IV. The European Monetary System and the International Monetary Fund
  • 1 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund
  • | 2 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund
  • | 3 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund

Abstract

In its Resolution of December 5, 1978, the European Council stated: “The EMS is and will remain fully compatible with the relevant articles of the IMF Agreement.”30 At the time of the establishment of the EMS, however, a number of questions were raised as to whether the operations of the EMS might impede the Fund in carrying out its functions in accordance with the Articles of Agreement. Questions were asked as to whether the Fund’s and the EMS’s approaches to the same problems might differ and whether conflicts might arise. These doubts concentrated on three areas: surveillance over exchange rate policies, conditionality in credit operations, and the creation of international liquidity.

In its Resolution of December 5, 1978, the European Council stated: “The EMS is and will remain fully compatible with the relevant articles of the IMF Agreement.”30 At the time of the establishment of the EMS, however, a number of questions were raised as to whether the operations of the EMS might impede the Fund in carrying out its functions in accordance with the Articles of Agreement. Questions were asked as to whether the Fund’s and the EMS’s approaches to the same problems might differ and whether conflicts might arise. These doubts concentrated on three areas: surveillance over exchange rate policies, conditionality in credit operations, and the creation of international liquidity.

While it may be too early to come to a final assessment, the experience of the first years with EMS operations allows some observations and conclusions. At the outset, it may be said that any clear incompatibility of goals or of general policy orientation would have been surprising, taking into account that in the economic field the objectives of the Fund, as laid down in its Articles of Agreement, and of the European Community, as established in the EEC Treaty, are often identical and certainly consistent. It should be noted, however, that while the Fund’s final objectives are of an economic nature, the EC, and with it the EMS, has ultimately a political purpose. The creation of the European Economic Community aspired, according to the Preamble of the Treaty, “to lay the foundations of an ever closer union among the peoples of Europe.”31 The EMS, in particular, is often viewed as preparing the ground for an eventual economic and monetary union by providing a high degree of exchange rate stability and a convergence of economic performance. While it is widely acknowledged that, during the first years of its existence, the EMS fell substantially short of some of its objectives, its ultimately political goals need to be kept in mind in judging policies and developments within the EMS.

Surveillance over Exchange Rate Policies

As described above, there have been several realignments of exchange rates in the EMS since its inception. While, in the beginning, exchange rate changes were apparently made without major controversy and, on the whole, in a smooth and timely fashion, more recent realignments led to discussions as to the direction and the size of adjustments “which became intense and at times difficult before unanimous consensus could be reached on a balanced rearrangement of the parity grid.”32 It should be recalled in this connection that exchange rate changes in the EMS are a matter of common decision making and require unanimity among EMS participants. This requirement is not surprising when one considers the importance of such decisions for the functioning of the EMS and for the achievement of its twin objectives, external and internal stability, and also bearing in mind other aspects of common EC policies.

The International Monetary Fund is not formally a partner in this decision-making process, and the formal obligations of EMS countries, in keeping with the bilateral nature of Fund-member relations, have been fully met by notifying the Fund promptly of any changes in exchange rate policies. It is obvious that the Fund and the EMS have a similarly strong interest in the effectiveness of exchange rates in facilitating international transactions and of securing international balance. There can always be differences in judgment regarding the timing of a decision, the magnitude of the exchange rate adjustment, and the appropriate mix of external and domestic measures. Such differences could arise from different weights placed on economic or other considerations and from different assessments of the impact of alternative policy adjustments. Recognition of such differences is implicit in the exercise of Fund surveillance over the exchange rate policies of its members, in which the Fund is required to respect the domestic social and political policies of members and to pay due regard to the circumstances of members.33 In recent years, a number of European countries have tended to stress steadiness in exchange rate policy as a factor in the sociopolitical processes which influence present and future economic developments. A case in point is the “hard currency” option which emphasizes the importance of a stable nominal exchange rate for maintaining a high degree of domestic price stability which, in turn, is expected to influence favorably the social climate and, as a consequence, wage and cost developments. The EMS also needs to take into account other elements of common EC policies. It must look at adjustment policies also in the light of the quest for convergence as a way toward closer economic and monetary union.

Decisions on exchange rates are taken by national governments and the Fund’s responsibility is to ensure that decisions taken (or not taken) by its member countries are appropriate given the interest of the international community. If there were serious doubts about the appropriateness of a particular decision, then the Fund would have a right and duty to question it.

Conditionality in Credit Operations

The question at issue is the desirability, indeed the need, to synchronize conditions in simultaneous or sequential borrowing operations by an EC country34 from the Fund and under the various EC credit facilities. While in a strict sense this need would only refer to the use of the EC mediumterm facilities (the mediumterm financial assistance and Community loan facilities), use of the unconditional shortterm monetary support scheme is also of interest since such shortterm borrowing could later lead to consolidation under one of the mediumterm facilities.

