Reforming the International Monetary and Financial System

Comments: On the Financial Role of the IMF

Alexander Swoboda, and Peter Kenen
Published Date:
December 2000
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Jack Boorman

Let me say right off that I fully agree with David Lipton that the proper role for IMF financing must be set within a strategy for the international financial architecture more broadly. Under the heading of architecture we include not just those elements that involve crisis resolution but, even more important, all those that involve a strengthening of surveillance and of risk assessment. The extent to which we succeed with the various initiatives aimed at strengthening the system—that is, at prevention—will color the nature of the crises that still occur.

I also agree with the important point he makes that liberalization and privatization do not imply a lesser role for government. This mistaken conception is what led to financial market deregulation in a number of countries running ahead of the capacity of governments to regulate and supervise private entities in those markets. If this crisis has taught us anything, it should be a reminder of the key importance of the institutional infrastructure needed to manage a successful market capitalist economy—legal systems, bankruptcy procedures, standards, transparency—many of the things now captured under the heading of architecture.

It is these changes—together with all the various elements discussed in the context of involving the private sector in both the prevention and resolution of financial crises—that we hope will create the conditions under which the IMF will not have to, as Lipton puts it, place its financial arsenal against the markets. Both countries and the IMF will have additional armaments in their arsenal beyond simply financing if this architectural agenda produces what some of us hope it will.

Mr. Lipton raises questions and makes proposals for three topics that I would like to comment on: exchange rate regimes, limitations on access to Fund resources, and an SDR mechanism to deal with systemic crises. Let me take up first the issues on exchange rate regimes, because I can be brief. Probably enough has been said on this in other sessions, and Lipton seems to be tilting in much the same direction as implied in those other discussions—namely, that the viable regimes are probably at the extreme positions of flexibility and fixity. But he also seems to give some indication that he would like to see most countries settling in at the flexibility end.

I will make just a couple of points on this section of his paper. First, it is worth remembering that floating rates remove some of the monetary policy discipline of pegged or adjustable peg regimes. We should not forget too easily the lessons of the 1980s from Latin America, and the high inflation and low growth that characterized that period.

Second, I think Mr. Lipton overstates the case when he says that “for the most part even intense capital market pressures stemming from doubts about balance of payments prospects would be relieved in a timely and healthy manner by exchange rate depreciation.” To the extent flexible rates limit the willingness of private parties to take on unhedged exposure and thereby remove one of the most destabilizing dynamic elements of what transpired in Asia, I would agree. But if markets go to sleep again as regards risk assessment (as happened in late 1996 and early 1997), until a massive swing in confidence in a country’s situation finally occurs, even a floating rate could be overwhelmed.

Third, just to note, as Michael Mussa did yesterday, that we need to take care in describing the large packages put together for the crisis countries and their relation to those countries’ defense of their exchange rates. I think Lipton exaggerates a bit when he notes that $180 billion was provided in support for the three Asia cases plus Brazil and Russia. Of course, those packages were not fully disbursed. Also, the markets themselves knew they contained some elements of questionable availability, such as the second line of defense components. In the cases of Thailand, Korea, and, ultimately, Indonesia, the resources that were disbursed were not used to defend the exchange rates—those rates had been floated before the IMF provided resources under the arangements with these countries.

On Lipton’s second issue, his suggestion to limit access to IMF resources, I agree that greater flexibility in exchange rates—or rather, I would put it, more timely changes in exchange rates regardless of the regime—as well as successful efforts to incorporate private sector restructuring into procedures for crisis management, could well have the beneficial effect of limiting the needed size of official support packages, including resources from the IMF. Beyond this, I am skeptical about the approach suggested. I have four points regarding this issue.

First, as I have already mentioned, I am less optimistic than Lipton is that adoption of flexible rates will limit intervention needs in all cases. There may well be cases where a shift in market sentiment could effectively be countered with, as he says, “foreign exchange sales on a modest scale, funded by IMF loans, … to play a constructive cushioning role in supporting imports.” But Mr. Lipton puts more faith in the capacity of floating rates to limit the buildup of debt problems than I think we can conclude from history.

