Introduction
The International Monetary Fund was established to promote economic and financial cooperation among its member countries in order to facilitate the expansion and balanced growth of world trade. In fulfilling this broad mandate, the Fund has come to play a central role in the international monetary sphere.1 An essential aspect of this role is the provision of financial assistance to members facing potential or actual balance of payments difficulties. In this area, the Articles of Agreement of the institution include the general norms to be followed in making Fund resources available to members. Briefly, these norms are that the Fund should adopt policies on the use of its resources that assist members in overcoming their balance of payments problems in a manner consistent with the purposes of the institution and that provide adequate safeguards to ensure that the use of the resources by members is temporary.2
Drawing on the experience gathered from a long and close relationship with a varied and growing membership, the Fund has developed a pragmatic and flexible body of policies and procedures—known by the term conditionality—to govern the use of its resources in a manner that will fulfill the prescriptions of the Articles of Agreement. These policies and procedures have always been aimed at supporting members’ adjustment efforts by encouraging the adoption of economic policy measures compatible with the particular member’s interests as well as with those of the Fund membership as a whole.
The principle of conditionality applies under most circumstances, but its practical implementation must take into account changes in the world economic environment. The need for an evolution of the practices of conditionality has long been recognized, and their implementation has been increasingly discussed in the past decade—a period in which the situation of the world economy was generally characterized by large payments imbalances, historically high inflation rates, and faltering growth rates, particularly in industrial countries. The purpose of this paper is to examine the principle and the practices of conditionality as they have evolved and as they are currently applied. The paper first discusses the rationale of the concept of conditionality and brings out its theoretical underpinnings as well as its economic policy implications. The paper then traces the practices for conditionality’s implementation that have been developed in the Fund over more than three decades to assist members in adjusting to an increasingly difficult and complex environment. The paper also discusses a series of issues that have arisen in the context of the application of conditionality and their implications for choice of policy instruments, setting of policy objectives, and interpretation of results. The paper concludes with a few remarks about the relationship between the Fund’s financial assistance (and the adjustment efforts it supports) and capital flows from other sources.
Principle of Conditionality
Rationale
From the Fund’s earliest days, conditionality, the key determinant of members’ access to the institution’s financial assistance, has been a controversial issue and, as such, has been closely scrutinized both inside and outside the Fund. Controversy has stemmed from the recognition that design and adaptation of policies on the use of Fund resources encompass many complex issues and involve important elements of judgment on which consensus is not always easy to attain. However, except for a brief period after the Fund came into existence, Fund members have agreed that the Fund’s financial assistance should be conditional on the adoption of adjustment policies.
In any examination of the rationale of the concept of conditionality, a key feature of the international adjustment process needs to be underscored, which is that external payments imbalances have to be corrected whenever they are not transitory or reversible. Under most circumstances, adjustment will take place whether or not there is policy action, in the sense that claims on resources will eventually have to be limited to those available. The issue at stake, therefore, is not whether adjustment will be carried out—because it will be—but whether it will be carried out efficiently—that is, without involving unwarranted welfare losses. Conditionality is a means of ensuring that the international adjustment process operates efficiently and thus benefits the Fund’s entire membership.3 In linking adjustment to the provision of financial resources, the Fund seeks to help members to attain, over the medium term, a viable payments position in a context of reasonable price and exchange rate stability, a sustainable level and growth rate of economic activity, and a liberal system of multilateral payments. For developing countries, a viable balance of payments typically means a current account deficit that can be financed, on a sustainable basis, by net capital inflows on terms that are compatible with the development and growth prospects of the country and, therefore, with its debt-carrying capacity. The provision of resources by the Fund extends the period of adjustment and thereby makes the process less severe than it would otherwise be.
The strategies used to finance and to adjust external imbalances are closely interwoven and form the core of the Fund’s policies on conditionality, which seek to strike an appropriate balance between the two. It is frequently argued that adjustment and financing are alternative strategies. This can be true only in the abstract sense that adjustment would not be necessary if financing were available indefinitely and, conversely, that adjustment would have to be immediate in the absence of financing. Both of these extremes hardly ever occur; in most practical instances, adjustment and financing are joint and mutually supporting strategies.
There are two principles that the Fund seeks to uphold in all programs that involve the use of conditional resources: uniformity of treatment among members and flexibility of treatment that takes into account the institutional characteristics and the particular circumstances of different countries. It is, therefore, necessary to strike a delicate balance between uniformity and flexibility of treatment; the principle of uniformity cannot be applied rigidly—that is, regardless of individual country circumstances—nor can individual circumstances be given such weight that uniform treatment loses all meaning. A common feature of the situations that involve programs supported by Fund resources is the existence of an adjustment need, and conditionality ensures that an appropriate adjustment effort is undertaken to meet this need. In general terms, uniformity of treatment requires that for any given degree of need, the effort of economic adjustment sought by the Fund in programs be broadly equivalent among its members.
Theory and Policy Implications
Balance of payments problems may be due to a variety of factors that are often distinguished according to whether they are external or internal and to whether they are transient or enduring. While the particular strategies of adjustment may vary depending on whether the payments difficulties are due to developments inside a country’s economy or to developments in the rest of the world, the fundamental question of whether adjustment is actually required hinges more on the assessment of the permanent or temporary character of the disturbance. Deficits stemming from adverse transitory (external or internal) factors typically call for temporary resort to financing. Mechanisms have been devised in the Fund and elsewhere to cope with situations of this sort—the Fund’s compensatory financing and buffer stock facilities and the European Community’s STABEX Fund are examples of such mechanisms.4 However, if the imbalances (whether of external or internal origin) are due to permanent factors, appropriate measures of adjustment must be taken to remove them.
The conditionality associated with the use of Fund resources requires the member to undertake a program to adjust its balance of payments. This requirement is designed to ensure that the Fund’s financial assistance supports the implementation of economic policies that give a substantial assurance that a viable payments position will be attained within a reasonable period of time; in most instances, this involves restoring a sustainable balance between the aggregate demand for, and the aggregate supply of, resources in an economy. The policies required to bring about this result depend, of course, on the nature and size of the existing and prospective balance of payments deficits. In turn, the particular policy instruments to be used are chosen in the light of the institutional setting and organization of the economy as well as of the economic and social priorities of the country.
Domestic Financial Policies5
Imbalances in an economy are usually reflected in the prevalence of inflation and balance of payments deficits, which are often associated with relatively high levels of economic activity but that soon lead to low rates of employment and growth. These imbalances can be due to a variety of factors, but one common element that generally characterizes them is an excessive or unsustainable expansion in aggregate demand. In most instances, variations in aggregate demand and expenditure, associated—as they often are—with a relatively stable aggregate supply function, are the major causes of short-run fluctuations in output, prices, and the balance of payments. These broad considerations are behind the demand management approach to stabilization policy, which is designed to monitor the performance of the economy over the short term in order to keep the level and the growth rate of aggregate demand in line with the level and the growth rate of productive capacity.6
Fiscal imbalances stemming from expenditure levels that exceed the public sector’s revenue-raising capacity are often the proximate causes of the unsustainable expansion in aggregate demand and the consequent weakness in the balance of payments. Correction of such imbalances normally entails the adoption of direct measures to restrain fiscal spending or to raise fiscal revenues in order to limit the size of the resulting public sector deficit to the amount of noninflationary financing available. This line of reasoning underscores the importance of consistency between fiscal (e.g., spending and revenue measures) and monetary (e.g., developments in bank credit and money flows) policies for the attainment of a sustainable pace of aggregate demand and, ceteris paribus, of a viable balance of payments position.
The relationship between aggregate demand and fiscal and monetary variables has been treated extensively in the literature.7 A well-recognized problem in the discussion of the relative role of fiscal and monetary measures has been the difficulty of distinguishing among them unambiguously, because most of the time both types of measures are at work together. This is because actions undertaken to influence public sector spending or revenues have a direct impact on the public sector borrowing requirement, in general, and on the public sector’s need for domestic bank financing, in particular. Because of the link between monetary flows, public sector spending, and aggregate demand, domestic monetary policy became a key element in demand management and stabilization policies. For a relatively long period, however, propositions of monetary theory were derived from analytical models based on the assumption of a closed economy and served to establish relationships between the rate of monetary expansion and the evolution of nominal income in broad terms and, more specifically, of the inflation rate. In this approach, the linkages between monetary variables and the balance of payments via the interplay of conditions in the money market were generally overlooked.8 As a result, the policy conclusions that were derived from this analytical framework ignored the existence of international transactions, but nevertheless they found their way into the analysis of open economies.
This procedure may be valid when the open economy operates under a completely flexible exchange rate, thus precluding the emergence of balance of payments surpluses or deficits and severing the link between the domestic money supply and international transactions.9 From the standpoint of policy, it may also be justified in economies that are nearly self-sufficient where the balance of payments imposes virtually no constraint on the implementation of domestic economic policies. However, from a theoretical perspective, economic policy designed for open economies seeking to attain the internal objective of a measure of price stability at full employment and the external objective of a viable balance of payments position (or, alternatively, of a realistic and stable exchange rate) has to be based on an analysis that takes explicit account of the role of international transactions. Recently, monetary theory has moved in this direction by focusing on the interdependence between the money supply and the balance of payments. This development has not involved essential modifications of the basic propositions of traditional monetary theory, but it has brought out the constraints that open economies face in the design of monetary policy in terms of its conduct and scope.10
For purposes of economic policymaking, the general argument for the effectiveness of monetary policy is based on the proposition that there is a stable demand for money. In the context of traditional (e.g., closed economy) monetary theory, this proposition led to the policy guideline that the path of the supply of money should be kept in line with that of the demand for money. This policy guideline implies that the money supply is within the control of the monetary authorities, which is not the case in an open economy. In such an economy with a fixed (or not totally flexible) exchange rate, the nominal quantity of money can be changed through international transactions—that is, through balance of payments surpluses or deficits. These surpluses or deficits can be seen as equivalent to imports or exports of domestic currency, so that any disparity created internally between the demand for, and the supply of, money can be eliminated by the balance of payments.11 In this environment, the monetary authorities have no direct control over the total quantity of money but only over the part that is supplied internally through domestic credit expansion, particularly by the central bank. When the exchange rate is perfectly flexible (or, equivalently, in a closed economy), an argument can be made that the quantity of money is under the control of the monetary authorities; but the practical importance of this argument is limited, because the money supply continues to be endogenous (that is, subject to influences from the rest of the economy and from abroad) as long as the authorities are concerned about the impact of their policies on the stability of the price level and the exchange rate.
This line of reasoning makes it clear that monetary policy in any open economy needs to be formulated in terms of domestic credit expansion (the internal supply of money) to attain overall financial balance.12 When the exchange rate is fixed, domestic credit policy is necessary to make the public’s demand for money compatible with the authorities’ demand for international reserves. When the exchange rate is flexible, domestic credit policy is necessary to satisfy the public’s demand for money and the authorities’ exchange rate and price level stability objectives. These theoretical propositions on the importance and role of domestic credit for purposes of macroeconomic and external payments balance provide the basis for the formulation of monetary policy in terms of domestic credit expansion either by the central bank or by the banking system as a whole, depending on the structure of the financial sector in the economy in question. These domestic credit policy guidelines have become a uniform characteristic of financial arrangements with the Fund.
External Debt Management13
The design of domestic monetary policy, therefore, needs to take into consideration the importance of the interplay between domestic credit expansion and a money demand forecast for the determination of the overall balance of payments. While the concept of the overall balance of payments is important for economic policymaking, particularly in the short run, it also has to be recognized that the overall balance addresses only one dimension of the concept of external balance—that is, the level and movements of net international reserves. Over a longer period of time, however, economic policy should also focus on the composition or the structure of the balance of payments—that is, on its current and capital account components.14
The link between the overall balance of payments and international reserve management is a particular instance of a more general relationship that can be established between the current account of the balance of payments and the management of external debt in its broadest sense.15 It is important to examine both the general and particular aspects of this relationship when one is assessing consistency among policy measures. For example, domestic credit policy will not generally be sufficient to attain a desired balance of payments objective—in terms of both its overall level and its composition—if it is formulated without regard to potential foreign borrowing. Under most circumstances, domestic credit and foreign credit are substitutes, so that domestic credit policy needs to be complemented and supported by foreign borrowing guidelines to ensure that the flow of total (i.e., domestic and foreign) financial resources available to the economy is compatible with the objectives sought not only for the balance of payments but also for the rates of economic growth and inflation. In principle, given an economy’s productive and absorptive capacity, there is a level of aggregate demand that is consistent with a desired path for those three target variables; in other words, the attainment of objectives with respect to the balance of payments, growth, and price performance requires that the flow of total financial resources be in broad alignment with such a level of aggregate demand. Thus, macroeconomic policy programming involves some broad specification of the link between a desired aggregate demand-supply relationship, on the one hand, and the total financial resources available to the economy, on the other.
