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The IMF Fifty Years Later

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 1995
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OVER its 50-year history, the IMF, while remaining the watchdog of the international monetary system, has broadened the scope of its activities in response to crises and changes in the world economy. In recent years, it has introduced several new programs that help developing and transition countries with economic reforms.

The Bretton Woods Conference of 1944, a landmark in international economic relations, laid the foundation for cooperation among nations in the solution of world monetary problems. The 44 countries participating in the Conference agreed to establish two new multilateral institutions: the International Monetary Fund (IMF), which would oversee a new international monetary system and serve as a forum for discussion and resolution of issues affecting the system, and the International Bank for Reconstruction and Development (IBRD), which would finance the reconstruction of war-ravaged countries and foster economic growth in developing countries.

The IMF’s founders wanted to safeguard the global economy against the type of devastating breakdown that had occurred in the 1930s. Their goal was an open and stable monetary system characterized by currency convertibility, the establishment of fixed exchange rates, and the elimination of harmful restrictions and practices, especially exchange controls and competitive currency devaluations.

During the first quarter-century of its existence, the IMF oversaw the “par value system” that was designed to ensure exchange rate stability—countries belonging to the IMF were required to define the value of their currencies in terms of US dollars or gold and to get IMF approval before they changed the “par value” by more than 10 percent. When this system of fixed but adjustable exchange rates was abandoned in the early 1970s in favor of floating exchange rates, friends and critics alike questioned whether the IMF had a future. But the IMF soon found its role expanding, not shrinking, in the wake of a world economic crisis.

A quarter-century later, on the occasion of its fiftieth anniversary, the IMF is once again at the center of debate. It is clear that the need for the IMF is greater than ever in today’s complex global environment. It is also clear that the IMF has an ability to respond quickly to changes in the world economy and to develop innovative solutions to new problems; thanks to this adaptability, it continues to play a leadership role in the international monetary system.

The early years

In addition to the establishment of the IMF’ and the IBRD, the Bretton Woods system, particularly the par value system, is considered by many to be the greatest achievement of the Bretton Woods Conference. Along with the General Agreement on Tariffs and Trade (GATT), concluded in 1947, which has provided rules for international trade, the Bretton Woods system, despite its weaknesses, furnished strong support for the long period of world economic growth that lasted from 1945 to 1971. The system, especially as implemented by the IMF, encouraged the industrial countries of Europe to adopt prudent macroeconomic policies, to achieve realistic exchange rates, to use monetary policy as a tool of macroeconomic policy, and to improve their payments positions by decreasing exchange and payments restrictions. The European countries were thus able to lower their inflation rates and reduce their balance of payments deficits. In addition to serving as a forum for consultation and collaboration, the IMF helped countries correct short-term balance of payments problems by lending them the foreign currencies they needed.

Margaret Garritsen de Vries,

a US national and one of the IMF’s first staff members, was the IMF’s Historian from 1973 until her retirement in 1987.

Increasing its financial resources. During the 1960s, the IMF made two important changes in how it operated. First, to ensure that it would have enough cash on hand to meet its members’ borrowing needs in the event of a balance of payments crisis by one of the large industrial countries, it introduced the General Arrangements to Borrow. These enabled it to supplement its financial resources—the quota subscriptions of member countries—by borrowing from the governments of the ten largest industrial countries (this has since increased to 12 countries). Second, in response to the threat of a shortage of international liquidity, it was empowered to create the special drawing right, or SDR, a type of reserve asset that member countries could add to their foreign currency and gold reserves and use for payments requiring foreign exchange.

Lending to developing countries. It was also during the 1960s that the IMF increased its attention to developing countries. It introduced two new lending mechanisms—the compensatory financing facility and the buffer stock facility—designed primarily to help developing countries deal with temporary declines in their export earnings stemming from fluctuations in the prices of primary products.

Two more decades of change

With the collapse of the par value system in the 1970s, the IMF was forced to adapt to a drastically changed environment. In view of the requirements of the floating exchange rate system, it amended its Articles of Agreement extensively to update its legal authority. Its new mandate gave it an intensified “surveillance” role—it would monitor not only the exchange rate policies of members but also their domestic economic policies affecting exchange rates. Two ministerial-level policymaking bodies were established—the Interim Committee and the Development Committee—that would meet in a smaller forum and more frequently than the Annual Meetings of the full Boards of Governors of the IMF and the World Bank (the IBRD and the International Development Association), and make decisions more quickly. Most important, the IMF introduced a new lending instrument, the extended Fund facility, tailored to the medium-term needs of the developing countries.

