Front Matter

Front Matter

James Boughton
Published Date:
December 2004
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M.E. Sharpe

Armonk, New York

London, England

Copyright © 2005 by the International Monetary Fund

All rights reserved. No part of this book may be reproduced in any form without written permission from the publisher, M.E. Sharpe, Inc., 80 Business Park Drive, Armonk, New York 10504.

Library of Congress Cataloging-in-Publication Data

Polak, J. J. (Jacques Jacobus), 1914–

Economic theory and financial policy : selected essays of Jacques J. Polak, 1994–2004 / by Jacques J. Polak; edited by James M. Boughton.

p. cm.

Includes bibliographical references and index.

ISBN 0-7656-1614-9 (hardcover : alk. paper)

1. International finance. 2. International economic relations. 3. Foreign exchange. 4. International Monetary Fund. I. Boughton, James M. II. Title.

HG3881.P5683 2004

332’.042—dc22 2004018548

Printed in the United States of America

The paper used in this publication meets the minimum requirements of American National Standard for Information Sciences Permanence of Paper for Printed Library Materials, ANSI Z 39.48-1984.

BM (c) 10 9 8 7 6 5 4 3 2 1


Publication of this book was made possible through the inspiration and support of the many people who helped prepare and conduct the celebration of Jacques Polak’s 90th birthday at the IMF in April 2004. The Working Group in charge of the celebration comprised Jeroen Kremers (Chair), Shailendra Anjaria, Jack Boorman, James Boughton, Patrick Cirillo, Thomas Dawson, Azizali Mohammed, Jonathan Ostry, Raghuram Rajan, Kathleen White, and Onno Wijnholds. The Acting Managing Director of the IMF, Anne Krueger, chaired the event, and the Dean of the Executive Board, Abbas Mirakhor, provided critical support and served as Honorary Chairman. Sean Culhane organized and coordinated the publication of the volume. Thanks also go to others who spoke at the celebration either in person or by video, including Andrew Crockett, Jacques de Larosière, Wim Duisenberg, Robert Flood, Peter Kenen, Sir Jeremy Morse, Michael Mussa, Boudewijn J. Van Eenennaam, Paul Volcker, Nout Wellink, and Johannes Witteveen.


James M. Boughton

As of 2004, Jacques Polak’s career as an international economist spans sixty-seven years. It began at the age of twenty-three, in October 1937, when he accepted a position as assistant and office mate to Jan Tinbergen at the League of Nations in Geneva. In 1940, with the war closing in, he and several more senior colleagues accepted an invitation from the Institute for Advanced Study in Princeton, New Jersey, to continue the league’s economics functions in the safer cloisters of an American university town (where, incidentally, they would share an office building with Albert Einstein, John von Neumann, and other scientific luminaries). Three years later, he moved to Washington, D.C., to take up a post at the Netherlands Embassy, where he immediately began studying the U.S. and British proposals for creating postwar international monetary institutions. That work led to his being appointed to the Netherlands delegation at the Bretton Woods monetary conference in July 1944: the seminal event in creating the institutions and the system of monetary cooperation in which he was to play such a major role and that would establish and define his professional legacy.

In the fall of 1944, Jacques Polak joined the staff of the United Nations Relief and Rehabilitation Administration (UNRRA), where he studied the economic recovery of countries assisted by the agency. When the war ended, however, the U.S. government lost interest in supporting UNRRA, and in 1947 Polak decided to move to the International Monetary Fund (IMF). For a young man who had now worked for two promising but now defunct international institutions and who had a growing family to support in a tight job market, the leap to the IMF was a major gamble. The Fund was far from being the preeminent institution that it would eventually become, and Polak would later admit that its early years were a “let-down from the high hopes held at Bretton Woods” (Polak, 1994a, p. xviii). This time, though, the gamble paid off.

In 1958, Polak succeeded Edward M. Bernstein to become the Fund’s second Director of Research, and in 1966 he was awarded the additional title of Economic Counsellor.1 In that capacity, among other achievements, he led the effort to create Special Drawing Rights (SDRs) as a new type of international reserve asset, and he helped direct the transformation of the IMF from the watchdog of the par-value exchange rate system to the overseer of exchange rate and macroeconomic policies throughout the world.