These arguments show the need for consistency between external debt management and domestic financial policies and bring to the surface their close relationship with international reserve management. Like domestic credit expansion, foreign borrowing also has important effects on the overall balance of payments and, consequently, on the money market;16 that is, over the short run, the relationship between domestic credit expansion and a forecast money demand path can result in different balance of payments results, particularly with respect to the current account, depending whether or not foreign borrowing takes place. In general, when imbalances are present in an economy, foreign borrowing provides an alternative to the use of international reserves for their financing. From this standpoint, both external debt and international reserve policies are important aspects of an economy’s overall portfolio management strategy.
The argument made so far emphasizes the relationship between foreign borrowing and demand management policies by pointing to the substitutability between foreign and domestic financing. However, the argument has to be taken one step further to bring out perhaps the most important of its ramifications. Domestic borrowing is a means of transferring resources from surplus to deficit sectors within an economy. In the absence of foreign borrowing and given a country’s resource endowment, output and growth depend on its propensity to save and the efficiency of its investment. The possibility of borrowing abroad adds to the resources available to the economy. Thus, although all macroeconomic policies can influence supply by their impact on the efficiency of resource allocation, foreign borrowing, in addition, acts directly on the global availability of those resources and thereby allows the economy to attain higher expenditure levels by providing in certain circumstances for higher growth rates than would otherwise prevail. Viewed from this perspective, a medium-term framework is clearly required for the formulation of macroeconomic policies in general and external debt management policies in particular, thus linking, via the current account of the balance of payments, demand management with the saving-investment process and the longer-run evolution of the economy. This linkage makes clear the reasons for the concern, in programs supported by Fund resources, with the attainment of a sustainable balance of payments position, which is equivalent to concern with the attainment of an appropriate relationship between savings and investment to ensure the realization of the economy’s growth potential.
Role of Price Incentives
In economic policymaking, the attainment and maintenance of appropriate price incentives have some of the characteristics of policy objectives and of policy instruments, and they frequently constitute one of the most controversial subjects in the process of policy formulation. The difficulties that arise in the design and implementation of measures that affect key variables— like the exchange rate, interest rates, or prices of goods and services of special importance to the economy—reflect the critical role these variables play in the allocation of resources. The effects of such measures are pervasive and not always popular in all sectors of the economy.
Arguments are frequently made against the desirability of relying on price incentives as a guide for resource allocation on two interrelated counts—price incentives place undue emphasis on the market system in general, and on private enterprise in particular. However, as long as the economic decisionmaking process needs to be based on the principle and the accurate measurement of the opportunity cost of scarce resources, prices are relevant for all economies (regardless of their particular lines of organization) and for all decision makers (whether in the private or the public sectors).
Exchange rate.—
Imbalances between aggregate demand and supply are frequently brought about by the pursuit of macroeconomic policies that are not compatible with the economy’s capacity to produce. If financing is available for imbalances, it is not uncommon to see them last for protracted periods, thus causing the patterns and movements of domestic prices and costs to diverge substantially from those prevailing abroad. The competitiveness of the economy is thereby eroded, and the efficiency of resource allocation is impaired by the creation of distortions in the structure of relative prices. At this stage, the typical situation is characterized by the prevalence of high inflation rates (at times combined with ad hoc attempts to repress price increases), faltering growth and employment rates, excessive recourse to foreign borrowing, losses in international reserves, and very often resort to restrictions on international transactions.
One of the options usually considered in these circumstances in the process of designing a set of corrective measures involves an adjustment in the exchange rate. Experience has shown that an exchange rate change is not only highly visible but also is often strenuously resisted. At times, resistance is rationalized by arguing that, from a theoretical standpoint, an imbalance created by unduly expansionary financial policies could, in principle, be redressed by a package of sufficiently strict domestic policy measures. In the abstract, such an argument is indeed correct. However, the cost of correcting an imbalance in this manner is also important and has to be considered. This is an empirical question for which a priori answers are not easy to provide, but there is an important theoretical proposition to keep in mind in this context, which is that there is no lasting trade-off between a devaluation and restrictive domestic financial policies. The trade-off is between the exchange rate adjustment and the degree of restrictiveness of domestic policies.17 Other things equal, the correction of a given imbalance is likely to require a less strict domestic policy stance when a currency devaluation is part of the strategy than when it is not. This being the case, an important factor in the choice of a policy strategy will clearly be the size of the imbalance. This is because as the size of the imbalance increases, it becomes increasingly difficult (and possibly costly) to avoid resorting to an exchange rate adjustment.
When domestic prices and costs (or their rates of increase) are rigid in the downward direction, a strategy that relies exclusively on demand management measures is likely to be unnecessarily costly in terms of employment and output. Such a strategy entails the use of domestic financial policies to bring about a decline in domestic prices and costs (or in their rates of increase) to restore them to a balanced relationship with foreign prices and costs. Given the downward rigidity of prices and costs, however, domestic employment and output will have to bear the brunt of the adjustment, an outcome that is likely to be more pronounced, the larger the decline needed in the level (or the rate of increase) of domestic prices and costs. The alternative is to accompany the demand management measures with an adjustment in the exchange rate; this amounts to restoring equilibrium to relative prices by raising the domestic currency price of internationally traded goods rather than by lowering the price of domestic goods—a strategy likely to require a less pronounced adjustment in output and employment.18
The usefulness of a devaluation lies in its broad and pervasive effects on the economy. In the first place, by raising the price of international goods relative to the price of domestic goods, the exchange rate adjustment shifts demand from the former to the latter (expenditure-switching effect). At the same time, by reducing the real value of nominal assets—thereby creating an excess in the demand for these assets—the devaluation lowers the level or the growth rate of aggregate demand for goods and services (expenditure-reducing effect) and shifts the flow of spending toward the restoration of balance in the market for nominal assets. This effect, by reinforcing their impact, renders demand management measures less strict than they would otherwise have to be.19 In general, when imbalances have been allowed to prevail for long periods of time, an exchange rate adjustment is likely to be an important, if not a critical, ingredient of a corrective policy strategy. This is because the exchange rate is not only an instrument that is used to balance the external accounts and to monitor domestic absorption but is also a key variable for the allocation of resources between the domestic and the external sectors.
Interest rates and prices.—
The majority of the points made on the role of the exchange rate apply also to interest rates and to prices of important goods and services in the economy. This is particularly the case with the idea that realistic interest rates and prices should be part and parcel of a well-conceived economic policy program, be it as objectives or as instruments, depending inter alia on the size of the prevailing imbalance.
Interest rates are important for the attainment of balance of payments viability. In general, this external objective calls for the prevalence of domestic interest rates that are internationally competitive in order to retain domestically generated savings and to encourage capital inflows. Normally, it can be expected that internationally competitive interest rates will also stimulate the mobilization of domestic savings—that is, they will result in positive domestic real interest rates. But this is by no means assured at all times. In this context, it is important to note that internationally competitive domestic interest rates are of immediate relevance to the balance of payments. Positive real interest rates, in turn, influence the domestic saving-investment process and thereby the current account of the balance of payments and the longer-term external position of the economy.
As with the exchange and interest rates, variations in the prices of key goods and services have significant financial, allocative, and distributive effects in the economy. Their importance cannot be overstressed, particularly because examples abound where such prices are kept unrealistically low (usually for purposes other than the achievement of economic efficiency), with the result that the allocation of resources is distorted, the financial position of the government is weakened, and the balance of payments performance is impaired. As in other economic policy areas, in pricing, in the broadest sense of the term, when an imbalance needs to be corrected, the choice, if any, is between adjustment now and more costly adjustment later.
Period of Bretton Woods Agreement
The conditionality practices that have evolved over more than three decades of Fund experience were developed in the context of a changing international economic environment and varying international arrangements. Those formulated during the 1950s and 1960s were devised in a world of relative economic stability, where growth was fairly stable and inflation in most of the industrial countries was low by current standards. Also during this period, substantial progress was made toward the liberalization of international trade and payments and toward currency convertibility under the par value system agreed upon at Bretton Woods. These factors contributed to the smooth functioning of the process of international payments adjustment.
Soon after its establishment in December 1945, the Fund strove to devise a body of practices and procedures to guide the use of its resources. At first, there was uncertainty as to what these practices should consist of, but the principle of conditionality itself was incorporated in the Fund’s lending policies as early as 1952.20 By that time, a broad consensus had emerged that the Fund’s attitude toward a member country’s request for financial assistance would be guided primarily by its judgment on whether the member’s policies were adequate to cope with its balance of payments problem and would enable it to repay the Fund within three to five years from the date the resources were received.
Stand-By Arrangements
The Fund developed the stand-by arrangement as the main instrument through which it would make financial resources available to members on a conditional basis. The stand-by arrangement can be described as a line of credit outlining the circumstances under which a member can make drawings on the Fund.21 In the early days, the arrangement was conceived as a precautionary device to assure access to members that had no immediate need for Fund resources but felt they might need such financing in the near future. It soon became evident, however, that the stand-by arrangement was also particularly well suited for channeling the Fund’s conditional resources to countries with urgent needs for balance of payments financing.22
The development of stand-by arrangements, which link a member’s use of Fund resources to its adoption of a program of action, reflected the realization that the Fund’s financial assistance would be most effective if the member country adopted policies designed to correct its external imbalance. The policy programs did not normally extend beyond a year, a period short enough to permit an economic forecast to be made but long enough to permit results of the policy measures to be assessed and judgment to be made as to whether additional measures or modifications of existing measures were warranted. Of course, this did not mean that adjustment was expected to be completed within such a limited time, regardless of the particular country circumstances. In fact, members often entered into consecutive stand-by arrangements with the Fund—a strategy that provided them with continued financial support until the imbalances were redressed.
Economic Policy Programs
With experience, it became clear that to be an effective instrument of action, a program had to be as specific and precise as possible. In particular, the main policy targets and instruments susceptible to relatively accurate measurement came to be stated in the financial programs in explicit quantitative terms. These quantified targets became the guideposts for assessing whether programs were being implemented satisfactorily and their objectives were being attained. For the reasons elaborated in the previous section, the indicators most frequently used related to the expansion of domestic credit by the central bank or the banking system; the reliance of the government or the public sector on domestic bank credit, as well as on short-term and medium-term foreign borrowing; and the management of net international reserves. A qualitative condition common to all stand-by arrangements was the avoidance of reliance on the introduction or intensification of exchange restrictions as a means of coping with balance of payments problems.
The quantitative formulation of policy programs was accompanied by two developments that became common features of stand-by arrangements.23 The first related to the way Fund resources were made available. Because programs were undertaken over a period, access to Fund resources came to be phased over that period to facilitate the implementation of policies as well as to prevent too rapid use of the drawings. The particular profile of phasing reflected the member’s specific circumstances and the speed of the expected balance of payments adjustment. Thus, the total amount of assistance came to be disbursed at specified intervals in installments that were linked to the periodic quantified targets.
The second development was the inclusion in stand-by arrangements of provisions—referred to as performance criteria—that had to be observed to ensure continued access to Fund resources. The rationale for these operational features of stand-by arrangements was that failure to observe the performance criteria served as a signal that the member’s program should be reviewed. Depending on the assessment of the causes of deviations, and the extent to which they could be remedied, the restoration of the member’s right to obtain resources from the Fund involved either amending existing performance criteria or reaching new understandings on the policies to be pursued or the measures to be taken over the remainder of the program period.24 In practice, the resumption of a member’s right to draw under an arrangement would be based on the following considerations: the granting of a waiver permitting the nonobservance of performance criteria (particularly when deviation was small); a modification of the criteria (when events beyond policy control made attainment of the criteria infeasible); and the replacement of an old arrangement with a new one (when modifications appeared inappropriate).
First Review of Conditionality
The conditionality practices developed during the 1950s and the early and middle 1960s were reviewed by the Fund’s Executive Board in 1968. The review encompassed all aspects of these practices and concluded with a decision that essentially summarized the major elements of the prevailing policies.25 The decision stressed the importance of providing adequate safeguards to preserve the revolving character of the Fund’s resources and the need to allow for flexible, and yet uniform, treatment of all members. It also recognized the usefulness of phasing and performance criteria.
