- International Monetary Fund
- Published Date:
- December 1999
Objectives of Surveillance
1. How is Fund surveillance defined? Our terms of reference requested us to examine “all channels and instruments of Fund surveillance, including bilateral surveillance, regional surveillance, multilateral surveillance and the content and format of the World Economic Outlook, and surveillance of international capital markets and financial systems and of the provision by member countries of economic and financial data to the IMF and the public.” We take surveillance as referring to all aspects of the Fund’s analysis of, scrutiny over, and advice concerning, member countries’ economic situations, policies, and prospects. Surveillance is conducted for the benefit both of the international community as a whole and of individual member states.
2. While the Fund regards the surveillance it undertakes on behalf of the international community as one function and our remit treats it as such, in practice it is clear that Fund surveillance is far from being one unified concept. In fact, as currently practiced, surveillance reflects a number of overlapping but conceptually distinct purposes. We have identified six such purposes.
- Policy advice. The Fund offers advice and proposals on the main economic policy dilemmas facing a member country. It also provides a sounding board for discussion.
- Policy coordination and cooperation.1 The Fund cannot, at least through the surveillance function, force cooperation. However, by providing what might be seen as neutral and reliable data, forecasts, and analysis, it provides machinery through which policy coordination can take place if countries so wish.
- Information gathering and dissemination. The Fund gathers both statistics and other information about the direction of policy. In this, it provides a service to member countries, who can rely on the Fund’s reports rather than having to maintain their own economic information-gathering networks. To the extent that the Fund then disseminates this information publicly, this service also benefits private markets and the general public.2
- Technical assistance and aid. In many countries, surveillance is essentially technical assistance; that is, it supplies expertise in macroeconomic policymaking that is scarce in the country. Not surprisingly, this is especially true of smaller and poorer countries, but it is also a role in some medium-sized and larger ones.
- Identification of vulnerabilities. This is an extension of the informational role and policy advice role that is particularly relevant when a country’s policies are likely to be unsustainable. It is also a role that has become much more prominent in the past five years. If the government is warned of such problems by an outside, objective source, it may be able to take the necessary policy measures. It is also suggested—although the Fund has yet to take such action—that by providing warnings to financial markets and the public, the incentives for policymakers to take measures in a timely fashion would be substantially increased.
- “Delivering the message.” This is an extension of the advice role. The Fund provides countries with policy prescriptions on numerous topics, from the advantages of moving toward a system of indirect instruments of monetary control to the need to liberalize labor markets. By doing so, the Fund provides a way by which the prevailing consensus of the economics profession is disseminated to government and policymakers throughout the world.
3. Why might Fund surveillance be necessary? When government, or another public authority like the Fund, produces goods or services, it is standard practice for economists to demand a justification. What is the market failure that prevents the good or service from being produced by the private sector? In the case of Fund surveillance, it is necessary to ask not only why the private sector does not do it, but also why national governments cannot. As the discussion of objectives above makes clear, Fund surveillance may be held to provide three types of services to members and the general public: information, policy advice, and policy coordination.
4. Information, including economic data and information about government economic policies, clearly has many of the characteristics of a public good. It is very difficult for a private supplier of information to capture all the returns to that information; in other words, the social return to the provision of information is likely to exceed the private return. As a result, less information may be supplied than is socially efficient. This is perhaps less true than it used to be; the private return to high-quality information in financial markets is quite high, and as a result there are a great many private sector providers of such information, especially in developed financial markets. However, even in industrialized countries, the private sector provides little information about economic data and policies that is not directly relevant to financial markets, and even less in developing countries. Moreover, private sector providers are likely to make the information they collect available primarily to paying clients; and in the case of some (e.g., investment banks), conflicts of interest may arise.
5. But all this does not in itself explain why the Fund, rather than national governments, should provide the information. Why have an international institution writing reports on each country rather than each country simply submitting an annual economic report? Surely the latter would be more efficient. The answer here is that such an arrangement would clearly create a conflict of interest; countries would have an incentive to be too optimistic, for both political and economic reasons. This would be true even if the analysis were merely for the use of other governments; it is even more so if the analysis is to form the basis for decision making in the private sector.
6. It should be noted here that the provision of information does not always unequivocally improve matters. In particular, while complete information is first-best, more information is not always better than less. This is a point that has recently been made in the context of the disclosure of countries’ reserve positions. Some finance ministries and central banks have argued that as long as supposedly important private sector players—such as hedge funds—face little or no obligation to disclose their positions, it is not clear that forcing countries to disclose theirs increases either economic efficiency or social welfare.