After reaching the IMF’s mandatory retirement age of 65 in 1979, Polak took on new assignments that posed substantial challenges. First, as adviser to the managing director, he worked closely with Jacques de Larosière as they fought a determined but unsuccessful battle to establish a “substitution account” that would have partially replaced volatile U.S. dollars with more stable SDRs in official international reserve portfolios. He then served six years as the executive director in the IMF for a grab bag constituency of countries, two of which—the Socialist Republic of Romania and the Socialist Federal Republic of Yugoslavia—were in processes of economic and political disintegration that he and the Fund tried but ultimately were powerless to alleviate. (The others were Cyprus, Israel, and the Netherlands.) His final official appointment was as president of the Per Jacobsson Foundation (1987–1997), but since that time he has continued to serve as an informal adviser and mentor to a new generation of Fund staff, working out of an office on the top floor of the IMF headquarters in Washington.

This recounting of a lengthy and distinguished career is merely the backdrop for Jacques Polak’s real vocation as a research economist. His main contributions—early econometric tests of macroeconomic regularities, in the late 1930s; a policy-oriented monetary model of the balance of payments, in the 1950s; analyses of the limits to international policy coordination, from the early 1960s on; and studies of the functioning of the international financial system, up to the present day—are well known and have been well surveyed before. Moreover, two collections of his papers have been published already, covering virtually all of his published work through the early 1990s—more than 100 papers in all.2 But those collections are now incomplete. In the past decade, Jacques Polak has contributed much to the debates on international financial policy, and the present volume brings together most of these recent papers to make them accessible to a broader audience.3

Part I. The Role of the International Monetary Fund

A hallmark of Polak’s recent research has been his ability to draw on several decades of personal experience and reflection to comprehend and describe the context for current policy debates. Each of the six papers in Part I of this volume illustrates this quality well.

In “The Essence of Bretton Woods” (Chapter 1), Polak debunks the notion that the Fund lost an essential function when the par value system of exchange rates collapsed in the early 1970s. The essential function, he argues, was not to maintain stable exchange rates but to establish “an institutionally organized cooperation” for countries to deal with monetary problems. The point of the chapter is not to defend the Bretton Woods agreements of 1944, but rather to stress the continuity of the IMF’s mandate to promote monetary cooperation among countries.

“The International Monetary Issues” (Chapter 2) draws lessons for the future from the work of the IMF in the 1960s and 1970s. The chapter recalls the international discussions of that era on five key topics: adjustment versus financing in response to reserve shocks, creation of SDRs, the SDR interest rate, the failed attempt to establish an SDR substitution account, and the use of objective indicators for assessing exchange rate pressures. Noting that these topics seemed outdated by the 1990s, Polak argues that important lessons can be drawn for contemporary problems: the need for consensus on adjustment policies, the appropriateness of SDR allocations for creating reserves for newly emerging countries, the need for a market interest rate on SDRs and on IMF operations, the value of a substitution mechanism for accommodating countries that would like to reduce dollar-denominated reserves without destabilizing currency markets, and the difficulty of establishing objective indicators of imbalances calling for exchange rate adjustment.

Chapter 3, “Fifty Years of Exchange Rate Research,” surveys exchange rate research in the IMF. Here, Polak observes that such research has fallen into three distinct periods: a formative era in the 1940s and 1950s when research focused on understanding the role of exchange rates in economic adjustment; a middle period in the 1960s and 1970s when research focused on determining equilibrium rates for the United States, the United Kingdom, and France; and a mature period when research has focused on assessing different types of exchange rate policy regimes.

The fourth chapter, “The IMF and Its EMU Members,” deals with relations between the IMF and the countries in the euro zone. Written in 1997, before the introduction of the euro, the paper draws in part on the Fund’s experience with other currency unions, notably the CFA franc zone in Africa and the Belgo-Luxembourg economic union in Europe, albeit primarily to draw contrasts with the broader systemic issues associated with the new European currency. Polak focuses particularly on the implications for the IMF of a situation in which the exchange rate, monetary, fiscal, and reserve management policies of an important group of countries are to varying extents determined supranationally.

The longest chapter in this group, “The World Bank and the International Monetary Fund” (Chapter 5), is a comprehensive historical review of how relations between the two Bretton Woods institutions evolved in their first half century. The paper notes that the overlap between the work of the two institutions grew substantially in importance in the 1980s and early 1990s, but that the basic functions remain (and should remain) distinct and separate.

“Liberalization of Capital Movements” (Chapter 6) concludes this section on the role of the IMF by arguing against proposals to amend the Articles of Agreement so as to give the Fund jurisdiction over the regulation of international capital movements. Polak argues that such an amendment is not needed and could be counterproductive, since complete freedom of capital movements is not necessarily wise and since the Fund already can promote capital-account liberalization in a measured way.