Subsequently, the Executive Board reviewed periodically the experience with particular performance criteria, such as those involving credit ceilings, foreign borrowing limitations, and balance of payments tests; these reviews and the resulting Board decisions helped to define further the Fund’s policies on conditionality. In this manner, the policies that the Fund had developed on the use of its resources were broadly formalized in Executive Board decisions, which then served as a guide to the actual implementation of conditionality.
Uncertain Environment of the 1970s
By the time the policies on the use of Fund resources were being consolidated, pressures had begun to mount on the international economy and on the Bretton Woods system.26 A succession of crises in foreign exchange markets during the late 1960s had cast growing doubts on the continued viability of the par value system. By 1971 the fixed exchange rate regime had ceased to be operative, and by early 1973 it had been abandoned by the major industrial countries. For many of these countries, an international monetary system based on flexible exchange rate arrangements came into effect. While these developments were taking place, the world economy experienced a series of disturbances related to unprecedented rises in world prices of energy and other primary commodities. These increases exacerbated existing inflationary pressures and eventually led to a severe recession in the industrial world, which also had particularly adverse consequences for the developing countries.
It became evident in the early 1970s that changes in the international economic environment would require a modification of the Fund’s conditionality practices. Relatively large increases and marked shifts in external payments imbalances called for a blend of adjustment and financing different from that formerly incorporated in stand-by arrangements. A reconsideration of the size and length of arrangements was also in order. Priority had to be given to prompt financing of imbalances to deal with the magnitude, suddenness, and intractability of the deficits. To meet this need, the Fund initially established temporary financing arrangements to provide members with resources of low conditionality. These initiatives were accompanied by other changes in the Fund’s lending practices, including the provision of adequate assistance to members experiencing balance of payments difficulties of a structural, more permanent character.
Resources with Low Conditionality
A first priority was to make resources available subject to relatively low conditionality in order to help members avoid introducing policies that would aggravate the recession in the international economy. Consequently, in 1974 the Fund established, on a temporary basis, an oil facility to help members finance payments deficits related to oil import price increases.27 The conditionality attached to drawings under this facility was minimal; besides the existence of a balance of payments need, it consisted of only two qualitative requirements; members were to consult with the Fund on their balance of payments policies and prospects, including the policies aimed at coping with the energy problem; and, in dealing with their difficulties, members were to avoid enacting restrictions on international transactions.
The financing from the 1974 oil facility provided a brief respite that enabled members and the Fund to assess the persistence and intractability of the imbalances and to gauge the extent of the adjustment needs. In April 1975, the Executive Board decided to extend the oil facility for another year.28 By then, it was evident that the sharp changes in the terms of trade that had taken place after the 1973–74 energy price rise would not be fully reversible. The decision on the 1975 facility, therefore, recognized that new financing would need to be accompanied by specific adjustment measures, and, as a result, the limited conditionality that had been attached to the use of resources under the 1974 facility was moderately tightened. In addition to the qualitative commitments undertaken under the 1974 facility, members in balance of payments need were required to provide a quantitative description of the policies they intended to pursue in order to achieve a medium-term solution to their balance of payments problems, and the adequacy of those policies was assessed by the Fund. The policy statement also had to contain a description of the particular measures members had taken or proposed to take in order to conserve petroleum or to develop alternative sources of energy. Generally speaking, while the policy measures were expressed in quantitative terms, they were not made subject to performance criteria, and drawings from the facility were neither linked to performance under the policy program nor phased. Thus, although the conditionality attached to the resources made available under the 1975 oil facility was greater than that prevailing under its predecessor, it still fell short of the standards applied under stand-by arrangements in the upper credit tranches.29
Steps were also taken to alleviate certain members’ difficulties posed by disturbances to the world economy. Thus, the Trust Fund was established, on a temporary basis, in 1976 for the benefit of low-income developing countries. The Trust Fund—which is legally separate from, but administered by, the International Monetary Fund—had resources that came from profits from the sale of gold owned by the International Monetary Fund. These resources were used to provide loans on highly concessional terms to eligible developing countries.30 Assistance was available to a member when the Fund was satisfied that it had a balance of payments problem and was making a reasonable effort to improve its payments position. The conditionality attached to Trust Fund loans was equivalent to that associated with assistance provided in the first credit tranche and under the 1975 oil facility. The loans were available to eligible developing country members that had entered into stand-by or extended arrangements with the Fund, which, of course, were subject to higher conditionality standards.31
Long-Term Conditional Resources
At the time the first oil facility was established, another major initiative was undertaken that focused on the duration of the adjustment process. The payments imbalances facing many members in the early 1970s required adjustment over longer periods than were provided for under stand-by arrangements at that time and, therefore, required larger amounts of assistance than could be made available under such arrangements. Consequently, in 1974 the Fund established an extended facility to provide medium-term assistance to countries experiencing particularly severe balance of payments problems.32
The extended facility was designed to alleviate two main categories of payments problems: (1) severe payments imbalances owing to structural maladjustments in production and trade, where cost and price distortions are widespread and long-standing; and (2) imbalances owing to a combination of slow growth and an inherently weak balance of payments position that constrains the country’s pursuit of active development policies. Arrangements under the extended facility cover periods of up to three years and assure a member of the availability of assistance equivalent to as much as 140 per cent of its quota. Repayment of extended facility drawings was to be made within four to eight years from the date of the drawings; this range has since been widened to four to ten years.
The standards of conditionality attached to drawings under the extended facility were similar to those applicable under stand-by arrangements covering the upper credit tranches. The difference between the two kinds of arrangements was not so much in the degree of conditionality as in the stronger assurance the member gave under the extended arrangements that appropriate adjustment policies not only would be adopted but also would be sustained over the medium term. Assistance under the extended facility was granted to support comprehensive economic programs designed to restore a sustainable financial balance to the economy. These programs included policies of the scope and character required to correct structural imbalances in production, trade, and prices. Particular attention was paid to policy measures intended to mobilize domestic and foreign resources, to improve their utilization, and to reduce reliance on restrictions on international transactions.
Requests from a member for extended arrangements were accommodated when the solution to its balance of payments problem clearly required a relatively long period and the intended policies were appropriate to cope with the problem. Under extended arrangements, members presented a comprehensive quantitative program covering the whole period of the arrangement. Within this medium-term framework, there was a detailed statement of objectives to be pursued and measures to be adopted for the first 12 months. There was also an understanding that for each following 12-month period, the member would present to the Fund a detailed assessment of the progress made under the arrangement and a statement of the measures to be used to further adjustment during subsequent stages of the program. As with stand-by arrangements, the quantitative targets constituted performance criteria that became provisions in the extended arrangement and determined the circumstances in which the member could make the phased drawings over the period of the arrangement.33
Need for Additional Resources
All these steps were aimed at adapting the mix of adjustment and financing in national stabilization programs to the circumstances of the 1970s, but they did not seem to be sufficient. External payments imbalances besetting the international economy were so large and persistent that the foreseeable demand for Fund resources would continue to be substantial, particularly after the lapse of the oil facilities in 1976. There were grounds for believing that given the size and number of prospective imbalances, a further expansion in the Fund’s provision of conditional finance would foster orderly payments adjustment and help promote the sound expansion of the world economy in the context of a relatively stable international financial system.
In 1977, the Executive Board decided to establish a temporary supplementary financing facility to provide additional assistance to countries facing external payments imbalances that were large in relation to their quotas.34 It was unlikely that such imbalances could be redressed in a short period; consequently, it was envisaged that stand-by arrangements involving supplementary resources would be extended beyond one year, up to a maximum of three years (the same as for extended arrangements). The facility was funded by borrowings from members in strong payments positions. The assistance made available under the facility was supplementary to the general resources that the Fund channeled to members under stand-by or extended arrangements and was subject to the same standards of conditionality. Broadly speaking, it doubled the amount of assistance that members could obtain under stand-by arrangements and extended arrangements, from 100 and 140 per cent of quota to approximately 200 and 280 per cent of quota, respectively. The facility provided for cases where even these large amounts would not be sufficient; a “special circumstances clause” allowing for even larger assistance was included in the Executive Board decision.35
Second Review of Conditionality
During the 1970s, the Fund’s policies on the use of its resources were modified both to increase the amounts of assistance available to members through a variety of facilities (themselves subject to different degrees of conditionality) and to allow for a gradual implementation of members’ adjustment programs. Toward the end of the decade, the Executive Board agreed that another comprehensive review of the practices of conditionality was warranted. The review commenced in 1978 and was concluded on March 2, 1979, with the adoption of a decision containing a set of new guidelines on the use of Fund resources.36 The new guidelines included many of the conclusions reached at the first review, which had been conducted in 1968. However, they also reflected a number of other, far-reaching considerations.
Countries frequently hesitate to undertake early adjustments and delay the adoption of corrective measures until balance of payments difficulties have become severe and stringent measures are needed to correct them. The guidelines encourage members to come to the Fund at an early stage of their payments problems. They also recognize that the adjustment programs sometimes cannot be completed in a short time and consequently provide for stand-by arrangements of up to three years in cases where imbalances are structural and particularly intractable; the guidelines thus confirm the practice that had already been introduced with the extended facility and that had also been allowed for stand-by arrangements in the supplementary financing facility decision.
Adjustment programs typically include measures that affect key and sensitive economic policy areas—fiscal, credit, incomes, foreign borrowing, and exchange rate policies as well as trade and payments restrictions. The guidelines made clear that, in helping members to design adjustment programs, the Fund will pay due regard to their social, political, and economic priorities and objectives as well as to their particular circumstances. In line with these purposes, the performance criteria included in arrangements supported by Fund resources are normally limited to those necessary to evaluate the implementation of the program. Generally, they are confined to macroeconomic variables and relate to other variables only when the latter “are essential for the effectiveness of the member’s program because of their macroeconomic impact.37
Approval of a member’s request for Fund assistance is recommended to the Executive Board when it is consistent with the Fund’s policies and when there is a reasonable assurance that the program of policy action will be carried out. The new guidelines recognize that, in certain circumstances, this may require the prior adoption of certain measures that are critical for the program’s successful implementation. There also are cases in which the economic situation of the member makes it especially difficult to establish in advance performance criteria for an extended period. In these instances, the guidelines provide for a review clause, so that the Fund can evaluate the member’s current macroeconomic policies and, if necessary, reach new understandings with the member.
Other important points stressed in the guidelines include the need to ensure broad coordination in the implementation of policies to assure the nondiscriminatory treatment of members and the need to review and adapt conditionality to changing circumstances. The guidelines also emphasize the assessment of individual country programs as they unfold in order to gauge their appropriateness. Global studies of arrangements with the Fund are to be conducted in order to evaluate the effectiveness of the national programs, the adequacy of the policy instruments, and the results achieved. These studies serve as a basis for further periodic and comprehensive reviews of conditionality by the Executive Board.
Opening of the 1980s
As the 1970s came to a close, the international economy was subjected to severe pressures associated with a new round of sharp increases in world energy prices. Many countries were still experiencing difficulties resulting from an incomplete adjustment to, and recovery from, the troubles of the early and mid-1970s. As a consequence, the world economic situation was characterized by a number of disturbing features.38 In many countries, inflation continued at historically high rates and showed no signs of slackening. Rates of economic growth were declining, particularly in the industrial countries, a trend that threatened to jeopardize the necessary expansion in world trade and to steer the world economy toward another recession. At the same time, the current account surpluses and deficits in the balances of payments of major groups of countries increased and underwent sudden shifts. These developments placed great strains on world payments and gave rise to wide spread concern about how the unprecedented deficits, especially those of the oil importing developing countries, could be financed. These economic developments led the Fund to modify its conditionality practices further. One of the initiatives taken involves a renewed emphasis on policies to increase productivity and to improve resource allocation. Another involves the strengthening of collaboration with the World Bank, a requirement made increasingly important by an environment that calls for structural adjustments in many members’ economies.
Need for Structural Changes
The payments problems experienced by many member countries in the late 1970s and early 1980s led the Fund to conclude that the establishment of special facilities to provide resources subject to low conditionality (along the lines of the oil facilities of the 1970s) would not be appropriate. A more comprehensive approach was necessary, for two main reasons. First, for an important number of countries, payments difficulties had not only worsened but were superimposed on long-standing imbalances; and the situation required more decisive policy action than had been taken until then. Second, although the causes of the increasing deficits were for the most part external in origin, they were not likely to be transitory; a realistic assessment of the medium-term perspective called for timely and resolute adjustment efforts to cope with the adverse external environment.
