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While the IMF was successful in assisting nations to deal with the crisis of 2008–9, it could not (even if it had wanted to) stem the systemic changes that marked a turning point in the global economy. The post–Bretton Woods configuration of economic power has been turned upside down. The advanced economies are burdened with the cost of repairing the damage done by their financial institutions while their recoveries have stalled. The emerging market and developing countries emerged from the crisis relatively unscathed but can no longer count on exports to the United States to fuel their economic growth. This chapter reviews the challenges the IMF will face as its members deal with changes in their economic and political positions.
A tepid economic recovery left fiscal burdens in many advanced economies, and the effects of this legacy are explored in the first section. Ireland, Greece, and Portugal are saddled with large sovereign debt liabilities and have required assistance from the IMF and other European governments. The IMF faces the danger of being caught in a crossfire among the debtor governments, those that contributed to their relief, and its other members concerned about the Fund’s exposure to the European borrowers.
The debt crisis slowed but did not stop the expansion of global financial markets after the end of the Bretton Woods era. The growth of capital flows, which had begun in the 1960s and 1970s, accelerated in the 1980s and 1990s. This chapter deals with the IMF’s response to the widening scope of international capital. The record demonstrates that the IMF saw no conflict during this period between encouraging capital account liberalization and its mandate to promote economic stability.
The first section provides an overview of the reemergence of global finance. The trend was more pronounced in the upper-income countries but was also a part of the increased economic openness of some emerging market nations. The movement to the integration of financial markets was driven by many forces, including advances in communications and financial instruments, the growing acceptance of market-based resource allocations, and the promotion of deregulation by those who stood to benefit from this trend.
The IMF has been criticized for fostering premature capital deregulation, and the evidence on this charge is presented in the second section. The evidence confirms that the IMF encouraged its members, including those that borrowed from it, to decontrol capital movements. While the IMF did not compel governments to remove capital account restrictions, it did underestimate the risks associated with increased financial flows. There was ample evidence of the instability associated with financial deregulation in the experiences of several South American countries.
Future historians may, in fact, dub this the Age of Currency Crises: never before, not even in the interwar period, have currency crises played such a central role in world affairs....Currency crises – both crises that actually do happen and the sometimes desperate efforts of national governments and international agencies to head them off – have become a defining force for economic policy in much of the world.
The wave of financial globalization during the early and mid-1990s was accompanied by crises that demonstrated the volatility of capital flows. This chapter describes the European currency crisis of 1992–3 and the Mexican crisis of 1994–5. These events revealed that capital inflows could be quickly reversed and pose a threat to financial stability by undermining exchange rate commitments.
The background and outbreak of the European crisis are presented in the first section. European governments had formed a fixed exchange rate pact in the 1980s as part of a move toward deeper economic integration within the EC and strengthened their ties in the 1990s. But increases in German interest rates put pressure on the exchange rate pegs and demonstrated how fixed rates and unregulated capital could constrain national policies. Most of the governments subsequently proceeded with the introduction of the euro, although the United Kingdom withdrew from the arrangement.
The era of economic stability that prevailed during the middle 2000s came to an end with the Great Recession of 2008–9. The shock emanating from the United States and other advanced economies swept through the global economy, contracting trade and financial flows and depressing economic activity. This chapter describes the IMF’s attempts to avert a crisis and its response when the collapse occurred.
The “Great Moderation,” described in the first section, was characterized by declines in inflation and output volatility in most nations. Moreover, growth rates accelerated in the emerging market economies. The one discordant note was the increase in current account deficits in several advanced economies, most notably the United States. These were matched by surpluses in many emerging market economies as well as the oil exporters, which were accompanied by increased foreign exchange reserves. The reasons for and implications of these “global imbalances” have been widely debated. Some viewed them as the result of the transfer of funds from emerging nations with high savings rates to advanced economies with liquid financial markets and did not believe that they posed a threat to international financial stability. Others emphasized the role of diminished private and public savings in the advanced economies that left those nations vulnerable to capital outflows.
The IMF is the IGO that has been entrusted with the responsibility of promoting the IPGs of international economic and financial stability. This chapter deals with the establishment of the IMF after World War II and its responsibilities within the Bretton Woods system that lasted from 1945 through 1973. In succeeding chapters we will contrast the record of the IMF’s activities within this rule-based system with its actions during the post–Bretton Woods era.
The first section provides an account of the founding of the Bretton Woods system and the specific responsibilities of the IMF. The Allied victors of World War II established a new international monetary regime to prevent a repeat of the economic chaos of the 1930s. The system was based on fixed-but-adjustable exchange rates and the removal of restrictions on current account transactions. The IMF monitored the observance of its members of these commitments while providing credit to those with balance of payments disequilibria. The Bretton Woods system differed from the Gold Standard (1870–1914) in its reliance on controls on capital flows to provide members with the ability to use monetary policy to achieve full employment.
The second section describes the governance structure of the IMF, which was shaped by the United States, the postwar hegemonic power, and its West European allies. These countries devised a voting system based on economic size that allowed them to dominate the actions of the IMF and its policies. The new organization created lending programs that required members that borrowed from it to implement policy measures before credit was disbursed.
The impact of the East Asian crisis rippled across other emerging market nations that had borrowed in the international capital markets. Unlike the Asian crisis, these crises primarily involved the public sector. Lenders reassessed the ability of governments to meet their obligations and maintain their exchange rate commitments. Capital outflows led to more crises as sovereign borrowers defaulted on their debt and currency crises led to large devaluations. The IMF was active in managing the response to the emergencies but was hampered in some cases during the precrisis periods by the political aims of its principal members. This chapter provides an overview of the events leading up to the crises in Russia, Brazil, and Argentina, and how the IMF responded.
