International Monetary Fund and Global Economic Stability
Economic stability is of major concern to economists and governments alike because of the critical role it plays in fostering a good health of the economy. In promoting economic stability, the goal is to keep inflation at optimal levels, eliminate high volatility in the financial and foreign exchange markets, stimulate economic activities to the desired levels, and to avoid an economic crisis. Instability in an economy can lead to serious negative consequences including stunted growth of the economy, uncertainty, lower standards of living, and reduced investments. The major challenge for many governments is to minimize economic instability and to ensure economic growth. Due to the increased globalization, most economies today appear as interconnected. This is to mean that a financial crisis in one economy is likely to affect other economies as well due to high dependencies among the economies. This paper is an evaluation of the International Monetary Fund’s (IMF) role in enhancing global economic stability.
History of the IMF
The IMF was founded in New Hampshire, United States, in 1944, during the Bretton Woods Conference. Bretton Woods Conference was held to discuss about the economic stability of nations in the postwar world (James, 1996). As World War II neared the end, the United Nations special agency saw the need to form an institution that could focus on stabilizing foreign exchange rates. Between the 1900 and 1945, the world experienced two world wars that significantly changed the economic landscape of most nations. In addition, the Great Depression had significant negative impacts on both the economies of Europe and the U.S. These world events created the need to establish an international monetary system that would ensure stability in major currency exchange rates (James, 1996).
The IMF was formed when various countries joined hands to form an international payment system. Initially, 44 countries participated in the drafting of the agreement for the formation of an international monetary institution to monitor balance of payments. Following the drafting of the initial agreement, 29 countries participated in ratifying the agreement (James, 1996). Towards the end of 1945, the countries signed the Articles of Agreement. The IMF began operating in 1946 with the appointment of the first executive directors (James, 1996). The mode of operation has been that member countries to pool funds using a quota system. Those countries experiencing a balance of payments deficit can be able to borrow money from the IMF. Countries experiencing a balance of payments deficit are able to borrow funds from the IMF and avoid using certain strategies such as devaluation and foreign exchange control, which could negative impact trade and the economy of other countries.
International Trade in the 20th Century and the Emergence of IMF
The growth of international trade in the 20th century brought about serious impacts in the balance of trade among countries. During this period, gold was used as backup for currency. This is to mean that any money created would be backed up using gold. A balance of trade deficit affecting a particular country meant an outflow of gold in order for the country to fill the deficit. In accordance with the mercantilist views, accumulating gold or other precious metals meant political dominance and thus the power to control other nations (James, 1996). Nations experiencing deficits in balance of payments would have less of the precious metals, which translate to serious economic and political weaknesses. Such a situation would force nations to engage in every means to ensure they have a favorable balance of payment.
Under the above system, most nations would be willing to apply damaging measures to ensure that their balance of trade remain favorable. It would be common for a nation to restrict critical imports just to establish a favorable balance of trade. Another possible tactic would be currency debasement in an effort to minimize the use of precious metals (James, 1996). In the worst-case scenarios, countries would likely engage each other in wars just to gain dominance. The result would be a loss on all countries engaging in international trade (Wellington, 2014). It is worth noting that when there is greater integration among countries engaged in international trades the higher the chances of having positive gains. This situation led to the establishment of a body that could eliminate conflicts among states engaged in trade.
The Bretton Woods conference provided nations with a great opportunity to develop an institutional framework that would guide international trade and eliminate conflicts among countries engaged in trade. In 1933, the World Monetary and Economic Conference evaluated the concepts of trade and balance of payments (Wellington, 2014). One of the notable outcomes from the conference, held in London, was the declaration that free trade would be critical in ensuring economic stability of nations. In addition, there were speculations that free trade would encourage the adoption of gold standards in trading among countries. However, it became apparent that nations were adamant to engage in free trade. The proposition made during the World conference and Economic Conference failed to materialize after it became apparent that no state was willing to practice free trade and eliminate trade quotas.
By the end of World War II, it had become apparent that trade policies would better be left at the discretion of individual nation states. Further, only a few simple nondiscriminatory trade policies would better serve nations engaged in trade (Wellington, 2014). In the 1930s, most countries developed monetary policies that would directly damage the economic position of their partners. For instance, countries would engage in currency devaluation as a war of punishing their trade partners (Wellington, 2014). During the Bretton Woods conference in 1944, it was apparent that there was need to place strict measures on currency devaluations or the monetary policy in general. This led to the establishment of a fixed exchange rate policy for all member states. This policy required that countries maintain a fixed currency exchange rate and engage in devaluation only in circumstances where there was a case of ‘fundamental disequilibrium’. Even in the case of a fundamental disequilibrium, a country would have to seek the go-ahead from the IMF.
