Post on 04-Jun-2018
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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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The Gold Exchange Standard
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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The Gold Exchange Standard
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