The first section summarizes the record of the Russian economy before its crisis in 1998 and its deterioration. The G7 leaders had supported Russia’s movement to a market economy and given the IMF and the World Bank the task of facilitating the transition. The Russian government successfully completed several programs with the IMF during the early 1990s. However, continuing fiscal deficits financed by capital inflows were a source of financial weakness. In 1998 another program was arranged with the IMF that included measures to improve the state’s finances, but the new policies were not approved by the Russian parliament. Capital flight from the country drained the country’s foreign exchange reserves, forcing the government to abandon the exchange rate peg and restructure its debt.
Among the many surprising features of the global financial crisis of 2008–9 was the emergence of the International Monetary Fund (IMF) as a leading player in the response to what has become known as the “Great Recession.” The news that the IMF was “back in business” was remarkable in view of the deterioration of the IMF’s reputation after the crises of the late 1990s and the decline in its lending activities in the succeeding decade. The IMF had been widely blamed for indirectly contributing to the earlier crises by advocating the premature removal of controls on capital flows, and then imposing harsh and inappropriate measures on the countries that were forced to borrow from it. The number of new lending arrangements approved by the IMF had fallen from twenty-six in 2001 to twelve in 2007 (Figure A.2), and all but two of the latter went to the IMF’s poorest members, which had little access to private sources of finance.
Moreover, the IMF, the intergovernmental organization assigned the task of promoting international economic and financial stability, initially had no direct role in dealing with the crisis. Finance ministers and central bank heads in the United States and Western Europe, where the financial institutions most affected by the crisis were located, sought to contain its impact by easing credit conditions and rescuing distressed financial institutions. The IMF was relegated to the sidelines as government officials in the advanced economies coordinated their responses to the crisis.
The year 1973 was a transitional one for the global economy. Attempts to revive the Bretton Woods system of fixed exchange rates were abandoned; increases in oil prices led to the occurrence of higher prices and falling output, which was labeled “stagflation”; and it was the last year that the U.S. government maintained restrictions on capital flows. There was one other event of somewhat lesser significance: my graduation from Georgetown University’s School of Foreign Service, where I developed an interest in international economics. After two years of work in New York, I entered Boston University’s graduate program in economics. I subsequently was fortunate to receive an appointment to the faculty at Wellesley College, where I have remained ever since.
I began my professional academic life, therefore, during the post–Bretton Woods era of currency regime and financial liberalization. The removal of capital controls by the United States was followed by financial deregulation in other developed economies in the 1970s, and by many Asian and Latin American countries during the following decades. Capital flows rapidly expanded, and by the end of the century it was possible to refer to the integration of financial markets across borders as the latest manifestation of globalization (Mishkin 2006). But it was also a period of economic volatility and upheaval, which included the debt crisis of the 1980s, the financial crises in the emerging markets of the 1990s, and, most recently, the global crisis of 2008–9.
The IMF's response to the global crisis of 2008–9 marked a significant change from its past policies. The Fund provided relatively large amounts of credit quickly with limited conditions and accepted the use of capital controls. This book traces the evolution of the IMF's actions to promote international financial stability from the Bretton Woods era through the most recent crisis. The analysis includes an examination of the IMF's crisis management activities during the debt crisis of the 1980s, the upheavals in emerging markets in the 1990s and early 2000s, and the ongoing European crisis. The dominant influence of the United States and other advanced economies in the governance of the IMF is also described, and the replacement of the G7 nations by the more inclusive G20, which have promised to give the IMF a role in their mutual assessment of policies while undertaking reforms of the IMF's governance.
The crises in Argentina and Turkey proved to be the last of the wave of financial crises in emerging market economies that had begun in Mexico in 1994. The postcrisis period was used by the IMF and its members to engage in investigations of the causes of the crises and evaluations of the IMF’s responses. This chapter presents on overview of the different lessons that the Fund and its members drew on how to counter the excessive volatility in financial flows and markets.
The IMF reassessed its crisis prevention and management policies and implemented a series of changes that are summarized in the first section. The Fund became more cautious in its approach to capital account deregulation and urged its members to implement regulatory and supervisory reforms before removing the barriers to capital inflows. But it continued to present an open capital account as the goal that middle- and low-income countries should pursue. Similarly, the IMF announced that it would apply conditions to its loans more sparingly, although the evidence on whether it adhered to this new policy is ambiguous. The Fund also attempted to develop new mechanisms for its own governance and to deal with sovereign defaults, but these initiatives were not accepted by its members.
The end of the universal system of fixed exchange rates and capital controls gave governments the ability to choose new responses to the “impossible trinity” in the post–Bretton Woods era. This chapter describes the institutional arrangements that arose as new exchange rate arrangements and capital account regimes were adopted and the impact of these choices on the IMF. The IMF’s revised duties in the post–Bretton Woods period were vaguely defined, and it was no longer the only IGO that dealt with economic and financial issues.
The IMF’s dominant members led the negotiations over the revision of the IMF’s Article of Agreement IV. The revised article, summarized in the first section, gave the membership the freedom to choose the exchange rate arrangement they found most suitable for their economies. This choice was constrained, however, by new obligations, and the IMF was given the responsibility to oversee compliance with these through its surveillance operations. However, the nature of its oversight powers was left ambiguous.
The growth of private capital flows occurred with much less planning or oversight. The second section explains how central bankers of the advanced economies where the major financial markets were located set up new organizational structures based at the Bank for International Settlements to monitor capital flows, exchange information, and discuss regulatory responses. But there was no consensus among the IMF’s membership regarding the deregulation of capital accounts, and the IMF itself played no role in these developments.