One of the benefits of working at CIGI is the opportunity it provides to interact with the bright, young students at the Balsillie School of International Affairs. Several weeks ago, I had a conversation with one student (hat tip: KE) on the evolution of the international monetary system and it got me thinking about an old theme regarding the role of the International Monetary Fund (IMF) that I have kicked around for many years (probably post-Asian financial crisis).
The way I look at it, the role of the IMF under the Bretton Wood system of fixed exchange rates and generalized capital controls can be viewed as a constrained discretion commitment device: under the rules of the Bretton Woods system, a member experiencing temporary balance of payments problems went to the IMF for financing – consistent with the first rule of international finance: finance temporary shocks; adjust to permanent shocks. In return for providing financing, the IMF could ask for policy adjustments, largely in terms of reducing domestic absorption through higher taxes or lower government spending.
No country liked the adjustments, but that was the quid pro quo for the financing. Such conditions were required under the IMF Articles of Agreement, which stipulates the IMF can only make its resources available under “sufficient safeguards” of repayment. At the same time, the conditionality of IMF programs made the system incentive-compatible, in the sense that a country that followed an excessively lax policy framework and incurred balance of payments deficits today, would have to tighten up, rein in those deficits and correct its balance of payments maladjustments tomorrow.
Contrast that with the situation today in which the IMF is unable to close balance of payment gaps, reflecting crises in the capital account, rather than current account problems, and in which exceptional financing has become the rule rather than the exception. The IMF is now in the game of trying to manage the expectations of a heterogeneous group of investors; to do so, it has relied on a much wider range of policies (beyond the simple, in some respects, mechanical rules of the Bretton Woods era). Such policies are intended to reassure private investors that growth prospects are favourable.
To be successful in this respect, policies need to be far more intrusive than the straight forward fiscal policies that compressed domestic absorption under constrained discretion. This has generated considerable unease in countries that have suffered the consequences of a panicked rush for the exits by private investors and has heightened concerns about the legitimacy, credibility and effectiveness of the Fund.
Assuaging legitimacy concerns through effective governance reforms that defuse the explosive charge that the IMF is being run by, and in the interests of, a limited number of advanced economies, as governance arrangements that reflect the global economy of the mid-20th century, is a necessary start. But to truly restore the IMF to its premier role in the global economy, members have to agree on a set of obligations that membership in the global economy of the early 21st century requires. Such obligations, agreed to fully and adhered to faithfully by the membership would allow the institution to return to a constrained discretion model and help restore its legitimacy,credibility, and effectiveness.
Make no mistake: getting agreement on new set of obligations designed to sustain the open, dynamic international trade and payments system that has been painstakingly erected over the past 60 years will not be easy. And I worry that the difficult, protracted adjustments that many members face will increase the temptation to “defect” from the cooperative game that creates the conditions for a positive sum game, and adopt beggar-thy-neighbour policies that transform the global economy into a zero-sum (or worse) game as countries attempt to raise employment at home at the expense of employment abroad. As the euro zone continues to teeter on the brink, the consequences of short-sighted policies in Europe and around the world increase in the risks to the outlook in the New Age of Uncertainty.