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Research at the IMF
Current Accounts: Determinants and Sustainability
Gian Maria Milesi-Ferretti
The current account is an important component of IMF operational work, both in terms of program design and in terms of macroeconomic surveillance for both industrial and developing countries. A substantial portion of research conducted at the IMF on current accounts has focused on two related questions: how to determine whether a given level of the current account deficit is "appropriate" or "excessive" and whether a particular level of the current account balance is sustainable from a longer-term perspective. A related path of research has examined the relationship between the current account and external crises. These questions involve several challenges in terms of the modeling framework, the design of empirical analysis, and the appropriate interpretation of the results. This article briefly summarizes recent research at the IMF on these and related issues.
Two key questions that arise in IMF country analysis are whether a given level of the current account deficit is "appropriate" or "excessive," and whether the current account balance is sustainable.1 Researchers who try to quantify these concepts face several difficulties. Establishing whether a given level of the current account is excessive requires a model or a framework that can determine what the "optimal" or "appropriate" level of the current account is—clearly not an easy task. Defining current account sustainability is also a difficult endeavor: the current account is the quintessential endogenous variable, and it is determined not just by public policy but also by private agents' saving and investment decisions. Therefore, automatically extrapolating the current level of this variable into the future, in order to assess whether a country will be able to service its liabilities and/or secure access to external financing for future liabilities, is an exercise fraught with uncertainties.2 Notwithstanding the difficulties highlighted above, a substantial portion of research at the IMF on the current account has indeed focused on these two related questions of "optimal" levels and sustainability. Some other papers have instead studied current account determinants and responses to shocks in both industrial and developing countries. A literature review of the two research approaches is presented below.
The model that is typically used to evaluate whether current account imbalances are excessive or not is a very stylized model based on the permanent income theory of consumption, in which the current account allows countries to smooth consumption over time when faced with transitory shocks. The model, initially applied to industrial countries to investigate whether capital flows were excessively volatile, has been used to evaluate current accounts in developing countries as well, and has been fairly successful in explaining current account fluctuations at business-cycle frequencies.3 Ghosh and Ostry (1997) extend the model to allow for a precautionary saving motive driven by income uncertainty (in addition to the standard consumption smoothing motive) and show that this extension contributes to better explaining cyclical fluctuations in current accounts in G-7 countries.4
Since the consumption-smoothing model assumes solvency and unfettered access to international capital markets at all points in time, it is best suited for examining the cyclical behavior of the current account; questions of current account sustainability are arguably connected to the trend behavior of the current account.5 A number of papers have assessed current account sustainability, taking into account a number of other macroeconomic and financial indicators such as the level of saving and investment, the level of the real exchange rate, the burden of external liabilities, the size of short-term debt relative to reserves, and, more generally, financial sector exposure and vulnerability.6 These studies are related to the more formal literature on "early warning indicators" that attempt to predict currency crises.7
Another research approach to current accounts has focused on analyzing current account determinants and the response of current accounts to different types of shocks.8 Debelle and Faruqee (1996) use a panel approach to examine the determinants of current accounts in industrial countries. Chinn and Prasad (2000) use a larger panel that includes both industrial and developing countries to examine the medium-term determinants of current accounts. They find that, in developing countries, current accounts are positively correlated with government budget balances, measures of financial deepening and initial stocks of net foreign assets.9 Calderon, Chong, and Zanforlin (2001) focus on the determinants of the current account in African countries, highlighting the observation that the degree of persistence in current account imbalances is smaller, and the sensitivity of the current account balance to private savings is larger, in African countries than in other developing countries. Cashin and McDermott (1998b) focus on five commodity-exporting developed countries and find evidence that terms of trade shocks induce strong income and substitution effects. Decressin and Disyatat (2000) examine the relative response of the current account and investment to productivity shocks across European countries and within regions in Canada and Italy, and find no systematic difference between the cross-country and the cross-regional evidence.10
A line of work related to both literatures on current account determinants and current account sustainability has been pursued by Milesi-Ferretti and Razin (1998, 2000).11 These authors point out that "unsustainable" current account deficits need to be reversed eventually, and that recent external crises have been characterized by very large swings in the current account. They focus their empirical analysis on large and sustained reductions in current account deficits (reversal episodes) and examine which factors help predict the occurrence of a current account reversal as well as what are the implications for macroeconomic performance. Their findings suggest that reversals are more likely to occur in countries with large external imbalances, low foreign exchange reserves, and deteriorating terms of trade. Interestingly, reversals are not systematically associated with output slowdowns or currency crises. Some countries experience faster growth rates during the reversal period, while, in others, growth is slower (particularly, in countries that start out with an overvalued real exchange rate).
