February 2006

The IMF’s Role in Foreign Exchange Surveillance

Principal objectives of the International Monetary Fund (IMF) include promoting exchange stability, maintaining orderly exchange arrangements among member countries, and avoiding competitive exchange depreciations. In today’s world of large global payment imbalances, the importance of attaining these objectives cannot be overestimated. At a February 2 AEI panel discussion, participants considered the reforms needed to improve the effectiveness of the IMF in carrying out its mandate, in general, and to improve the way that the IMF conducts exchange-rate surveillance, in particular.

Desmond Lachman
AEI

Today’s global payment imbalances are of an unprecedented scale. Unless these are addressed fairly soon, they could unwind in a way that is harmful to international prosperity. People focus on the U.S. trade deficit, which is equivalent to 6.5 percent of gross domestic product (GDP), but there is another side--the large current account surplus. Many Asian countries are intervening in the foreign exchange market, aiming to keep their currencies cheap and in the process force international adjustment.

The IMF is charged with the task of promoting orderly exchange arrangements and avoiding competitive depreciation. Anyone who looks at its record over the past few years must conclude that it has been conspicuously passive in this role, and the statements that were made by its managing director, Rodrigo Rato, at the World Economic Forum in Davos do not give me the impression that they are about to embark on a more proactive role in this respect.

Timothy D. Adams
U.S. Treasury

Everywhere I go it seems that we have the same discussion. The issue is global imbalances, but more specifically the role of the IMF. This institution has weathered so many different storms over the past fifty years, and with the changes in the global environment just in the past ten years, it is important that we talk about its future.

Last September at a conference on the future of the IMF, I called for a return to basics. As we reconsider the function of the institution, we must remember that talent alone is not enough; we must also focus on the fundamentals. The G7, G20, and think tanks are also providing contributions to the debate. The United States in general can provide some leadership on these issues.

The IMF has wrestled for years with the difficult issue of exchange-rate surveillance. There are problems with the compatibility of an exchange-rate regime with domestic economic policies and priorities. There are questions of which regimes are appropriate relative to the characteristics of an economy--whether they are large or small, open or closed economies, and whether they have strong or weak institutions and developed or undeveloped capital markets.

There is an asymmetric bias at the fund--they focus more on the deficit countries than on the surplus countries. There is another bias--elected officials are not going to deflate their economies, and they are not going to contract their economies. Politicians will usually be biased toward their domestic economy rather than external balance, and we must acknowledge this while thinking of reforming the institution.

There are four different areas in which the IMF can play a better leadership role: clarifying the exchange-rate surveillance principles, improving the Article Four surveillance process reviews, destigmatizing special consultations, and improving the multilateral surveillance process.

We never defined what protracted large-scale intervention and excessive exchange accumulation meant. It was intentionally left vague to allow for the accumulation of experience as we learned how the global monetary system worked. We now have that knowledge, and it is important to start to think more specifically about these things.

Regarding Article Four, there is a question of emphasis and what the analytical assessment looks like. Where are there inconsistencies between fiscal policy and the exchange-rate regime, and how might prove problematic down the road? It would be nice to have those conversations regarding Argentina early on in the process. What is the appropriate exit strategy and the timing? We have tended to see exit strategies that occurred under duress and have tended to come at great dislocation and cost. Integrating the multilateral process into the bilateral surveillance process could ensure a more consistent approach.

Special consultation is a useful tool but has only been used twice. Some of these concepts are used so infrequently so that when utilized; they become headline news when utilized. We should destigmatize these tools.

There is a tremendous amount of work within the fund being done on these issues, but I think it should be made public so that we can have an open discussion. We have an obligation over the next few months to think through the tools that this institution has available to it. As shareholders and advisers to this institution, we can help shape it. The fund is not just the managing director and staff. The shareholders must play a critical role in evolutionary or revolutionary change at the institution.

Ted Truman
Institute for International Economics

Today the fund is behind the curve on the central issue of the first decade of the twenty-first century--promoting macroeconomic and exchange-rate adjustment.