7. It is also far from clear that the Fund is any better positioned than the private sector to play the role of identifying vulnerabilities to private markets. Its opinion on the sustainability of a country’s policies is presumably valuable to private markets because the Fund has access to information that enables it to produce a better analysis than private sector agents can; that is, it has a comparative advantage. However, if countries know that the Fund will “blow the whistle” in certain circumstances, they are unlikely to provide it with such information, so the Fund will lose its comparative advantage. These are clearly complex issues.
8. Turning to policy advice, why should an international organization provide it? As noted above, in some cases governments may simply not have sufficient capacity to do as much or as good policy analysis as they would like. In this case, surveillance, like other Fund technical assistance, is essentially a form of development aid, provided and financed by the international community. More problematic are the circumstances under which the country itself has ample capacity within government to formulate economic policy. In this case, the justification for Fund surveillance must be that the Fund can provide some forms of advice more efficiently than the government can do itself; in other words, that it has a comparative advantage. In particular, it could be argued that the Fund might have a comparative advantage in the provision of advice on the international macroeconomic environment, on the policies adopted by other countries, or in specific areas where it has developed a particular expertise (hypothetically, for example, the identification of financial sector vulnerabilities).
9. The presumed objectivity of the Fund may also be an advantage in the provision of advice, even if its basic analysis is no better than that of the government or of private sector agencies. This is particularly relevant when there are internal disagreements within the government: the Fund may be able to say things that certain branches of government cannot, or to strengthen the position of those within government arguing for appropriate policies; or even to serve as the scapegoat for the implementation of unpopular policies (although this is probably more relevant in the context of an IMF-supported program).
10. Finally, the economic literature on international policy coordination describes the circumstances in which countries might benefit from coordination. For example, in the classic “Prisoners’ Dilemma” example, two agents, or countries, that set policy noncooperatively both end up with outcomes that are inferior to those attainable under coordination. In the international macroeconomic policy arena, this might be thought to apply to fiscal expansion, competitive devaluation, trade barriers, etc. It might be thought that the Fund would have a role in enabling countries to coordinate to achieve the best outcome for all. In the macroeconomic policy area, the Fund is clearly a plausible candidate for such a role.
11. That role could in principle range from the minimalist—providing reliable information and data, and perhaps some analysis—to a much more powerful one of setting and enforcing international coordination. In the extreme, the Fund could identify the set of policies that would produce the optimal outcome for the world as a whole, and even provide some sort of enforcement mechanism to ensure that countries adopted them. Of course, even if such an arrangement were desirable—and there are a number of arguments, both theoretical and practical, why it might not be—it is clearly highly implausible at present. The Fund’s current role is much closer to the minimalist end of the spectrum.
12. It should also be noted that the nature of this role varies along a second dimension, depending on whether international policy coordination is based on discretionary action or on rules and standards.3 Under the Bretton Woods regime, there were major elements of a rules-based system; countries were supposed to conduct domestic policies in a manner consistent with their chosen exchange rate. Since 1973, policy cooperation has been largely discretionary in nature. But recent initiatives to place more emphasis on rules and standards—not through fixed exchange rates, but through codes of conduct and the like—may lead to the pendulum swinging back again, with important implications for surveillance, as discussed in Chapter V.
13. This discussion suggests that Fund surveillance will be most useful and efficient when the service provided is a public good, that is, undersupplied by the private sector; and where the Fund, as a particular type of international organization, has a comparative advantage in providing such a service, either by virtue of its resources or its “objectivity.” In all three areas—information, policy advice, and policy coordination—there are tasks the Fund may undertake that meet these criteria. However, that does not mean that it is sensible for the Fund to undertake every conceivable task in these areas. There are many areas of policy advice, for example, where it may not command the best expertise available.
Origins and Development of Fund Surveillance4
Origins and Legal Basis
14. Scrutiny of members’ economic policies—even outside the context of Fund programs or of a prospective change in the exchange rate regime—has always been one of the functions of the Fund. Indeed, the concept of a degree of oversight of the international monetary system, undertaken by an international organization and based on some common framework of norms for the economic policies of individual countries, originated with the League of Nations, although the League was a political rather than economic organization.5 Many authorities see this as the underlying principle on which the Fund is based: “There is a well-defined thread that binds together all the activities of the IMF: the promotion and safeguarding of an international code of economic conduct.”6
15. In the immediate postwar period, the Fund’s main task, in addition to the oversight of the Bretton Woods par value system, was to encourage members to move toward current account convertibility. In this context, the Fund examined the economic circumstances of individual members under Article XIV of the Fund’s Articles of Agreement.7 This authorized members to maintain certain exchange restrictions, provided that they held regular consultations with the Fund “as to their further retention.”