A consensus developed that the Fund should be able to respond to the needs of members in particularly difficult circumstances. The supplementary financing facility, the resources of which had remained uncommitted in the first months of its operation, proved to be a particularly useful instrument for the provision of larger-than-normal commitments under stand-by and extended arrangements. Thus, as an interim step—under the “special circumstances” clause—commitments of supplementary resources could be made of up to the equivalent of 300 per cent of the member’s quota.39 An important aspect of this interim step was the decision to accommodate requests by members for Fund resources when the policy measures introduced gave substantial assurance that the necessary adjustment efforts would be carried out and, therefore, that viability would be restored to the balance of payments.
In the meantime, an examination of the wide range of issues pertaining to the Fund’s role in financing payments imbalances and in supporting adjustment policies was initiated. There was general agreement that the imbalances that currently existed were structural and therefore not amenable to correction over a short period of time. Adjustments to such disequilibria were likely to require extensive changes in members’ economies, in particular those of the oil importing countries, if the restoration of viability to their balances of payments was not to jeopardize their development and growth prospects over the medium-to-long term.
The characteristics of the economic environment made the necessary adjustments particularly difficult.40 Inflation and inflationary expectations had become entrenched in many countries; yet there was a danger that sustained anti-inflationary policies—which, by all accounts, were essential— might dampen growth rates further at a time when they already were below historical levels. These developments, in turn, could slow the growth in, or even reduce, the volume of world trade and thereby complicate the task of adjustment even further. These considerations led the Fund to move toward a relatively long time frame for the adjustment effort to allow for changes in the patterns of production and demand—changes that can only be effected gradually.
The ultimate aim of Fund financial assistance to members continues to be balance of payments viability in a context of reasonable price stability and sustained economic growth without resort to controls on trade and payments. These basic purposes have not been altered by the recent disturbances that have beset the international economy; only their attainment has become more challenging, if not more arduous. Consequently, the stance and the mix of policies supported by the Fund have become more complex.
The broad demand management policies usually included in programs supported by the Fund, particularly in the fiscal and credit areas, continue to be needed, perhaps even more than before, to hold aggregate domestic demand to a level consistent with the global availability of resources. Demand management policies provide an appropriate framework for development and growth, because financial stability encourages the mobilization of domestic savings and the efficiency of investment. But recent events have called for attention to be given to complementary measures aimed directly at bringing about an efficient utilization of resources to strengthen an economy’s productive base; consequently, the Fund has stressed policies to improve production incentives.
Supply Considerations
Strictly speaking, interest in supply is not a new development in the Fund. While the achievement of a sustainable level of aggregate demand and the consequent achievement of financial stability may have been the proximate objectives of Fund policies, the attainment of supply potential has always been the ultimate aim. The novelty is in the emphasis now openly found in the Fund and elsewhere on the effects that adjustment policies have on resource utilization and, therefore, on production. It is, of course, as difficult to distinguish between demand and supply measures as it is to determine which of the two blades of scissors does the cutting, to borrow Alfred Marshall’s classic analogy. Policy measures have an impact on both demand and supply; and for the distinction to be useful, the measures need to be cataloged according to where they have their greatest effect.
The relationship between demand and supply management is illustrated by several factors that normally constitute part of the design of a domestic stabilization program. In many instances, programs incorporate foreign borrowing strategies that directly increase the resources available to the member. As a result, higher levels of expenditure can be achieved, as well as higher growth rates over the medium term. In the formulation of an adjustment program, it is also common to include an important number of policy understandings that provide the basis on which the feasibility of the domestic financial policies is predicated. These understandings can be critical for the attainment of financial balance and sustainable growth rates. They normally include public sector policies on prices, taxes, and subsidies, which can contribute to the elimination of financial imbalances and the promotion of efficiency in public sector activities; interest rate policies, which foster the generation of domestic savings and improve intertemporal resource allocation; exchange rate policies, which not only help to control absorption and the external accounts but also constitute a powerful tool for development; and incomes policies, which keep claims on resources from overstepping their availability.
Actions in these policy areas are of direct interest to the Fund because they foster savings and investment—the basis for expanding supply potential and for sound development of an economy. Such measures elicit supply responses on two different levels: by ensuring appropriate pricing in the broadest sense, the flow of output from a given stock of resources is maximized; and by fostering the mobilization of savings and the efficiency of investment, the medium-to-long-term growth rate of output is enhanced.
Collaboration with the World Bank
Both the World Bank and the Fund share a concern over the economic and financial policies followed by member countries.41 Within this area of broad common interest, there is substantial scope to distinguish areas of primary responsibility for each institution. In general terms, it has long been agreed that the Fund is primarily responsible for balance of payments adjustment policies and the Bank for development programs and project evaluation. Over time, the two institutions have collaborated effectively in providing consistent policy advice to members while maintaining their distinct characters and separate functions.
The complementary roles of the Fund and the Bank have acquired increased importance in view of such recent developments as the sharp increase in energy costs, the greater emphasis on appropriate supply responses, and the greater need for productive investment flows. As the Fund has extended the time frame of its arrangements and enlarged the scale of its assistance, the Bank has undertaken a program of lending to countries with balance of payments difficulties that require structural changes; this kind of lending will be an important complement to Fund assistance.
These recent Fund-Bank initiatives have called for an important additional measure of coordination. The range of subjects on which coordination is required includes the structure and functioning of money and capital markets, the generation of domestic savings, the financial implications of development programs, and external debt management. In providing policy advice, the Fund continues to focus on macroeconomic and balance of payments adjustment policies, while the Bank concentrates on the quality and effectiveness of development plans and investment priorities. This division of responsibilities remains essential; nonetheless, there is increasingly close consultation between the two institutions as more members enter into adjustment programs supported by financial resources from both agencies.
Scale of Fund Assistance
The size and structural nature of the current account imbalances, on the one hand, and the emphasis on promoting supply responses, on the other, provided a basis for a consensus achieved by the Fund’s Executive Board early in 1980 on continuing to make resources available in substantially larger amounts, and for longer periods, than had been done before. Several interim steps were consequently taken to implement this policy.42 Until that time, limits on the resources provided to a member by the Fund had been based on a concept of total, cumulative use, but attention then shifted to a concept of annual use, albeit within a maximum global limit. A part of the Board’s consensus was that broad norms for the maximum use of Fund resources in terms of annual amounts should be adopted to support members’ adjustment efforts, the completion of which, in all likelihood, would in many cases take more than one year.
Soon after this consensus was reached, the Seventh General Review of Quotas was completed, raising most members’ quotas by 50 per cent. Guidelines on maximum commitments of Fund resources (excluding those under the compensatory financing and buffer stock facilities) in relation to these new quotas were adopted by the Fund’s Executive Board;43 in general, the guidelines provide for commitments of Fund resources of up to an average of 150 per cent of quota a year within a maximum of 450 per cent of quota over a three-year period. These guidelines, which will be subject to periodic reviews, were supplemented by a maximum limit on total cumulative access to Fund resources, net of scheduled repurchases or repayments, of 600 per cent of quota. Such a maximum absolute limit was necessary to take into account past use of Fund resources, so that members would be treated uniformly regardless of whether they had used Fund resources before the adoption of the new guidelines.
Flexibility was built into the guidelines to accommodate the circumstances of a particular member without impairing the principle of uniformity of treatment. Amounts in excess of the guidelines can be drawn in clearly exceptional cases—for example, when there is general recognition that a member’s quota is unusually low in relation to the size of its economy or when an exceptionally strong and wide-ranging adjustment program is undertaken involving, inter alia, the dismantling of controls and other restrictions that would require, at least in the initial stages, large financial support.44
Some Issues in the Context of Conditionality
Assessments of adjustment programs supported by Fund resources have been undertaken regularly at the Fund, both on a case-by-case basis and on a general level. The guidelines on conditionality adopted by the Executive Board in 1979 have called for periodic studies “to evaluate and compare the appropriateness of the programs, the effectiveness of the policy instruments, the observance of the programs, and the results achieved.”45 The purpose of these studies is to obtain insights from the varied experience with numerous financial arrangements in order to improve the methods and techniques of framing adjustment programs. Of necessity, the observations derived from these studies cut across a wide spectrum of countries that have diverse characteristics with respect to their institutional setting, level of development, and degree of openness to international trade. For this reason, inferences drawn from such a diversity of experience can only be of a general character.46
The issue of the length of the period covered by stand-by arrangements was discussed at the Fund as early as 1966, when two-year stand-by arrangements were first proposed. The proposal was not followed up at the time, partly because of the practice whereby many member countries entered into successive one-year stand-by arrangements for cumulative periods of several years. Since the mid-1970s, this practice has become less common, and an increasing number of financial arrangements have involved policy programs formulated to cover more than one year.
The adjustment period in extended and stand-by arrangements was lengthened in recognition of the prevalence of structural problems, slow growth rates, and large payments imbalances. The mid- and late 1970s witnessed, together with sharp terms-of-trade variations, the emergence of rigidities in many economies in an unfavorable world economic environment that tended to make adjustment more strenuous than in earlier periods. The issues that have arisen in this context are complex and interrelated; they concern, in particular, policy objectives, policy instruments, and their interrelationship; from many perspectives, they remain unresolved.
As discussed earlier, variables like the exchange rate, interest rates, and relative prices can be seen as policy objectives or as policy instruments. The perception of these variables as belonging to one or the other category depends on a number of factors, in particular, the time framework of the analysis, the size of the disequilibrium, and the required speed of adjustment. With respect to the time framework, developments in the exchange rate, interest rates, and prices at a particular point in time (abstracting from influences from the rest of the world) are the result of past economic policies; from this standpoint, future values of these variables do constitute valid objectives of current economic policies. With respect to the prevailing imbalance, a significant size typically indicates that it is of a long-standing nature and, therefore, that prices in general have become unrealistic; this usually means that exchange rate, interest rate, and other price adjustments have become well-nigh inevitable; this is particularly the case when, in addition, the disequilibrium has to be corrected rapidly; from this standpoint, these variables operate as policy instruments.
In this section, some of the general issues related to the adjustment process will be discussed; to facilitate the presentation, the issues will be organized in terms of the implications of the adjustment process for (1) policy objectives, (2) policy instruments, and (3) the interpretation of actual results.
Policy Objectives and Period of Adjustment
The tendency toward longer periods of adjustment essentially meant that economic policy programs, even if they were to be implemented on an annual basis, had to be formulated in the context of a medium-term horizon. Such a framework brought to the surface the various dimensions of the broad objective sought by programs supported by Fund resources—the restoration and maintenance of viability to the balance of payments in an environment of price stability and sustainable rates of economic growth.
Economic Activity and Growth
An economic environment characterized by uncertainty and the prevalence of large imbalances tends to hamper the ability or the willingness of countries to adjust rapidly. This may be because the perceived cost—in terms of output and employment—of correcting payments imbalances and controlling inflation has risen compared with what it was in more stable environments. To put it differently, it is not inconceivable that a deterioration has taken place in the trade-off that frequently exists, or is perceived, in the short run between balance of payments deficits and inflation rates, on the one hand, and levels of employment and growth rates, on the other.
Lengthening the adjustment period reduces the number of economic variables that can be considered exogenous for purposes of policy formulation. This is particularly the case with policy effects on the level of economic activity and the rate of real economic growth, which for short periods of time can be disregarded as either small or nonexistent.47 This assumption loses plausibility when the time frame is extended. The experience of countries undertaking an adjustment effort with respect to their growth rates is generally mixed. This raises the question of whether, in the process of adjustment, too much emphasis has been placed on demand management measures and whether the appropriate strategy would have been to supplement them with measures aimed directly at improving the allocation of resources and at stimulating the growth of productivity and aggregate supply.
This line of reasoning underscores the need to gain a better understanding of the relationship between growth and other economic policy objectives to minimize the cost of an adjustment effort that has to be made over a foreseeable period. Experience with processes of stabilization has been that growth rates in the short run may fall below their previous trends. This should not be surprising where expansionary policies were pursued to stimulate activity and the growth rate beyond sustainable levels because, logically, a reversal of those policies can be expected to have temporary effects that at first might be perceived as adverse. Available evidence indicates that there is little scope for avoiding outcomes of this sort; typically, unsustainable growth rates can be reached by decreasing international reserves or increasing foreign indebtedness, and neither of these methods can be resorted to indefinitely.