Also of interest are a few papers that focus on the theoretical implications of a credible disinflation program and of pension reform on the current account.12 Finally, research is under way at the IMF to model the determinants and dynamics of net foreign assets—the stock concept associated with the external current account. Lane and Milesi-Ferretti (1999) construct a comprehensive historical database of net foreign assets for a large group of industrial and developing countries. In more recent work, these authors explore the cross-country determinants of net foreign asset positions.13
During the last two decades, numerous economic and political developments—the worldwide trend toward democracy, the emergence of new economic federations and of decentralized fiscal structures in transition economies (Russia, in particular), a general dissatisfaction with central governments' fiscal performances, and the creation of common currency unions—have reinvigorated an old debate about the efficacy of fiscal decentralization. Proponents on one side of the debate use a traditional, normative model to evaluate the observed patterns of fiscal decentralization. The other side emphasizes a positive approach asking whether attempts at fiscal decentralization have, in practice, produced the intended benefits, such as enhanced public service delivery, higher growth, lower poverty, better macroeconomic management, and better governance. While opinions seem to have converged regarding the normative analysis, underscoring the importance of getting the fundamentals right, the evidence appears to have diverged with regard to the empirical analysis. This summary reviews the debate and surveys research that has been done at the IMF since 1997.
Fiscal decentralization has been a topic in the public finance literature for almost 40 years.1 It is often defined as the devolution of fiscal responsibilities from the central government to subnational levels of government (e.g., states, regions, provinces, districts, municipalities) but this definition, in itself, is not complete. In fact, the basic issue in fiscal decentralization and fiscal federalism is that of assigning specific fiscal responsibilities to the proper level of government.2 These responsibilities, which range from the design to the implementation of various aspects of intergovernmental fiscal relations, raise a number of questions:
Generally, allocative efficiency calls for assigning to lower levels of government those responsibilities where the costs and benefits are confined to a local jurisdiction and reflect the preferences of the local community (e.g., local police and garbage collection services). Income redistribution policies (e.g., pensions, social assistance) and macroeconomic policies (e.g., financing of government expenditures, monetary policy) are generally assigned to the central government or to a unique, central authority because certain tax bases (e.g., corporate income tax) are mobile and have economywide, automatic, stabilizing effects; some expenditures have large aggregate demand effects (e.g., federal transfers to states, interstate transportation networks, unemployment benefits); and price-stabilizing measures supercede the jurisdictions of subnational governments and are best left to a central monetary authority.
research on fiscal decentralization at
the IMF—based on country-
Finally, the debate on fiscal decentralization also hinges on the role of the state in the economy, an issue which is at the heart of many transition economies. Attempts at decentralization should come only after the rationale for state intervention in a particular activity is firmly established. In the absence of a firm rationale for state intervention, privatization of any public sector activities, regardless of whether they are carried out by the central or subnational governments, should always be the preferred alternative to fiscal decentralization.
1Richard A. Musgrave, The Theory of Public Finance (New York: McGraw-Hill, 1959).
2Wallace E. Oates, "An Essay on Fiscal Federalism," Journal of Economic Literature, September 1999, pp. 1120-49. See also Musgrave (1959).
