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International Financial and Monetary Stability:
Remarks by Michel Camdessus
A Global Public Good?
Managing Director of the International Monetary Fund
At the IMF/Research Conference
Key Issues in Reform of the International Monetary and Financial System
Washington, D.C., May 28, 1999
Thank you Ladies and gentlemen. As one of the fundamental purposes of the IMF is "To promote international monetary cooperation through a permanent institution that provides the machinery for consultation and collaboration on international monetary problems," I believe that it is particularly appropriate that the Fund should sponsor this conference, with its extremely wide range of participants from around the world, on Key Issues in Reform of the International Monetary and Financial System. Also, as a manifestation of our increasingly close cooperation with our sister Bretton Woods institution, I can't help noting the symbolic appropriateness of the location of today's dinner--thank you Jim. My concern tonight is that I cannot pretend, in my intellectual input, to match the outstanding--by Washington standards--culinary contribution you have made to this occasion!
Let me start with the proposition that the international monetary and financial system may be seen as a global public good. It is essentially the same system for everyone. If it works well, all countries have the opportunity to benefit; if it works badly, all are likely to suffer. Hence, all have an interest in reforms that will improve the system for the global public benefit. And, as is so frequently true for public goods, not many people care for, and even fewer are prepared to pay for, its improvement even if many comment about it. But let us set aside such jaundiced comments and let me touch on three issues that reflect on the international monetary system as a public good might suggest.
The first key area where we have important issues concerning international public goods lies at the very heart of the international monetary system and of the IMF's responsibilities. There is no world money controlled by a world monetary authority which performs the essential functions of medium of exchange, store of value, and unit of account at the global level. Rather, the monies of the largest industrial countries, most importantly the U.S. dollar, the Euro, and the Japanese yen do double duty as the monies for their respective countries and as the monies used by most other countries for conducting their international trade and financial transactions.
Inevitably, there is an important public goods aspect to monetary policy at the national level--there is only one monetary policy that affects everyone. When non-residents use a national money, as is extensively the case for the world's major national monies, national monetary policies acquire aspects of global public goods. Exchange rates always, to some extent, involve issues of international public goods as an exchange rate is the relative price of two national monies and is affected by the corresponding national monetary policies. This international public goods aspect rises to global significance for exchange rates among the world's major currencies as use of these currencies is global and movements in their exchange rates have widespread effects.
Quite understandably, the monetary policies of the major currency countries (including the Euro area) are directed at domestic economic objectives, which may be broadly described as promoting domestic economic and financial stability. Reasonable stability of the domestic price level is increasingly recognized as the most basic objective of monetary policy. Given this objective, monetary policy also typically seeks to support maximum sustainable growth and to promote general stability in financial markets. The behavior of exchange rates may sometimes influence the monetary policies of the major currency areas, but usually only to the extent that exchange rates affect the more basic objectives of monetary policy.
From the global perspective, this domestic orientation of monetary policies in the major currency areas is generally desirable. As experience has unfortunately taught us on several occasions, economic and financial instability in the dominant economies of the world is bad for them and for the rest of the world as well. Thus economic policies that promote domestic economic and financial stability in the largest economic areas of the world are not only desirable--they are essential--for economic stability and prosperity elsewhere.
That said, it may still be asked whether it might be desirable for economic policies in the largest currency areas to pay somewhat more attention to their international consequences, particularly in the area of promoting greater exchange rate stability? My answer, I suspect, will not entirely surprise you. I am, after all, the Managing Director of the International Monetary Fund. I have a job to do. I try to do it with enthusiasm.
Beyond that, I believe that recent experience suggests--suggests rather pointedly--that somewhat more attention can be paid to international consequences and specifically to exchange rates in the management of economic policies in the largest economies with beneficial results for these economies as well as for the rest of the world. In early 1995, the U.S. dollar plunged below 80 yen and below 1.35 deutsche marks. This sharp weakening of the dollar tended to undermine recovery in the weak Japanese economy and, arguably, was a factor in the slowing of growth in Europe. Also, the instability of the dollar/yen exchange rate that began in early 1995 contributed to the problems that led up to the Asian crisis.
Consistent with advice given by the IMF, in 1995, official actions did seek to forestall and reverse the excessive weakness of the dollar. In the late winter and spring, official interest rates were cut in both continental Europe and Japan and were cut further in Japan during the summer. Coordinated intervention by Japan and the United States was used to send signals to the market. These official actions were, in my judgment, both successful and important in helping to reverse the dollar's unwarranted weakness; and they provide an example that shows the potential usefulness of official efforts to counteract excessive and unwarranted movements of exchange rates among the major currencies.