Part II. New Thoughts on the SDR

Jacques Polak has long advocated streamlining the IMF’s financial structure by basing it entirely on the SDR rather than on a mixture of SDRs and national currencies. When the IMF was established in the 1940s, its financial structure was formally based on the principle that all currencies were created equal. The reality, however, was that the U.S. dollar was—and was expected to remain for some time—the dominant currency in the world economy. Moreover, the dollar provided an anchor for international payments by being linked firmly to gold. Member countries would contribute resources to the IMF, partly in the form of gold and partly in the form of securities or bookkeeping entries in their own currency. For the first decade of IMF operations, almost all lending was in U.S. dollars, but the institution eventually started lending other internationally accepted currencies. Sixty years later, the Fund uses the currencies of more than 40 countries in its lending operations (in addition to SDRs) and holds some 140 others that are not presently usable. The Fund’s accounts have thus become increasingly complex and confusing.

The SDR—defined initially as equal to a fixed quantity of gold that was then worth one U.S. dollar, and later redefined as a basket of currencies—was designed for an era when exchange rates were fixed and internationally accepted currencies might be in short supply for settling official payments balances. In 1996, the IMF held a seminar on the future of the SDR, at which experts from around the world addressed questions related to the function and importance of the SDR in a world of mixed exchange regimes and no obvious global shortage of reserve assets. Jacques Polak’s contribution to that debate (Chapter 7, “Should the SDR Become the Sole Financing Technique?”) was to demonstrate the benefits of having the Fund lend only SDRs (i.e., lend by making bookkeeping entries rather than by conveying currencies contributed by members). To make the SDR into the sole financing vehicle for the Fund, however, would require allowing commercial banks to hold SDRs, in order to create a liquid market for the asset.

Polak elaborated on this theme in a subsequent paper, published as a Princeton Essay (“Streamlining the Financial Structure,” Chapter 8). That article explains the changes in the IMF’s balance sheet and financial structure that would have to be made in order to have a Fund that was based entirely on the SDR rather than currencies. Those changes would require extensive amendments to the Articles of Agreement but would result in a greatly simplified charter and more transparent and readily understood financial practices.

The final chapter in this group (Chapter 9), written jointly with Peter B. Clark, advocates resuming allocations of SDRs. Here, Polak acknowledges that the original argument for allocating SDRs—to overcome a general shortage of world liquidity—no longer has any real meaning and cannot be used to justify a new allocation. Nonetheless, official reserves are a valuable asset in the modern world economy, even for countries with floating exchange rates, and many newly emergent or less developed countries lack the resources to accumulate reserves by market means (i.e., by running surpluses in their balance of payments). That shortcoming is widespread enough to reasonably be called a “long-term global need … to supplement existing reserve assets,” which is the prerequisite for an SDR allocation specified in the Articles of Agreement. To avoid any possibility of excess liquidity creation, Clark and Polak argue for a series of small annual allocations rather than occasional large jumps in the outstanding stock.

Part III. International Economic Policy: Theory and Practice

Jacques Polak’s most enduring contribution to the economics literature was his exposition of the policy implications of the monetary approach to the balance of payments. In a 1957 article in IMF Staff Papers, he set out a simple four-equation model that required few data and fewer assumptions to estimate but that nonetheless was capable of determining a policy path that was likely to equilibrate a country’s balance of payments. The theory underlying the model was similar to the monetary approach being developed by Harry Johnson around the same time at the University of Chicago. Polak’s insight was that the monetary model could be interpreted as an open-economy model of a Keynesian one-period equilibrium, rather than as a model of steady-state monetary relationships as in Johnson’s formulation. The Polak model thus could be used to estimate the degree of adjustment in monetary or fiscal policy that would be needed in real-world situations to equilibrate the balance of payments without a change in the exchange rate.

The first two chapters in the final section of this volume exposit the Polak model from the perspective of forty years of experience and evolution in macroeconomic theory and practice. “The IMF Monetary Model at 40” (Chapter 10) recounts the origins of the model and the ways it has been used by the IMF staff over the years. Remarkably, a model that was developed for a world of fixed exchange rates, limited international capital mobility, and rudimentary domestic bond markets has proved adaptable to a wide variety of more complex circumstances through the simple expedient of introducing flexibility outside the model rather than by expanding the model itself. Chapter 11, “The Two Monetary Approaches” (the italics being Polak’s own emphasis of the distinction between him and Johnson), shows how the Polak model differs in its analysis and policy implications from the superficially similar Chicago model.

Chapter 12 provides a fresh look at another type of model, the gravity model of international trade. Polak finds it implausible on a priori grounds to regard the Asia-Pacific region as a natural trading bloc, an argument that had been made by Jeffrey Frankel and co-authors. Frankel found support for this idea in estimates of a gravity model, and in response Polak shows that the usual specification of the model produces results that are biased in favor of finding significant regional effects for a geographically dispersed area such as the Asia-Pacific region.

