IIE Chapter 17

8/13/2019 IIE Chapter 17

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Chapter 17: TheInternational Monetary

FundAn Introduction to International Economics: New

Perspectives on the World Economy


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Analytical Elements

Countries

Currencies

Financial assets


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The Year 1941

Working for the British Treasury, JohnMaynard Keynes began to write a proposal foran International Clearing Union (ICU) Keynes Plan

Working for the United States Treasury, HarryDexter White write a proposal for anInternational Stabilization Fund (ISF) White Plan

These plans were taken up at the BrettonWoods Conference of July 1944 and becamethe International Monetary Fund (IMF)


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Monetary History

Throughout 20thcentury, countriesstruggled with various arrangements for

the conduct of international finance None proved satisfactory In each case, the systems set up by

international economists were overtaken

by events Appears international financial system had adynamic of its own, stronger than thegovernance systems it overturned


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The Gold Standard

Late 19thand early 20thcenturies werecharacterized by a highly integrated worldeconomy

Supported from approximately 1870 to1914 by an international financialarrangement known as the gold standard

Each country defined the value of its currencyin terms of gold

Most countries also held gold as officialreserves Since value of each currency was defined interms of gold, rates of exchange among thecurrencies were fixed


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The Gold Standard

When World War I began in 1914, thecountries involved in that conflictsuspended the convertibility of theircurrencies into gold

After the war, there were unsuccessfulattempt to return international financialsystem back to gold standard


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The Gold Exchange Standard

In 1922, there was an attempt to rebuild thepre-World War I gold standard. New gold standard was different from the

pre-war standard due to then current goldshortage Countries that were not important financial centers

did not hold gold reserves but instead held gold-convertible currencies

For this reason, the new gold standard was knownas the gold-exchange standard

Goal was to set major rates at their pre-war levels,especially British pound

In 1925, it was set to gold at the overvalued, pre-war rate of US$4.86 per pound Caused balance of payments problems and market

expectations of devaluation


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At a system-wide level, each major rate wasset to gold, ignoring the implied rates amongthe various currencies

Gold-exchange standard consisted of a set ofcenter countries tied to gold and a set ofperiphery countries holding these center-country currencies as reserves

By 1930, nearly all the countries of the world

had joined However systems design contained a

significant incentive problem for theperiphery countries


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Gold Exchange Standard

Suppose a periphery country expected that thecurrency it held as reserves was going to bedevalued against gold

Would be in interest of country to sell its reservesbeforedevaluation took place so as to preserve

value of its total reserves Would put even greater pressure on center

currency As the British pound was set at an overvalued

rate there was a run on the pound (1931)

Forced Britain to cut pounds tie to gold, leadingto many other countries following suit By 1937, no countries remained on gold-

exchange standard


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Overall standard was not a success Some international economists (e.g.

Eichengreen, 1992) have even seen it as amajor contributor to Great Depression

Throughout 1930s a system of separatecurrency areas evolved

Combination of both fixed and floating rates

Lack of international financial coordinationhelped contribute to the economic crisis ofthe decade

At the worst of times, countries engaged in agame of competitive devaluation


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Bretton Woods System

During World War II, United States andBritain began to plan for the post-wareconomic system

White and Keynes understood thecontribution of previous breakdown ininternational economic system to war Hoped to avoid same mistake made after World War

I But were fighting for relative positions of countries

they represented

White largely got his way during 1944 BrettonWoods Conference Conference produced a plan that became known as

the Bretton Woods system


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Bretton Woods System

Essence of the system was an adjustable goldpeg US dollar was to be pegged to gold at $35 perounce

Other countries of the world were to peg to the

US dollar or directly to gold Placed the dollar at the center of the new internationalfinancial system

Currency pegs were to remain fixed exceptunder conditions that were termedfundamental disequilibrium However, concept was never carefully defined

Countries were to make their currenciesconvertible to US dollars as soon as possible But process did not happen quickly


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Triffin Dilemma

Belgian monetary economist Robert Triffendescribed problem of expanding dollar reserves inhis 1960 book Gold and the Dollar Crisis Problem became known as the Triffin dilemma