Rate of Inflation
Control of inflation and attainment of price stability are among the major objectives of an adjustment effort. Experience in this area indicates that the adoption and implementation of corrective policy measures generally succeed in stopping inflation from rising; outcomes with respect to a reduction in inflation, however, can be quite varied. This raises the issue of the appropriate way of setting an inflation target. In earlier periods, policies supported by Fund resources were aimed at bringing inflation to a level compatible with exchange rate stability; this basically meant setting an upper limit on the rate of inflation broadly equivalent to that prevailing abroad. In cases where the domestic inflation rate was so high that it could not be realistically expected that it would be brought down to international levels over a short period of time, a gradual reduction was programmed instead, and this target was accompanied by a strategy of flexible exchange rate management. This approach was based on the argument that the elimination of the inflation differential was not essential for balance of payments viability because the latter could be attained and maintained by an appropriate degree of exchange rate flexibility.
There is an important element of truth in the argument that exchange rate flexibility can insulate the balance of payments against the adverse impact of inflation. However, the argument does not end there. In the first place, it overlooks the resource cost of inflation and its adverse effects on the efficiency of resource allocation; on both of these counts, inflation clearly tends to impair the performance of the balance of payments; from this perspective, a flexible exchange rate may keep the balance of payments viable but at an unnecessarily high cost. In the second place, while the argument could be considered valid from a single-country standpoint, it loses validity when applied to the world economy as a whole because in such a context, the argument amounts to accepting the proposition that the world inflation rate is not subject to control.
All of these reasons make inflation control over a reasonable period of time a desirable objective of economic policy. In this regard, it would seem important to distinguish between an inflation target—the policy objective or desired outcome—and an inflation forecast—the likely outcome. The two need not, and indeed in most instances they will not, coincide. In general, corrective policy programs should aim at reductions in the inflation rate that are perceived as significant in order to influence expectations in the right direction. It should also be kept in mind, however, that a balance must be struck between the realism and the ambitiousness of the target.
Balance of Payments
The length of the period of adjustment has implications for the choice of the balance of payments objective. When the period under consideration is relatively short, an appropriate balance of payments target can be set by reference to the overall balance; in effect, this amounts to aiming at a certain desired development in net international reserves, which is to be brought about by any combination of outcomes in the current and capital accounts of the balance of payments.
As the period over which objectives are set and policies are formulated expands, the particular combination of outcomes on current and capital accounts becomes increasingly important. A viable payments position over the medium-to-long term calls for a sustainable structure or composition of the balance of payments. As a result, a variable like the current account becomes a legitimate policy objective in itself because it measures the rate at which the economy accumulates liabilities or assets vis-a-vis the rest of the world; alternatively, focusing on this variable, which measures the gap between domestic investment and savings, is necessary to ensure a sustainable relationship between aggregate demand and supply.
Like growth and inflation rates, the balance of payments can be both a result and an objective of economic policy. In contrast to them, however, the balance of payments has an additional dimension—it is equivalent to an economy’s budget constraint vis-à-vis the rest of the world and, as such, always has to be met, regardless of policies. From this perspective, a perceived improvement in the balance of payments, such as a reduction in the current or the overall deficit need not be a reflection of a policy improvement; it may be the result of a financing constraint imposed by the lack of foreign exchange. This particular characteristic of the balance of payments at times has contributed to the impression that policies supported by Fund resources were excessively biased toward balance of payments results because these seemed to be attained more often than price and growth targets.
Policy Instruments and Period of Adjustment
The lengthening of the period of adjustment also has implications for the choice of policy instruments, if only because it tends to increase the range of endogenous variables—that is, variables that can be expected to respond to policy action. A particular question that has been raised in the context of the process of policy formulation concerns the appropriateness of the mix of measures to control aggregate demand and measures to stimulate aggregate supply.
Demand and Supply Measures
Stabilization programs typically aim at controlling aggregate demand through the establishment of constraints on the availability of financial resources. The principal objective is to keep the level or the growth rate of demand within broad limits judged to be compatible with growth and price stability objectives. In the very short run, an argument (though by no means a conclusive one) can be made that issues relating to the source of aggregate demand—that is, whether demand comes from the public or private sectors— or to its composition—that is, whether consumption or investment—are not of immediate concern in the formulation of domestic financial policies. As the time horizon for policy formulation expands, however, the issue of whether demand is composed mainly of consumption or investment becomes increasingly relevant for the future performance of the economy. In many instances, this consideration is also accompanied by concern about the particular source of demand and expenditure.
Except in the very short run, both the level and the composition of aggregate demand are generally important considerations for the design of economic policies. This is because it is possible to have an acceptable level of demand with an inappropriate composition that will probably cause the growth rate to fall below its potential level. This line of thought is related to the argument made earlier in the context of the balance of payments objective, where it was contended that a given deficit in the current account is compatible with an indefinite number of combinations of savings and investment, not all of which are sustainable.
From this perspective, it is a matter of concern whether an adjustment in aggregate demand in general or in the fiscal position in particular is brought about by curtailing consumption or (total or public sector) investment. Given the importance of productive investment for the future performance of the economy, the question may be raised as to whether an adjustment made through reductions in investment is an appropriate strategy; the restoration of short-term financial balance to an economy (a proximate objective of demand management) needs to be attained by means that do not jeopardize its medium-to-long-term growth prospects (which are an ultimate goal of economic policy). While total investment is what matters in this context, in many countries, the public sector is the largest investor, and its capital spending dominates total investment activity. In this respect, adjustment programs should seek to generate public sector savings to ensure that investment financing is available domestically on the required scale.
Another problem in designing adjustment programs is how to improve resource allocation in order to raise the flow of output from the existing stock of factors of production. This assessment hinges on judgments about the appropriateness and realism of relative prices, both within the economy and in comparison with those prevailing in the rest of the world. Frequently, to attain its objectives, an adjustment effort must include modifications in key prices in the economy, including the exchange rate and interest rates. In many instances, such measures are necessary elements of global macroeconomic policies.
Macroeconomic and Microeconomic Variables
The distinction between macroeconomic and microeconomic variables recurs in discussions of programs supported by Fund resources.48 In some sense, this distinction is related to those frequently made between demand and supply measures, on the one hand, and between short-run and medium-to-long-run measures, on the other. While it is generally agreed that the term “macroeconomic” conveys the idea of globality and aggregation, agreement is less clear with respect to its concrete definition and scope. Overall credit and fiscal policies aimed at demand management, the impact of which is generally a short-term one, typically are formulated on the basis of variables that are classified as macroeconomic. Measures that affect variables such as particular prices in the economy are normally considered microeconomic; rather than directly influencing aggregate demand, they affect resource allocation, productivity, and, hence, supply and tend to yield results over the medium-to-long term.
Some broad observations can be made on the subject of macroeconomic and microeconomic variables. One concerns the dangers involved in over-stressing the relevance of the distinction between the two types of variables.
The distinction is useful for certain purposes and in certain contexts, but like most distinctions in economics, its validity and usefulness are by no means universal. At times, it has been used to support the proposition that micro-economic variables such as relative prices do not affect macroeconomic variables such as the level of income, the rate of inflation, and the balance of payments; such an argument, at a minimum, requires a degree of price and cost flexibility in the economy that does not prevail in most cases. As a result, microeconomic variables can have considerable macroeconomic effects, and, therefore, the distinction becomes less useful from an operational point of view.
A second observation is that microeconomic variables do affect resource allocation and, hence, the distribution of income. In this context, programs aimed at redressing financial imbalances without impairing medium-term growth prospects need to include microeconomic measures to remove distortions and improve resource allocation. Such measures are, at times, difficult to undertake because they often have unpopular short-run effects, but they can, nevertheless, be essential for the success of the adjustment effort.
Assessment and Interpretation of Results
From a very general standpoint, it can be said that in most instances, the policy programs supported by use of Fund resources have tended to steer economies in the directions originally intended. This being said, it must be recognized that the experiences under stand-by and extended arrangements have taken place under a wide variety of circumstances and settings; they are subject to a variety of interpretations and, in general, they indicate that the relationship between policy instruments and policy objectives—though generally well established in terms of the direction of events—is by no means clear-cut and precise. For all these reasons, not many observations can be made that apply to all cases; however, useful inferences may be drawn from assessment of outcomes and measurement of performance. These inferences reflect a particular, but by no means unique or universally agreed, interpretation of events based on the theoretical framework described earlier in the paper.
Standards of Measurement
There are a variety of standards that can conceivably be used to assess policy results and economic performance, all of which can be appropriate, depending oh the nature and the intent of the assessment. These possible standards can be classified into three broad categories. The first is a positive or practical standard that would measure performance under adjustment programs by comparing their results to the situation that prevailed in the economy prior to the introduction of policy measures; this standard amounts to a measure of what is relative to what was. The second is a normative standard that would measure performance by comparing actual results under programs to the targets specified in those programs; this standard compares, in a sense, what is with what should be. The third is a standard that might be called conjectural or judgmental and would compare actual performance to the outcome that would have taken place in the absence of a policy program; this standard focuses on a comparison of what is versus what would have been.49 Needless to say, this third standard is the most controversial one, if only because of its basically hypothetical nature that makes the observations based on it a matter of conjecture.
Inferences drawn by using the first standard are generally the least controversial because they simply compare sets of factual information; this characteristic is the main advantage of the positive standard; the disadvantage is that the standard does not provide insights into areas like the quality or degree of implementation of policies or like the transmission mechanism between policy instruments and targets. From the standpoint of this standard, the general experience has been that in terms of the three main objectives as a whole (balance of payments, growth, and inflation), the degree of disequilibrium was reduced after the introduction of policies relative to what it had been before— that is, in many instances, the global situation on the economic activity, balance of payments, and price fronts broadly improved. In comparative terms, the most favorable outcomes were registered on the balance of payments, followed by inflation and growth, in that order. As indicated previously, however, this standard of measurement is limited to factual statements and does not allow for the formulation of cause-and-effect relationships.
The second standard, which compares results to targets, allows for a measure of judgment, if only because views may vary about the adequacy of the targets. Precisely because judgment needs to be exercised, this normative standard can create controversy. While experience is less amenable to generalization under this standard than under the previous one, there is a degree of consistency in the information provided by the two of them; in comparing results to targets, the experience is broadly more favorable for the balance of payments than for the other two objectives. However, an important number of caveats need to be added with respect to comparisons based on this standard. An immediate one was stated earlier by pointing out the particular dimension of the balance of payments as a type of budget constraint, which at some point necessarily limits the size of the possible deficits. The existence of the constraint is independent of the quality of policies, but its elasticity is not, in the sense that the more inadequate the policies, the tighter the constraint. This relationship, ex post, may lead to the impression of a balance of payments improvement—because the deficit may not rise and, in fact, may even fall—when there has been none. A second, and perhaps more elusive (though not less important), caveat is that targets should not be confused with forecasts. In many circumstances, targets will not be attained; as a matter of strategy, they will be exceeded or will fail to be reached. Frequently, targets are formulated with a view to influencing the actual results. This is particularly the case with expectations; the demonstration effects of the announcement of policy targets are important elements of adjustment strategies in that they often influence the formation of expectations. This argues in favor of setting “ambitious” (though perhaps “unrealistic”) targets even when it seems, a priori, clear that their complete attainment is unlikely.50 A comparison between targets and results in these circumstances would not be meaningful.
The third, or conjectural, standard is even more controversial, and yet it can be argued that from some perspectives it is the most appropriate. What would be interesting to know in gauging performance under an adjustment program are the developments that would have taken place if either policy action had not been undertaken or different policies had been adopted. In general, a need for adjustment calls for an effort to steer the economy from its current (eventually unsustainable) path toward one that can be sustained. Lack of policy action in these circumstances is likely to bring about disruptions created by severe foreign exchange constraints, rising inflation rates, and faltering growth rates. Compared with such a prospect, adjustment, even though it may involve a short-run cost by some measurements, would appear to be desirable.
Some Problem Areas and Unresolved Issues
Problems areas abound in the field of economic policy implementation. To a large extent, this reflects the fact that policies are frequently intended to reverse situations characterized by excesses of claims on resources over their availability. In most instances, these conflicting situations are created by the pursuit of a set of objectives that, while plausible in its components, ends up being unsustainable in its totality. As a result, the adoption of adjustment measures is correctly perceived as a means of scaling down the objectives sought, and it is therefore resisted as being opposed to the country’s priorities.
