It is a privilege to address the Senate Subcommittee on International Trade and Finance.
Before outlining the valuable role the International Monetary Fund can play in today’s global economy, it must be clearly established what role it does not and can not play.
The IMF was created in a world of capital controls and immature capital markets. However, today, in an environment of massive free capital flows, it plays no role in the core financial markets of the international economy. It is not a central bank, a regulator, a policy maker or a lender of last resort, nor does it command the resources to impact major financial systems. These functions stand squarely in the domain of the Federal Reserve, the European Central Bank, the Bank of Japan, the Bank of England, and the Bank for International Settlements. Only on the periphery of the global economy – developing countries and economies in transition – are the IMF’s forces adequate to intervene in crises and, by protecting the prosperity of these nations, enhance the economic well-being of the industrialized world.
Though the Fund’s balance sheet shows approximately $330 billion in total resources, including its financing capacity under the Arrangements to Borrow, the effective base is only $230 billion after deducting $100 billion of member subscriptions in currencies
that are not usable for international transactions. The IMF’s outstanding and committed loan portfolio and minimum working balances reduce the current resources available for intervention to $120 billion.
A $40 billion rescue package may be sufficient to address a crisis in Brazil when the central bank is losing $1 billion in reserves per day. However, if a crisis erupted in any of the 10 largest industrial economies, $40 billion would be gone in a nanosecond. The IMF’s total resources would be wiped out in an instant.
What is the role of the IMF in a world of global capital markets?
One of the key goals of international economic policy must be the reduction of the frequency and severity of financial crises. The IMF has the ability to play a significant part in the global framework. The Fund’s roles would be:
The IMF currently attempts to fulfill these functions but its effectiveness is dramatically reduced by its other activities and the mechanisms it utilizes.
First, its primary focus of financial emergency assistance is diluted by its attempts to provide long-term programs for structural adjustment, development and poverty alleviation. This intervention in the operational sphere of the development banks leads to duplication, confusion and waste. The functions of lender of last resort and long-term program financing are separated in domestic economies. When the U.S. government decided to encourage home ownership, it did not ask the Federal Reserve to provide mortgage financing, it established specialized institutions.
Second, the tool of subsidized long-term loans with policy conditions is inappropriate for a lender of last resort. Under the current system, the IMF provides financing to countries in difficulty at an interest rate far below the borrower’s cost of funds in times of prosperity, let alone crisis. This has transformed the Fund into the lender of first resort. Short-term loans should be provided to illiquid but solvent borrowers at a penalty interest rate above the borrower’s precrisis cost of funds. An incentive to return to private sector
financing as quickly as possible must be created. The imposition of policy conditions on loans is inappropriate for crisis lending, even if the conditions are fulfilled. A crisis, by its nature, requires immediate intervention. The weeks necessary to negotiate the conditions only increase the severity of the problems.
The Commission’s recommendations regarding the IMF’s function and methods of assistance attempt to remedy the shortcomings of the prevailing system. These measures would allow the Fund to play a valuable role in promoting the stability and prosperity of the global economy.
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