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The course take-away:• Institutions matter…• The ways countries interact in the international arena
partly depends on their institutional context.
• What is an institution?– A set of rules (structures/constraints/mechanisms)
that govern the behavior of a given set of actors in a given context.
– An equilibrium?
What do international institutions do?• Informational role?
– E.g., trade agreements
• Lock-in– E.g. Human rights agreements– Ulysses & the sirens– (Lock-in works for democracies, what about
dictatorships?)
• Obfuscate– dirty laundry, scapegoat, dark knight?
• Solve collective action problems?– Pool reserves in case of financial crises?
Why was the IMF created?
Why did we ever need the IMF?A puzzle
1944
Degree of global capital mobility
1971-3
Fixed exchange rates
+
Capital controls
Floating exchange rates
+
Open capital flows
Conclusion:
Cannot maintain (global) fixed exchange rates in the presence of
high capital mobility…?
A puzzle:Why were countries able to maintain fixed exchange
rates with high capital mobility in the late 19th century?
1944
Degree of global capital mobility
1971-3
Fixed exchange rates
+
Capital controls
Floating exchange rates
+
Open capital flows
1870 Interwar period
Fixed exchange rates
+
Open capital flows
Why?
Answer: Democracy
1944
Degree of global capital mobility
1971-3
Fixed exchange rates
+
Capital controls
Floating exchange rates
+
Open capital flows
1870 Interwar period
Fixed exchange rates
+
Open capital flows
Growing #’s of democraciesFew democracies
Growth of democracy (minimalist definition)
1870 (7): 1884 (8): 1897 (12): 1911 (17):
United States Norway Netherlands Sweden
Canada 1885 (9): 1901 (14): Portugal
France United Kingdom Australia 1912 (18):
Switzerland 1890 (10): Denmark Argentina
Greece Luxemburg 1909 (15):
Orange Free State 1894 (11): Cuba
New Zealand Belgium Chile
(lost OFS – 1902)
Why?
• So, why do fixed exchange rates pose a problem for democracies in the face of highly mobile capital?
Pure gold standard• Country A imports from Country B
• Gold moves from A to B (re-coined/minted)
• Less money in A lower prices
• More money in B higher prices
Country B imports from Country A
• Balance is restored
With paper money
• Central Banks intervene by adjusting interest rates
• So gold doesn’t actually flow
• Gold Standard strict discipline!
What is “discipline”?
• What do “lower prices in Country A” mean?
• Supply of money down
• More expensive to borrow
• Jobs cut!
• People don’t eat!
People don’t eat
Under authoritarianism:
• Let them eat cake
Under democracy:
• Incumbents lose elections
Hazard Rate over Time for Democracies (Solid Line) & Dictatorships (Dotted Line) – Time in years
2015105
0.625
0.5
0.375
0.25
Time (years)
Hazard Rate
Time (years)
Hazard Rate
Stylized history• Late 19th century:
– Mobile capital, authoritarian governments
• Interwar years:– Mobile capital + democracy beggar-thy-neighbor
• Bretton Woods (1944-1971/3):– Capital controls + democracy
• Post Bretton Woods:– Floating exchange rates
What was the IMF supposed to do?
• Soften the blow
• Lend to “Country A” deficit-countries so that adjustment can be gradual
Problem• Keynes Plan called for contributions totaling $26 billion
(with $23 billion from the US)
• The White Plan called for only $5 billion (with $2 billion from the US)
• Compromise:– $8.8 billion, with just $2.75 billion from the US
• The US would only provide Marshall Plan assistance to countries that did not seek additional assistance from the IMF
• On the eve of the current crisis:– instead of having reserves approximating half of the value of
global imports, the IMF holds on reserve a total of less than 2 percent of global imports
IMF Arrangementshttp://www.imf.org/external/np/exr/map/lending/index.htm
• Iceland
• Turkey
• Seychelles
• Pakistan
• Georgia
• Mongolia
What is theInternational Monetary Fund?