Contradiction between requirements of

international liquidity and internationalconfidenceLiquidity refers to the ability to transform assets into

currencies

International liquidity required a continual

increase in holdings of dollars as reserve assets As dollar holdings of central banks expanded relative to

US official holdings of gold, however, internationalconfidence would suffer

The United States could not back up an ever-expandingsupply of dollars with a relatively constant amount ofgold holdings


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Figure 17.1: The TriffinDilemma


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Triffin Dilemma

In October 1960 London gold market price rose above $35to $40 an ounce Calls for a change in the gold-dollar parity In January 1961, the Kennedy Administration pledged to

maintain $35 per ounce convertibility U.S. joined with other European countries and set up a gold pool in

which their central banks would buy and sell gold to support the $35price in London market

At 1964 annual IMF meeting in Tokyo, representativesbegan to talk publicly about potential reforms ininternational financial system Attention was given to the creation of reserve assets

alternative to US dollar and gold In 1965, the United States Treasury announced that it was

ready to join in international discussions on potentialreforms Johnson Administration was more flexible than the Kennedy

Administration


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Triffin Dilemma

British pound was devalued in November of 1967 President Johnson issued a statement

recommitting the United States to $35 per ouncegold price However, in early months of 1968, the rush out

of dollars began In early 1971, capital began to flow out of dollar

assets and into German mark assets Thereafter, capital flowed from dollar assets to

yen assets US President Nixon accepted US Treasury

Secretary John Connallys recommendation to

close its gold window


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The Non-System

At Smithsonian conference in 1971, severalcountries revalued their currencies againstdollar Gold price was raised to $38 per ounce

In June 1972, a large flow out of US dollarsinto European currencies and Japanese yenoccurred Flows stabilized, but new crisis reappeared in

January 1973 On February 12th, US announced a second

devaluation of the dollar against gold to $42

The international financial system had

crossed a threshold, although this was notfully appreciated at the time


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The Non-System

During 1974 and 1975, countries wentthrough nearly continuous consultation

and disagreement in a process ofaccommodating their thinking to floatingrates

In November 1975, proposed amendment

to IMFs Articles of Agreement restrictedallowable exchange rate arrangements to Currencies fixed to anything other than gold Cooperative arrangements for managed valuesamong countries

Floating


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The Operation of the IMF

IMF is an international financialorganization comprised of 187 membercountries

Purposes, as stipulated in its Articles of

Agreement, are to Promote international monetary cooperation Facilitate the expansion of international trade Promote exchange stability and a multilateral

system of payments Make temporary financial resources available tomembers under adequate safeguards

Reduce the duration and degree of internationalpayments imbalances


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Table 17.1: AdministrativeStructure of the IMF

Body Composition Function

Board ofGovernors

One Governor and oneAlternate Governor for eachmember

Meets annually; highest decision-making body

Executive

Board

24 Executive Directors plus

Managing Director

Day-to-day operations; operates

by consensus and voting

ManagingDirector

Head of Staff and Chair ofExecutive Board; responsible forstaffing and general business

DeputyManagingDirector

First Deputy ManagingDirector and two otherDeputy Managing Directors

Assist Managing Director

Staff Citizens of membercountries

Run departments


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IMF Quota System

The IMF can be thought of as a global creditunion in which countries shares are

determined by their quotas Quotas determine both the amount members

can borrow from the IMF and their votingpower within the IMF

One quarter of a members quota is held in areserve currency US dollar, British pound, euro, yen or IMF special

drawing right (SDR)

Three quarters of the quota is held in amembers own currency


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Figure 17.2: IMF Quotas asof 2008


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IMF Lending

IMF lending takes place through acomplex process involving three stages

Reserve tranche: 25 percent of quota Credit tranche

Special or extended facilities

Since the reserve tranche is considered to

be part of a members foreign reserves, itis automatic and free of policy conditions

