2 Initial Objectives
- Margaret De Vries
- Published Date:
- June 1986
When the International Monetary Fund was established, the founders had six purposes in mind. These were, as stated in Article I of the original Articles of Agreement:
To promote international monetary cooperation through a permanent institution which provides the machinery for consultation and collaboration on international monetary problems.
To facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objectives of economic policy.
To promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation.
To assist in the establishment of a multilateral system of payments in respect of current transactions between members and in the elimination of foreign exchange restrictions which hamper the growth of world trade.
To give confidence to members by making the Fund’s resources available to them under adequate safeguards, thus providing them with the opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.
In accordance with the above, to shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members.1
CODE OF CONDUCT
The intention was that countries which joined the Fund would conform to certain standards of behavior in international financial matters. An elaborate and detailed code of what was considered good conduct was drawn up; it called for exchange stability, orderly exchange arrangements, the avoidance of competitive exchange depreciation, and a liberal regime of international payments—that is, convertibility of currencies and freedom from exchange restrictions.
Adherence to this code of conduct was not an end in itself. The specific goals of exchange rate stability, freedom from exchange restrictions, and convertibility of currencies were rather viewed as essential for the achievement of full employment and the maximum development of productive resources—objectives regarded by practically all countries at the close of World War II as primary.
The logic was that good conduct in international financial relations would foster a high level of international trade and investment. More specifically, the Fund’s purposes implied that fixed exchange rates, freedom from exchange restrictions, and multilateral trade and payments were the best basis for international financial cooperation and for promoting world trade and investment. Expanding world trade and investment were, in turn, regarded as essential for the attainment of the even broader objectives of full employment and economic development in all member countries. In the past, national economic policies had frequently led to restrictive measures in the international field, and thereupon to international economic conflict. The purpose of the new cooperation to be achieved through the Fund was to reconcile domestic and international objectives.
It was recognized that such reconciliation could not be assumed. In the forefront of economists’ attention at the time were the questions whether full employment and balance of payments equilibrium could be attained simultaneously and, if so, what policies in the international field were compatible with the maintenance of full employment at home.2 There were those who argued that, under certain assumptions, multilateral trade and payments might not maximize world trade.3 The issue of the consistency of economic development—especially in what were only later to be called “the less developed countries”—with the international objectives of exchange stability and free trade and payments was still in the wings, rather than on stage, in economists’ thinking.4 While these questions were being debated, those who were proceeding with setting up and operating the Fund took the view that these goals were not only compatible but even mutually reinforcing.
The architects of the Fund were fully aware that a permanent institution would be needed if the specified aims were to be accomplished. International cooperation was now to replace the exclusive authority of governments in fields in which decisions had previously been taken solely in the national interest. Resolving the conflicts that would arise and making the necessary day-to-day decisions would inevitably require continuous consultation and collaboration among the members. The Fund was thus intended as part of the permanent machinery of international monetary cooperation to be set up after World War II, rather than as an emergency agency to meet the temporary needs associated with the aftermath of war.
But it was also realized that the Fund would need to do more than enforce a code of conduct. The harmful practices that had characterized international relations prior to the Fund’s establishment had been adopted because countries were short of foreign exchange. The Fund was, therefore, provided with large resources which it could make available to its members. Consequently, while countries joining the Fund agreed to strict rules for the conduct of their international financial relations, they became members of an institution that possessed a large reserve of gold and foreign currencies with which it could assist any member that had payments difficulties.
The Fund could thus be thought of as having two types of functions. What were sometimes called its regulatory functions consisted of determining and enforcing the code of behavior in international financial and monetary matters. Its financial functions consisted of making available to its members the resources to which it had access.
Other agencies of international cooperation were to supplement the Fund’s functions. The International Bank for Reconstruction and Development (World Bank) was established to assist countries in obtaining funds for long-term investment. The International Trade Organization (ITO) was planned—but never came into being—to reduce barriers to international trade, such as tariffs and trade quotas, and to set standards of behavior in the international trade field analogous to those established by the Fund in international financial matters.
The initial code of conduct that was to be administered by the Fund and the nature and terms of its financial assistance, as envisaged in the original Articles are as follows.
Exchange Rate Stability The first three elements of the code of conduct referred to exchange stability, orderly exchange arrangements, and the avoidance of competitive depreciation and consisted of rules about exchange rates. Article IV provided for fixed exchange rates. Members agreed to decide through the Fund on a system of exchange rates—par values—for their currencies and not to change these rates without consulting the Fund. Related obligations concerned the price of gold.
Exchange rate stability was not, however, tantamount to rigidity. On the contrary, the exchange rate was to be adjusted when necessary to correct a fundamental disequilibrium in the member’s balance of payments. But it was implicit in the original Articles that exchange rates should be adjusted only at infrequent intervals: fundamental disequilibrium (although it was never formally defined) was distinguished from merely ephemeral balance of payments disequilibria, such as those associated with seasonal, speculative, or possibly even short cyclical disturbances.
The initiative for changing an exchange rate was reserved for the member concerned: the Fund could not propose it. With minor exceptions, however, the member had to seek the Fund’s approval for the proposed change, and the Fund concurred if it was satisfied that the change was necessary and sufficient to correct a fundamental disequilibrium. If a member changed the par value of its currency despite the Fund’s objection, the Fund had the authority to declare the member ineligible to use its resources and, subsequently, even to require the member to withdraw from membership.
