Chapter

Opening Address

Editor(s):
Richard Bart, and Chorng-Huey Wong
Published Date:
June 1994
Share
  • ShareShare
Show Summary Details
Author(s)
Michel Camdessus

This seminar is particularly timely in view of the fact that countries in Eastern Europe and the former Soviet Union are in the process of establishing or securing new monetary and exchange arrangements, while many developing countries are actively pursuing external sector liberalization and moving toward currency convertibility.

What guidelines should these countries be using in the design of their monetary and exchange arrangements and their exchange rate policies? This is among the questions you will be considering over the next week or so. I am sure you would agree that good monetary and exchange arrangements are those that help secure the two objectives of macroeconomic stability—domestic price stability together with sustainable internal and external imbalances—and the efficient allocation of financial and real resources. Thus there should be workable arrangements for the effective conduct of monetary policy in pursuit of its paramount objective, price stability. But monetary and exchange arrangements should also facilitate the economy’s adjustment to internal and external shocks and promote allocative efficiency. In the context of allocative efficiency, it is natural to stress the importance of an open, multilateral system of payments, together with a liberal trade regime, because the promotion of such a system is one of the most important purposes of the IMF. Openness will help to ensure that the domestic economy is subject to the discipline of international competition and that domestic prices are in line with world prices.

Let me now say a few words about the particular problems faced by transition economies, particularly those in Eastern Europe and the former Soviet Union. While embarking on the transformation process, these countries have been encumbered with their inheritance from the previous system, which includes, among other things, distortions and restrictions in international payments and trade; widespread domestic price controls, with prices distorted and insensitive to market forces; large macroeconomic imbalances; low official foreign exchange reserves; and large excess money balances that represent repressed inflation. When introducing new monetary and exchange arrangements in pursuit of the objectives to which I have referred, the authorities in these countries have had to make delicate strategic choices.

One set of strategic choices concerns the adoption of currency convertibility and the resolution of problems with payments arrangements among the former centrally planned economies. I am glad to say that in the countries of Eastern Europe, a substantial degree of currency convertibility has been established. In the former Soviet Union, a substantial degree of convertibility has been established in the Baltic states, and current account convertibility is a policy objective of the Russian authorities recognized in Russia’s current arrangement with the IMF. However, I would emphasize that substantial problems remain to be resolved in payments arrangements between the states; I shall return to these in a moment, in the context of the ruble area.

Another set of issues relates to the choice of an exchange rate regime, the conduct of monetary policy, and the connection between the two. As we have all observed, the initial stage of the transformation process brings especially virulent inflationary pressures, the result of price liberalization against a background of monetary overhang. In order to fight inflation effectively, monetary policy needs to be tight and supported by fiscal policy. It is also helpful if there is an intermediate target on which to focus.

For transition economies that have a strong fiscal position, adequate foreign exchange reserves, and a credible central bank, I believe there is something to be said for pegging the exchange rate to a hard international currency in the early stage of the transition. But if these conditions are not met, premature attempts to peg may, when they fail, actually diminish the credibility of the authorities’ policy intentions. Thus, it is not surprising that the former centrally planned economies have adopted a variety of exchange rate regimes, depending upon what is feasible in individual country circumstances.

For countries without an exchange rate peg, a nominal anchor must be sought elsewhere, primarily in targets for monetary growth, and supported by appropriate fiscal targets and incomes policy. But even in a flexible exchange rate system, the exchange rate itself should play a role, because it will be an important indicator of domestic monetary conditions (such an arrangement is specified in our agreement with Russia, for example). Let me emphasize here that official intervention in the foreign exchange market is likely to have only limited usefulness in countering exchange market pressure unless that intervention is accompanied by changes in monetary conditions. As monetary authorities in the established market economies have found, intervention can help to stabilize disorderly market conditions and to signal the stance of monetary and fiscal policies but is unlikely, on its own, to have a sustained effect on the exchange rate. It is amazing to see how leaders and commentators are frequently mistaken on this point and how they believe in the magic of intervention—that good intervention can do a lot. So I hope you will not be disappointed if I tell you that at the end of this seminar you will not be able to go back to your countries with the magic trick of intervention in your pockets.

A word about the ruble area. The recent agreement at the Bishkek Heads of State meeting was a welcome step forward, but a clarification of policies is still urgently needed. It is essential for those staying in the ruble area that effective and workable arrangements for the coordination of monetary and exchange policies be established. The lack of monetary cooperation inside the area has led to extensive trade restrictions and a major shrinkage of interstate trade that has been a primary factor in the decline in output. Moreover, without improved monetary cooperation inside the area, it will be difficult, if not impossible, to reduce inflation and stabilize the ruble. I would also emphasize that countries choosing to exercise their legitimate right to withdraw from the area must recognize that a decision to adopt a separate currency does not reduce the need for fiscal and monetary discipline or for cooperation with the countries staying in the area. Countries that choose to leave the area must also do so in a way that minimizes the disruption of trade and payments arrangements: it is in the interests of all that the common economic space be preserved.

Let me turn now to some of the more general issues on exchange rate policy in developing countries. Two decades have passed since the breakdown of the Bretton Woods system. Over this period, we have witnessed economic disturbances that have made economic adjustment in developing countries most complex and challenging. At the same time, countries have gained experience in formulating adjustment programs under different circumstances. In the area of exchange rate policy, it is clear from the experience of many developing countries that exchange rate flexibility can help in maintaining international competitiveness and thus ensure a viable balance of payments position. In cases where imbalances are large, exchange rate changes can play a role in correcting the underlying cost-price distortions and limiting the cost of adjustment in terms of forgone output. To be effective, an exchange rate action in such a situation must be supported by restrictive monetary and fiscal policy and by appropriate structural measures. The IMF has been giving increasing attention to structural problems, because more and more we have discovered that good monetary and fiscal policies cannot do the job if the structural rigidities are not addressed.

The role of the exchange rate seems to be more problematic in the case of countries seeking to stabilize after a protracted history of inflation and financial imbalances. In such cases, a fixed or stable nominal exchange rate can serve a useful role as an anchor for price stability, both by providing a benchmark for price level expectations and by serving as a highly visible signal of the authorities’ commitment to financial discipline. However, as in the transition economies, such a strategy requires not only a firm resolve to maintain sound financial policies but also the availability of the means to defend the exchange rate, in the form of exchange reserves or access to external funds.

Developing countries have also learned some lessons in using exchange rate rules. In particular, it has been found that rigid adherence to a real exchange rate target may prove destabilizing, not only because of the usual problems associated with indexation, but also because of the difficulties inherent in identifying the equilibrium real exchange rate and the fact that this rate moves over time in response to domestic and external shocks.

I have not spoken about exchange rate policy in major industrialized countries and the IMF’s systemic responsibilities, because these are beyond the scope of the seminar. But I have alluded to exchange rate issues in the industrial countries, and I hope I have convinced you that their problems and the susceptibility of their officials to mistakes in this area are basically the same as yours. As you know, the subject of exchange rates is at the core of the IMF’s responsibilities. It is important for us to ensure that the IMF is helping its members in an appropriate way to deal with the problems confronting them in changing circumstances.

    Other Resources Citing This Publication