1 / 38

The International Monetary Fund

The International Monetary Fund. CHAPTER 16. Introduction. 1941 is a turning point in the history of global financial arrangements British economist John Maynard Keynes wrote a proposal for an International Clearing Union (ICU) Known as the Keynes Plan

emily
Download Presentation

The International Monetary Fund

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. The International Monetary Fund CHAPTER 16

  2. Introduction • 1941 is a turning point in the history of global financial arrangements • British economist John Maynard Keynes wrote a proposal for an International Clearing Union (ICU) • Known as the Keynes Plan • Subsequently taken up by the British Treasury • US Treasury official Harry Dexter White wrote a proposal for an International Stabilization Fund (ISF) • Subsequently embraced wholeheartedly by US Treasury Secretary Henry Morgenthau • Known as the White Plan • Two plans were taken up at the Bretton Woods Conference in July 1944 • White Plan gained prominence, resulting in creation of the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (the World Bank)

  3. Monetary History • Throughout 20th century, countries struggled 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 a dynamic of its own

  4. The Gold Standards • Late 19th and early 20th centuries were characterized by a highly integrated world economy • Supported from approximately 1870 to 1914 by an international financial arrangement known as the gold standard • Each country defined the value of its currency in terms of gold • Most countries also held gold as official reserves • Since value of each currency was defined in terms of gold, rates of exchange among the currencies were fixed • When World War I began in 1914, the countries involved in that conflict suspended the convertibility of their currencies into gold • After the war, unsuccessful attempt to return international financial system back to gold standard

  5. Gold-Exchange Standard • In 1922, there was an attempt to rebuild the pre-World War I gold standard. • New gold standard was different from the pre-war standard due to then current gold shortage • 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 known as 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 • At a system-wide level, each major rate was set to gold • Ignoring the implied rates among the various currencies • Politics of the day prevailed over economics

  6. Gold-Exchange Standard • Gold-exchange standard consisted of a set of center countries tied to gold and a set of periphery countries holding these center-country currencies as reserves • By 1930, nearly all the countries of the world had joined • However system’s design contained a significant incentive problem for the periphery countries • Suppose a periphery country expected that the currency it held as reserves was going to be devalued against gold • Would be in interest of country to sell its reserves before devaluation 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 pound’s tie to gold, leading to many other countries following suit • By 1937, no countries remained on gold-exchange standard

  7. Gold-Exchange Standard • Overall standard was not a success • Some international economists (e.g. Eichengreen, 1992) have even seen it as a major contributor to Great Depression • Throughout 1930s a system of separate currency areas evolved • Combination of both fixed and floating rates • Lack of international financial coordination helped contribute to the economic crisis of the decade • At the worst of times, countries engaged in a game of competitive devaluation

  8. The Bretton Woods System • During World War II, United States and Britain began to plan for the post-war economic system • White and Keynes understood the contribution of previous breakdown in international 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 Bretton Woods Conference • Conference produced a plan that became known as the Bretton Woods system

  9. The Bretton Woods System • Essence of the system was an adjustable gold peg • US dollar was to be pegged to gold at $35 per ounce • 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 international financial system • Currency pegs were to remain fixed except under conditions that were termed “fundamental disequilibrium” • However, concept was never carefully defined • Countries were to make their currencies convertible to US dollars as soon as possible • But process did not happen quickly

  10. The Bretton Woods System • Problems became apparent by end of 1940s • Growing non-official balance of payments deficits of United States • Deficits reflected official reserve transactions in support of expanding global dollar reserves • Although Bretton Woods agreements allowed par values to be defined either in gold or dollar terms • In practice, the dollar became central measure of value

  11. Triffin Dilemma • Belgian monetary economist Robert Triffen described problem of expanding dollar reserves in his 1960 book Gold and the Dollar Crisis • Problem became known as the Triffin dilemma • Contradiction between requirements of international liquidity and international confidence • “Liquidity” 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, international confidence would suffer • Triffin argued that US could not back up an ever-expanding supply of dollars with a relatively constant amount of gold holdings

  12. Figure 16.1. The Triffin Dilemma

  13. Triffin Dilemma • In October 1960 London gold market price rose above $35 to $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 $35 price in London market • At 1964 annual IMF meeting in Tokyo, representatives began to talk publicly about potential reforms in international 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 potential reforms • Johnson Administration was more flexible than the Kennedy Administration

  14. Triffin Dilemma • British pound was devalued in November of 1967 • President Johnson issued a statement recommitting the United States to $35 per ounce gold price • However, in early months of 1968, the rush began • In early 1971, capital began to flow out of dollar assets and into German mark assets • German Bundesbank cut its main interest rate to attempt to curb purchase of marks • Germany and a few other European countries joined Canada’s floating dollar rate in 1971 • Thereafter, capital flowed from dollar assets to yen assets • US President Nixon accepted US Treasury Secretary John Connally’s recommendation to close its “gold window” • Effort to force other countries to revalue against US dollar

