EMU and the International Monetary System

6 Implications of EMU for the IMF

Thomas Krueger, Paul Masson, and Bart Turtelboom
Published Date:
September 1997
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Philippe Maystadt

The creation of EMU will make history in the world. It will be a remarkable development in international relations, without precedent in the history of the IMF. It will be—allow me to quote the Managing Director—“the most important and the most promising monetary development in the post-Bretton Woods period.”

The challenge today is to fully grasp the external implications of this development for both the international monetary system and the International Monetary Fund. This is a major task and I have no doubt that this conference will provide a good basis for the Fund and its membership to adjust to the introduction of the euro.

In this context, I would like to share with you some thoughts on its implications for Fund/EMU relations. This, of course, will be a preliminary exploration of the many questions related to this issue, on which discussions both within the Community and with the Fund will have to take place in the coming months.

Implications for the Fund Membership

The first question I would like to address, concerns the implications of EMU for the membership of the Fund. Little has yet been said on this question. This is not a reason to avoid addressing the issue. Time is ticking away; there are only 654 days left to January 1, 1999. It is time to draw a number of tentative conclusions.

I believe that EMU members will remain individual members of the Fund, at least during a transition period. In other words, the status quo is likely to be the preferred or compromise solution, at least in the short term, and not the other main alternative, namely, the merger of EMU members into a single member of the Fund with a single quota.

The main reason that will push toward the status quo is the fact that EMU will imply only a limited transfer of areas of decision making at the supranational level. Indeed, the transfer of competence from national to EMU level will mainly concern the monetary policy of the EU, which will be the exclusive responsibility of the ECB, and its exchange rate policy, which will be in the hands of ECOFIN and the ECB. On the other hand, economic policies will remain mainly within national competence. Of course, member states are expected to regard their economic policies as a matter of common concern, to coordinate them closely, and to avoid excessive government deficits. However, the general view in Europe remains that member states retain ultimate responsibility for economic policies. For this reason, a number of member states may wish to maintain a close relationship with the Fund.

Two other factors will need to be taken into account. First, a decision to merge EMU members into a single member of the Fund with a single quota would require unanimity of the member states participating in EMU. As the reshuffling of EMU members’ quotas into a single quota would imply a loss of national sovereignty, I doubt that it would be easy to reach a consensus among EMU members on this possibility. Second, the status quo will be in line with the Articles of Agreement of the Fund, which require that membership in the Fund is available to countries individually. Thus, if EMU members would opt for a unique representation of EMU to the Fund, this would require an amendment of the Articles and complicate the matter even further, at least in the short term. Against this background, it is most likely that EMU members will remain individual members of the Fund, at least during a transition period and perhaps forever.

This is not to say that the status quo in the membership of the Fund will be an easy approach to solving all the issues that will arise in Fund/EMU relations with the introduction of the euro. The opposite is probably true. Indeed, the Fund’s Articles of Agreement are based on the norm that a member of the Fund is a country with a currency of its own. Thus, the fact that the euro will be the currency of a number of members of the Fund will imply some problems for individual EMU members in performing some of their obligations of Fund membership and for the Fund in ensuring that EMU members will enjoy the same rights as any other member of the Fund.

There are, of course, precedents of monetary and currency unions, and the Fund has always adjusted to changing situations. However, past experience will not provide all the answers, because it will be the first time that the single currency of a group of Fund members will most likely emerge as a major international currency. The result of this is that EMU will have a global impact and raise policy issues of a systemic nature. For this reason I am convinced that a substantial amount of work will be required to adapt Fund/EMU relations to the introduction of the euro. This is what I would like to stress by discussing the potential implications of EMU for (1) the SDR, (2) Fund surveillance over EMU countries and policies, and (3) the potential access of EMU members to Fund resources.

Future of the SDR

My first point is on the principles of the valuation of the SDR. Those principles are provided in a decision that was adopted by the IMF Executive Board in September 1980 and that requires, first, that the SDR basket includes the currencies of the five members with the largest exports of goods and services during a five-year review period and, second, that the weighting system reflects the exports of goods and services of the members and their reserve liabilities.

Following the 1980 decision, the SDR basket includes the U.S. dollar, the deutsche mark, the Japanese yen, the French franc, and the pound sterling. With the creation of EMU, it is very likely that at least two of these currencies will disappear. Therefore, the currency composition of the SDR will need to be reviewed, and I also believe that such a change will call for a review of the method of the SDR’s valuation. Indeed, although it is quite clear that the euro will join the SDR, the question arises whether the euro will be considered as the currency of two or three members with the largest exports, in line with the 1980 decision, or as the currency of the EMU as a whole.

To address this question, it will be necessary to review the principles governing the composition of the SDR with a view to deciding whether the SDR should be a “country-based” basket or a “currency-based” basket. Obviously, a “country-based” SDR basket would be in line with a decision to preserve the status quo as regards the representation of EMU members in the IMF. Following this approach would imply determining the weight of the euro on the basis of the value of the exports of goods and services by a small group of EMU members. This would mean that the weight of the euro would not reflect its relative—and potential—importance in international trade and finance. Would this make sense?