An area of policy implementation to which increasing attention will have to be paid is the relationship between what earlier were called macroeconomic and microeconomic variables. In many programs, the implementation of certain macroeconomic policies, such as those in the credit and fiscal fields, is contingent on the adoption of certain microeconomic measures dealing, for example, with particular prices in the economy, taxes or expenditure patterns of the public sector, and the like.51 If these are not undertaken, the global basis of the program is undermined. The linkage between the global and the specific aspects of economic policymaking is a function, inter alia, of the size of the required adjustment. The smaller the adjustment that has to be made, the more likely it is that macroeconomic policies will be sufficient to bring the economy back to a sustainable path. Conversely, as the size of the imbalance is allowed to expand, the efficiency of global macroeconomic measures designed to correct it will tend to decline with the emergence of distortions that call for the adoption of microeconomic or specific measures.
A second area of interest in this context is the speed of the required adjustment effort. This issue, usually referred to as the choice between a “shock” versus a “gradual” approach to the adjustment process, has not been conclusively resolved. Such a choice is usually constrained by the relationship that exists between the availabilty of finance and the size of the imbalance, but it is also affected by the resolve and speed of policy response to emerging difficulties. The issue remains unresolved because it is not at all obvious that a gradual adjustment is preferable to a rapid one in all circumstances. The choice between shock and gradual strategies is only available with respect to policies, because as far as results are concerned, there is no choice but to accept gradualism. In the policy context, when choosing a strategy, one needs to distinguish between policies that have a time dimension (flow policies such as credit expansion, borrowing, and expenditure) and policy steps that are of a once-and-for-all nature (such as a price adjustment or an exchange rate change). The gradual approach to policy formulation is likely to fit the former much better than the latter. Policy measures of a once-and-for-all nature are best undertaken as soon as they become necessary, if only because delays, ceteris paribus, will require that larger policy adjustments be made to attain a given result or to bring the economy to a given position.
Concluding Remarks
This paper has traced the origin of Fund conditionality, and by discussing its theoretical underpinnings and its policy implications, the paper has sought to explain the evolution of practices and procedures devised for the implementation of conditionality since the establishment of the Fund more than three decades ago. A comprehensive set of such practices and procedures was developed during the relatively stable period of the Bretton Woods Agreement. Conditionality practices, however, are continuously evolving, and following the abandonment of the par value system, they were adapted to ensure that reasonable balance between adjustment efforts and financing needs of members in balance of payments difficulties would be attained over a foreseeable period. This was necessary to allow for the correction of the prevailing imbalances and also to safeguard the revolving character of Fund resources prescribed by the Articles of Agreement.
Any evaluation of the Fund’s collaboration with members in designing adjustment programs must recognize that the effectiveness of the Fund as an institution goes far beyond the provision of its own resources. One of the most important aspects of the Fund’s financial assistance to members with external payments problems is the close and predictable relationship it establishes between the provision of resources and the adoption of comprehensive policy programs. A critical side effect of this relationship is the catalytic effect it has had in helping members to attract flows of capital from sources other than the Fund. A financial arrangement with the Fund has traditionally been useful for members seeking to tap the capital markets because it provides a clear indication of the objectives to be sought and the policies to be followed, thereby reducing uncertainties about the future course of the economy.
A number of members have a relatively substantial and continuing dependence on flows of grant aid and concessional loans to finance their development efforts. Here again, technical and financial assistance from the Fund and other multilateral agencies has served to encourage donor countries to provide funds for members that have limited resource bases and are at low levels of development.
The problems of adjustment faced by member countries remain particularly complex. The prevailing large current account imbalances are likely to persist. Appropriate adjustment policies, therefore, will continue to be needed to justify and encourage sustainable flows of capital on both concessional and commercial terms.
The policies and practices on conditionality of the Fund’s resources are dynamic. The developments analyzed in this paper illustrate how those policies and practices have evolved as economic circumstances have changed and as understanding of economic processes and of the transmission mechanism between policy instruments and target variables has been sharpened with experience. In this manner, realistic and workable compromises can continue to be attained among the varied Fund membership to allow the institution to respond, in the most effective and timely manner, to the evolving needs of its members.
APPENDIX: Selected Executive Board Decisions on Use of Fund’s Resources
Use of Fund’s Resources and Repurchases
1. The Managing Director has made the following statement which should be the framework for his discussions with members on use of the Fund’s resources:
“The present proposals are designed to provide a practical basis for use of the Fund’s resources in accordance with the purposes of the Fund. When the proposals are agreed they will, of course, have to be carried into effect through actual cases. Decisions will have to be made in accordance with the particular circumstances, and in this manner a body of practical criteria will gradually be built up. However, even at the outset I think it must be clear that access to the Fund should not be denied because a member is in difficulty. On the contrary, the task of the Fund is to help members that need temporary help, and requests should be expected from members that are in trouble in greater or lesser degree. The Fund’s attitude toward the position of each member should turn on whether the problem to be met is of a temporary nature and whether the policies the member will pursue will be adequate to overcome the problem within such a period. The policies, above all, should determine the Fund’s attitude.
“In addition, the Fund should pay attention to a member’s general creditworthiness, particularly its record with the Fund. In this respect, the member’s record of prudence in drawing, its willingness to offer voluntary repayment when its situation permitted, and its promptness in fulfilling the obligation to transmit monetary reserves data and in discharging repurchase obligations would be important. I would expect that in the years to come, with extended activities of the Fund, we shall be able more and more to rely on the Fund’s own experience, thus providing a further and most useful link between Fund drawings and repurchases.
“After a period of relative inactivity of the Fund, it would be too much to expect that we should be able to solve with one stroke the entire problem of access to the Fund’s resources so that each member would always know how any request would be received by the Fund. We shall have to feel our way. Sometimes a member may want to submit to the Fund a specific request for drawings, with adequate information as to the particular situation which prompts the request. At other times discussions between the member and the Fund may cover its general position, not with a view to any immediate drawing, but in order to ensure that it would be able to draw if, within a period of say 6 or 12 months, the need presented itself. The Fund itself might take the initiative in discussing with one or more members transactions which it believes suitable for the Fund and helpful to the members concerned. In cases where it would appear appropriate and useful, the Fund might arrange drawings to deal with special short-run situations accompanied by arrangements for repurchase in a period not exceeding 18 months.”
2. a. In view of the Executive Board’s interpretation of September 26, 1946, concerning the use of the Fund’s resources, and considering especially the necessity for ensuring the revolving character of the Fund’s resources, exchange purchased from the Fund should not remain outstanding beyond the period reasonably related to the payments problem for which it was purchased from the Fund. The period should fall within an outside range of three to five years. Members will be expected not to request the purchase of exchange from the Fund in circumstances where the reduction of the Fund’s holdings of their currencies by an equivalent amount within that time cannot reasonably be envisaged.
b. The Fund has recently determined that when the charges on the Fund’s holdings of a member’s currency in any bracket have reached a rate of 3½ per cent per annum, the Fund and the member, in accordance with Article V, Section 8(d) “shall consider means by which the Fund’s holdings of the currency can be reduced” (EB Meeting 717, 11/19/51). In the course of consultations arising from purchases of exchange taking place after December 1, 1951, the Fund and the member will agree upon appropriate arrangements to ensure the reduction of the Fund’s holdings of the member’s currency as soon as possible, with the maximum period to be permitted in any such agreed arrangement requiring that within five years of each purchase made by the member there will be an equivalent repurchase of the Fund’s holdings unless they have otherwise been reduced.
c. With respect to each future purchase which raises the Fund’s holdings of the member’s currency from not less than 75 percent to not more than 100 percent of its quota, a member whose currency held by the Fund has not been otherwise reduced within three years will be requested by the Fund to agree upon an arrangement providing that within five years of each purchase made by the member there will be an equivalent repurchase of the Fund’s holdings unless they have otherwise been reduced.
d. When unforeseen circumstances beyond the member’s control would make unreasonable the application of the principles set forth in paragraph 2 above, the Fund will consider extensions of time.
e. When requesting use of the resources of the Fund in accordance with the arrangements described above, a member will be expected to include in its authenticated request a statement that it will comply with the above principles.
f. These principles will be an essential element in any determination by the Fund as to whether a member is using the resources of the Fund in accordance with the purposes of the Fund.
3. Each member can count on receiving the overwhelming benefit of any doubt respecting drawings which would raise the Fund’s holdings of its currency to not more than its quota.
4. The Managing Director should communicate with members concerning means to speed the collection and reporting of monetary reserves data and means to reduce the delays in reaching agreement under Rule 1-6 in cases where a repurchase obligation has been computed. The Fund should also make it clear that an important element in its judgment respecting the use of its resources will be the cooperation of the member in helping to make Article V, Section 7 effective, including the timely provision of information and the facilitating of settlement.
5. This decision will be effective until December 31, 1953 and will be reviewed by the Executive Board before that date.
Decision No. 102-(52/11)
February 13, 1952
Use of Fund’s Resources and Stand-By Arrangements
The Executive Board has reviewed the Fund’s policy with respect to the use of its resources under stand-by arrangements (SM/68/128 and Supplements 1-4, SM/68/141) and agrees that the Fund shall be guided by the approach in the conclusions set forth in SM/68/128, Supplement 4 as revised.
Decision No. 2603-(68/ 132)
September 20, 1968
Conclusions
In the light of experience over the past years and taking into consideration the necessity of adequate safeguards for the Fund and the need for flexibility while ensuring uniform and equitable treatment of all members, it is proposed that Fund policies and practices on the use of its resources, including tranche policies, shall continue to apply subject to the following:
1. Appropriate consultation clauses will be incorporated in all stand-by arrangements.
2. Provision will be made for consultation, from time to time, with a member during the whole period in which the member is making use of the Fund’s resources beyond the first credit tranche whether or not the use results from a stand-by arrangement.
3. Phasing and performance clauses will be omitted in stand-by arrangements that do not go beyond the first credit tranche.
4. Appropriate phasing and performance clauses will be used in all stand-by arrangements other than those referred to in paragraph 3, but these clauses will be applicable only to purchases beyond the first credit tranche.
5. Notwithstanding paragraph 4, in exceptional cases phasing need not be used in stand-by arrangements that go beyond the first credit tranche when the Fund considers it essential that the full amount of the stand-by arrangement be promptly available. In these stand-by arrangements, the performance clauses will be so drafted as to require the member to consult the Fund in order to reach understandings, if needed, on new or amended performance criteria even if there is no amount that could still be purchased under the stand-by arrangements. This consultation will include a discussion by the Executive Directors which could culminate in a communication of their views to the member under Article XII, Section 8.
6. Performance clauses will cover those performance criteria necessary to evaluate implementation of the program with a view to ensuring the achievement of its objectives, but no others. No general rule as to the number and content of performance criteria can be adopted in view of the diversity of problems and institutional arrangements of members.
7. In view of the character of stand-by arrangements, language having a contractual flavor will be avoided in the stand-by documents.
Guidelines on Conditionality
The Executive Board agrees to the text of the guidelines on conditionality for the use of the Fund’s resources and for stand-by arrangements as set forth [below].
Decision No. 6056-(79/38)
March 2, 1979
Use of Fund’s General Resources and Stand-By Arrangements
1. Members should be encouraged to adopt corrective measures, which could be supported by use of the Fund’s general resources in accordance with the Fund’s policies, at an early stage of their balance of payments difficulties or as a precaution against the emergence of such difficulties. The Article IV consultations are among the occasions on which the Fund would be able to discuss with members adjustment programs, including corrective measures, that would enable the Fund to approve a stand-by arrangement.
2. The normal period for a stand-by arrangement will be one year. If, however, a longer period is requested by a member and considered necessary by the Fund to enable the member to implement its adjustment program successfully, the stand-by arrangement may extend beyond the period of one year. This period in appropriate cases may extend up to but not beyond three years.
3. Stand-by arrangements are not international agreements and therefore language having a contractual connotation will be avoided in stand-by arrangements and letters of intent.
4. In helping members to devise adjustment programs, the Fund will pay due regard to the domestic social and political objectives, the economic priorities, and the circumstances of members, including the causes of their balance of payments problems.
5. Appropriate consultation clauses will be incorporated in all stand-by arrangements. Such clauses will include provision for consultation from time to time during the whole period in which the member has outstanding purchases in the upper credit tranches. This provision will apply whether the outstanding purchases were made under a stand-by arrangement or in other transactions in the upper credit tranches.
6. Phasing and performance clauses will be omitted in stand-by arrangements that do not go beyond the first credit tranche. They will be included in all other stand-by arrangements but these clauses will be applicable only to purchases beyond the first credit tranche.