The credit and special or extended

facilities are not automatic and involvepolicy conditions


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IMF Lending: CreditTranches

Each credit tranche is in terms of 25percent of a members quota

Lower credit tranche: first 25 percent ofquota above reserve tranche

Upper credit tranches: subsequent 25

percent of quota increments Obtained through Stand-By Arrangements(SBAs)

Conditions set out in letter of intent

The higher the credit tranche, the moreconditions placed on the borrowing member


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Purchase-RepurchaseArrangments

IMF lending above the reserve tranche canbe conceived of as a purchase-repurchasearrangement

See Figure 17.3 When the IMF lends to a member, that

memberpurchasesforeign reserves usingits own domestic currency

The member then repays the IMF byrepurchasingits domestic currencyreserves with foreign reserves


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Figure 17.3: IMF Lending


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Special or ExtendedFacilities

Special non-concessional lending: StandardIMF charge in purchase-repurchase

Extended fund facility (EFF) Flexible Credit Line (ECL)

Emergency assistance

Special concessional lending: IMF charge

below the standard rate Extended Credit Facility (ECF)

Standby Credit Facility (SCF)

Rapid Credit Facility (RCF)


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Sources of IMF Funds

Members quotas

Selling gold holdings

Multilateral borrowing arrangements General Arrangements to Borrow (GAB)

New Arrangements to Borrow (NAB)

As of 2009, the total resources availableto the IMF were increased to US$750billion

Ongoing discussions are considering

raising this to US$1 trillion


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History of IMF Operations:1950s

In its initial years, the IMF was nearlyirrelevant

However, Suez crisis of 1956 forcedBritain to draw on its reserve and firstcredit tranches

Japan drew on its reserve tranche in 1957 From 1956 through 1958, the IMF was

involved in policies that lead to theconvertibility of both British pound andFrench franc

The IMF then began to sign a number ofSGA with a growing number of countries,including developing countries


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History of IMFOperations:1960s

Reflecting the Triffin dilemma, the IMFbecame concerned about the United Statesability to defend the dollar and other majorindustrialized countries abilities to maintaintheir parities

This lead the IMF to introduce the GeneralArrangements to Borrow (GAB) in 1962

The GAB involved the central banks of tencountries (the Group of 10) setting aside aUS$6 billion pool to maintain the stability ofthe Bretton Woods system

Over time, the Group of 11 (includingSwitzerland) expanded the GAB

The GAB and NAB are currently funded to

US$750 billion


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History of IMF Operations1960s

By 1965, US faced two unappealing options Reduce world supply of dollars to enhance

international confidence by reducing internationalliquidity

Expand world supply of dollars to enhanceinternational liquidity by reducing internationalconfidence

But where would the world turn for a reserveasset? In 1969, the IMF introduced the special drawing

right (SDR) as a new reserve asset

Initially defined in value in terms of gold, it is nowdefined as a basket of: the US dollar, the British

pound, the yen, and the euro


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Oil Shocks of the 1970s

The oil price increases of 1973-1974 causedsubstantial balance of payments difficultiesfor many countries of the world

In 1974 and 1975, the IMF established

special oil facilities to assist these countries The IMF acted as an intermediary, borrowing thefunds from oil-producing countries and lending themto oil-importing countries

Despite these facilities, most of the oil

producing country revenues were recycledto other countries via the commercial bankingsystem


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Debt Crisis

In 1976, IMF began to sound warningsabout sustainability of developing-countryborrowing from commercial bankingsystem Banking system reacted with hostility to thesewarnings, arguing that the IMF had no placeinterfering with private transactions

The 1980s began with a significantincrease in real interest rates and asignificant decline in non-oil commodityprices

Increased cost of borrowing and reduced exportrevenues


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Debt Crisis

In 1982, IMF calculated that US bankingsystem outstanding loans to Latin Americarepresented approximately 100% of totalbank capital

In August 1982 Mexico announced it would stopservicing its foreign currency debt At the end of the month, Mexican governmentnationalized its banking system

1982 also found debt crises beginning in

Argentina and Brazil The IMF introduced a number of SBAs and

special facilities to address what became aglobal debt crisis


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Debt Crisis

Starting in the 1990s, private, non-bankcapital began to flow to developingcountries in the form of both direct andportfolio investment