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With unrealistic exchange rates for gold and other precious metals in the 1930s, countries had fewer options but to engage in currency devaluation, import restrictions, and protectionism policies such as tariffs, import quotas, and subsidies. Devaluing the national currency had the impact of creating greater value to a country’s exports. This placed nations at a better competitive advantage compared to their trading partners. Import restrictions helped countries achieve a favorable balance of trade by directly curbing cash outflows to their trading partners. According to Hagiu and Apostol (2017), the overall global trade declined by more than 60 percent between 1929 and 1932. The decline in trade was the result of efforts by individual countries to improve on the balance of trade and thus gain economic and political leverage on the world stage.
Role of the IMF in Global Economic Stability
The IMF plays a critical role in maintaining a global economic and financial stability. Economic and financial stability are critical in the economy of any nation. Stability promotes investment, economic growth, and can lead to improved standards of living and among other benefits. Investors prefer stable economies as compared to economies likely to undergo frequent burst and boom cycles. In the latter economies, there are increased operational risks that might contribute to substantial losses. The IMF plays a supportive role to countries experiencing deficits in the balance of payments and other economic difficulties. This section is an analysis of how the IMF helps in achieving global economic and financial stability.
Providing Consultation on International Monetary Issues
This is one of the key roles of the IMF. The institution provides economic advice to member countries enabling them to achieve economic stability and avoid falling in financial and economic crisis (Hagiu & Apostol, 2017). The IMF plays a critical role in evaluating global economic trends. The information gathered is disseminated to member countries to enable them make prudent decisions. Monitoring of trends in the global economic system is critical to enable countries to prepare in advance for unfavorable economic conditions. The IMF also provides technical assistance to member countries’ institutions (Hagiu & Apostol, 2017). This enables the various institutions such as central banks of member states to make sound economic decisions and policies.
The IMF is critical in ensuring that member states implement the right economic policies. The IMF conducts research on behalf of the member states and provides information to members at no cost (Hagiu & Apostol, 2017). Each country must adhere to the directions provided by the IMF on economic matters. The IMF conducts consultations with individual member states mainly on an annual basis. These consultations involve IMF staff discussing key financial and economic developments with key representatives from the member countries. The representatives may be individuals drawn from the private sector, trade unions, civil society, academia, and representatives from government (Hagiu & Apostol, 2017). The IMF provides advice to help member states in achieving economic and financial stability and thus promote economic growth.
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This is one of the key roles of the IMF, and the main reason behind the establishment of the fund. The IMF provides funds to individual countries experiencing unfavorable balance of payments (Fidrmuc & Kostagianni, 2015). The financial assistance is critical to countries experiencing shortage of international reserves. Such countries cannot be able to engage in trade especially the importation of goods due to shortage of international reserves meant for the exchange of goods. The IMF steps in for such countries by granting loans that enables them to import goods and ensure stability of their currency. This gives such countries adequate time to reevaluate their macroeconomic policies and put in place the right policies that can reverse the unfavorable balance of trade position.
The IMF grants loans to members based on the specific requests they make. The IMF drafts a loan agreement that often includes the measures that the specific country aims to take in order to resolve the unfavorable balance of payments issue (Fidrmuc & Kostagianni, 2015). The borrowing member country in conjunction with the IMF devises appropriate economic policies that can help in achieving a favorable balance of payments position. The amount of IMF disbursements fluctuates over time. Generally, the total disbursements closely reflect the global economic prevailing conditions. For instance, during the 2008/2009 recession, the total disbursements to member states significantly went up. This signifies the unfavorable balance of trade that most countries were experiencing.