Readers whose primary interest is in the functioning of the international financial system should resist the temptation to skip over Polak’s essay on historical relations between Belgium and the Netherlands (Chapter 13). This anecdotal essay illustrates some broad principles for the conduct of monetary and commercial policy between close partner countries. Here Polak argues that fixing bilateral exchange rates, as these two countries did in 1943, can serve an important but transitory service, subservient to the broader objective of liberalizing and promoting international trade. This essay also includes the little-known story of how two small countries obtained and then held on to their own seats on the IMF Executive Board from 1946 to today.

The final chapter in this volume (Chapter 14), though inspired by the specific circumstances of the 1992–93 crisis in the European Monetary System, examines international economic and financial integration in broad terms. The world has changed since Bretton Woods, and it continues to change in ways that complicate the making and the coordinating of economic policy. Polak focuses on two key developments: the rise of the private sector as a major actor in the international financial system and the increasing recognition of the limitations to macroeconomic stabilization policy. For both reasons, international policy coordination today is more difficult to implement effectively then it was in an earlier age (when it was already difficult enough).

The concluding paragraphs of this concluding chapter nicely sum up Jacques Polak’s philosophy of political economy. He disdains the “droves of babes in Bretton Woods” who persist in believing in an optimum world economic order founded on fixed exchange rates or even a global currency union and buttressed by rational policy coordination. Such a result, he argues, is impossible to achieve unless one first somehow creates a single world “political area.” As of this writing, this philosophy seems overly pessimistic, particularly since Polak uses it to express (writing in 1994) “grave doubts about the attainability of [European monetary union] without the prior achievement of a much greater degree of political integration than appears anywhere on the horizon.” Will the euro succeed in the long run without a major tightening of European political integration? Time will reveal the answer, but that will have to await the next volume of Jacques Polak’s collected papers.


Bibliography, 1992–2004

A complete bibliography of works by Jacques J. Polak through 1991 was published in International Economic Policy: Essays in Honor of Jacques J. Polak, ed. by Jacob A. Frenkel and Morris Goldstein (Washington: International Monetary Fund in Association with De Nederlandsche Bank, 1991), pp. 39–46. This bibliography is a sequel, covering publications through 2004. Items marked with an asterisk are included in the present volume. Most earlier publications were reprinted in Polak (1994a). An earlier compilation is even more complete within the period it covers, as it includes a number of internal IMF documents and early articles in Dutch. That collection, Jacques J. Polak, Collected Papers, volumes 1 and 2, was compiled by Lillian H. Cooley and privately printed by the IMF in 1979. Copies are held at the Joint IMF-World Bank Library (see and at De Nederlandsche Bank in Amsterdam.

    1992a“Reserve Currency,”The New Palgrave Dictionary of Money and FinanceVol. 3 pp. 33942.

    1992b withAnneKrueger andJohnNewtonPanama Post–1989 A.I.D. Program Evaluation (Arlington: Nathan Associates Inc.).

    1993a“Comentario—¿Importa la cuenta corriente? El punto de vista tradicional y el moderno”(Comment: Does the current account matter? Traditional and modern perspectives)Economia MexicanaVol. IINo. 1 (January-June) pp. 5961.

    1993b“Fifty Years Later,”International Economic InsightVol. IVNo. 5 (September/October) pp. 5661.

    1994aEconomic Theory and Financial Policy—The Selected Essays of Jacques J. Polak (2 vols.) (Aldershot: Edward Elgar Publishing Limited).

    1994b“Entretien avec Jacques Polak”(Interview with Jacques Polak) inBretton Woods—Mélange pour un cinquantenaireed. byThierryWalrafen (Paris, Association d’économie financière) pp. 3134.

    *1994c“The Essence of Bretton Woods: Monetary Cooperation,” inThe Making and Remaking of the Bretton Woods System: A Fiftieth Anniversary Retrospective (Professional Bankers Association).

    *1994d“Financial Relations between The Netherlands and Belgium: 1943 to 1993,” inMonetary Stability through International Cooperation—Essays in Honour of André Szászed. byAgeBakker and others (Amsterdam: De Nederlandsche Bank) pp. 18399.

    1994e“Het toezicht van het IMF op het economische beleid van zijn lid-staten”[Surveillance by the IMF of the Economic Policies of its Members] in“Vijftig jaar na Bretton Woods,”ed. byW.Mak and H.Visser (Utrecht: Koninklijke Vereniging voor de Staathuishoudkunde, LEMMA) pp. 1932.