It can be assumed that any borrowing by an EC member country from the Fund or from an EC facility would have the same objective, namely, to give a country time to bring its balance of payments back in order. Again, as for other countries, differences may arise as to the nature of the adjustment policies to be implemented, perhaps in this case reflecting constraints related to common EC policies. However, such differences would be consistent with the Fund’s obligation to pay due regard to the social and political objectives, the economic priorities, and the circumstances of members, provided the measures taken are adequate.35

The EC credit facilities (apart from the very shortterm financing facility) have been used infrequently and not at all since the start of the EMS. Consequently, no distinct pattern for the decision-making process and the character of conditionality has developed within the EC. However, in connection with a change in the provisions governing the Community loan mechanism in March 1981, the procedures to be followed were more precisely defined. These procedures are very much in line with the Fund’s policy as regards conditionality. Thus, the EC approach, called “graduation of conditionality,”36 contains the elements of performance criteria, intermediate reviews, and the phasing of disbursements subject to compliance with the objectives of a stabilization program. Due to the limited number of its members and the special structure of its institutions, the decision-making process of the EC differs in character from that of the Fund. Regarding the mediumterm facilities, the Council of Ministers, representing all EC countries, will determine whether a loan will be granted, the amount of a loan, and the economic policy conditions. The decisions of the Council will be prepared by the EC Commission and the EC Monetary Committee, which consists of high government and central bank officials and representatives of the Commission. In this way, from the beginning, all member governments, as well as the Commission, will be actively involved in designing and negotiating the framework for balance of payments assistance.

In its report on this subject37 the Monetary Committee also states that no a priori position should be taken as to whether a country in need of balance of payments assistance should first use the one or the other mediumterm EC facility or should seek assistance from the International Monetary Fund. Rather, the ranking of calls on the various sources of financing should depend on the circumstances at a given time.

Creation of International Liquidity

When the European Monetary System was being established, the question was raised of whether any capacity of the EMS to create international liquidity on its own would not diminish the interest of EMS countries in the creation of international liquidity, conditional or unconditional, by the IMF. It should be pointed out, however, that any international liquidity created by the EMS would not be “global” but “regional” in character. Any excess creation of such liquidity by the EMS would, over time, inevitably undermine the payments situation of the EMS, very much as the creation of excess national liquidity will erode a currency’s international strength.

The creation of ECUs against the contribution of 20 percent of a country’s gold and gross U.S. dollar reserves to the EMCF does not in itself constitute the creation of international liquidity. It only substitutes globally usable liquidity (U.S. dollars and gold) for liquidity that, at present, can only be used regionally and is subject to special restrictions.

While the creation of ECUs against gold does not create liquidity, it mobilizes reserves that otherwise may not have been used, and in this way may encourage less stringent policies. Because of the differences between the valuation of gold in the books of some EMS central banks and the market-related rates at which it is exchanged against ECUs, there is a statistical increase in international liquidity as shown in International Financial Statistics,38 though this does not change the real liquidity position of a country. However, some of the central banks concerned employ procedures under which the domestic liquidity effect of such differences in gold valuation is sterilized.

The use of the EC and EMS credit facilities does not necessarily create international liquidity. For a credit under the very shortterm financing facility, the amount of the creditor central bank’s currency in circulation increases, and a debtor position in ECUs is created. While the debtor position will disappear with settlement of the debt, the question of whether the newly created amount of the creditor currency remains in circulation or will disappear depends on the means the debtor central bank will employ to meet its settlement obligations. If, under a credit facility like the shortterm monetary support or the mediumterm financial assistance, a credit was granted in EMS currencies, the effect would be similar to a transaction under the very shortterm financing facility. If it was granted in foreign exchange (U.S. dollars) or in ECUs, there would only be a transfer of international liquidity from one central bank to another. A temporary creation of international liquidity could be imagined if the creditor central banks were to regard the claims they acquired as liquid, similar to a reserve tranche position in the IMF.

If, in the future, a European Monetary Fund were to be empowered to grant credits, the situation would be somewhat but not greatly changed. The granting of credits by a European Monetary Fund in ECUs would imply the replacement of national liquidity sources by an EC source. Presumably, the debtor central bank would convert ECUs with creditor central banks into national currencies or foreign exchange for intervention purposes, or use them outright for meeting settlement obligations. The effects in each case would be the same as in similar transactions described earlier, although with one important difference. Instead of claims on other central banks as at present, the creditor banks would receive newly issued ECUs, which are indistinguishable from other ECU holdings. In this way, there would be a temporary increase in international liquidity to the extent that actual use was made of loans from a European Monetary Fund. In the longer term, credit operations by a European Monetary Fund could give rise to a varying but permanent outstanding amount of additional ECUs.

An altogether different situation would exist once a European Monetary Fund is empowered to issue ECUs, not only against contributions in gold and U.S. dollars and in connection with credit operations, but also against national currencies or simply without any counterpart, similar to the IMF’s allocation of special drawing rights (SDRs). The ECUs thus created would be indistinguishable from others and could be used in the same manner for settling intervention debts (or for any other international transaction that might be possible by then), and thus would contribute to an increase in international liquidity.

In this connection, it is interesting to examine whether the attitudes of EMS member countries on matters of monetary and liquidity policies have differed as they arose in the context of the IMF, the EMS, or in a strictly national framework. A careful look at individual EC member countries that participate in the EMS reveals that they attempt to adopt a consistent approach on monetary policy both in an international or national context. There are countries that follow a more conservative stability-oriented line in domestic monetary policy, with regard to liquidity creation within the EMS as well as with regard to the size of quota increases or the creation of SDRs in the IMF. And there are others that have adopted a less conservative and more expansion-oriented policy stance regarding domestic and international monetary problems.

To sum up, the European Monetary System does not at present permanently create international liquidity, except in a statistical sense. Schemes that could lead to the permanent creation of international liquidity, although only of a somewhat limited usability, will probably not be realized for some time to come. The present attitude of EMS member countries with regard to monetary policy does not give reason to assume that they would adopt different standards for monetary policy depending on whether they arise in the context of the International Monetary Fund or the European Monetary System.

The Experience, 1979-82
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