Proving Keats Wrong: The IMF as a Guardian of International Financial Stability, Address by Anne O. Krueger, First Deputy Managing Director, IMF

August 25, 2004

Proving Keats Wrong: The IMF as a Guardian of International Financial Stability
Anne O. Krueger
First Deputy Managing Director
International Monetary Fund
Address to Pacific Council on International Policy
San Francisco, August 25, 2004

Good evening. Thank you for that kind introduction, Tim. I am delighted to be here this evening. San Francisco has a long history of interest in global affairs and I know the Pacific Council does much to foster that here—as, indeed, it does right along the West Coast.

And this city has a special significance for those who believe in, and are committed to, the postwar multilateral framework. Next spring you will be marking the 60th anniversary of the famous conference held here that set up the United Nations. That has proved to be an enduring monument to the vision and ambition of those preparing for peace in 1945.

We in the international financial institutions—the International Monetary Fund which I represent and our sister institution, the World Bank—have been marking our own anniversary this summer. The Bretton Woods Conference that established the IFIs, as we are now collectively known, took place in July 1944. The framework established at that now-famous hotel in New Hampshire has proved every bit as durable.

For the IMF, this important anniversary has offered a useful opportunity to reflect on what has been achieved and, looking ahead to the future, to the challenges that remain. I'd like to share some of those reflections with you tonight.

Economic stability

Some of you are probably intrigued by the title of my talk. I hope so: it was meant to tantalize! For those of you not familiar with the whole of Keats's canon—and I must now confess that the phrase I chose comes from one of his letters and not a poem—let me share the whole quotation with you:

There is nothing stable in this world: uproar's your only music.

After some of the recent international political and economic upheavals, that is a sentiment that many people might share today.

Yet appearances can be deceptive. The global economy and the international financial system are, and have been, remarkably stable over the past six decades. And the postwar era turned out to be an age of tremendous prosperity for nearly everyone.

Just look at some of the figures. Industrial countries experienced rapid growth in the 1950s and 1960s—at rates that were unprecedented by historical standards. Between 1950 and 1973, for instance, per capita incomes in America grew on average by 2.4% a year. Germany saw growth rates at more the double that over the same period, and Japanese per capita income growth exceeded 8% annually.

Inflation was a bit higher than we have become accustomed to lately, but only by a small margin, and unemployment was much lower than even America and the UK have managed since that golden age.

We are all familiar with the benefits that such a rapid rise in living standards brought for citizens in the rich countries. We all quickly grew used to owning refrigerators, washing machines, telephones and cars.

What is much less often realized is how extensive the benefits of the postwar expansion were. Of course, we know all about the Asian tiger economies: their growth rates soon made those of the industrial countries look anemic.

The Korean economy was one of the first to be transformed, following the reform program set in train in the late 1950s and early 1960s. Its per capita income rose sevenfold between 1962 and 1992—an extraordinary achievement over such a long period. In each decade the Korean economy was expanding by as much as the British economy did in the nineteenth century.

But other Asian countries followed Korea with annual growth rates of 7%, 8% and more between 1985 and 1994. Official figures show China's growth rate exceeded 10% annually over that period. I have just returned from China where the changes taking place provide a striking example of the positive benefits of globalization. Growth driven by trade is transforming the country. Perhaps it is not surprising that Shanghai is unrecognizable from when I last visited it in the 1980s. But I have been in Beijing much more recently: and it too has changed beyond recognition.

Even India, a country whose growth performance had long been disappointing, started to expand more rapidly after economic reforms were started in 1991. Indian growth was around 6% a year on average during the 1990s after the reforms.

Such growth performance transformed the lives of millions. If anyone doubts the causal link between economic growth and rising living standards for most and not just a few, they need only look at the numbers.

Infant mortality rates fell sharply in most developing countries. The official figures show that the infant mortality rate in China fell by around 83% between 1960 and 2002. Thailand, Indonesia and Sri Lanka saw drops of a similar magnitude. Singapore saw a decline of 90%. Even in Bangladesh, one of the world's poorest countries, infant mortality fell by more than 67% between 1960 and 2002, to 48 deaths per 1000 live births. In many cases, infant mortality in developing countries today is significantly lower even than it was in industrial countries in 1960.

Or take literacy rates. In the Philippines and Thailand, the literacy rate now exceeds 93%. It is more than 77% in Kenya, whereas less than half the population was literate in 1970.

