of direct trade quotas, tariffs, etc., has similar objectives.
In such a world, as has already been noted, countries must broadly keep abreast of one another in their price developments. Any country indulging in inflation by itself will be hauled up short by a balance of payments deficit. The Fund is, of course, equipped with large financial resources to assist members that are in balance of payments difficulties. But the assistance is designed to be temporary. Its purpose is to tide a member over an abnormal situation that will presently disappear, or over a situation that is in process of correction by the member itself. The member knows when it draws upon the Fund’s resources that it must normally repay within a period of three years—or, at most, five. Its drawings beyond the gold tranche are subject to a scale of charges that increases with the amount drawn and the length of time the drawing runs. While drawings within the gold tranche (i.e., the amount of a member’s gold subscription to the Fund) are granted freely, drawings beyond that amount involve a review by the Fund of the adequacy of the member’s corrective program, and this review becomes more searching the larger the amount requested. Under a stand-by arrangement, which assures a member’s right to draw for a specified period such as a year, there is normally a fixed schedule of repayment for any drawing that may be made under it and a detailed official statement by the member of the measures that it proposes to employ to correct its balance of payments situation. This official statement becomes part of the understanding on which the stand-by is granted. When a comprehensive stabilization program is being evolved or put into operation by a country that needs technical help, the Fund may send a member of its staff for an extended period to assist in the implementation of the program. Thus, when balance of payments deficits occur as a result of uneven monetary expansion among member countries, or for other causes, the Fund does not merely finance the deficit—it marries its aid to corrective measures designed to ensure that the deficit will be temporary.
There was little scope for this type of financing immediately after the war. At that time reconstruction needs were of so overwhelming a character that countries experiencing them were almost forced to plan for chronic balance of payments deficits. They needed the real resources that balance of payments deficits would bring. As we know, these deficits were covered largely by long-term loans and outright grants from the United States and Canada. Such types of financing called for no immediate repayment, and no conditions were attached with a view to checking the inflations that were under way. Indeed, it would have been difficult to have prevented the excess liquidity built up during the war period from working its way into equilibrium with the economy via the inflation route, although conceivably steps might have been taken to have curtailed some of the postwar additions to the supply. But the great compensatory grants and long-term loans that covered most of the deficits of the immediate postwar years have now largely disappeared from the picture. Most of the long-term loans and grants today are for military or development projects rather than to supplement a country’s reserves in covering the over-all gap in its balance of payments. During the 1950’s, the world’s balance of payments picture has basically changed, and the Fund’s type of short-term aid married to corrective measures has come to be the chief form of reserve-supplementary assistance.
This development has markedly tightened the relationships between countries from the standpoint of inflation. The objectives toward which the Fund and the GATT and various regional organizations, particularly the European, have been working have now been carried far enough along so that there are wide areas of relatively free competition on the basis of stable exchange rates. Within these areas are governments and central banking systems of varying degrees of power and effectiveness. The demands of the public beat upon them for greater expenditures and more credit for a host of worthy purposes. The national interest cannot be served by supplying financing for more goods and services than the nation can produce (allowance being made for net international transfers and lending). That way lies inflation with its ultimate disorganizing effect on production and its impairment of the real national output. But each pressure group is convinced that it can better its own well-being if its demand is granted. It is willing to take its chances so far as the nation is concerned. Nothing is more difficult than to gain general public acceptance of the degree of credit firmness or restraint in public finance that may be necessary to avoid the wastes of inflation. In such a situation the emergence of a balance of payments deficit as the country gets out of step with its world markets may suddenly strengthen the hands of the monetary authorities. The flow of reserves abroad may make the public sit up and take notice. And when the country finds it necessary to resort to the Fund, the impact is heightened still more. The simple fact that the Fund must be repaid within a short period of years is itself clear evidence that the situation must be corrected. If anything further is required to strengthen the hands of those who are striving to maintain an orderly price system at home, it will be supplied by the necessity of demonstrating to the Fund that effective corrective measures are in fact being instituted.
From this standpoint it may almost be a blessing that the independent reserves of some countries are not on too generous a scale. The fact that any persistent balance of payments deficit soon forces resort to the Fund means that corrective measures are more likely to gain public acceptance at an early stage. The Fund takes care of the immediate balance of payments situation, but in such a way as to help the domestic monetary authorities do what is advantageous and necessary at home.
To be sure, the Fund is no deus ex machina. It cannot make an entrance on the stage and with one stroke eliminate the basic problems that beset a member. The type of program that is needed to bring order and achieve the full economic potentialities of a country may be politically impossible—at least for some time—because of the vested interests that have grown up around the distortions already in existence. The Fund, which is a group of member countries functioning at the international level, is acutely aware of all the national and regional attitudes that must be harmonized in reaching its own decisions. It must proceed as best it can, judging how far a given program is practicable and how far Fund resources should be employed when political realities bar the way to a fully satisfactory economic solution. Plans initially put into effect may later have to be reorganized in the light of experience. But through it all the Fund remains a solid influence toward the preservation of economic order.