  15. The Non-System • At Smithsonian conference in 1971, several countries revalued their currencies against dollar • Gold price was raised to $38 per ounce • Canada maintained its floating rate • In June 1972, a large flow out of US dollars into European currencies and Japanese yen occurred • Flows stabilized, but new crisis reappeared in January 1973 • Swiss franc began to float • In February, there was pressure against German mark and there were closures of foreign exchange markets in both Europe and Japan • On February 12th, US announced a second devaluation of the dollar against gold to $42

  16. The Non-System • During 1974 and 1975, countries went through nearly continuous consultation and disagreement in a process of accommodating their thinking to floating rates • In November 1975, proposed amendment to IMF’s Articles of Agreement restricted allowable exchange rate arrangements to • Currencies fixed to anything other than gold • Cooperative arrangements for managed values among countries • Floating

  17. The Operation of the IMF • IMF is an international financial organization comprised of 183 member countries • 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 to members under “adequate safeguards” • Reduce the duration and degree of international payments imbalances

  18. The Operation of the IMF • Major decision-making body is its Board of Governors • Each member appoints a Governor and an Alternate Governor • Day-to-day business rests in the hands of Executive Board • Composed of 22 Executive Directors plus Managing Director • Six of the 22 Executive Directors are appointed by largest IMF quota holders • Remainder elected by groups of member countries not entitled to appoint Executive Directors • Managing Director is appointed by Executive Board and is traditionally European (often French) • Chairs Executive Board and conducts IMF’s business • Currently three Deputy Managing Directors

  19. Table 16.1. Administrative Structure of the IMF

  20. The Operation of the IMF • Most important feature of IMF is its quota system • Determine both the amount members can borrow from the IMF and their relative voting power • Higher a member’s quota, the more it can borrow and the greater its voting power • Members’ quotas are their subscriptions to the IMF • Based on their relative sizes in the world economy • Pays one fourth of its quota in widely-accepted reserve currencies (US dollar, British pound, euro, or yen) or in Special Drawing Rights • Pays remaining three-quarters of quota in its own national currency

  21. The Operation of the IMF • The IMF engages in four areas of activity • Economic surveillance or monitoring • Dispensing of policy advice • Lending • Perhaps most important • Technical assistance

  22. Tranche • If an IFM member faces balance of payments difficulties • Can automatically borrow one fourth of its quota in the form of a reserve tranche • When the IMF lends to a member country, what actually happens is domestic country purchases international reserves from the IMF using its own domestic currency reserves • Member country is then obliged to repay IMF by repurchasing its own domestic currency reserves with international reserve assets • IMF lending is known as a “purchase-repurchase” arrangement

  23. Tranche • Credit tranches • Originally, each were equal to ¼ of the members’ quotas • In the late 1970s, credit tranches were increased to 37.5% of quota • First credit tranche is more or less automatic • Second through fourth credit tranches require that the member adopt policies (conditionality) that will solve balance of payments problem at hand • Effectively limits a member country’s credit to 150 percent of its quota • As IMF evolved, it created a number of special credit facilities that extend potential credit beyond 150% level • Drawings on IMF by its members have to be repaid • Five-year limit was established

  24. Figure 16.2. IMF Lending

  25. Table 16.2. Special Credit Facilities

  26. Ideal Role of the Fund • Development of a country requires an inflow of private foreign savings • Inflow would cover a current account deficit often caused by import of capital goods • Occasionally, this private foreign savings disappears • Resulting in a balance of payments crisis • In these instances IMF steps in • Member draws on its reserve and credit tranches • Repaying credit tranche debts in five years time • Thus, IMF offers short-term credit, stepping in to replace private foreign savings on those rare occasions

  27. History of IMF Operations—1950s-1960s • In its initial years, the IMF was nearly irrelevant • However, Suez crisis of 1956 forced Britain to draw on its reserve and first credit tranches • Japan drew on its reserve tranche in 1957 • Between late 1956 through 1958 IMF was involved in policies that lead to the convertibility of both British pound and French franc • Concerned about the United States’ ability to defend the dollar and other major industrialized countries’ abilities to maintain their parities • IMF introduced the General Arrangements to Borrow (GAB) in October 1962 • Involved the central banks of ten countries setting aside a $6 billion pool to maintain stability of Bretton Woods system • Countries involved became known as Group of Ten or G-10 and comprised a rich countries club

  28. History of IMF Operations—Mid-to-Late 1960s • By 1965, US faced two unappealing options • Reduce world supply of dollars to enhance international confidence by reducing international liquidity • Expand world supply of dollars to enhance international liquidity by reducing international confidence • But where was the world to turn for a reserve asset? • 1964 and 1968 annual meetings of IMF resulted in creation of a new reserve asset to supplement both gold and dollar • Known as a special drawing right or SDR

  29. History of IMF Operations—Special Drawing Rights, 1970s • Came into being in July 1969 • In 1971, when United States broke gold-dollar link, the SDR was redefined in terms of a basket of five currencies—dollar, pound, mark, yen, and franc • Allocated in proportion to members’ quotas • Never played the important role envisaged for them • Perhaps best seen as one of many attempts to resolve Triffin dilemma