Based on:
Vreeland, James Raymond, The International Monetary Fund: Politics of Conditional Lending (Routledge, January 2007).
• 1944: 44 countries signed the Bretton Woods agreement
– International Monetary Fund (stability)
– World Bank (development)
• The “Bretton Woods” Institutions.
The IMF was given 2 tasks:
1. Surveillance.
2. Lending.
The IMF has mainly focused on the latter function – so we will too…
But I’ll touch on surveillance at the end.
Why lending?• Gold standard – each currency’s value was
ultimately backed up by gold.
• A balance of payments deficit could lead to a depletion of gold reserves
• Lowered confidence that the government can really back up the value of the currency
• Run on the currency… hyperinflation, breakdown of economic order!
• Governments close up trading!
IMF lending as insurance
• A loan from the IMF enables a country to survive a temporary balance of payments deficit.
• The world shifted away from the Bretton Woods-gold standard in the 1970s
• The old exchange system collapsed.
• The IMF faced a crisis of purpose.
• But the IMF was already involved in the developing world.
• Expanded this role – not just lending for stability, but also to promote development.
The shift?
Was there really a shift?Figure 1.1: Percentage of countries participating in IMF programs
0.00
0.05
0.10
0.15
0.20
0.25
0.30
0.35
0.40
0.45
0.5019
46
1949
1952
1955
1958
1961
1964
1967
1970
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
Year
Per
cen
t
Western Europe, US and Japan Rest of the world
• Who is the IMF?
• Where do the resources for “loans” come from?
Stepping back a moment…
• Currently 185 members.
• (Non-member independent countries: Andorra, Liechtenstein, Nauru, Taiwan, Cuba, and North Korea)
• Members have “votes” according to the size of their subscription to the IMF…
Who is the IMF?
Where do the resources for “loans” come from?
• Members provide a contribution called the member’s quota (held on reserve).
• The size of the quota is a function of the country’s economy:
• GDP
• current account transactions
• official reserves
Largest: USA (SDR 37,149.3 million). Smallest: Palau (SDR 3.1 million).
Quotas
• Determine “voting power” at the IMF.–US: 17%–G5: 38%
These guys call the shots! An issue we’ll get back to…
So…as an international lender,
• If a country gets into a balance of payments crisis, or for whatever reason, has a shortfall in its foreign reserves,
• The IMF can provide a loan (lest this country enter into destructive policies).
• Problem: This “bailing out” option lowers the incentive to pursue sound policy.
“Moral Hazard.”
Solution?• If the IMF determines that the need for an IMF loan
is due to bad policy,
• The Fund imposes policy conditions in return for the loan.
• This arrangement of conditions for loans is known as “Conditionality.”
• Note that the loan is not provided upfront, but disbursed in “tranches,” subject to reviews of compliance with conditions.
Policy conditions usually entail:• Fiscal austerity
– cutting government services and increasing taxes
• Tight monetary policy– raising interest rates and reducing credit creation
• Currency devaluation.
• What are the goals of IMF programs?
– Economic stability.
– Economic growth.
La loi
• LETTER OF INTENT
• Drafted (by whom?)… signed by finance minister, central bank president, and/or chief executive.
• Sent to the Executive Board for approval
• 1st “tranche” of loan released.
Recidivism is the norm
Extreme examples from around the world:
• South Korea spent 13 years under consecutive agreements from 1965 to 1977.
• Zaire 14 years straight (1976-1989).
• Liberia 15 years (1963-1977).
• Peru participated in consecutive agreements from 1954 to 1971 (18 years).
• Panama from 1968 to 1987 (20 years of consecutive agreements)
• After a stint of seven years (1961 to 1967), Haiti entered into agreements again from 1970 to 1989, for a total of 27 out of 29 years.
Review of background on the IMF:• Similar to a credit union (access to pool of
resources).
• Can lend from this pool to countries in crisis.
• Moral hazard: lowers the incentive to avoid bad policies.
• Thus, Conditionality – force the country to follow “good” policies in return for a loan.
So, you can think of an IMF program as having 2 components: loan + conditions.
