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The world has changed dramatically since the Bretton Woods Agreement of 1944, says Rodrigo de Rato, but the IMF’s role is as vital as ever –

The International Monetary Fund (IMF) was founded in 1945 on multilateral principles, which stood in sharp contrast to the unilateralism and beggar-thy-neighbour policies of the 1930s. The international community intended the IMF to serve three related purposes. First, it would operate as a forum for multilateral economic cooperation, in recognition of the fact that one country’s policies affect other countries. Second, it would help countries to identify and adopt the macroeconomic policies that would help them to achieve and maintain high levels of employment and real income. Third, the Fund would provide temporary financial support, under appropriate safeguards, to help members address balance of payments difficulties without resorting to measures that could damage national or international prosperity.

Although there have been dramatic changes in the world economy over the past six decades, the IMF’s mandate has been sufficiently flexible to enable it to adapt to these changes and to the evolving needs of its expanded membership. Its key instruments – surveillance, lending and technical assistance – have been developed and amended, enabling it to continue serving its purposes in a changing world.

Challenges faced

What have been some of the key changes in the global economy that have affected the IMF? Perhaps the most fundamental development was the collapse of the Bretton Woods system of pegged exchange rates in the early 1970s, which was replaced by a system that left countries free to choose their exchange rate regimes. The second amendment to the IMF’s Articles of Agreement gave the Fund a new role of exercising “firm surveillance” over countries’ exchange rates and macroeconomic policies to ensure the effective operation of the international monetary system and to foster orderly economic growth with reasonable price stability. This radically altered how the Fund operated and, since then, much work has gone into strengthening Fund surveillance.

Another development that transformed the IMF in profound ways was the emergence of newly independent nations in Africa and elsewhere, beginning in the late 1950s. The Fund had to adapt its financing and policy advice to support growth-oriented structural reforms. And, since many of these countries could not afford to borrow on standard terms, it established arrangements for loans on concessional terms and, in collaboration with the World Bank, debt relief for heavily indebted poor countries.

The end of the Cold War led to another wave of new members joining the IMF. The Fund supported programmes in many countries in central and eastern Europe and the former Soviet Union, once again adapting its financing and policy advice – this time to help these countries make the transition from centrally-planned to market-based economic systems.

The challenges ahead

Today, we face another set of challenges. The expansion of the role of markets and their increasing globalization will continue to transform the international economy. These forces have brought great opportunities for the more efficient allocation of global saving but, at the same time, greater interdependence and potential for financial crises and spillovers.

In the past two decades there have been several devastating crises that have reverberated across countries, as domestic imbalances have combined with abrupt movements in capital flows. Moreover, rapid changes and sharp movements in the supply of and demand for global savings can be expected to continue in response to demographic and other changes. Populations are ageing in many industrialized and emerging market countries, and the AIDS pandemic has had devastating consequences in Africa and elsewhere. Savings flows might be further affected by shocks to energy markets, climate change, natural disasters, conflict and terrorism. Continued progress with trade liberalization will also have an important influence.

In addition, there have been – and will continue to be – changes in the balance of economic and political power. On the one hand, globalization and the rapid growth of emerging markets allow prosperity to be shared more broadly. On the other, many countries remain mired in poverty. There are also moves worldwide toward stronger regionalism in political, monetary and trade relations. Global trends toward democracy, broader participation in decision-making, and a growing prominence of civil society groups within and across borders have highlighted the importance of participatory process and outreach in decision-making. All these trends have implications for the Fund’s operations and its own governance structure.

Maximizing the IMF’s effectiveness

The IMF is already dealing with this new reality, and significant progress has been made. Yet these challenges will not be resolved overnight. And there will undoubtedly be further, unforeseen developments in the global economic system that will need to be addressed. I believe that the IMF is uniquely positioned to respond to such challenges. With its near universal membership, it is the only organization that maintains regular discussions on economic policies with almost all countries. It has the capacity to conduct comprehensive economic policy analysis at the global, regional and country levels. And its members are committed to providing information and engaging in peer review. The IMF’s normal process of internal review, which was strengthened following the Asian economic crisis of 1997-98, has helped to give the Fund a culture that is open to change and critical assessment. It also recognizes that continual evaluation is necessary to ensure that we can effectively help our member-countries design and implement the policies needed to raise domestic and global prosperity.