The principal intention was to empower the Fund to prevent undue fluctuation or undue depreciation of exchange rates, or both. An explicit purpose of the Fund was to outlaw competitive exchange depreciation, that is, depreciation in excess of that required to remove a fundamental disequilibrium.
Liberal Regime of International Payments The fourth element of the code of conduct referred to a liberal regime of international payments and consisted of rules governing exchange restrictions and similar practices; it required members to establish and maintain a multilateral system of payments. It was envisaged that each member, after a transitional period of varying duration, would accept certain obligations set out in Article VIII. This Article provided that no member might, without the approval of the Fund, impose restrictions on the making of payments or transfers for current international transactions, or engage in discriminatory currency arrangements or multiple currency practices. Article VIII further provided for the convertibility of currencies—namely, for arrangements by which any trader exporting from one member country to another could secure effective payment in his own currency, and by which a member was free to use a payments surplus with any other member to pay for its deficit with a third country. The aim was that exchange restrictions should be minimized—indeed eliminated—on the conviction that they are harmful to the growth of world trade and result in distortions in the domestic economies which discourage maximum economic growth and rising standards of living.
It was recognized at Bretton Woods, however, that conditions after World War II would probably be such as to make it impossible for some time to come for many members to accept in full the obligations pertaining to abolition of restrictions and establishment of convertibility. A transitional period, during which members might maintain and adapt their exchange restrictions, was therefore provided by Article XIV. But members taking advantage of this Article were still to do their best to remove restrictions as soon as possible. After five years they were to consult with the Fund annually regarding any remaining restrictions, and the Fund was given authority to apply pressure on them to withdraw such restrictions.
The Fund’s financial assistance to a member took the form of an exchange of currencies. When a member wished to draw on the Fund’s resources, it purchased from the Fund some foreign currency that it could use and paid in a corresponding amount of its own currency, which the Fund then held. Conversely, when a member repaid the drawing, it repurchased its own currency from the Fund with gold or some currency acceptable to the Fund. Such transactions were analogous to borrowing and repaying.
These transactions affected the Fund’s holdings not only of the currency of the drawing or repurchasing member, but also of the currencies of other members. While a drawing, for instance, increased the Fund’s holdings of the currency of the member making the drawing, it reduced the holdings of the currency drawn. The Articles provided that the Fund should be a revolving fund; that is, whatever the Fund paid out to its members would sooner or later be returned to it. The drafters at Bretton Woods planned that in ideal conditions the Fund would hold 75 percent of each member’s quota in that member’s currency.5
The purpose for which the Fund’s resources were to be made available was stated in Article I(v) to be that of providing members “with opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.” This purpose implied temporary use of the Fund’s resources. The concept of the Fund’s assistance was that the Fund’s resources formed a secondary source of reserves for a member with a temporary balance of payments deficit; the member’s own reserves constituted its first line of defense. Use of the Fund’s resources was to make it unnecessary for a member, in the absence of adequate reserves of its own, to resort to other means for coping with a temporary payments deficit. The solutions especially to be avoided for a short-term deficit were exchange rate devaluation—reserved by the Fund’s original Articles for balance of payments deficits of a fundamental character—and exchange restrictions which curbed the flow of trade and payments.
The provisions for repurchase and for charges on drawings also indicated the temporary nature of the Fund’s assistance. The idea on which the repurchase provisions in the original Articles was based was that an increase in a member’s monetary reserves indicated an improvement in its balance of payments position. Any member that had drawn from the Fund an amount equal to more than half of its balance of payments deficit in any one year had to pay back the excess; thereafter, half of any payments surplus, or rise in reserves, had to be paid to the Fund in the form of a repurchase of the member’s currency, although such repurchases were not required of a member whose reserves had fallen sharply or were less than its quota. Charges on drawings increased not only with the amount of the drawing outstanding relative to quota, but also with the time for which the drawing had been outstanding.
Note: This article was published earlier in a slightly different form as part of Chapter 2 in History, 1945–65, Vol. II, pp. 19–24.
These purposes, as expressed in Article I, remained unchanged after the First and Second Amendments of the Articles of Agreement, in 1969 and 1978, respectively.
These questions were discussed, for example, at the 59th annual meeting of the American Economic Association in January 1947 see “Papers and Proceedings,” American Economic Review, Vol. 37, No. 2 (May 1947), pp. 560–94. They also formed the subject of James Meade’s The Theory of International Economic Policy; Vol. I, The Balance of Payments (London, 1951).
Ragnar Frisch, “On the Need for Forecasting a Multilateral Balance of Payments,” American Economic Review, Vol. 37, No. 4 (September 1947), pp. 535–51.
The second volume of James Meade’s The Theory of International Economic Policy, subtitled Trade and Welfare, was, however, devoted to the related question of how direct trade and payments controls can increase welfare.
These principles and techniques involved in a member’s use of the Fund’s resources remained unchanged as of 1985 but substantive changes have been made in the ways in which they are implemented. A description of these changes can be found in Margaret Garritsen de Vries, The International Monetary Fund, 1972–1978: Cooperation on Trial (Washington: International Monetary Fund, 1985), Vol. I, pp. 559–81 and Vol. II, pp. 723–29. (Hereinafter cited as History, 1972–78.)