The IMF provides member countries with different loan instruments that help in meeting diverse needs. Countries may need to satisfy current balance of payments, medium term, and long-term deficits (Reinhart & Trebesch, 2016). For instance, the IMF provides both concessional as well as non-concessional loans to member countries. Concessional loans attract lower interest rates compared to normal loans. In addition, these loans are given under favorable terms and conditions to member countries. Possible favorable terms are extended repayment periods than most loans available in the market. Low-income member states often receive concessional loans. Non-concessional loans are given at market-based interest rates. In addition, the repayment period is usually shorter
A common type of non-concessional loan available to advanced countries is stand-by arrangements (Dreher, Sturm, & Vreeland, 2015). These are loans given to developed countries with a repayable period of between one to two years. Another type of non-concessional loan available is the flexible credit line. This form of loan helps in crisis mitigation. Another type of non-concessional loan available to member countries is the extended funding fund (Dreher, Sturm, & Vreeland, 2015). This fund is given to member countries facing significant structural problems that may take time to resolve. This type of loan could have a reimbursement period longer than two years. Another type of non-concessional funding is the rapid financing tool, which provides funds to member states on short notice. This acts like more of an emergency fund for member states. The last type of non-concessional funding is the precautionary and liquidity loan, which helps member states with sound macroeconomic policies but experiencing widespread economic problems (Dreher, Sturm, & Vreeland, 2015).
There are three types of concessional loans provided by the IMF. The first type is extended credit facility (Hagiu & Apostol, 2017). These funds are available to countries experiencing unfavorable balance of trade payments over an extended period. The fund aims at improving the economic and financial position of such a country. The repayment duration is between three and five years. The other type of concessional fund is the pending credit facility (Hagiu & Apostol, 2017). This fund is available to low-income nations experiencing short-term balance of payment problems. As such, the loan has a maximum repayment duration of two years. Another type of concessional loan is rapid credit facility (Hagiu & Apostol, 2017). This type of fund is available to low-income countries that experience urgent need of cash to fill an unfavorable balance of payments. Under this option, the IMF does not charge any interest and can give a repayment period of up to five years.
The IMF plays a critical role in capacity development. Capacity development is the process of equipping member states with the skills they need to thrive and survive in the turbulent world characterized by fast-changing economic conditions (International Monetary Fund [IMF], 2017). In 1964, the IMF developed the Institute for Capacity Development (ICD) to carry out the role of capacity building in various member states (Hagiu & Apostol, 2017). In its capacity-building mandate, the IMF creates economic institutions that provide member states with technical assistance as well as training. The goal here is to help member states in strengthening their economies by creating the right policies. The IMF helps member states in improving their banking systems, generating higher revenues, building strong legal frameworks, improving the quality of economic forecasts, and in reporting key microeconomic variables (IMF, 2017). The IMF works closely with relevant government ministries and central bank in order to enhance capacity building among member states.
In building capacity development, the IMF focuses on four key areas. The first area is strengthening the tax policies of member states (Hagiu & Apostol, 2017). The IMF advises member states on how to develop a comprehensive tax policy that can maximize revenue collection and ensure the revenue is spent on key projects that create the greatest economic value. With regard to this, the IMF helps countries in developing budgets, managing debt (both internal and external), social security works, developing a customs policy, and in public financial management (Hagiu & Apostol, 2017). By improving on the human and institutional capacity to make the right tax policies, member states are in a better position to make the right economic decisions and thus enable the countries achieve economic stability.
The second key area is in helping member states to develop a sound legal framework (Hagiu & Apostol, 2017). In order to achieve economic and financial stability, it is critical that countries must establish sound legal framework. This is important because a strong legal framework helps in fighting corruption, money laundering, and acts of terrorism. Corruption and money laundering has been key hindrances to growth and development in most low-income countries. By fighting corruption and money laundering, low-income nations stand a better chance of achieve high economic growth rate. The IMF is critical in helping the low-income nations align their legal frameworks with those of developed nations.
The third key area is in developing strong monetary and financial policies among member states (Hagiu & Apostol, 2017). The IMF works with central banks and finance ministries in member countries with the aim of providing assistance in modernizing financial systems. The IMF provides guidance to central banks over how they can maintain control over commercial banks in order to regulate the economy. Banking supervision is crucial in economies since commercial banks influence the level of spending by varying the interest rates. The IMF helps member states in controlling inflation and keeping exchange rates stable. Controlling inflation is critical to ensure the overall growth of the economy.
The fourth key area is in collecting relevant statistics on behalf of the member states. The IMF collects and analyzes key macroeconomic variables relating to each member state and the world at large. Collecting statistics is critical in helping firms make informed economic choices (IMF, 2015). The IMF helps in not only collecting statistical data but also ensuring improvement in the quality of statistical data collected. This helps in ensuring the relevance of the data collected to each member state. The IMF leverages on technology application to improve on data collection and dissemination practices to the relevant states (IMF, 2015). Data collection is critical in making analysis of the economy and making decisions or policies regarding the economy.