Surveillance will remain the centrepiece of our efforts. Over the past decade, there has been significant progress in strengthening our dialogue with member-countries that aims to improve their economic policies and prevent financial crises. We strive to ensure that our surveillance is based on a clear understanding of the specific circumstances of each country, as well as the linkages across economies that arise from financial and trade integration. Even when a country is not itself at risk, it might be adversely affected by the policies of others, and its own policies might affect other countries and the stability of the system as a whole. Accordingly, we seek to conduct surveillance even-handedly across our membership – developing and industrial countries alike. We are giving increasing emphasis to surveillance at the regional and global levels. And, in a world of integrated financial markets, financial system soundness has also become a surveillance priority. More than 90 countries have so far received health check-ups of their financial sectors under the IMF/World Bank financial sector assessment programme.

Perhaps the most difficult challenge in strengthening surveillance is to make it more effective in influencing policies. Clearly the foundations of surveillance are high-quality analysis and policy advice that is realistic yet challenging. But we must also find ways of making that advice more persuasive. One avenue we have already started down is that of increased transparency, which helps markets to assess risks more accurately and improves accountability. Although the Fund must continue playing its traditional role of confidential policy adviser, increasingly our members are choosing to make public the results of Fund surveillance. Indeed, more than three-quarters of the IMF’s country reports are now published.

Yet, no matter how good our surveillance is, crises will not disappear, and the Fund will be called upon to help mitigate their impact. Over the past decade, crisis resolution has sometimes required the commitment of substantial amounts of Fund resources. In most cases – for example, Mexico in 1995, Korea in 1997, and Brazil and Turkey in recent years – this commitment has paid off by supporting strong stabilization and reform programmes and helping to limit or avoid contagion. That said, we also need a Fund that can say “no” – one that is selective in supporting only programmes that put members firmly on the road to external viability, and one that does not protect the imprudent from the consequences of their decisions.

Moreover, the international community needs other crisis resolution instruments, in addition to conditional lending by the IMF. Ad hoc attempts to manage crises by coordinating private lenders, which had some success in the 1980s and more recently in Korea, have become more difficult as bond finance has gained in importance. The introduction of collective action clauses in bonds issued under New York law is a welcome step. So, too, are efforts in the financial community to develop a voluntary code to guide the conduct of debtors and creditors. Over time, these steps could address some of the problems that stand in the way of efficient and timely debt restructurings. But we will be able to assess whether they are enough only in the light of experience. The fight against poverty

In addition to efforts to strengthen crisis prevention and resolution, the IMF must also ensure that it is an effective partner in the global effort to eradicate extreme poverty. In the past few years, poverty-reduction strategies drawn up by low-income countries have served as the basis for the Fund’s partnership with them. We have sought to support these strategies through the provision of advice and technical assistance on macroeconomic and financial sector policies and on the sound institutions that underpin them – our core areas of expertise – and through concessional lending and debt relief. The fundamental tenet underlying this approach is that there can be little hope of sustained poverty reduction without macroeconomic stability. We have seen encouraging improvements in economic performance and social indicators in countries where such stability has been complemented by structural reforms and by the targeting of public spending to areas of greatest benefits to people – such as in Mozambique, Tanzania, and Uganda. Growth rates have also picked up in other African countries that have made progress in curbing inflation and establishing better control of the public finances. But much more needs to be done, especially if the Millennium Development Goals are to be achieved by 2015 – an objective agreed by the international community.

Good governance starts at home

Finally, maximizing the IMF’s effectiveness will also require it to adopt the best governance and management practices. We are continuing to look for ways to guarantee that the voices of all our member-governments are heard and that we take account of the full range of views and values of the Fund’s diverse membership. To this end, it is important that the executive board maintains a consensus approach to decision-making, and that we ensure appropriate representation of all regions and countries on the IMF’s staff. But many members want deeper progress on issues of voice and participation that would take into account the increased economic weight of Asia and other emerging market economies, and the need for the Fund’s poorest members to have a stronger voice in the Fund’s decisions. Changes in quota and voting shares will require a political consensus among our members that is not yet evident. Yet the Fund will not be fully effective unless all members feel that it is their institution.

I conclude that we do not need another Bretton Woods Agreement. The IMF has evolved in many ways over the past 60 years, while remaining true to its original purposes. Its evolution will surely continue. Our founding fathers got it right, and our mandate – to foster international economic cooperation, to promote rising prosperity and high employment, and to safeguard global financial stability – remains as vital as ever.

Rodrigo de Rato
Rodrigo de Rato is the managing director of the International Monetary Fund.