On the other hand, if the “currency-based” approach is followed, questions such as the following are likely to arise: Should other currencies join the SDR to keep five currencies in the basket or should the number of currencies concerned be revised downward after the introduction of the euro? How should the weight of the euro be determined, given there will be no data available on international trade and financial activities in euros before January 1, 1999?

As you can see, the introduction of the euro in the SDR basket will raise questions of principle and measurement, which will be indirectly related to a fundamental issue—the place of the euro in the international monetary system and its relative position vis-à-vis the dollar.

Thus, it will be difficult to avoid debating very sensitive issues, and appropriate solutions will have to be adopted, in a spirit of cooperation between the Fund, its membership at large, and EMU countries.

Fund Surveillance of EMU Countries and Policies

The start of the euro is also likely to raise challenging questions about Fund surveillance of EMU countries and policies.

Assuming that EMU participants remain members of the Fund, the Fund will need to maintain its Article IV consultations with each of the countries that will participate in EMU. However, in the context of those consultations, EMU will have to be taken as a fact and advice will center on economic and structural policies. I believe that, in many respects, the existing relations between the Fund and its European members that have pegged their currencies to the deutsche mark for a number of years predetermine the type of bilateral consultations that the Fund will conduct with EMU members.

The pursuit of those bilateral consultations will allow the Fund to remain well informed about the economic situation in EMU members, to give advice in areas such as medium-term fiscal consolidation, restructuring of the tax system, social security reforms, and strengthening of the banking system, and in this way to promote sound economic policies and stronger economic performance. In this respect, I fully agree with Professor Thygesen that “Fund surveillance will be a useful supplement, precisely because it is broader in scope… [and] confronts EMU Fund members with a wider and still highly relevant policy experience throughout the world.”

This being said, it is clear that, conversely, the country-by-country surveillance will have to be supplemented by consultations between the Fund and the main European institutions or bodies having responsibilities in the field of economic and monetary policymaking. Obviously, this will be required because the definition and conduct of the monetary and exchange rate policy will cease to be a national responsibility after the start of EMU. Furthermore, it is quite clear that the Fund will wish to examine the policy mix of the euro zone and discuss its implications for the world economic outlook.

To this effect, suitable arrangements will need to be established. Without wanting to prejudge the concrete and final form of these arrangements, I would like to put forward a few remarks to contribute to the debate.

First, with respect to monetary policy, the Fund will need to engage in a close and fruitful relationship with the ECB. I have no doubt that the long tradition of cooperation between the Fund and central banks, on the one hand, and the centralization of monetary sovereignty in the hands of the Governing Council of the ECB, on the other hand, will help in finding suitable procedures of consultation between the Fund and the ECB. It would appear desirable that these procedures provide for discussions of a staff report in the Executive Board, which could reach conclusions on monetary policy in EMU.

Second, surveillance over the exchange rate policy of EMU will also fall within the core mandate of the Fund. This may prove more difficult to organize because exchange rate policy under EMU will be a joint responsibility of the ECOFIN Council and the ECB. Nevertheless, EMU members will have “to collaborate with the Fund and other members to assure orderly exchange arrangements and to promote a stable system of exchange rates,” in accordance with their general obligation under Article IV. Accordingly, specific procedures will need to be adopted to help the Fund exercise its surveillance over the exchange rate policy of the EMU region.

Third, EMU members will have to be ready to engage in consultations with the IMF on the policy mix of the euro zone. Those consultations will be particularly important in the context of the preparation of the World Economic Outlook by the Fund staff, and the Broad Economic Guidelines by the European Commission. On the latter, which constitute the institutional framework for the coordination of economic policies between the member states of the EU, a strengthening of the relationship between both institutions could be called for to enable the European Commission to benefit from the Fund’s advice and to enrich the IMF staff’s knowledge with lessons drawn from multilateral surveillance in the EU.

Fourth, the ECOFIN Council and the ECB will have to decide about the representation of EMU at meetings of the IMF’s Executive Board when the above-mentioned matters will be discussed. This is a matter to be settled, in agreement with the Fund, in accordance with the provisions of Article 109 (section 4) of the Maastricht Treaty. For example, a consensus could be reached that these institutions—ECOFIN Council and ECB—should be represented in the Fund by Alternates in the office of Executive Directors representing EMU members.

Finally, consultations between the Fund and EMU members and the Community institutions concerned, could also take place at the level of the Economic and Financial Committee, which will replace the present Monetary Committee after the establishment of EMU. This could be a natural body of dialogue between the Fund staff and EMU members for three reasons. First, this committee will keep under review the financial and economic situation of EMU members and of the Community, and report regularly thereon to the ECOFIN Council; second, the committee will have a key role to play to ensure the coordination of economic policies; and third, EU member states, the European Commission, and the ECB will be represented on the committee.

Access of EMU Members to Fund Resources

A third area of concern is the impact of EMU on the potential access of EMU members to Fund resources. Here, too, a number of questions will need to be examined carefully. The questions are simple: Will EMU members still be entitled to use the resources of the Fund? Will it be possible for the Fund to provide financial assistance to the euro area as a whole?

