How to Avoid International Financial Crises and the Role of the International Monetary Fund--Stanley Fischer
IMF News, October 14, 1997
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- Published: October 14, 1997
I. Recipient country policies
- Key premise: globalization of trade and financial markets is among the most important economic developments of the late 20th century.
- Key statistics:
- "In 1996 net international capital flows to developing countries amounted to $235 billion—an impressive 0.8 percent of world GDP, and more than two percent of developing country GDP."
- Large current account deficits in the range of "5-8 percent of GDP, and certainly any higher" should be cause for concern.
- Findings on sustainability and composition of external finance:
- Sustainability of the current account depends on the economy’s growth rate and the real interest rate at which the country can borrow.
- Current account deficits financed by longer-term borrowing and foreign direct investment are more sustainable.
- Sizable deficits financed in large part by short-term capital flows are a cause for alarm.
- Policy recommendations for managing capital inflows and exchange rates:
- First line of defense against short-term inflows: tightening of fiscal policy.
- Second response: increase the flexibility of the exchange rate.
- If pegged, it is "almost certainly better to peg to a basket of currencies rather than a single currency."
- Consider exchange rate bands with very wide margins, perhaps a crawling band depending on domestic inflation; be prepared to move the band if warranted.
- Adjust macroeconomic policy when the exchange rate or balance of payments moves out of desired ranges.
- Financial system strength:
- A strong financial system is essential for growth; a weak system invites macroeconomic crisis and amplifies its severity.
- Strengthening measures: improve supervision and prudential standards; ensure banks meet capital requirements; provision for bad loans; limit connected lending; publish informative financial information; ensure rapid resolution of insolvent institutions.
- Implementation is often difficult, especially where political pressures hamper supervisory authorities, but the task is urgent for crisis recovery and crisis prevention.
- Information transparency:
- Poor quality of information worsened the Mexican crisis; the Thai crisis reinforces the need for better and more timely information, including on central bank forward operations.
- Two arguments for publishing intervention information:
- Better informed markets are likely to make better decisions (may hasten needed adjustments).
- Obligation to publish affects the extent and nature of interventions and can help prevent unwise decisions.
- IMF data initiatives:
- The Special Data Dissemination Standard was established in early 1996.
- The associated Dissemination Standards Bulletin Board had "43 subscribers, including virtually all industrial and emerging market economies" by September 1997.
II. The Role of the IMF
- Two primary roles: crisis prevention and crisis mitigation.
- Prevention tools: IMF surveillance, technical assistance, and information provision.
- Mitigation tool: IMF lending in support of a country’s adjustment program.
- Surveillance:
- Increased emphasis on timely surveillance of market developments since the Mexican crisis.
- Surveillance includes regular reporting to the Executive Board and member countries on each country’s economy and emerging problems.
- Example: "the Fund’s new surveillance procedures worked well in the case of Thailand"—Thai authorities were warned of the likelihood of a crisis and measures to avert it.
- Limitations: a country may be warned but not act (disbelief or incapacity); privileged access to information constrains how much the Fund can publicize without risking the creation of crises.
- Expectation: improved publication of analyses over time, but perfect surveillance is unattainable; "Crises will happen."
- Technical assistance and information dissemination:
- IMF provides technical assistance on financial systems, tax systems, monetary policy, and exchange rate systems.
- Extensive publication of statistics, including through the Data Standards Bulletin Board, strengthens market capacity.
- Lending, moral hazard, and resources:
- Purpose of IMF lending: "To give confidence to members by making the general resources of the Fund temporarily available to them under appropriate safeguards..."
- The Board of Governors voted at the September 1997 Hong Kong meetings to increase Fund quotas by "45 percent."
- The Board approved work toward amending the IMF Articles of Agreement to make liberalization of international capital flows one of the Fund’s purposes.
- Two related expectations:
- As international capital markets become more efficient, there may be fewer crises requiring official funding but they may be larger in scale.
- IMF lending creates moral hazard: availability of financing may make private lenders too willing to lend, believing the Fund will be a backstop.
- Moral hazard nuances:
- The hazard is less that governments seek the Fund recklessly (they are often slow to come) and more that private sector lenders may underprice risk.
- Easier to address moral hazard for private sector lending (creditors bear some losses; restructuring/closures occur) than for lending to governments (no accepted bankruptcy procedure for governments; severe legal complications for moratoria).
- Policy implication: the international system needs solutions ensuring the private sector shares in the financial costs of crises involving governments.
III. Concluding Comments
- Responsibility allocation:
- Primary responsibility for correct policies rests with national authorities; the Fund can inform, analyze, suggest, persuade, and cajole, but governments must evaluate and decide.
- Market participants also bear responsibility to appraise underlying economic situations accurately; given adequate information, market incentives should help markets operate efficiently.
- Summary of policy priorities in a globalized capital market:
- Countries should pursue sound macroeconomic policies and strengthen financial systems, including providing information on government and private sector activities.
- Policy adaptability is crucial if external conditions shift and capital inflows decline or reverse—this likely requires willingness to adjust fiscal policy quickly and allow the exchange rate to move.
- For the IMF: strengthen surveillance; assist members in policy and structural reforms; support rapid dissemination of accurate economic and financial information; ensure adequate financial resources to support members when needed.
- Final assessment:
- The IMF will "do all we can to reduce the risk of financial crisis, but that risk cannot be eliminated, and we need also to be ready to help deal with the consequences."
How to Avoid International Financial Crises and the Role of the International Monetary Fund--Stanley Fischer, October 14, 1997