The fund’s role of exchange-rate surveillance relates to the twenty or thirty systemically important members, the G20 countries, plus maybe another dozen whose actions have consequences for all. Countries have obligations not to manipulate exchange rates or the international economic system in order to gain competitive advantage, and the fund is to exercise firm surveillance in this area. Unless management, staff, and members of the IMF can more effectively identify and resolve global imbalances, the performance of the global financial system will suffer as a result.

The IMF’s leverage is limited. Its leadership and staff must start with quiet analysis and persuasion. The managing director of the fund says that they now have the balance about right between confidential advice and public pronouncements. I respectfully disagree and endorse four reforms to help the IMF increase its effectiveness.

First, the fund should be more proactive in its Article Four consultations, introducing an element of naming and shaming of countries for their policy mistakes or inactions. Instead of telling a country that its budget deficit should be reduced or that its exchange rate should appreciate, it should specify by how much. Article Four reviews for all systemically important countries should contain sections explaining why the country has not taken the IMF’s policy advice.

Second, the fund needs to establish an overall framework for surveillance for all the systemically important countries that is grounded on policies appropriate for achieving external and internal balance.

Third, the fund should embrace Morris Goldstein’s proposals: issuing a series of semi-annual reports on exchange-rate policies, it should make more frequent use of existing powers for consultations, and review its existing guidelines for surveillance.

Finally, the fund should engage in a collective consultation with the major Asian countries about their exchange rates and macroeconomic policies. I would not demand for Asian countries to appreciate their countries in concert against the dollar, but would call for an Asian Smithsonian Agreement to bring about a set of discrete appreciations against the dollar with appropriate supporting economic policies. Exchange-rate manipulation among Asian countries is at the core of macroeconomic imbalances and since Asian countries look at their neighbors policies before setting their own, we have a collective action problem. It is the IMF’s job to resolve precisely this kind of problem.

I regret that the move by the U.S. government to multilateralize what has been perceived to be a bilateral U.S. problem has been a bit slow. I hope that the rest of the G7 will take this topic more seriously. It has responsibility on this issue, but has so far failed to find a resolution.

Notwithstanding Tim Adams’ comment that we do not want to correct the U.S. current account deficit by reducing GDP by 6 percent, which is correct, if the deficit is to be cut in half over the next three to five years, the budget deficit will have to be eliminated.

Yusuke Horiguchi
Institute of International Finance

One of the key issues in the area of surveillance of exchange-rate policy is: who should do it? The United States has been busy doing it, whereas the IMF has been half asleep. The fund is always asleep in terms of key officials, who have been known to take a pretty good nap in the board room. Despite participation by the U.S. Treasury in this business, this is the fund’s job. Although I understand that under the Trade Act of 1988, the Treasury has an obligation of surveillance, it is not entirely healthy to rely on nations effectively taking justice into their own hands.

Tim Adams mentioned an intention to destigmatize special consultation in order to make better use of it and strengthen multilateral surveillance. I would like to recommend putting these together in order to have multilateral special surveillance.

The fund has done a very good job in identifying the basic causes of the global current account imbalances and in coming up with a sensible set of policy recommendations pertaining to the United States, the Eurozone, and China--emphasizing the importance of concrete action by every one of them. However, the work done in analyzing the problem is not enough. The fund should go a step further to make full use of all of its operational capabilities to force each of these countries to take the needed policy action required to resolve the global current account imbalances. The authority of special consultation ought to complement regular consultation and should not be seen as a “nuclear” option.

To gain the necessary action, the fund could dispatch a special consultation mission to each of the critical nations--with the findings of such missions spelled out in staff reports, which should all be discussed by the executive board at the same time. It should then set out a set of measured to be taken by each country, with a specific timeline attached to each and every measure. The IMF should put its seal of approval to the comprehensive action program, announce it publicly, and mandate that management and staff keep score and inform the executive board--on a quarterly basis, of what each economy has and has not done. For those not performing, another special consultation could be in order, in the form of direct discussion with the managing director. For transparency, the fund should make this score card public, which should provide a pretty good incentive to behave.

AEI research assistant Chris Pope prepared this summary.