Last September and October, in the wake of Russia's default and the near failure of the hedge fund, LTCM, a liquidity crisis gripped a wide range of financial markets. The markets most affected were the second tier markets for lower rated and unrated credits of both industrial and developing country issuers. Indeed, yields on the highest rated U.S. Treasury and German government bonds fell sharply, while spreads widened dramatically and new issue activity dried up for virtually all emerging market issuers. Although adverse effects on the U.S. economy were not apparent, recognizing the danger posed by this crisis, the U.S. Federal Reserve took the lead among major currency area central banks in easing monetary conditions. In this instance, forward looking monetary policy action, in the United States, the Euro area, and Japan, which took account of conditions in global financial markets beyond those of immediate domestic concern, clearly helped to forestall important risks of a deeper global economic downturn and, correspondingly, has helped to create the more favorable prospects for global growth that we see today.
We must not, of course, overplay our hand. When domestic considerations relevant for monetary policy in the major countries run counter to external considerations, it will often be a mistake, domestically and internationally, to give much weight to external considerations. With respect to efforts to limit exchange rate instability, it must be recognized that sometimes substantial movements of major currency exchange rates are economically appropriate and can be helpful from a macroeconomic policy perspective. For example, the relatively strong U.S. dollar at present is consistent with the strong cyclical position of the U.S. economy and is helping to forestall possible inflationary pressures in the U.S. and is usefully deflecting some of the rapid demand growth in the U.S. to countries with large margins of slack.
Moreover, even when exchange rates may seem to have moved too far, it is not always wise to adjust macroeconomic policies even marginally to try to affect exchange rates. For example, when the yen fell to 145 to the U.S. dollar in mid 1998 many would have thought that this was a bit too far, especially in terms of the pressures placed on some Asian emerging market economies. But, in view of the economic conditions prevailing in Japan and in the United States neither a tightening of Japanese monetary policy nor an easing of U.S. monetary policy appeared appropriate in any effort to resist further depreciation of the yen. On the other hand, (sterilized) official intervention could have been used more actively and on a coordinated basis to send a signal that markets were taking the exchange value of the yen too low.
Concerning intervention, we know from as far back as the Jurgensen report, that this is not a very powerful tool for influencing markets, especially when it is not supported by other policies. However, markets do not always get exchange rates right. Under the influence of bandwagon effects, manias, panics, and other anomalies, markets sometimes take exchange rates a considerable distance away from levels consistent with economic fundamentals in circumstances where this is detrimental to global economic performance. With due modesty about our ability to diagnose such developments and appropriate caution in implementing countervailing policies, I believe that the official sector can and should press further to resist unwarranted movements in major currency exchange rates. The successes that have been achieved in the relatively limited actions undertaken in recent years surely suggest that further efforts, within reason, would produce international public goods. Excessive ambition for the success of such efforts would be a mistake; but too much timidity is a mistake as well.
A second vital area of IMF responsibilities where international public goods are at issue is in assisting countries facing difficulties with their external payments. The purposes of the Fund's activities in this area are clearly defined in its Articles of Agreement, and I like very much the paragraph of Article 1, that enjoins us: "To give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with the opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity."
The objective of "giving confidence to members" applies not only to times of difficulty. More generally, because open policies toward international trade bring public goods benefits to the global economy, it is desirable to persuade members to adopt such policies by offering some assurance of assistance in the event that they encounter external payments difficulties. I would assert that this argument applies as well to open and prudent policies toward international capital movements, and that it is high time for the Fund's Articles to be amended to reflect this.
The constraint that use of the Fund's general resources should be "temporary," subject to "adequate safeguards" and used to "correct maladjustments" without resorting to "destructive measures" reflects the policy of the international community to be prepared to provide interest-bearing loans, but not grants, to assist countries that are themselves acting constructively, from an international as well as a domestic perspective, to address their own problems. Thus, promotion of the global public good, not merely the correction of disequilibrium in the assisted country, is the clear purpose of the Fund's financial assistance.
I should add that these constraints on how and when the Fund provides assistance to its members show the prescient concern of the framers of the Articles for what is now referred to as the problem of "moral hazard" potentially arising from international financial support. Because the Fund provides loans with firm expectations of repayment, it is not absorbing losses that should be borne by members or their creditors and is thus not contributing directly to problems of moral hazard. Furthermore, through the safeguards built into the Fund's conditionality, members receiving Fund assistance are pressed to reform their policies not only to correct current problems but also to reduce the risk of future payments difficulties. Such reforms, including particularly the financial sector reforms that have been central to many recent Fund programs, work to correct problems of moral hazard that tend to be generated by national economic policies. With these reforms, and the continuing efforts to improve the architecture of the international monetary system and involve constructively the private sector in both lessening the risks and ameliorating the effects of financial crises, I am convinced that, the problem of moral hazard can be adequately contained, though of course it cannot be completely eliminated.