Although it can be argued that any request by EMU members to use conditional credit from the IMF is very unlikely, I believe that these are valid questions because they relate to the need to preserve the general rights of members of the Fund as well as the capacity of the Fund to provide a safety net for countries and currencies that are in difficulty.

The first question relates to the interpretation of the concept of “balance of payments need” for members of a monetary union. Indeed, it should be recalled that the conditions governing the use of the Fund’s general resources (Article XIX, section 3) require that the member concerned “has a need because of its balance of payments or its reserve position or developments in its reserves.”

Well, are we sure that after joining EMU, countries will still be open to balance of payments difficulties? Will the participation in EMU not relieve its members from their balance of payments constraint? These are questions on which it would be useful to have the opinion of the Fund.

Indeed, imagine—for a second—that the Fund would be of the opinion that it could not assist EMU members in a manner consistent with the provisions of the Articles of Agreement. This would limit—in an exceptional way—the general rights of EMU members and the fundamental principle of universality of treatment of different members.

On the other hand, not all issues would be settled if a broad interpretation of the concept of the “balance of payments need” is accepted and if the Fund is allowed to provide financial assistance to individual EMU members. Indeed, the question would arise whether it would be possible for the Fund to assist the euro area as a whole if EMU were not a member of the Fund.

One way to solve this issue would be to permit a joint request by the EMU members. However, if it is agreed that a simultaneous purchase from the Fund is possible, it remains to be decided with whom the Fund would negotiate the conditionality attending the use of its resources.

My view is that one should not overlook the validity of this question because it is closely related to the implications of EMU for the architecture of the international monetary system. Indeed, with the advent of the euro, the international monetary system will probably move from a dollar-denominated system to a new system with two or three reserve currencies—the dollar, the euro, and the yen. Obviously, the emergence of this new system will pose challenging questions and the Fund will have the major responsibility of overseeing the orderly transition to this new system. On the part of the Fund, this will require not only reviewing the mechanisms of surveillance of the international monetary system, but also reassessing its financial relations with the three reserve currencies. The point I want to stress in this context today is the following: one will have to ensure that the Fund provides a safety net against the risks of excessive exchange rate fluctuations, not only with regard to the dollar and the yen, as is the case today because the countries that issue those currencies are full members of the Fund, but also with regard to the euro, even if EMU does not become a member of the Fund.

Concluding Suggestions

The creation of EMU will have important implications for the working of the IMF and the international monetary system as a whole. Even though this conference will help to highlight a number of these implications, important questions will remain unsolved tomorrow evening. The reason is simple. Neither the EC Treaty nor the Articles of Agreement of the Fund provide all the answers.

Against this background, by way of conclusion, I would like to make the following two suggestions. First, I would recommend that the Fund take all the necessary steps to be ready to welcome the euro as the new currency of a group of its members. The experience shows that one should not underestimate the time and the energy such a change requires, and therefore it might be useful to set up a special task force within the Fund to prepare the decisions that will be required to adjust the financial organization and operations of the Fund to the advent of the euro.

Second, I see a need to agree on a “working method” to deal with the questions that will require consultation and resolution at the international level between the main actors concerned. The range of questions that should be examined ranges from seemingly technical questions to obviously political ones. That is the reason why not only academics but also politicians should take the necessary time to discuss them seriously.

As regards the calendar, it seems to me that the Interim Committee of the IMF, which—let’s not forget—-was established to advise and report to the Board of Governors on issues related to the management and the adaptation of the international monetary system, will wish to discuss the implications of EMU for the Fund and the international monetary system, at the latest during the fall of 1998 and perhaps even before, during its spring meeting next year. The time constraint we are facing is therefore quite tight.

One way to make rapid progress could be for the Fund staff to prepare, possibly after consultations with the European Commission and the European Monetary Institute, a paper accompanied by a questionnaire on the main issues to be addressed in the short, medium, and long term, which could stimulate the discussions within, on the one hand, the Executive Board of the IMF and, on the other hand, the ECOFIN Council and the Monetary Committee of the EU. Assuming that this approach would be followed, it seems to me that it would be useful if this paper could be prepared early enough for the ECOFIN Council to have a first exchange of views at its informal session next September. This would clarify the extent of the challenges facing the IMF and the international monetary system about 15 months before the introduction of the euro, and give the main actors concerned the time needed to prepare the orderly adjustment of the international monetary system to EMU.

The model that the EU has adopted to lay down its monetary union does not fit in perfectly with all the existing arrangements and practices that have been developed over the years to allow the Fund to carry out its mission. A number of adaptations will be necessary to align the Fund’s arrangements and practices with the characteristics of EMU. This will require serious discussion within the Community to come forward with practical proposals to be discussed with the Fund. Without denying the potential difficulties, I am confident that the ability the Fund has shown in the past to adapt to changing circumstances and the willingness of the EU to be an effective and responsible actor on the international stage will allow the necessary consensus on suitable arrangements to be reached in due time.

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