This is another key role of the IMF in its effort to ensure economic and financial stability. The IMF conducts the surveillance role by monitoring the key macroeconomic variables on constant basis and informing member states about key changes that may affect their economic stability (Hagiu & Apostol, 2017). The IMF conducts surveillance on a national and international scale, and in the process identifies the various risks to the stability of member states. On identifying the risks, the body recommends to the member states key policy adjustments that can help in ensuring economic and financial stability amid the foreseen economic changes. The economic environment is constantly changing. As such, countries must keep adjusting their policies to fit the emerging needs in the economy (Hagiu & Apostol, 2017). The IMF provides vigilance to identify risks that threaten the stability of the economy of member states and provide warnings in advance to enable the countries avoid the risky economic situations.
The IMF conducts its vigilance roles on regional as well as global economic trends. The body provides multiple reports to member states detailing the economic outlook. The IMF makes efforts to strengthen its surveillance capacity on constant basis. According to Hagiu and Apostol (2017), the IMF reviews its surveillance potential or capabilities after every three years. This helps in ensuring that its surveillance capabilities are up to standards. The IMF provides surveillance focusing not only on regional and global trends but also on the interconnections among countries. This is because there is a high probability of decisions made by one country negatively affecting other trading partners. The high interconnectedness among the countries increases the risk of policy decisions made by one country affecting other countries that engage in trade with it.
The IMF conducts a thorough analysis of the economies and sectors in order to establish the links between them (Reinhart & Trebesch, 2016). This involves conducting specific country surveillance as well as multilateral surveillance to document the changes in the global economy. In the recent past, the IMF has focused its efforts on cross-border connections among countries and the impact to the economies. The IMF has also focused efforts on conducting more risk assessments in order to ensure that countries prepare in advance for risk economic situations in the future. The IMF may conduct different forms of surveillance as discussed below.
The first type of surveillance is macro-financial surveillance. This involves efforts to develop a better understanding of the linkages between a country’s macro-financial aspects (IMF, 2017b). In developing a better understanding of these linkages, the IMF can be able to inform policy. The 2008 financial crisis helped in raising the need for conducting macro-financial surveillance in order to deepen the knowledge on the financial sector linkages and thus avoid financial disasters in the future. One of the elements covered in conducting a macro-financial analysis is the evaluation of vulnerabilities facing the financial sector of a particular country (IMF, 2017b). The happenings in the financial sector of a country significantly affect the overall macroeconomic conditions in a country. For instance, credit issuance by commercial banks significantly affects key macroeconomic aspects of a country such as growth rate, employment, and inflation.
The second type of surveillance is external stability surveillance. This involves the evaluation of external economic factors or even policies that could have significant impact to countries. Policies made by different countries could have significant impact on the economic position of other countries. The IMF conducts evaluation of global economic trends whereby it helps in addressing various critical issues such as global overspills, financial turmoil, and monetary policies set by other countries (IMF, 2018). The IMF also conducts an evaluation of the global capital markets to determine various key economic factors such as capital flow.
The last type of surveillance concerns an evaluation of the macro-structural policies. In this type of surveillance, the focus is on promoting a stable economic environment that enhances employment opportunities and promotes financial stability. Under this option, the IMF also makes efforts to reduce inequalities that exist in an economy. The IMF also examines the exchange rate policies set by member states. Member states provide information to the IMF to help in making crucial decisions. All member countries must maintain their currency exchange rates at a value relative to other major currencies such as the U.S. dollar.
In summary, the International Monetary Fund plays a crucial role in ensuring economic and financial stability in countries. Prior to the establishment of the Fund, countries had to rely on the gold standard as a way of effecting transactions involving currency exchange. Due to the reliance on gold and other precious metals as a backup for local currencies coupled by mercantilist views of possession of precious metals as gaining power, most states employed tactics that discouraged trade with their partners. In addition, states were more likely to adopt policies that negatively affected their trading partners while using the gold standard. For instance, states were more likely to devalue their currency or restrict imports in order to gain a favorable balance of payments position. With the coming of the International Monetary Fund, trade expanded among member states since it became easier for countries to obtain funds when they had an unfavorable balance of payments position. In ensuring economic and financial stability, the IMF carries out four major roles that include providing consultation, financial assistance, capacity development, and surveillance roles.
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