7. The Managing Director will recommend that the Executive Board approve a member’s request for the use of the Fund’s general resources in the credit tranches when it is his judgment that the program is consistent with the Fund’s provisions and policies and that it will be carried out. A member may be expected to adopt some corrective measures before a stand-by arrangement is approved by the Fund, but only if necessary to enable the member to adopt and carry out a program consistent with the Fund’s provisions and policies. In these cases the Managing Director will keep Executive Directors informed in an appropriate manner of the progress of discussions with the member.
8. The Managing Director will ensure adequate coordination in the application of policies relating to the use of the Fund’s general resources with a view to maintaining the nondiscriminatory treatment of members.
9. The number and content of performance criteria may vary because of the diversity of problems and institutional arrangements of members. Performance criteria will be limited to those that are necessary to evaluate implementation of the program with a view to ensuring the achievement of its objectives. Performance criteria will normally be confined to (i) macroeconomic variables, and (ii) those necessary to implement specific provisions of the Articles or policies adopted under them. Performance criteria may relate to other variables only in exceptional cases when they are essential for the effectiveness of the member’s program because of their macroeconomic impact.
10. In programs extending beyond one year, or in circumstances where a member is unable to establish in advance one or more performance criteria for all or part of the program period, provision will be made for a review in order to reach the necessary understandings with the member for the remaining period. In addition, in those exceptional cases in which an essential feature of a program cannot be formulated as a performance criterion at the beginning of a program year because of substantial uncertainties concerning major economic trends, provision will be made for a review by the Fund to evaluate the current macroeconomic policies of the member, and to reach new understandings if necessary. In these exceptional cases the Managing Director will inform Executive Directors in an appropriate manner of the subject matter of a review.
11. The staff will prepare an analysis and assessment of the performance under programs supported by use of the Fund’s general resources in the credit tranches in connection with Article IV consultations and as appropriate in connection with further requests for use of the Fund’s resources.
12. The staff will from time to time prepare, for review by the Executive Board, studies of programs supported by stand-by arrangements in order to evaluate and compare the appropriateness of the programs, the effectiveness of the policy instruments, the observance of the programs, and the results achieved. Such reviews will enable the Executive Board to determine when it may be appropriate to have the next comprehensive review of conditionality.
REFERENCES
Alexander, Sidney S., “Effects of a Devaluation on a Trade Balance,” International Monetary Fund, Staff Papers, Vol. 2 (April 1952), pp. 199-212. This article is reproduced in Readings in International Economics, ed. by Richard E. Caves and Harry G. Johnson (Homewood, Illinois, 1968), pp. 359-73.
de Larosière, J. (1980 a), Address to the Economic and Social Council of the United Nations, Geneva, July 4, 1980. The address is reproduced in the IMF Survey. See “Managing Director Tells ECOSOC He Foresees Sufficient Resources for Expanded Recycling Role,” IMF Survey, Vol. 9 (July 7, 1980), pp. 202-206.
de Larosiàre, J. (1980 b), Address to the 1980 Annual Meeting of the World Bank and the International Monetary Fund, Washington, September 30, 1980, The address is reproduced in the IMF Survey. See “de Larosiere Explains Policies for Financing and Adjustment,” IMF Survey, Vol. 9 (October 13, 1980), pp. 311-15.
de Vries, Margaret Garritsen, The International Monetary Fund, 1966-1971: The System Under Stress (Washington, 1976).
Dornbusch, Rudiger, and Stanley Fischer, “Exchange Rates and the Current Account,” American Economic Review, Vol. 70 (December 1980), pp. 960-71.
Frenkel, Jacob A., and Harry G. Johnson, eds. The Monetary Approach to the Balance of Payments (London, 1976).
Frenkel, Jacob A., and Harry G. Johnson, eds., The Economics of Exchange Rates: Selected Studies (Reading, Massachusetts, 1978).
Frenkel, Jacob A., and Michael L. Mussa, “Monetary and Fiscal Policies in an Open Economy,” American Economic Review, Papers and Proceedings of the Ninety- Third Annual Meeting of the American Economic Association, Vol. 71 (May 1981), pp. 253-58.
Friedman, Milton, Essays in Positive Economics (University of Chicago Press, 1953).
Friedman, Milton, The Counter-Revolution in Monetary Theory, Occasional Paper No. 33, Institute of Economic Affairs (London, 1970).
Gold, Joseph, The Stand-By Arrangements of the International Monetary Fund: A Commentary on Their Formal, Legal and Financial Aspects (Washington, 1970).
Gold, Joseph, Conditionality, IMF Pamphlet Series, No. 31 (Washington, 1979).
Gold, Joseph, Financial Assistance by the International Monetary Fund: Law and Practice, IMF Pamphlet Series, No. 27 (Washington, Second ed., 1980).
Goreux, Louis M., Compensatory Financing Facility, IMF Pamphlet Series, No. 34 (Washington, 1980).
Guitián, Manuel, “Credit Versus Money as an Instrument of Control,” International Monetary Fund, Staff Papers, Vol. 20 (November 1973), pp. 785-800. The article is reproduced in International Monetary Fund (1977), pp. 227-42.
Guitián, Manuel, (1976 a), “The Effects of Changes in the Exchange Rate on Output, Prices and the Balance of Payments,” Journal of International Economics, Vol. 6 (February 1976), pp. 65-74.
Guitián, Manuel, (1976 b), “The Balance of Payments as a Monetary Phenomenon: Empirical Evidence, Spain, 1955-71,” in Frenkel and Johnson (1976), pp. 338-56.
Guitián, Manuel, “Dutch Monetarism: A Comment,” Journal of Monetary Economics, Vol. 3 (July 1977), pp. 379-81.
Guitián, Manuel, a series of three articles on “Fund Conditionality and the International Adjustment Process” that appeared in Finance and Development: “The Early Period, 1950-70,” Vol. 17 (December 1980), pp. 23-27; “The Changing Environment of the 1970s,” Vol. 18 (March 1981), pp. 8-11; and “A Look into the 1980s,” Vol. 18 (June 1981), pp. 14-17. The series was reprinted as a single paper—Manuel Guitian, Conditionality: Access to Fund Resources (Washington, 1981).
Guitián, Manuel, (1981 a), “Economic Management and Fund Conditionality,” paper presented at an International Monetary Fund/Overseas Development Institute seminar on The IMF, the Third World and the Global Payments Problem, Croydon, England, October 16-18, 1981. The paper will be reproduced in Adjustment and Financing in the Developing World: The Role of the IMF (forthcoming in 1982).
Guitián, Manuel, (1981 b), “Policies on Access to Fund Resources—An Overview of Conditionality,” paper presented to an International Monetary Fund conference on The International Monetary System in the Face of Payments Disequilibria—Adjustment and Financing, Paris, November 23-25, 1981.
Hooke, Augustus W. (1981 a), “The Brandt Commission and International Monetary Issues,” Finance and Development, Vol. 18 (June 1981), pp. 22-24.
Hooke, Augustus W. (1981 b), The International Monetary Fund: Its Evolution, Organization, and Activities, IMF Pamphlet Series, No. 37 (Washington, 1981).
Horsefield, J. Keith, The International Monetary Fund, 1945-1965: Twenty Years of International Monetary Cooperation (Washington, 1969).
International Monetary Fund, Selected Decisions of the International Monetary Fund and Selected Documents, Eighth Issue (Washington, May 10, 1976).
International Monetary Fund, The Monetary Approach to the Balance of Payments: A Collection of Research Papers by the Staff of the International Monetary Fund (Washington, 1977).
International Monetary Fund, Articles of Agreement (Washington, 1978).
International Monetary Fund, World Economic Outlook: A Survey by the Staff of the International Monetary Fund (Washington, 1980).
International Monetary Fund, (1981 a), IMF Institute, Financial Policy Workshops:The Case of Kenya (Washington, 1981).
International Monetary Fund, (1981 b), Selected Decisions of the International Monetary Fund and Selected Documents, Ninth Issue (Washington, June 15, 1981).
Johnson, Harry G., International Trade and Economic Growth: Studies in Pure Theory (London, 1958).
Johnson, Harry G., (1972 a), “The Monetary Approach to Balance of Payments Theory,” Journal of Financial and Quantitative Analysis, Vol. 7 (March 1972), pp. 1555-71.
Johnson, Harry G., (1972 b), Inflation and the Monetarist Controversy (Amsterdam, 1972).
Johnson, Harry G., Further Essays in Monetary Economics (Harvard University Press, 1973).
Johnson, Harry G., and Alexander K. Swoboda, eds.,The Economics of Common Currencies: Proceedings of the Madrid Conference on Optimum Currency Areas (London, 1973).
Keller, Peter M., “Implications of Credit Policies for Output and the Balance of Payments,” International Monetary Fund, Staff Papers, Vol. 27 (September 1980), pp. 451-77.
Landell-Mills, Pierre M., “Structural Adjustment Lending: Early Experience,” Finance and Development, Vol. 18 (December 1981), pp. 17-21.
Loser, Claudio M., “External Debt Management and Balance of Payments Policies,” International Monetary Fund, Staff Papers, Vol. 24 (March 1977), pp. 168-92.
McKinnon, Ronald I., “The Exchange Rate and Macroeconomic Policy: Changing Postwar Perceptions,” Journal of Economic Literature, Vol. 19 (June 1981), pp. 531-57.
Mookerjee, Subimal, “Policies on the Use of Fund Resources,” International Monetary Fund, Staff Papers, Vol. 13 (November 1966), pp. 421-42.
Mookerjee, Subimal, “New Guidelines for Use of Fund Resources Follow Review of Practice of Conditionality,” IMF Survey, Vol. 8 (March 19, 1979), pp. 82-83.
Mundell, Robert A., “A Fallacy in the Interpretation of Macroeconomic Equilibrium,” Journal of Political Economy, Vol. 73 (February 1965), pp. 61-66.
Mundell, Robert A., International Economics (New York, 1968).
Mundell, Robert A., Monetary Theory: Inflation, Interest and Growth in the World Economy (Pacific Palisades, California, 1971).
Polak, J. J., “Monetary Analysis of Income Formation and Payments Problems,” International Monetary Fund, Staff Papers, Vol. 6 (November 1957), pp. 1-50. The article is reproduced in International Monetary Fund (1977), pp. 15-64.
Prais, S. J., “Some Mathematical Notes on the Quantity Theory of Money in an Open Economy,” International Monetary Fund, Staff Papers, Vol. 8 (May 1961), pp. 212-26. The article is reproduced in International Monetary Fund (1977), pp. 147-61.
Reichmann, Thomas M., “The Fund’s Conditional Assistance and the Problems of Adjustment, 1973-75,” Finance and Development, Vol. 15 (December 1978), pp. 38-41.
Reichmann, Thomas M., and Richard T. Stillson, “Experience with Programs of Balance of Payments Adjustment: Stand-By Arrangements in the Higher Tranches, 1963-72,” International Monetary Fund, Staff Papers, Vol. 25 (June 1978), pp. 293-309.
Robichek, E. Walter, “Financial Programming: Stand-By Arrangements and Stabilization Programs” (unpublished, International Monetary Fund, January 6, 1971).
Salop, Joanne, and Erich Spitaller, “Why Does the Current Account Matter?” International Monetary Fund, Staff Papers, Vol. 27 (March 1980), pp. 101-34.
Selden, Richard T., “A Critique of Dutch Monetarism,” Journal of Monetary Economics, Vol. 1 (April 1975), pp. 221-32.
Triffin, Robert, The World Money Maze: National Currencies in International Payments (Yale University Press, 1966).
Witteveen, H. Johannes, Address to the 1978 Euromarkets Conference, London, May 8, 1978. The address is reproduced in the IMF Survey. See “Fund’s Conditional Assistance Promotes Adjustment Programs of Members, Witteveen States,” IMF Survey, Vol. 7 (May 22, 1978), pp. 145-50.
Wright, E. Peter, “World Bank Lending for Structural Adjustment,” Finance and Development, Vol. 17 (September 1980), pp. 20-23.
Fora detailed exposition of the history and activities of the Fund, see Horsefield (1969) and de Vries(l976).
Sec Article I(v) and Article V, Section 3(c) of the Fund’s Articles of Agreement (International Monetary Fund (1978)).
For an exposition of the various financial facilities available at the Fund, see Gold (1980), Sec also Goreux (1980) for a detailed analysis of the compensatory financing facility.
This subsection summarizes the main arguments that constitute what is now called the monetary approach to balance of payments analysis; see, for example, Johnson (1972 a).