    *1994f“The International Monetary Issues of the Bretton Woods Era,” inThe International Monetary System: Proceedings of a Conference Organized by the Banca d’Italia (July1992honoring the memory of Rinaldo Ossola) ed. by Peter B.KenenFrancescoPapadia and FabrizioSaccomanni (Cambridge: University Press) pp. 1934.

    *1994gThe World Bank and the International Monetary Fund: A Changing Relationship (Washington: The Brookings Institution). Reprinted in The World Bank-Its First Half Centuryed. byDevesh KapurJohn P.Lewis and RichardWebbVol. 2:Perspectives (Washington: The Brookings Institution,1997) pp. 473522.

    1994h“The World Bank and the IMF: the Future of their Coexistence,” inBretton Woods: Looking to the Future (Washington: The Bretton Woods Committee) pp. 14955.

    *1995a“Fifty Years of Exchange Rate Research and Policy at the International Monetary Fund,”IMF Staff PapersInternational Monetary FundVol. 42No. 4 (December) pp. 73461.

    *1995b“Repairing the International Monetary System—An Unfinished Task?” inThe International Monetary System—Its Institutions and its Futureed. by HansGenberg (Berlin: Springer) pp. 1319.

    1996a“The Contribution of the International Monetary Fund,” inThe Post-1945 Internationalization of Economics”ed. byA.W.Coats (Durham, NC and London: Duke University Press) pp. 21124.

    *1996b“Is APEC a Natural Regional Trading Bloc? A Critique of the ‘Gravity Model’ of International Trade,”The World EconomyVol. 19No. 5 (September) pp. 53343.

    *1996c“Should the SDR Become the Sole Financing Technique for the Fund?” inThe Future of the SDR in Light of Changes in the International Financial System (Proceedings of a Seminar Held in Washington D.C. March 18–19 1996)ed. byMichaelMussaJamesM. Boughton and Peter Isard (Washington: International Monetary Fund) pp. 21124.

    *1997a“The IMF and its EMU Members,” inEMU and the International Monetary System,”ed. byPaul R.MassonThomas H.Krueger and Bart G.Turtleboom (Washington: International Monetary Fund) pp. 491511.

    1997b“The IMF Monetary Model: A Hardy Perennial,”Finance & DevelopmentVol. 34No. 4 pp. 1619.

    1997c“The Significance of the Euro for Developing Countries,”International Monetary and Financial Issues for the 1990s: Research Papers for the Group of Twenty-Four (New York and Geneva: United Nations) Vol. IX pp. 5769.

    *1998a“The Articles of Agreement of the IMF and the Liberalization of Capital Movements: Should the IMF Pursue Capital-Account Convertibility?” inEssays in International FinanceNo. 207 (Princeton, NJ: Princeton University).

    *1998b“The IMF Monetary Model at 40,”Economic ModellingVol. 15No. 3 (July) pp. 395410.

    1998cIMF Study Group Report: Transparency and Evaluation (Washington, DC: Center of Concern) pp. 118.

    *1999“Streamlining the Financial Structure of the IMF,”Essays in International FinanceNo. 216, (Princeton, N.J.: Princeton University).

    *2002“The Two Monetary Approaches to the Balance of Payments: Keynesian and Johnsonian,”The Open Economy Macromodel: Past Present and Futureed. byAronArie and WarrenYoung (Dordrecht: Kluwer Academic Publishers) pp. 1931.

    2003An International Economic System (London: Routledge); reprint of the 1954 edition.

    *2004a withPeter B.Clark“International Liquidity and the Role of the SDR in the International Monetary System,”IMF Staff PapersVol. 51No. 1 pp. 4771.

    2004b withPeter B.Clark“A New Perspective on SDR Allocations: To Provide A Major Reduction in the Cost of Holding Reserves,” inPublic Finance in a Globalizing World: Innovations in Theory and Practice (New York: United Nations Development Program) forthcoming.

This title effectively acknowledged Polak as one of the top two staff members in the IMF, alongside Joseph (later Sir Joseph) Gold and above the other 11 department heads. Gold, the Fund’s top lawyer, was given the title of General Counsel at the same time.

For a survey, see “Major Themes in the Writings of Jacques J. Polak,” by Jacob A. Frenkel, Morris Goldstein, and Mohsin S. Khan, in the Festschrift edited by Frenkel and Goldstein, cited in the annex to this introduction. The two previous collections, issued in 1979 and 1994, did not include eight books and monographs that Jacques Polak had written or edited. For a list, see Polak (1994a), Vol. 1, p. xxxi.

Papers that are subsequent to the Frenkel-Goldstein bibliography but omitted from the present volume are either short expository or topical pieces or those that overlap substantially with an included paper. For a complete list, see the annex.

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