Lending activities increase. During the 1970s, sudden, steep increases in oil prices caused massive imbalances in external payments. Inflation also reached historic highs, and then, as a severe worldwide recession followed, many countries found themselves confronted with a hitherto unknown phenomenon: rising prices coexisting with high unemployment. There was the prospect of exchange rate instability and competitive devaluation—a prospect frighteningly reminiscent of the 1930s. To meet these challenges, the IMF introduced additional new lending facilities that took into account the need to focus on eradicating structural rigidities as well as short-term macroeconomic imbalances.

Today, the IMF’s loans support member countries’ efforts to adopt appropriate fiscal and monetary policies, correct distortions in price structures, achieve realistic exchange rates, and take other measures to improve the efficiency of production. These reforms are aimed at strengthening countries’ prospects for economic growth. As a growing number of countries seeking to strengthen their external payments positions and domestic economies realized the necessity of undertaking macroeconomic and structural adjustment programs in the 1980s and 1990s, the IMF’s lending activities continued to expand. For decades, the IMF had made financial resources available on a short-term basis to member countries. These arrangements were not suited to low-income developing countries with protracted balance of payments problems, however. The IMF established the structural adjustment facility in 1986 and the enhanced structural adjustment facility in 1988, renewed the latter in 1994, and is now able to offer poorer countries concessional loans to support medium-term macroeconomic and adjustment programs.

The debt crisis. The oil shocks of the 1970s, which forced many oil-importing developing countries to borrow heavily from commercial banks, and the higher interest rates that resulted from the industrial countries’ attempts to control inflation converged to bring about the debt crisis of the 1980s. In the last quarter of 1982, indebted countries suddenly found themselves unable to service their external debt.

The crisis posed a serious threat to the international banking and financial system. From the outset, the IMF was a major player in seeking solutions. At first, the IMF and the industrial and developing countries believed the debt crisis would be temporary; they assumed that the worldwide recession that had depressed demand for exports from heavily indebted countries would not last. Economic growth in the industrial countries was expected to resume within one or two years, once inflation had been brought under control. It was assumed that economic recovery in the industrial countries, combined with the correction of certain problems in the indebted countries—excessive budgetary deficits, easy monetary policies, and overvalued exchange rates—would restore high growth rates in the indebted countries. Financial officials also believed that the large amounts of flight capital that had left indebted countries would return after these countries had realigned their policies, and that investment would then increase; it was assumed that commercial banks, then unable or unwilling to engage in substantial debt relief or forgiveness, would continue to lend voluntarily to indebted countries.

The IMF responded to the crisis by working with all interested parties—debtor and industrial countries, and official and private creditors—to find solutions on a country-by-country basis. It helped design and implement adjustment programs tailored to individual debtor countries. It provided financial resources to indebted countries and facilitated financial flows to them from governments, commercial banks, and other international financial institutions. It worked with creditors and debtors on the rescheduling of debt payments.

In the end, assumptions that the debt crisis would be temporary proved to be too optimistic—it lasted ten years. Countries began to experience “adjustment fatigue,” and the IMF came under attack for the adjustment programs it had developed with indebted countries in return for financial support. IMF “conditionality”—when using IMF resources to solve balance of payments problems, countries are expected to pursue certain economic policies—was blamed when standards of living, already at subsistence levels in many countries, fell even lower.

In 1989, because the success of stabilization policies was being undermined by the size of the debt burden in many countries, the debt strategy was modified to accelerate debt- reduction operations. A number of heavily indebted countries—especially in Latin America but also in other regions—made debt-restructuring, debt-conversion, and debt- reduction arrangements with both official creditors and commercial banks to alleviate their debt-service obligations. At the same time, some countries began to reap the benefits of stabilization and structural adjustment programs. In the 1990s, improvements have begun to be apparent, especially in the Western Hemisphere, with growth rates rising for many countries; a number of countries, however, particularly in sub-Saharan Africa, still face very difficult debt problems.