Perhaps the most telling statistic is life expectancy. The AIDS epidemic has had a negative impact in some countries, of course. But in general, life expectancy in developing countries has risen as at astonishing pace. In Indonesia, it is now around 64 years, a rise of more than 60% since 1960. In Malaysia, life expectancy for men is now close to 70 and for women it is almost 75.

Since 1960 life expectancy in the world's poorest countries has risen at roughly double the rate in the richest. The gap between life expectancy in industrial and developing countries has narrowed from around 30 years in 1950, to around 10 years today.


In short, more people have become better off and at a more rapid pace than ever before. The benefits of rapid and sustained economic growth have been passed on to ordinary citizens as living standards have risen, and poverty has been reduced.

And underpinning the postwar surge in growth was the multilateral framework put in place at the end of the Second World War. There had been rapid economic growth before 1945, of course, although not on the scale we have seen since 1945. The global economy started to grow rapidly—by historical standards—in the nineteenth century as the industrial revolution spread out from Britain across Europe and the Atlantic. International trade and economic growth seemed by the standards of the day to be spectacular, fuelled by technological advances in transport, communications and productive capacity. A combination of falling transport costs and tariff reductions brought a significant boost to trade.

But that period of rapid expansion quickly ground to a halt after the First World War. The upheavals of that war and the ensuing political chaos in much of Europe undermined the international framework that had encouraged international trade and capital flows.

The depression of the thirties was accompanied by damaging unilateralist policies that reinforced the downward cycle and made recovery much more difficult. The Smoot-Hawley Act of 1930 ensured that American tariffs were among the highest in the world. The beggar-thy-neighbor approach to international economic relations gained a strong hold, and at the very least intensified the Great Depression.

There were advocates of free trade who fought hard to reverse this unilateralist approach, just as the nineteenth century opponents of the British Corn Laws had done. But in the early 1930s, the protectionist momentum, and the damage it inflicted, was unstoppable. As tariffs rose, trade flows contracted, international capital flows shrank and real wages and employment fell.

Protectionists, always masters of self-delusion, blamed these policies on the consequences of economic contraction. The truth was quite the opposite. Curbing the mobility of goods and capital hampered economic recovery and compounded the problems of collapsing investor confidence and mis-guided monetary and fiscal policies.

The architects of the postwar international economic system were determined to avoid a repetition of the inter-war years. The founders of the Bretton Woods institutions wanted to establish a stable economic order. But not as an end in itself. They had already realized that trade and growth were wholly interdependent. They also knew that economic prosperity needed a liberal expansionary trading system; and that this could not happen in the absence of a stable financial system. Hence the creation of the IMF.

I want to describe how the Fund has sought to deliver financial stability across the globe since its inception and how it has done so by adapting to changing circumstances while remaining true to its mandate.

But I want first to reiterate what I said earlier about the importance of trade to postwar economic success. The benefits of free trade have long been clear—Richard Cobden was forcefully making the case during the nineteenth century Corn Law debates. Cobden had to argue his case from a theoretical standpoint, saying free trade was right "in the abstract". Thanks to the multilateral trade framework established after the war—first the General Agreement on Tariffs and Trade, or GATT, and then the World Trade Organization—we no longer need rely on theory alone.

We have clear evidence that the surge in growth accompanied a massive expansion of global trade. In 1950, world merchandise exports accounted for about 8% of world GDP; by 2002 that figure had risen to 19%. Global trade, in other words, expanded far more rapidly that global GDP—it was the engine that drove economic growth.

A city like San Francisco, on the Pacific Rim, knows all about the importance of trade for economic health and progress. I don't need to remind anyone here, I'm sure, about the economic benefits that flow from the free exchange of goods among countries.

But protectionists aren't easily discouraged whether they be those seeking to protect special interests—jobs or firms—from competition, or those, like some of the anti-globalization protesters, who have a genuine but mis-guided belief that free trade harms the poor. So it was especially encouraging to see that last month, after some eleventh hour wrangling, agreement was finally reached on a negotiating framework for the next stages of the Doha round of international trade talks.

There can be no doubt that a successful Doha round will benefit all countries, but especially those in the developing world. The World Bank estimates that around two thirds of the benefits of the round—worth several hundred billions dollars—will go to developing countries.