Indeed, with its new facility, the Contingent Credit Line (CCL), the Fund has a new tool to promote desirable reforms for countries that are not yet in difficulty but fear contagion. The additional incentive for reform comes from limiting access to this, essentially precautionary, facility to countries that are judged to already have a sound framework of economic policies_ a new approach that provides a reward in advance for good policies, rather than assistance conditional on reform when bad things are already happening.
For the Fund's traditional approach of conditional support for members in difficulty, a good deal of controversy has recently arisen about the size of financial support packages and about their conditionality. Some argue that, to better contain possible moral hazard, support packages should have been much smaller and conditionality should have been tougher. Others, who focus on the very large costs of recent crises, argue the contrary, for larger support packages with easier conditionality. I believe that, if traditional Fund programs are to serve best their intended function to promote the global public good by reducing the likelihood of and damage from external payments crises, then both adequate financing and firm conditionality are required. And I am delighted to affirm that this has been the firmly held line of the Executive Board all through this demanding time.
On the scale of some recent support packages, I would emphasize that the Fund has not been alone; important additional support has come from the World Bank, the Asian Development Bank, the Inter-American Development Bank, and bilaterally from national governments and central banks. Clearly, in these cases, the responsible judgment of the international community was that financial support beyond the substantial amounts provided by the Fund was necessary and appropriate. Recent initiatives to increase support, notably that of the Japanese government for several Asian countries, confirm this judgment.
On conditionality, initial economic assumptions in several recent programs proved substantially too optimistic, and it was appropriate to exploit the flexibility of program revisions to better adapt economic policies to unforeseen circumstances_in some cases leading from a prescribed initial tightening to a subsequent substantial easing of fiscal policies. For monetary policies, initial tightenings were, in my view, not only the right policies, but the absolutely essential policies to resist what were already excessive exchange rate depreciations with threatening domestic and international implications.
More generally, I believe that it is a grave mistake to think that there is an easy way out when a country and its government have lost the confidence of financial markets. Countries that tried for an easy way out, that backed away from their programs, have not fared well. Those that have pressed vigorously ahead are beginning to see the fruits of their efforts even earlier than expected. Going forward, the main worry is not that too rapid reform may impair recovery, but rather that recovery may blunt the impetus for reform. To generate the greatest possible global public good out of the difficulties of the past two years, it is essential to keep the reform process moving forward. I was happy when visiting Asia last week to see that this is a view firmly held by the authorities.
A third area where provision of international public goods is an important concern for IMF activities may not seem so immediately relevant to the main issues discussed at this conference. Nonetheless, I believe it is crucial if the benefits of reform of the international monetary and financial system are to be truly global. I refer to efforts by the international community to assist its poorest members, which increasingly are becoming marginalized and are not sharing fully in the benefits of global economic and financial integration.
This concern is partly symmetric, better integration of the poorest countries into the international system will produce public goods benefits for other countries through increased trade and expanded opportunities for investment. However, the public goods issue is broader than the potential for symmetric benefits. At the national level, we all recognize the public responsibility to assist the less fortunate to become more productive members of our societies. A similar ethic applied at the global level suggests that the public good requires meaningful efforts to reduce disparities of income, resources, and opportunities that are substantially greater than typically exist within our national societies. In the face of widening divergences between the richest and the poorest countries, and with generally declining amounts of assistance forthcoming from the richer countries, it seems clear that more needs to be done to redeem this aspect of the international public good.
At the IMF, we are working on several fronts, in cooperation with others. This includes the provision of policy advice through our deepening process of surveillance, an extensive program of technical assistance and training to help develop skills in our areas of expertise, and concessional financial assistance to eligible members through ESAF. In addition a variety of proposals have been made to strengthen the HIPC Initiative for providing debt relief to the worlds poorest and relatively most heavily indebted countries. We are working closely with the World Bank to refine a set of principles that would provide a basis for moving forward with this initiative. Next months G-7 summit in Cologne will mark an important step in this process.
However, policy advice, technical assistance, new concessional financing, and debt relief, although crucial, will not alone provide many of these countries with the ability to grow their way out of poverty. In addition our policies on aid and debt relief need to be better coordinated with and supported by policies on trade and investment. Ample evidence from the experience of countries that have successfully moved up the development ladder demonstrates the importance of trade linkages and of direct investment flows in fostering sustainable economic growth. It is for this reason that I have argued for across-the-board, duty free access to advanced country markets for the least developed countries as a way of promoting growth and reducing poverty in these countries. Elimination of misguided protectionist policies that also impair growth in the poorest countries should also be undertaken, although not as a prerequisite for action by the advanced countries.
An increasingly open system of world trade, and an increasingly and prudently liberalized system of world finance are the two great global public goods that have been produced by the international community in the postwar era. The effort to reform the system is fundamentally the effort to sustain and enhance these public goods.
IMF EXTERNAL RELATIONS DEPARTMENT