Number of highly-indebted countriesbegan to show increasing unpaid IMFobligations

In November 1992, a Third Amendmentto the Articles of Agreement allowed forsuspension of voting rights in the face oflarge, unpaid obligations

Mexico underwent a second crisis in late1994 and early 1995, and the IMFresponded in cooperation with the USTreasury


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Asian Crisis

In 1997-1998, crises struck a number ofAsian countriesmost notably Thailand,

Indonesia, South Korea, and Malaysia Resulted in sharp depreciations of the

currencies In the cases of Thailand, Indonesia and

South Korea, the IMF played substantial and

controversial roles in addressing the crises Loan packages were designed with accompanying

conditionality agreements Questions were raised about the appropriateness of

the packages and the IMFs advocacy of liberalizingcapital accounts


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Russian Crisis

The Russian economy was hit by a crisis in1998

IMF support of the Russian transition hadbegun in the early 1990s

The IMF arranged a very large loan to Russiain 1995

This proved to be insufficient as a full-fledgedbanking and currency crisis occurred in 1998

This required the IMF to draw on the GAB forthe first time since 1978

The IMFs role here was severely criticized


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Brazil and Argentina

In 1998, the IMF tried to support theBrazilian currency to attempt to insulate it

from the Asian and Russian crises The IMF failed, and Brazil was forced to

devalue in 1999

The IMF had also been involved for some

years in supporting a currency board inArgentina

This came spectacularly undone in 2001 andleft the IMF open to criticism for not having

mapped out an exit strategy for the country


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Recent Changes

The early 2000s found the IMF sinking intoirrelevancy

Between 2001 and 2008, the number of newarrangements declined precipitously (seeFigure 17.4) This reflected booming private capital markets and

the accumulation of large foreign reserve balancesin many Asian countries

Because the IMFs operating budget dependson its loan charges, this proved to be difficult


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Figure 17.4: NewArrangements Approved,1990-2009


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Recent Changes

The IMF was unprepared for the globalfinancial crisis that began in 2007

The IMFs 2007 World Economic Outlookstated: Notwithstanding the recent bout of

financial volatility, the world economy stilllooks well set for robust growth in 2007 and2008

The crisis, however, put the IMF back into

business with agreements increasingsubstantially in 2009, many to Europeancountries

2008 was also a year when the quotas

reported in Figure 17.2 were established


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Political Economy of IMFLending

The analysis of the political economy of IMFlending takes place in terms of two variables

The value of loans (L) The number and strength of conditions (C)

These are depicted in Figure 17.5 in terms ofa hard bargaining line and an easy

bargaining line IMF member country governments weigh the

(marginal) benefits and costs of approachingthe IMF for a loan

Sovereignty costs are part of thesecalculations


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Figure 17.5: IMF Lending


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Political Economy of IMFLending

Newer thinking and research suggests that, insome cases, country governments mightprefer points along line B in Figure 17.5 topoints along line A

This would be to push reforms through in theface of domestic political opposition

Here blame is shifted to the IMF

This research also suggests that countrygovernment failures to abide by conditionalityagreements can simply be the result of achange in the benefit-cost calculations ofmember country governments


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An Assessment

The IMF was originally designed to support theBretton Woods system, a system the no longerexists

It is now operating in an era of unforeseen

capital mobility and has an uneven record ofsuccess

International financial arrangements are oftenevaluated in terms of their contributions to

liquidity and adjustment The IMF has never had the resources necessary to

contribute substantially to global liquidity

By only penalizing debtor members (no matter whatthe source of the adjustment problem) and not

creditor members, it has also been limited in its ability


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Options for Reform

Options for radical reform of the IMF fall intotwo categories

Reconstitution in the form of a global centralbank Reaffirming the SDR as a reserve asset

Giving the IMF responsibility for regulating global

liquidity Spreading adjustment requirements over

both debtor and creditor members This was the original vision of the Keynes plan of

1941

Documents

IIE Chapter 17