  30. History of IMF Operations, 1970s • Oil price increases of 1973-1974 caused substantial balance of payments difficulties for many countries of the world • In June 1974, the IMF established an oil facility to assist these countries • Acted as an intermediary, borrowing funds from oil producing countries and lending them to oil importing countries • A second oil facility was established in 1975 • Slightly more strict than the first • During this time, a bias towards private-sector lending helped to prevent sufficient increases in IMF quotas • Given the limits of the quota system, IMF was becoming more of a financial intermediary—less of an international cooperative credit arrangement

  31. History of IMF Operations, 1970s-1980s • In 1976, IMF began to sound warnings about sustainability of developing-country borrowing from commercial banking system • Banking system reacted with hostility to these warnings • Argued Fund had no place interfering with private transactions • The 1980s began with a significant increase in real interest rates and a significant decline in non-oil commodity prices • Increased cost of borrowing and reduced export revenues

  32. History of IMF Operations—1980s • In 1982, IMF calculated that US banking system outstanding loans to Latin America represented approximately 100% of total bank capital • In August 1982 Mexico announced it would stop servicing its foreign currency debt • At the end of the month, Mexican government nationalized its banking system • 1982 also found debt crises beginning in Argentina and Brazil • Argentina: Overvalued exchange rate, used as a “nominal anchor” to curb inflationary expenditures • Brazil: Rates of devaluation did not keep up with rates of inflation, causing an overvalued real exchange rate

  33. History of IMF Operations, 1980s • International commercial banks began to withdraw credit from many of the developing countries of the world • Debt crisis became global • Within a few years of outbreak phenomenon of net capital outflows appeared • Involved capital account payments of debtor countries exceeding capital account receipts • By second half of 1980s, some debt was trading at discounts in secondary markets • In 1989, US Treasury Secretary Nicholas Brady proposed a plan in which IMF and World Bank lending could be used by developing countries to buy back discounted debt • Amounted to partial and long-needed debt forgiveness, were approved by the IMF and became known as the Brady Plan • Also allowed for extending time periods of debt and provided for new lending

  34. History of IMF Operations, 1990s • Starting in the 1990s, private, non-bank capital began to flow to developing countries in the form of both direct and portfolio investment • Number of highly-indebted countries began to show increasing unpaid IMF obligations • In November 1992, a Third Amendment to the Articles of Agreement allowed for suspension of voting rights in the face of large, unpaid obligations • Mexico underwent a second crisis in late 1994 and early 1995 • IMF was unable to respond effectively—US Treasury assembled a loan package

  35. History of IMF Operations, 1990s • In 1997-1998, crises struck a number of Asian countries—most notably Thailand, Indonesia, South Korea, and Malaysia and also Russia • Resulted in sharp depreciations of the currencies • In the cases of Thailand, Indonesia, and South Korea, IMF played substantial and controversial roles in addressing crises • Loan packages were designed with accompanying conditionality agreements • Supplementary Reserve Facility was introduced to provide large volumes of high-interest, short-term loans to selected Asian countries • In October and November 1998, IMF put together a package to support Brazilian currency, the real • Attempt to prevent Asian and Russian crises from spreading to Latin America • Still, Brazil was forced to devalue the real in January 1999

  36. History of IMF Operations, 1990s • Recent years have witnessed important changes at the IMF • In 1997 General Agreement to Borrow was supplemented by the New Arrangement to Borrow • Involves 25 IMF members agreeing to lend up to US$46 billion to IMF in instances where quotas prove to be insufficient • In 1999, a new lending facility was added • Poverty Reduction and Growth Facility was created to replace the 1987 Enhanced Structural Adjustment Facility • Represents beginning of an attempt to integrate poverty reduction consideration into macroeconomic policy formation of IMF • In 1999, quotas were increased by 45% to a total of US$283 billion

  37. An Assessment • When IMF opened for business in 1947, its quotas were approximately 13% of world imports • Quotas failed to address the needs of the post-war European economy • Since 1947, IMF quotas as a percent of world imports have fallen to approximately 4% • A number of observers have questioned whether IMF has succeeded in addressing global liquidity • John Maynard Keynes envisioned a global central bank with an international currency • This central bank would be responsible for regulating expansion of international liquidity • In light of concerns over liquidity, some observers have called for a return to the global central bank idea

  38. An Assessment • Keynes’s original Bretton Woods proposal also included adjustment requirements being distributed among deficit and surplus countries • However adjustment is solely the responsibility of deficit countries • Deficit countries are required to adjust no matter what the source of the deficit • Dell (1983) argues that requisite adjustments are too severe and violate purposes of IMF • Reform of existing IMF framework could involve • Reconstituting it more along the lines of a world central bank • Reaffirming role of the SDR as a reserve asset • Giving IMF independent responsibility for regulating world liquidity through expanded quotas and SDR management • Redesigning adjustment mechanisms to spread responsibility over deficit and surplus countries • Changes are radical and would require a complete redrafting of the IMF’s Articles of Agreement

More Related