The IMF's primary purpose is to ensure the stability of the international monetary system—the system of exchange rates and international payments that enables countries (and their citizens) to transact with one other. This system is essential for promoting sustainable economic growth, increasing living standards, and reducing poverty. The Fund’s mandate has recently been clarified and updated to cover the full range of macroeconomic and financial sector issues that bear on global stability.
The IMF was established at the Bretton Woods conference in 1944 to provide short term financial assistance to countries experiencing problems with their trade deficit or other Balance of Payments issues, so they could maintain stability in exchange rates i.e. stay fixed to USD value (i.e. gold value). Otherwise in case of a major trade deficit or Balance of Payments issues, countries may be tempted to print more money and devalue currency.
In 1971 the dollar de-linked from gold and subsequently in the Jamaica Agreement in 1976, the IMF acknowledged its new role which was an evolution from protecting fixed exchange rates to surveillance of currency floats and managing economic stability. The IMF promotes clean floating i.e. there is minimal government intervention in establishing exchange rates and the market determines rates. As compared to “managed” (rates influenced by government intervention) or “dirty” floats (unfair government intervention).
IMF conditionality refers to the requirement by the IMF for the debtor nation to make certain structural reforms in exchange for the money loaned (in addition to interest on the loan).
Policy prescriptions usually include reduction of budget deficits (reduce spending/increase taxes), increase in interest rates to encourage foreign investment and liberalizing trade to ensure free flow of goods/services. A last resort prescription would be currency devaluation.
Extreme liberals argue that the IMF’s involvement creates moral hazard by intervening in the market and incurring an obligation to intervene again in the future. This intervention distorts market forces and creates a dependence upon government. Structural criticisms of the IMF include perceptions that it serves only the wealthiest nations and imposes unnecessary hardship on debtor nations.
There are also informal groups of creditors (London Club - commercial banks; Paris Clubs- governments) that work with debtor nations after the IMF has reached an agreement to resolve debts.
According to Article IV of the IMF agreement, the IMF will engage in regular discussions on economic policies and development with members. The IMF also publishes a statement on its assessment of the country’s economic health.
Typically the IMF imposes conditions before providing funding: cut “excessive” domestic demand, cut public spending/raise taxes which addresses the fundamental crisis of the budget and balance of payments deficit. Raising interest rates which increases foreign investment, trade liberalization which makes local industries more competitive, devaluation of currency (under IMF guidelines) which is a last resort effort to establish competitiveness
The IMF follows a liberal ideology, its member nations are all considered alike with each country submitting a fee of 25% of its quota (proportional to the country’s GDP). Members can purchase hard currencies by paying an equivalent amount in domestic currency i.e. a currency swap. Repayment of domestic currency requires hard currency and occurs at the original exchange rate - results in no net loss to IMF.
Funding is provided in tranches (installments) so that the IMF could retain leverage and the country would be encouraged to fix the problems that caused it to come to the IMF in the first place.
The size of a country’s GDP influences the amount of contribution required to join IMF and the percent of voting power. The US has the larger GDP compared to other countries and therefore the larger weighting of votes. This is criticized by Economic nationalists as it skews the voting power of LDCs.
The IMF Board of Governors is composed of representatives of the 185 member countries. The Executive Board has 24 members that usually represent a coalition of like-minded countries in one representative. Lending decisions are made with consensus in a simple majority vote. Structural decisions require 60% majority where, G-5 countries collectively can nearly veto since they currently have 38% vote. Fundamental structural decisions e.g. changes in voting power require 85% majority; US has enough voting power to veto (>15%).
Economic nationalists would say that the IMF voting structure enables powerful countries to promote their own national interests. Structuralists would say rich capitalist countries have the most voting power which is to the detriment of the developing countries. Embedded liberals would say that the type of conditions IMF imposes and the aid it provides helps troubled countries get back on track, stimulates their economy and gets the trade balance in equilibrium.
In December 1997 the IMF announced a $57 billion loan package to bail South Korea out of its financial crisis accompanied by strict conditions. Some short term conditions were to reduce government spending, increase taxes and raise interest rates. Longer term structural reforms were also mandated: liberalizing foreign investment policies, opening domestic financial markets, implementing western lending standards, closing insolvent banks, reforming labor laws and reducing import tariffs.
While the IMF views its involvement in Korea as a “success case”, embedded liberal economists like Feldstein and Sachs criticized IMF’s cookie cutter approach stating that it forced Korea into a recession.
Joseph Stiglitz a chief economist at the World Bank during the Asian Financial crisis in 1997 was a vocal opponent of the IMF’s approach. He argued that the IMF made the Korean crisis worse by raising interest rates and slowing down the economy.
The key flaws that Stiglitz pointed out were: * Cookie Cutter approach to fixing economic issues * Not understanding the nuances of the economic scenario of each country that IMF stepped in to rescue * Using outdated mathematical models when calculating assistance strategy * Implication that the IMF’s actions were responsible for the “contagion effect” of the crises spreading to other Asian countries
Stiglitz also accused the IMF of carrying on covert negotiations and a total lack of transparency with local governments when engaging in important policy discussions.
Contrasting Stiglitz’ criticisms of the IMF, Rogoff countered that the IMF made the most of difficult circumstances when stepping in as last resort to aid countries in financial trouble. He also challenged Stiglitz’s suggestion that governments in financial crisis should issue currency, stating that this would simply lead to higher inflation and hurt the local economy instead of helping it.
The Argentine economist, Raoul Prebisch, called for the reform of the major international institutions. As a result, a new financing facility was created at the IMF, the Compensatory and Contingency Financing Facility (CCFF). If a country is exporting a primary product (i.e. Products extracted out of ground that don’t hold their value as well as manufactured products) and does not have adequate export revenues in order to feed their population, these countries should get special access to loans through CCFF. This is the first time the IMF was acknowledging that countries exporting primary products where at a disadvantage.
Buffer Stock Facility was also implemented at the IMF. It provided special financing to countries exporting primary products. So they could even out their export products. Financing was provided to build warehouses to stock their products during surplus years; then draw upon it during leaner years. This reflects a shift in the IMF way of thinking and away from the liberal views.