This line of thought can be used, at least for expository purposes, to distinguish stabilization policies from development and growth policies; while the former are generally aimed at aggregate demand, the latter are aimed at aggregate supply.
For example, see Friedman (1970) and Johnson (1973).
For earlier statements of a similar character, see. for instance. Polak (1957) and Triffin (1966).
This is particularly the case with Milton Friedman’s monetary policy framework, which needs to be interpreted in the light of his article, “The Case for Flexible Exchange Rates” in Friedman (1953), pp. 157-203.
See International Monetary Fund (1977) and Frenkel and Johnson (1976) for collections of theoretical and empirical articles on these subjects. Sec also Frenkel and Mussa (1981).
See, for example, Prais (1961).
See the discussion in Johnson (1972 b); Mundell (1968) and (1971); Guitián (1973) and (1977); and Selden (1975).
This subsection contains arguments that are based on the income-absorption approach to balance of payments analysis that was developed in the early 1950s; see, in particular, Alexander (1952).
It may be noted that the link between the overall balance and international reserve management is to the monetary approach to the balance of payments what the link between the current account and the management of foreign assets and liabilities, in their broadest sense, is to the absorption approach to the balance of payments. It is curious that the monetary approach is associated with the Fund much more often than the absorption approach, which was also extensively discussed and written about in the institution; see Rudolf R. Rhomberg and H. Robert Heller, “Introductory Survey.” in International Monetary Fund (1977), pp. 1-14.
See Loser (1977) and Keller (1980).
See Guitián (1976 b).
For a recent collection of essays on exchange rates, see Frenkel and Johnson (1978). See also McKinnon (1981). The effects or exchange rate changes on output have been discussed explicitly in Ruben D. Almonacid and Manuel Guitián, “The Optimal Rale ol Devaluation.” in Johnson and Swoboda (1973), pp. 281-97; and Guitián (1976 a).
For an excellent discussion of the expenditure-reducing and expenditure-switching effects, see Harry G. Johnson’s “Towards a General Theory of the Balance of Payments.” in Johnson (1958). pp. 153-68.
See Executive Board Decision No. l02-(52; 11), pp. 37-40 in International Monetary Fund (1976). The decision has been reproduced in the Appendix. For a complete exposition of the development of the policies on the use of Fund resources during this period, see Mookcrjec (1966).
See Robichek (1971).
For a complete analysis of this important instrument of Fund policies as it evolved during the 1950s and 1960s, see Gold (1970).
For an illustration of financial programming exercises, see International Monetary Fund (1981 a).
During the 1950s and the 1960s, the Fund became increasingly active in its operations with member countries. In the 1950s. 57 stand-by arrangements were concluded lor a total of about USS4 billion. During the 1960s, the number of stand-by arrangements increased to 231 for a total amount in excess of USSI4 billion.
See Executive Board Decision No. 2603-(68/132), pp. 47-49 in International Monetary Fund (1976). The decision has been reproduced in the Appendix.
For a detailed exposition of events during the late 1960s and early 1970s, see de Vries (1976).
The resources made available under this facility were additional lo any other assistance that members might have been able to obtain from Ihe Fund under regular and special facilities that had been established at an earlier lime; see Gold (1980). See also Executive Board Decision No. 4241-(74/67) in International Monetary Fund (1976), pp. 70-74.
Sec Executive Board Decision No. 46344-(75/47), pp. 127-28 in International Monetary Fund (1976).
The oil facilities were terminated in March 1976; during their two-year duration, they provided 55 members with about SDR 7 billion in financial assistance. All of these steps to smooth out necessary adjustments to economic disturbances were supplemented in 1975 by an important liberalization of other special Fund facilities subject to a low degree of conditionality in particular the compensatory financing facility, which had been established in 1963 to finance temporary shortfalls in members’export receipts.
See Executive Board Decision No. 5069-(76/72), pp. 185-95 in International Monetary Fund (1976). Trust Fund loans carried a 0.5 percent interest rate per year and were to be repaid within a period of five to ten years.
The Trust Fund, as a provider of direct balance of payments loans, was terminated on April 30. 1981. During its existence, it made loans of some SDR 3 billion to eligible developing countries. Another step in this direction was the establishment in 1975 of a subsidy account to reduce the interest cost of drawings under the 1975 oil facility to the most seriously affected (MSA) developing countries designated by the Secretary General of the United Nations.
See Executive Board Decision No. 4377-(74/114), pp. 50-54 in International Monetary Fund (1976).
In the 1970s, commitments of financial assistance from this facility were made under 11 extended arrangements for the equivalent of nearly SDR 3 billion. This assistance was an important supplement to the more than SDR 13 billion of resources provided to members under 166 stand-by arrangements during the same period. It may be noted that commitments under the extended facility have picked up strongly since the beginning of the 1980s, having already added close to SDR 10 billion toward the end of 1981.
See Executive Board Decision No. 5508-(77/127), pp. 31-37 in International Monetary Fund (1981 b). The facility was intended to serve as a bridge until the Seventh General Review of Quotas, which provided for a 50 per cent increase, was completed.
The supplementary financing facility became effective on February 23, 1979, when its resources reached nearly SDR 8 billion. By early 1981, all of those resources had been committed.
See Executive Board Decision No. 6056-(79/38), pp. 19-22 in International Monetary Fund (1981 b). The decision has been reproduced in the Appendix. See also Mookerjee (1979) and Gold (1979).
See Paragraph 9 of Executive Board Decision No. 6056-(79/38). p. 21 in International Monetary Fund (1981 b). The decision has been reproduced in the Appendix.
It may be recalled here that supplementary resources were borrowed by the Fund and that their cost is market-related. The difficulties that the high cost could pose for some members were recognized, and a subsidy account to lower the interest cost of supplementary financing facility loans lo low-income developing countries was established in November 1980. The account is to be financed mainly with resources obtained from the repayment of Trust Fund loans and from voluntary contributions made by countries in strong payments positions. See Hooke (1981 a).
See Wright (1980) and Landell-Mills (1981).
For a description of these inlerim steps, see Manuel Guitián. “Fund Conditionality and the International Adjustment Process: A Look into the 1980s.” finance and Development, Vol. 18 (June 1981), pp. 14-17, reprinted in Manuel Guitián, Conditionality: Access to Fund Resources (Washington, 1981).
See Executive Board Decision No. 6783-(81/40), pp. 39-43 in International Monetary Fund (1981 b).
For a description of a number of initiatives taken at various stages that supplement those discussed in this paper, see Hooke (1981 b).
See paragraph 12 of Executive Board Decision No. 6056-(79/38), p. 22 in International Monetary Fund (1981 b). The decision has been reproduced in the Appendix. See also Gold (1979).
For general studies of financial arrangements in the 1960s and early 1970s, see Reichmann and Stillson (1978) and Reichmann (1978).
For a discussion of this point in another context, see Mundell (1965).
Sec paragraph 9 in Executive Board Decision No. 6056-(79/38), p. 21 in International Monetary Fund (1981 b). The decision has been reproduced in the Appendix, See also Gold (1979).
An exchange of views with John Williamson, formerly a member of the Fund staff and currently with the Institute for International Economics (Washington), added a nuance to this third standard by introducing a comparison of actual performance to what would have obtained in the presence of a different set of policies; this is equivalent to comparing what is with what might have been.
As was pointed out earlier, the argument is constrained by the need to ensure that targets, however ambitious they may be, must be perceived as feasible; otherwise, credibility will be lost and expectations will be adversely affected. In this context, expectations may be influeneced more by the resolve or determination with which the policy action is carried out than by its apparent feasibility.
The Fund often provides technical assistance in response to requests from members to help improve both the revenue and expenditure performance of governments so that the global macroeconomic criteria usually included in arrangements with the Fund can be observed.
IMF PAMPHLET SERIES
International Monetary Fund Pamphlet Series
(All pamphlets have been published in English, French, and Spanish, unless otherwise stated)
*1. Introduction to the Fund, by J. Keith Horsefield. First edition, 1964. Second edition, 1965. Second edition also in German.
*2. The International Monetary Fund: Its Form and Functions, by J. Marcus Fleming. 1964. In English only.
3. The International Monetary Fund and Private Business Transactions: Some Legal Effects of the Articles of Agreement, by Joseph Gold, 1965.
4. The International Monetary Fund and International Law: An Introduction, by Joseph Gold. 1965.
*5. The Financial Structure of the Fund, by Rudolf Kroc. First edition, 1965. Second edition, 1967.
6. Maintenance of the Gold Value of the Fund’s Assets, by Joseph Gold. First edition, 1965, Second edition, 1971.
7. The Fund and Non-Member States: Some Legal Effects, by Joseph Gold. 1966.
8. The Cuban Insurance Cases and the Articles of the Fund, by Joseph Gold. 1966.
9. Balance of Payments: Its Meaning and Uses, by Poul HØst-Madsen. 1967.
*10. Balance of Payments Concepts and Definitions. First edition, 1968. Second edition, 1969.
11. Interpretation by the Fund, by Joseph Gold. 1968.
12. The Reform of the Fund, by Joseph Gold. 1969.
13. Special Drawing Rights, by Joseph Gold. First edition, 1969. Second edition, with subtitle Character and Use, 1970.
14. The Fund’s Concepts of Convertibility, by Joseph Gold, 1971.
15. Special Drawing Rights: The Role of Language, by Joseph Gold, 1971.
16. Some Reflections on the Nature of Special Drawing Rights, by J.J. Polak. 1971.
17. Operations and Transactions in SDRs: The First Basic Period, by Walter Habcrmeicr. 1973.
18. Valuation and Rate of Interest of the SDR, by J.J. Polak. 1974.
19. Floating Currencies, Gold, and SDRs: Some Recent Legal Developments, by Joseph Gold. 1976. Also in German.
20. Voting Majorities in the Fund: Effects of Second Amendment of the Articles, by Joseph Gold. 1977.
21. International Capital Movements Under the Law of the International Monetary Fund, by Joseph Gold. 1977.
22. Floating Currencies, SDRs, and Gold: Further Legal Developments, by Joseph Gold. 1977. Concluding section also in German.
23. Use, Conversion, and Exchange of Currency Under the Second Amendment of the Fund’s Articles, by Joseph Gold. 1978.
24. The Rise in Protectionism, by Trade and Payments Division. 1978.
25. The Second Amendment of the Fund’s Articles of Agreement, by Joseph Gold. 1978.
26. SDRs, Gold, and Currencies: Third Survey of New Legal Developments, by Joseph Gold. 1979. Concluding section also in German.
27. Financial Assistance by the International Monetary Fund: Law and Practice, by Joseph Gold. First edition, 1979. In English only. Second edition, 1980.
28. Thoughts on an International Monetary Fund Based Fully on the SDR, by J.J. Polak. 1979.
29. Macroeconomic Accounts: An Overview, by Poul Host-Madsen. 1979.
30. Technical Assistance Services of the International Monetary Fund. 1979.
31. Conditionality, by Joseph Gold. 1979.
32. The Rule of Law in the International Monetary Fund, by Joseph Gold. 1980. In English and French. Spanish in preparation.
33. SDRs, Currencies, and Gold: Fourth Survey of New Legal Developments, by Joseph Gold. 1980.
34. Compensatory Financing Facility, by Louis M. Goreux. 1980.
35. The Legal Character of the Fund’s Stand-By Arrangements and Why It Matters, by Joseph Gold. 1980.
36. SDRs, Currencies, and Gold: Fifth Survey of New Legal Developments, by Joseph Gold. 1981. In English. French and Spanish in preparation.
37. The International Monetary Fund: Its Evolution, Organization, and Activities, by A.W. Hooke. 1981. In English and Spanish. French in preparation.
38. Fund Conditionality: Evolution of Principles and Practices, by Manuel Guitián. 1981. In English. French and Spanish in preparation.
39. Order in International Finance, the Promotion of IMF Stand-By Arrangements, and the Drafting of Private Loan Agreements, by Joseph Gold. 1982. In English, French and Spanish in preparation.
*Out of print. Photographic or microfilm copies of all English editions, including numbers that are out of print, may be purchased direct from University Microfilms International, 300 North Zeeb Road, Ann Arbor, Michigan 48106, U.S.A., or, for those living outside the Western Hemisphere, from University Microfilms Limited, 30/32 Mortimer St., London, WIN 7RA, England.
Copies (unless out of print) may be requested from:
External Relations Department, Attention: Publications
International Monetary Fund, Washington, D.C. 20431, U.S.A.
Telephone number: 202 477 2945
Cable address: Interfund