The International Monetary Fund

1. The International Monetary Fund

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. 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

12. 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

13. Table 16.1. Administrative Structure of the IMF

14. 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

15. 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

16. Figure 16.2. IMF Lending

17. Table 16.2. Special Credit Facilities

18. 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

19. 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

20. 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

21. THANK YOU