16. Between 1958 and 1961, most European industrialized countries moved to convertibility; that is, acceptance of Article VIII of the Fund’s Articles of Agreement. As a result, they would no longer have been subject to regular consultations. The United States, however, did not want the Fund to lose its capacity to provide information and analysis of European economies. The Europeans, for their part, wanted symmetry, so that the Fund should also be able to examine the United States (and Canada).8 It was therefore agreed that the Fund should introduce voluntary consultations for all members, beginning in 1961 with the United Kingdom.
17. These consultations dealt with the general economic circumstances of the country, thus ranging wider than simply issues relating to exchange restrictions. However, they had no formal status. As a result, there was a limit to how meaningful they could be, particularly in the par value system established at Bretton Woods. In such a system, the real issue for a country with serious problems is whether to adjust the exchange rate. There was little prospect that countries would discuss such an option seriously in voluntary consultations.9
18. Multilateral surveillance would have been an obvious task for the Fund; under the Bretton Woods system there was a need, when imbalance became apparent, to determine who should adjust to whom. However, the Fund’s work in the 1960s was almost exclusively based on country-by-country analysis, except for the evaluation of the need for international liquidity. It was left to the Organization for Economic Cooperation and Development (OECD) to initiate multilateral surveillance, through its Working Party 3 and through work on systematic comparisons of national policy experience in various policy areas.10
19. In August 1971, the United States closed the “gold window,” effectively ending the par value system. However, it took several years before policymakers recognized that the system of fixed exchange rates could not be revived. So it was not until January 1976, at the Interim Committee meeting in Jamaica, that a framework for the new international monetary system was created. This new system accepted floating exchange rates, but foresaw a key role for the Fund in avoiding “excessive” fluctuations. In particular, under the new Article IV of the Articles of Agreement, the Fund: “shall exercise firm surveillance over the exchange rate policies of members and shall adopt specific principles for the guidance of all members with respect to those policies.”11
20. The introduction of surveillance as an explicit part of the Fund’s mandate therefore came as part of the Fund’s adaptation to the post-Bretton Woods monetary system. In particular, the use of the phrase “firm surveillance over the exchange rate policies of members” was an attempt to ensure that the international community still exerted some discipline over exchange rates, even in a world of floating rates.12 As such, it represented a compromise between those who believed that a substantial degree of international coordination was necessary to maintain exchange rate stability, pending—it was hoped—a return to a more managed system of exchange rates, and those who believed that such an objective was unrealistic (correctly, as it turned out) and probably undesirable.13
21. Surveillance also had an important role in the Fund’s lending activities. The policy advice given by the Fund in the surveillance exercise was likely to provide the framework for the conditionality attached to any future Fund program.14 It has often been argued that, as a consequence, surveillance is the one essential core of the Fund’s activities.15
22. For operational purposes, the Fund’s Executive Board set out five ways in which surveillance would occur. 16
- Periodic (usually annual) consultations with individual members would take place;
- The Board was periodically to review “broad developments in exchange rates”;
- The Managing Director was to maintain close contact with members regarding exchange rates;
- Members were to be required to notify the Fund of any changes in exchange rate policies; and
- The Managing Director could initiate “special consultations” with members.
22. The third and fourth of these points had little substantive content, while the fifth (as described below in paragraph 30) has been invoked only very rarely. However, the first and second formed the basis for the Fund’s bilateral and multilateral surveillance operations, respectively.
23. It was always recognized that “exchange rate policies” could not be viewed in a vacuum, and that the sustainability or otherwise of a country’s exchange rate policy was likely to be determined by its compatibility with domestic macroeconomic policies. As the original Decision put it, the Fund’s appraisal of exchange rate policies: “shall be made within the framework of a comprehensive analysis of the general economic situation and economic policy strategy of the member, and shall recognize that domestic as well as external policies can contribute to timely adjustment of the balance of payments.”17 Of course, virtually any domestic policy could be argued to affect, in some way, the external position. Therefore, as one practitioner put it: “the challenge is to identify the domestic policy areas that influence primarily the economy’s external position, so as to provide the basis for a general consensus among the membership that they are of legitimate international concern and properly belong within the scope of surveillance.”18
24. So Article IV consultations always focused on monetary and fiscal policy. However, there is clearly a difference between examining a country’s macroeconomic policies solely with a view to determining whether they are consistent with its exchange rate policy and pronouncing more generally on the merit of those policies.19 Even early on, the Fund generally took the broad approach. And over time, the scope of surveillance has steadily expanded into “structural” policies (e.g., market policy, privatization, industrial policy, and competition policy), into the financial sector (e.g., capital account issues, banking supervision, deposit insurance, and other financial sector regulation), and into a number of other areas (e.g., the environment, military spending, the “millennium bug”).20