Second, we have to recognize that both trade and capital flows have far outrun the size of Fund quotas. It was mentioned yesterday that quotas relative to trade flows are now only one-ninth what they were in the early days of the IMF. Surely, in relation to capital flows they are vastly smaller, and this is an average! We all know that for some countries, their quotas are even smaller, Korea being the case in point. This explains, in part, the largest multiple of quotas ever committed by the IMF to a member in Korea’s case.

Third, I believe Lipton would still be willing to see large access for truly systemic cases. But I am not sure we know which cases are indeed systemic when a crisis is only beginning to unfold. Were the Asian crisis countries systemic? They surely had some of those characteristics ex post. Brazil must have been at least technically “systemic,” as that was a requirement for the use of NAB/GAB resources in that case. I would fear that limits on access, except for systemic cases, either would not be believed by markets—and hence not affect the moral hazard issue—or would tie the hands of the IMF in making decisions in individual cases. Moreover, I am not sure how the bridge is crossed from the low-access cases to the major systemic cases—the intermediate ground is not void.

Fourth, I believe the IMF needs to keep itself equipped to deal with countries facing stress in the “old-fashioned way,” by which I mean an effort to restore market confidence and a spontaneous reflow of private market finance through a judicious mixture of policy adjustment and official finance.

Yes, I am a strong advocate of pressing ahead to develop the instruments that private markets and the official community need to ensure maintenance of exposure to limit the exit of private creditors in certain cases. But I believe a role will remain for the old-fashioned medicine, and in some of those cases larger access to IMF resources may be needed and may be appropriate.

I believe my argument applies as well to the SRF and the CCL. Nevertheless, and especially on the latter, I would hope that the potential need for large-scale resources can be mitigated by incorporating measures to ensure the involvement of the private sector.

In this connection, I agree with most of what Lipton says regarding workouts. I have wondered, however, whether the debate between a European/Canadian view, on the one hand, of the need for rules or a framework and the U.S. view, on the other hand, that everything should be kept case-by-case is very productive. I believe the reality is that the international community needs to develop the necessary instruments to bail in the private sector—bond clauses, measures to limit and better price short-term flows, Fund policies for lending into arrears, and perhaps an official mechanism to endorse a stay on a country’s debt-service payments. With this tool kit, though, each case will have to be dealt with in light of its specific circumstances. So in the end it will all be case by case.

Finally, just a few words on the idea of an SDR trust fund. As an opener, I am not completely sure I see where Lipton is coming from on this. His model seems to envision that most cases will be nonsystemic and could be dealt with through restricted access to IMF resources. But he opens the possibility of a systemwide problem “when there is a need for a large number of countries to be spending international reserves simultaneously.” As my earlier remarks suggested, I foresee cases in between these two extremes, which is why I would not too firmly tie the IMF’s hands on access and would leave a greater degree of “constructive ambiguity” in the system.

Whatever the difference, we can accept the proposition that there may, at times, be a very large systemic need. I think Lipton’s ideas for dealing with such a situation are interesting and deserve study plus a review of earlier discussions that raised some of the same questions. Some of the questions that would have to be explored are the following:

  • 1. Could an allocation be secured quickly in the event of a crisis? It takes 85 percent and history is not very encouraging on this possibility.

  • 2. If a trust fund of SDRs were to be established, would that solve the decision problem by creating that mechanism before a crisis, to be activated only at the moment of crisis? Here again, history has not been kind. If national authorities hesitate to approve a large quota increase, would they agree to a very large SDR allocation cum trust fund that would have many of the same purposes?

  • 3. Even if such a mechanism were established, could a country, say the United States, take a decision to activate it and lend from it to another country—at its own risk, as Lipton suggests—without new legislation at the time of the crisis? Is this feasible?

  • 4. Would the general IMF membership be willing to see the decision-making authority of the organization tied up in the hands of a “selected” group of countries that put their SDRs into the trust fund—especially in a crisis management situation?

  • 5. Would the countries that control the trust fund be willing to see the resources made available in a straightforward fashion or would they be tied up like the second lines of defense in the Asia cases? If the latter, I would be very cautious on such a scheme.

Together, these questions are more than enough of an agenda to pursue if the idea of an SDR trust fund is to be considered further.

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