The IMF's role

As I noted a moment ago, the importance of financial stability in fostering trade and economic growth was recognized from the outset by those who constructed the postwar framework. The Fund has been a steadfast supporter of trade liberalization: and the best practical way for us to provide that support is by delivering global financial stability. That remains our mandate, sixty years on, though how we have carried it out has changed over the years.

Adaptability is crucial to success in this area. After all, the economic environment in which we now operate is very different than that prevailing in 1945. Not least, one of the Fund's primary responsibilities in those days was to support the system of fixed but adjustable exchange rates set up in part to prevent a repetition of the competitive devaluations of the 1930s.

The period between 1946 and 1973 was not without its ups and downs. But that system of fixed exchange rates served the world economy well for many years. The switch to floating exchange rates among the industrial countries from 1973 onwards was both far more successful than many anticipated, and fortuitous. It enabled countries and the system as a whole to cope with the oil price shocks of the mid and late 1970s much more successfully than might otherwise have been the case. Floating rates made possible a flexible response to the pressures posed by rapid and very large rises in the oil price.

The oil shocks are sometimes seen as a turning point in postwar economic history. In fact, the rise in oil prices was related to the worldwide surge in inflation in the late 1960s and early 1970s. But they certainly marked an important turning point for the Fund. It was in this period, and subsequently, that developing countries became the IMF's biggest customers.

The oil producing countries suddenly found themselves awash with cash surpluses in need of a home. As oil revenues were recycled, Western commercial banks lent aggressively to oil-importing developing countries, usually on a floating rate basis. With hindsight, the result was predictable, many countries were unable to service their debts as interest rates rose in the early 1980s as part of the drive to curb inflation in the industrial countries. The IMF played a leading role in helping resolve what became known as the third world debt crisis of the early 1980s.

Financial crises have always been part of the Fund's work; they still are. For the IMF delivering global financial stability means doing everything possible to prevent crises, but when they do occur, seeking to resolve them as smoothly as possible. Of course, even if the Fund were always right in detecting trouble ahead, governments would not necessarily follow the advice on offer.

Failure to heed warnings by the Fund can lead to crisis. Crises in individual countries have been frequent: but they have rarely brought widespread disruption to the global financial system.

As the 1980s drew to a close, the pace of global economic change seemed to quicken. The most dramatic change, of course, was the collapse of the Soviet empire. The political upheaval was momentous and altered the character of international relations. It brought us a large number of new members, all urgently needing our help. They needed financial assistance, of course. But they also needed advice on how to develop normally functioning market economies. We, along with other agencies and governments, tried to provide that advice.

In the early days, the learning curve was steep for everybody concerned: the sort of economic transformation needed had never been attempted before. But it is perhaps a measure of how far all those involved succeeded that many of the countries that for decades had been completely outside the international financial system have recently joined the European Union.

This was change on a scale that should have been enough to keep the Fund and its staff fully engaged. But no. We had other things to worry about as well. Some of the biggest financial crises the Fund has ever dealt with have erupted in the past decade or so. Mexico's so-called tequila crisis in 1994; the Asian crisis of 1997-98, Russia in 1998, Brazil in 1999, Turkey in 2000 and, most recently, Argentina in 2001: these all involved enormous upheaval for the countries concerned, for the IMF and, to a greater extent than usual, for the international financial system.

These crises were different in nature as well as scale. The most significant factor was that they were capital account crises, rather than the current account crises that the IMF had been used to handling. They erupted much more quickly, and the provision of assistance was often much more urgently needed. Many belatedly realized that financial market liberalization brought with it the need always to be conscious of the markets' judgment. At the time, that judgment can sometimes seem harsh; it can certainly be unforgiving. But we and our member countries are learning to live with and benefit from the discipline that the market can impart.

A learning process

I noted that capital account crises can occur very rapidly and require an immediate response. Such crises occur because the holders of a country's debt lose confidence in its ability to service that debt. In principle, a crisis can occur even if the country's current macroeconomic policies are sound, if the creditors believe such policies will not be sustained. When there are real, and justified, doubts about a country's economic policy, these can erupt into a full-blown crisis with astonishing speed. The only effective response is to restore creditors' confidence that a country will be able to meet its debt obligations in full. That, I hardly need add, is easier said than done.

So the past decade or so has been a very steep learning curve: for the IMF, for economists in general, and for governments. We have been trying to work out how best to detect when a crisis is imminent, how to respond to the warning signs, and, of course, how to handle crises when they do occur. Our conclusions have led us to shift the focus of much of our work: though I should point out that, for the IMF, the learning process is continuous because the world economy is always evolving and we adapt to new information and developments.