26. This expansion, which has been particularly rapid in recent years, has been driven by a number of factors.
- The need for the Fund to address the problems of formerly centrally planned economies. In these countries, structural questions—like public enterprise reform and privatization—clearly had major macroeconomic implications. While most of these countries had Fund-supported programs, the effects of this shift tended to permeate throughout the organization and hence into surveillance.
- Political pressures. As the Fund became more open, and as nongovernmental organizations focused more of their attention on international organizations like the Fund and the World Bank, there were pressures for the Fund to look wider than macroeconomic policy, conventionally defined, to the implications of issues like the environment and poverty reduction. In recent years, the U.S. Congress has exerted considerable indirect pressure on the Fund in this regard.
- A growing consensus in the economics profession that a number of important economic variables, including unemployment and growth rates, can in the short term be affected by demand management policies, but are primarily determined in the long term by supply-side factors, combined with a desire on the part of the Fund to be relevant to what was regarded as important.
- The Mexican crisis (see below) and other financial crises in developed and developing countries (from Sweden to Indonesia, but particularly the recent Asian crisis) focused attention on the potential for external crises to be precipitated not only by traditional macroeconomic policy failures (government fiscal or monetary laxity) but also by structural weaknesses in the financial sector.
27. Of course, these factors do not necessarily explain why the Fund is involved in all these issues. From an institutional perspective, the origin of this expansion is the fact that the Fund is the only organization that has a mandate to examine on a regular basis the economic circumstances of virtually every country in the world. So even though this mandate was originally intended to apply only to a strictly limited set of macroeconomic questions, when the international community thinks that surveillance is required in other areas—even if those areas go somewhat beyond the Fund’s original mandate—the Fund is the obvious institution to call upon. Policymakers frequently say that it is the only institution that actually has “troops on the ground.” This has been particularly noticeable in the recent move toward giving the Fund the responsibility of monitoring international standards in areas like accounting, auditing, and corporate governance.21
28. Within the Fund, both the Executive Board and management have supported this expansion of the Fund’s mandate. In the general context, the most recent guidance promulgated by the Board in the discussion of lessons from the Asian crisis in March 1998 stated that “the focus of surveillance needs to extend beyond the core short-term macroeconomic issues, while remaining selective.” In relation to individual countries, when discussing staff reports, an Executive Director frequently asks why a particular issue, which he or she considers relevant to the economic circumstances of the country in question, has not been covered: this generates pressure for the staff to cover that issue in future reports on that country and others in similar circumstances. And, especially in recent years, Fund management has signaled a readiness to expand the mandate of the organization to issues like social policy.22
29. A perennial issue in the operation of Fund surveillance has been the tension between “equal treatment” and “focus.” On the one hand, on the principle that all Fund members, all sovereign states, are equal, many of them have argued for surveillance to be comprehensive and comparable among all members. Moreover, there is a natural tendency for a large bureaucracy with many functions to seek to organize its work around a predetermined and relatively fixed schedule. As the description of the current Article IV consultation process below shows, this is precisely what happens. On the other hand, some members are clearly more important to the world economy and their neighbors than others; some members are more vulnerable to the external environment and to external shocks; and some members have a less well developed capacity to formulate and implement sound economic policies. Given that Fund staff resources are, and should be, limited, some have argued that the Fund’s attention should focus more closely on members falling into one or more of these categories. As indicated in the Executive Board discussion of the 1997 biennial review of surveillance:
Directors emphasized that the principle of annual consultations represented a cornerstone in ensuring the continuity of Fund surveillance. At the same time, Directors recognized the need for flexibility in Fund procedures to ensure an effective focus of Fund surveillance, particularly in the context of the Fund’s strained resources.