The need for strengthening the hands of the monetary authorities is obviously much less in some of the more developed countries. Indeed there is a strong presumption that a country which is playing the role of an international banker should have large independent reserves of its own. The possession of such reserves by the United States has enabled it to pursue a policy of stable growth during the decade of the 1950’s quite irrespective of the inflow or outflow of reserves. The fact that it was able to run a budget deficit and to ease money markets so vigorously despite a heavy drain on its reserves in 1958 was undoubtedly a major factor in limiting the scope of the recent recession.
But even in the United States there are signs that a balance of payments deficit may now be reinforcing somewhat the efforts of the monetary authorities to prevent inflation. Voices have warned recently that the United States may be in danger of pricing itself out of some of its world markets; and the Federal Reserve System seems to be finding in this possibility added reasons for striving to maintain the sort of stability at which it has been aiming right along. And can anyone doubt that the 7 per cent bank rate in England and the fiscal and other measures that accompanied it were accepted by the public largely because of the compelling nature of the balance of payments difficulties through which the country was passing? Those measures were essential from the domestic standpoint; but even so disciplined a people as the British might have found them hard to take had the drain on reserves and the necessity of resorting to the Fund and employing other emergency types of financing not driven home the imperative need for restraint.
When all nations must keep in step with the strongest on the balance of payments front, there is, of course, the danger that the strongest may set too severe a standard. It may force deflation on the world. But there is little evidence that this has in fact been happening in the postwar period. Almost without exception, prices have worked their way upward. Even in the United States and in resurgent, but conservative, Germany the trend in the cost of living index has been upward. The imports of goods and services of both countries have undergone a notable growth, and private capital outflow, despite fluctuations, has been on an expanded scale, so that the rest of the world has been able to earn an ever larger supply of their currencies. If at times it has not earned enough to cover the purchases it would like to make, it has usually been because of its own more rapidly expanding demand—not because the United States and Germany have been contracting. The perennial problem has been that of how to hold inflation in check.
This being so, when the decision was taken to increase the resources available for financing balance of payments deficits, it was undoubtedly the part of wisdom to enlarge the Fund’s resources rather than to mark up independent gold reserves. Such a markup could hardly have been implemented without touching off anticipatory speculation on a major scale. Moreover, the additional resources would have gone mainly to countries already well equipped with gold rather than to those that are short of it. In the Fund these resources will be conserved until a need develops and then will be pinpointed on that need. In due course the currency used will be repaid and can again be pinpointed on a future need as it develops in some other area. In this way maximum results can be obtained from every dollar or other needed currency that is available for use.
But there is a still greater advantage in employing the instrumentality of the Fund. A markup of gold would be manna from the skies—a windfall with no conditions attached. Countries that had reached a nice balance of forces with the reserves they have might find themselves unbalanced again in the direction of inflation. It is one thing to earn reserves as the European countries have been doing in the 1950’s. In the process a surplus must be developed in the balance of payments, and that means that the whole economy must be made competitive in world markets. The discipline that a country maintains in achieving this outcome means that the reserves it acquires are likely to stick, except for temporary oscillations. But the reserves that are dropped unconditionally in the lap of a country that is still running a deficit may merely be the means of financing a larger deficit. If inflation lies behind the deficit, the gift of reserves may merely feed the inflation. It may postpone the day of correction. The Fund, however, provides resources to members only on a temporary basis and in conjunction with corrective measures. Hence the increase of more than 50 per cent in its resources that is now being acted on by the governments of its member countries1 is a means for improving the smooth handling of international settlements without intensifying the risks of inflation. On the contrary, any resort to the Fund strengthens the hands of those who are combating inflation at home.
Before closing this paper, I should perhaps say a few words, however sketchy and incomplete, about some aspects of the work of the Fund’s staff on the inflation process; for this work plays into Fund decisions and, in some degree, into the programs of member countries. It has, of course, been necessary from the outset for the staff to have a concept of surplus or deficit in international transactions. This has meant pulling apart the traditional presentation of the balance of payments and recombining it in such a way that autonomous transactions are grouped “above the line” and the compensatory financing that is brought into play to cover the gap is shown below. The financing of the surplus or deficit in autonomous transactions may be supplied by compensatory government grants or loans, or it may be supplied by the banking system. Not all the movements in foreign assets and liabilities of the banking system, however, represent compensatory financing. Insofar as the commercial banks are acting on their own behalf rather than on behalf of the central bank, and are handling their funds abroad in response to profit opportunities like other private investors, the capital movements involved belong with ordinary market transactions “above the line.” They are part of the aggregate of autonomous transactions for which compensatory financing must be supplied.