The development of sustainable economic policies has always been at the heart of our work. What's changed is how we define sustainability. We now pay particular attention to debt sustainability, for example, and mis-matches in exposure. Debt sustainability analyses are standard. Capital account crises invariably involve the market concluding that a country will not be able voluntarily to continue to service its debts. Assessing a country's debt burden, and its ability to service that debt, is one important way in which we can seek to prevent crises.

But we also pay close attention to the financial sector, not least because of the contingent liabilities involved. There are several important ways in which we can make a judgment about the robustness of the financial sector. These include the health of the banking system—and here the level of non-performing loans is relevant; the extent to which risk is clearly defined in the financial system; and the systems' transparency.

We have made our financial sector assessments more rigorous. In 1999, we introduced the Financial Sector Assessment Program (FSAP) that aims to help member governments strengthen their financial systems by making it easier to detect vulnerabilities at an early stage; to identify key areas which need further work; to set policy priorities; and to provide technical assistance when this is needed to strengthen supervisory and reporting frameworks. The end result is intended to ensure that the right processes are in place for countries to make their own substantive assessments.

The FSAP also forms the basis for Financial Stability Assessments (FSAs) in which IMF staff address issues directly related to the Fund's surveillance work. These include risks to macroeconomic stability that might come from the financial sector and the capacity of the sector to absorb shocks. FSAPs have benefits for the whole range of our membership.

We have also worked with the World Bank to develop a system of Standards and Codes—using internationally-recognized standards—that form the basis for Reports on Standards and Codes (ROSCs). These cover twelve areas, including banking supervision, securities regulation and insurance supervision. The financial sector ROSCs are an integral part of the Financial Sector Assessment Program and are published by agreement with the member country. They are used to sharpen discussions between the Fund—and, where appropriate, the World Bank—and national authorities; and, in the private sector, including rating agencies, for risk assessment purposes.

I think our work in this area, and the experience of the Asian and other crises of the 1990s, also greatly reinforced the importance we attach to transparency. The Fund is now far more transparent than it used to be—we try hard to be clear about what we do and why. And for national governments, transparency can be a vital ingredient for success. It has become clear that policymakers did not used to talk even to each other enough; such was the culture of secrecy that surrounded much economic and financial policymaking. As we saw, though, that increases the risk that policies will be inappropriate and the shocks bigger and far more painful to deal with.

Our member governments—there are 184 of them currently—have learned the benefits of transparent policymaking, though we sometimes need to remind them how significant these benefits can be in terms of strengthening confidence and so, in some cases, reducing borrowing and transactions costs.

This might all sound rather worthy but dull. Don't be mistaken. As several countries around the world can attest, when financial crises erupt, they do so suddenly and brutally. They can quickly lead to panic and even, in extreme cases, chaos on the streets. Anything we can do to reduce the risk of that happening is clearly of the utmost importance.

Looking ahead

A lot of progress has been made at both the national and international level. One illustration of this is that there were surprisingly few financial crises in the global economic downturn of 2001-2002. That is exactly when we would expect to see problems erupt in countries that remain vulnerable because of less-than-sound macroeconomic policies or that have weak financial sectors.

That we escaped the last downturn relatively unscathed should not, though, be an excuse to relax our guard. Indeed, the Fund is urging countries to seize the currently benign outlook to push ahead with further economic reforms. Too many emerging market countries have budget deficits that are too high; too many have large public debt burdens that are expensive to service and will rapidly become even more expensive as world interest rates rise. And too many countries have weak or poorly-regulated financial sectors that leave them vulnerable in the event of a downturn or some kind of international financial disruption.


In other words, for the Fund it is business as usual. We must always remain alert to potential sources of instability: prevention is always better than cure, though too often our advice and help is sought when the time for prevention is past.

I sometimes ask people to imagine a world without the IMF. It is difficult not least because it is clear what we do is vital to the maintenance of global financial stability. If we didn't exist someone would have to invent us.

Of course I am not claiming we have always got everything right. But stability is important, as Keats realized, even if he doubted it was possible to have. In fact, it is more than important, it is arguably vital to economic prosperity. Without financial stability, trade would not expand, economic activity would be undermined and attempts to reduce poverty would be fatally weakened. As Keats said, uproar would be our only music—not a pleasant prospect.

Thank you.


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