30. In general, the Fund has resolved this dilemma in the direction of equal treatment rather than selectivity. Furthermore, although the Fund has the power to initiate “special” or “supplemental” consultations with countries whose exchange rate policies are, in the view of the Managing Director, of particular concern, this procedure has only been invoked extremely rarely because of the perceived political implications.23 When a member’s economic situation gives rise to serious concern, the Fund’s response has usually been informal and confidential, taking for instance the form of a letter or visit from management.24
31. One respect in which the focus of surveillance has changed is in the balance between the industrialized and developing countries. The surveillance mechanism, as described above, was part of a framework primarily aimed at securing exchange rate stability among the major industrialized countries. In the 1970s and early 1980s, much of the Fund’s efforts and resources were concentrated in that area, albeit with mixed results. However, from 1982, the Fund became heavily involved in efforts to resolve the debt crisis. And, in the 1990s, with the growth of private capital flows to emerging market countries, surveillance has increasingly come to be seen—both inside and outside the Fund—as a way of helping these countries to attain or preserve domestic macro-economic stability, so as to allow them to preserve or expand their access to such capital flows. Meanwhile, the interest of the Group of Seven industrial countries (G-7) in international policy coordination has waxed and waned; it certainly has not shown much inclination to give the Fund any major role in exchange rate management. As a consequence, the focus of Fund surveillance—at least in the public mind—is increasingly on developing and emerging market countries, particularly those considered to be of systemic significance.
32. Not surprisingly, the central problem of multilateral surveillance since the breakdown of Bretton Woods has been the exchange rate system.25 The dilemma has always been that while a floating rate regime has frequently allowed the exchange rates of the major economic powers to diverge significantly from fundamentals, with consequent destabilizing effects on international trade and capital flows, no better system has been on offer. In particular, estimates of “fundamental equilibrium” exchange rates are fraught with uncertainty. Moreover, even if such consensus estimates existed, there would still be ample scope for dispute—both political and economic—over the appropriate policy instruments to be adopted to bring market rates into line. So, while the Fund has sought to make estimates of equilibrium exchange rates, if only for internal use, it has recently been rare for it to make significant policy recommendations to the major countries on this basis.
33. Multilateral surveillance has therefore tended to concentrate on forecasting and analysis rather than policy prescription. It has centered on the World Economic Outlook (WEO), produced at first annually and now semiannually. The WEO, with the forecasting and analytic apparatus that its production requires, provides a comprehensive set of economic forecasts for the world economy. This in turn provides a basis for discussion by countries in multilateral forums like the G-7. However, unlike the Article IV surveillance exercise, there is no attempt by the Fund itself to develop a comprehensive set of policy recommendations, although the published WEO contains some discussion of individual countries’ policies.
34. Initially, it was clear that surveillance was for the benefit of the Fund’s member governments, not for private markets or the public at large. However, over time, the Fund has moved toward greater openness. To a large extent, this was the result of pressure from certain governments to make public some of the material produced in the surveillance process. In the 1980s, some countries began to release the Fund mission’s “concluding statement.” In the context of the 1980s debt crisis, the Fund agreed to allow a few countries making use of the “enhanced surveillance” procedure to make available the staff report itself to private sector creditors, on a confidential basis.
35. The first formal publication of Article IV material by the Fund came in 1989 when the “Recent Economic Developments” (RED) for Germany was published. Over time, the principle of routine publication of REDs (now “Selected Issues”) was established. However, the RED/Selected Issues papers are usually either factual and statistical, or more like academic working papers, focusing on a medium- or long-term policy issue. As such, they are less sensitive than the staff report itself, which includes the more politically and market-sensitive discussion and recommendations on current macroeconomic policies and exchange rate issues.
36. In May 1997, the Fund introduced Press Information Notices (PINs, later Public Information Notices), described in more detail below. Although publication has remained voluntary, this initiative represented the first real recognition that the Article IV analysis of current macroeconomic developments and policies was of concern and interest, not only to the governments of members, but also to the general public and to financial market participants.
37. In terms of resources, surveillance is the Fund’s most important activity. In 1999 surveillance is budgeted to account directly for 617 staff-years, 22 percent of the total. However, this is misleading, since considerable surveillance resources are attributed to central functions such as administration and external relations. Of the three principal “outputs” of the Fund—surveillance, “use of Fund resources” (programs), and technical assistance—surveillance accounts for about 42 percent. This proportion is forecast by the Fund to remain roughly constant in the next few years. Within the total resources devoted to surveillance, well over one-half was attributed to bilateral surveillance (Article IV consultations), with the remainder divided among multilateral surveillance, policy development, research, and evaluation.