This splitting of the international transactions of the banking system between (1) autonomous transactions that help to create the surplus or deficit and (2) compensatory transactions that help to finance it makes it difficult to record the balance of payments gap in tables showing the foreign impact on the domestic money supply via the banking system. The Fund is, of course, as much concerned with domestic monetary developments as with international. International transactions merely reflect the changing relationships between national economies. The Fund’s staff has, therefore, been working up a series of monetary surveys, country by country, in which once again the sectoring is designed to throw light on the decision-making process. At the moment it is also playing a leading role in developing the national accounts more fully on the side of transactions in financial claims and is helping to bring financial institutions back into the picture. The canceling out of some of the most important functions of financial intermediaries in the traditional formulation of the national accounts has obscured the creative role they really play in the unfolding of our monetary economies.
The staff is also at work trying to distinguish the prime movers for which statistics can be supplied when the balance of payments, the monetary surveys, and the national accounts are studied in combination. The prime movers operate on the national income; and the dependent factors, which are functions of the national income, must adjust themselves accordingly. Finding prime movers, however, that can be isolated in the statistics is a difficult task. It is clear that the surplus or deficit that a country is experiencing in its balance of payments, crucial though it is from the standpoint of decision-making, is a consequence rather than a prime mover. Exports of goods and services, on the other hand, are genuine prime movers in the domestic economy so long as changes in them reflect changes in the world markets that they serve. These are external to the country. But insofar as the changes reflect shifting home market demand or home costs of production, exports are a function of financial expansion and the state of output within the country. Similarly, in the statistics of the financial system, the prime movers are found in an open market operation by the central bank, central bank loans to the government, a change in the government’s cash balance, or in other such actions implementing the decisions of the monetary authorities. The effects on commercial bank assets and liabilities are consequences and cannot be treated as independent prime movers in themselves. Often it is difficult to isolate in the statistics the prime movers as they must be theoretically conceived and to trace through their effects via the appropriate coefficients.
Nevertheless there are enough fairly persistent relationships to make it worthwhile to draw the pattern. The methods are particularly applicable to underdeveloped countries where, for example, the assumption can usually be made that fluctuations in their exports reflect changes in external markets much more than shifting costs and market demand at home. And the line of analysis accounting for the money supply is also less complex. At any rate, the work already done has helped the Fund’s staff in the field to present alternative courses of possible action in terms of their probable effects on a country’s reserves and on its price level. All elements in a model are concretely shown. The staff may even upon occasion indicate where the alternative of an altered exchange rate would lead. Such presentations have been welcomed by the member governments concerned and the monetary authorities, who must weigh the economics of the situation against their assessment of the political pressures. When the alternatives are sharply and concretely presented, the chances are much stronger that inflation will not be the deliberate choice.
This paper has consistently dealt with the Fund in its role of helping members to avoid inflation. Inflation is the subject of our meeting; and, in the postwar world as it has in fact developed, inflation, latent or realized, has been the perennial problem. Recessions have been short-lived. I should not, however, wish to leave you with the impression that the Fund is any less concerned about curbing contractionary developments should they threaten to become serious. It has already acted on a substantial scale to prevent incipient breakdowns of confidence from developing and spreading from country to country. Had it not been in position to act to meet the strains on sterling following the Suez crisis or on several major currencies during the unsettled year of 1957, the world situation might have been much worse today. Wherever a member is under pressure, either from external causes such as a shrinkage in its foreign markets or from its own policies at home, the Fund stands ready to help it through its period of adjustment. And with the notable strengthening of its resources that is now in the mill, it should prove to be an even more powerful bulwark against deflation.
These greater resources, however, will not lead the Fund to go soft or to relax in seeking its objective of a world in which countries freely trade with one another at stable rates of exchange. Such a world can be achieved only if inflationary tendencies are successfully resisted and countries so handle their domestic policies that they broadly keep in step with one another in their international balance of payments. In such a world, those major countries that are maintaining the most stable and orderly price systems will set the standard to which others must repair.
Mr. Gardner is Deputy Director of the Department of Research and Statistics. He prepared this paper for the Round Table on Inflation that was held at Elsinore, Denmark, September 2–10, 1959, under the auspices of the International Economic Association. It is one of 23 papers that were presented on that occasion by economists from various parts of the world. All the papers, together with a summary of the discussions that took place during the nine days, are to be published by Macmillan and Company. The views expressed in this paper by Mr. Gardner are entirely his own and have not been passed upon in any way by the Executive Board of the Fund.
Subsequent to the preparation of this paper (July 2, 1959), the increase in Fund resources went into effect (September 15, 1959).