Economies in transition. In the 1990s, the IMF is once more adapting its operations to important changes in the international environment—namely, the breakup of the former Soviet Union and the attempts of the resulting states to make the difficult transition to market economies. In 1991, at the Houston economic summit, the heads of state of the seven largest industrial countries—the Group of Seven—charged the IMF with assisting the countries of the former Soviet Union with far- reaching economic stabilization and reform measures. The IMF committed itself to channeling significant amounts of financial assistance to these countries. In 1993, the IMF established the temporary systemic transformation facility, which was extended in 1994, to make financing available to the countries of the former Soviet Union as they transform their centrally planned economies to market- based systems.

In addition to supporting reforms with loans, the IMF is helping the countries of the former Soviet Union achieve better macroeconomic management by training government officials, enhancing the quality of statistical data, assisting with reforms of the tax system and government expenditure management, designing social safety nets, and improving the operations of the central banking and financial systems. To help train government officials closer to home, the IMF, in conjunction with other international organizations, established a new institute in Vienna.

Policy analysis. In recognition of the complexity and intractability of the problems faced by the developing and transition economies, the IMF has broadened its focus when considering the economic policies of the countries it assists. For example, it emphasizes the importance of policy measures that will promote sustainable, quality growth, even though these measures may take time to bear fruit. It is also increasingly concerned with the effect the policy reforms supported by its financing will have on poverty and income distribution, as well as with the impact adjustment programs and economic policies will have on the environment.

The impending challenge

Despite the changes of the past 50 years, the IMF retains its original and very important role: it continues to oversee the international monetary system and to monitor the world economy. Because of growing economic interdependence among countries, the IMF has even more relevance now than 50 years ago. But its job has become much more difficult.

In part, this is because the industrial nations have been pursuing fiscal, monetary, and structural economic policies that tend to serve national interests, often at the expense of the international community. The volatility of the principal currencies’ exchange rates creates uncertainty that hurts trade and investment. The industrial countries have also come to rely heavily on monetary policy as a tool for macroeconomic management, and need to make timelier adjustments to prevent the emergence of inflationary pressures. Because of widespread large budget deficits, fiscal policy has become inflexible, overburdening monetary policy. International liquidity from private sources now dwarfs official liquidity. Nevertheless, the IMF has a unique surveillance role to play with respect to the industrial countries, encouraging them to adopt sound economic policies and fostering a more orderly and stable exchange rate system.

Over the past few decades, the developing countries have become a new and important force in the global economy. Many of them have been growing faster in recent years than the industrial countries; others, however, hobbled by their own policies and the slow recovery of several industrial countries from the recession of the early 1990s, are seeing little growth. Although private capital flows to the developing world have increased substantially, these flows have been highly concentrated in Latin America and Asia. Surges in capital inflows have complicated economic management in a number of developing countries, forcing them to juggle policies so as to minimize the inflationary effect of the flows and their impact on the exchange rate. In some countries, these flows have masked low domestic savings and unsustainably large current account imbalances. The dangers of dependence on capital inflows were amply demonstrated by Mexico’s recent economic crisis.

There is thus a continuing need for the IMF to provide both financial and technical assistance to developing and transition economies in support of efforts to liberalize prices and trade and exchange regimes, contain inflationary pressures, carry out structural reforms quickly, and establish cost-effective social safety nets to protect the most vulnerable. And, while the strong growth of private capital flows has led some observers to question the utility of the SDR, the IMF’s special reserve asset, the ability of developing countries to borrow on reasonable terms in international capital markets is confined to a privileged few. In any case, in an increasingly global economy and financial system, the question of a central reserve asset issued by an international monetary authority is a pressing one.

An important recent development for the global economy was the conclusion of the Uruguay Round of trade negotiations. In the open, more competitive environment created by the Uruguay Round agreement, there will be a need for IMF surveillance over exchange rate and macroeconomic policies, and the IMF will work with GATT’s successor, the World Trade Organization, toward further trade liberalization.

Present circumstances offer opportunities for greater cooperation among nations. The IMF is now what it was first intended to be—a truly universal organization, with 179 members, almost all of the countries in the world. Once again, as at Bretton Woods 50 years ago, with sufficient political will, nations could work together to build a stable and open monetary system for the benefit of the entire international community.

Margaret Garritsen de Vries

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