3Teresa Ter-Minassian, ed., Fiscal Federalism in Theory and Practice (Washington: International Monetary Fund, 1997); Ehtisham Ahmad, ed., Financing Decentralized Expenditures: An International Comparison of Grants (Cheltenham, U.K.: Edward Elgar, 1997); and a series of studies, cited below, which were presented in a conference organized by the IMF in November 2000. For a recent application of fiscal federalism issues to the Caribbean countries, see Carri Zeljko Bogetic and Janet Stotsky, Fiscal Federalism and Its Relevance in the Caribbean (Kingston, Jamaica: University of the West Indies, forthcoming).
4Hamid R. Davoodi and Heng-fu Zou, "Fiscal Decentralization and Economic Growth: A Cross-Country Analysis," Journal of Urban Economics, March 1998, pp. 24457; Danyang Xie, Heng-fu Zou, and Hamid R. Davoodi, "Fiscal Decentralization and Economic Growth in the United States," Journal of Urban Economics, March 1999, pp. 22839; Luiz de Mello, "Fiscal Decentralization and Intergovernmental Fiscal Relations: A Cross-Country Analysis," World Development, February 2000, pp. 36580; Luis de Mello, "Fiscal Federalism and Government Size in Transition Economies: The Case of Moldova," IMF Working Paper 99/176, 1999 (also forthcoming in Journal of International Development); John Anderson and Hendrik Van den Berg, "Fiscal Decentralization and Government Size: An International Test for the Leviathan Accounting for Unmeasured Economic Activity," International Tax and Public Finance, May 1998, pp. 17186.
5Ter-Minassian (1997); Vito Tanzi, "On Fiscal Federalism: Issues to Worry About," 2000.
6Luiz de Mello, "Can Fiscal Decentralization Strengthen Social Capital?" IMF Working Paper 00/129, 2000; Luiz de Mello and Matias Barenstein, "Fiscal Decentralization and Governance: A Cross-Country Analysis," forthcoming IMF Working Paper; Daniel Treisman, "Decentralization and the Quality of Government," 2000.
7Ugo Panizza, "On the Determinants of Fiscal Centralization: Theory and Evidence," Journal of Public Economics, October 1999, pp. 97139.
9Jose Alfonso and Luiz de Mello, "Brazil: An Evolving Federation" .
10Jorge Martinez-Vazquez, Era Dabla-Norris, and John Norregaard, "Making Decentralization Work: The Case of Russia, Ukraine, and Kazakhstan"; and Ehtisham Ahmad, Li Keping, and Thomas Richardson, "Recentralization in China?" .
11Ehtisham Ahmad and Ali Mansoor, "Indonesia: Managing Decentralization," 2000.
12See also Luis de Mello, "Intergovernmental Fiscal Relations: Coordination Failures and Fiscal Outcomes," Public Budgeting and Finance, Spring 1999, pp. 325.
13Reza Baqir, "Districting and Government Overspending," forthcoming IMF Working Paper.
14Michael Keen and Christos Kotsogiannis, "Does Federalism Lead to Excessively High Tax Rates?" forthcoming in American Economic Review. See also Michael Keen, "Vertical Tax Externalities in the Theory of Fiscal Federalism," IMF Staff Papers, Vol. 45, No. 3, 1998, pp. 454–85.
India has had an impressive economic performance over the past decade. Its growth rate has been among the highest in the world, inflation has been relatively well contained, and the balance of payments has been maintained at comfortable levels. This performance has been achieved despite the Asian financial crisis, the international sanctions that were imposed following the nuclear tests in 1998, and a series of adverse weather-related shocks and natural disasters. While poverty has declined over time, it remains at a high level, with more than one-quarter of the population living below the poverty line. Moreover, macroeconomic imbalances, particularly on the fiscal side, and slow progress in key structural policy areas appear to be dampening growth prospects. Against this background, recent IMF research on India—much of which is collected in the new book, India at the Crossroads: Sustaining Growth and Reducing Poverty—has focused on what policies are needed to sustain the rapid growth that is essential to reducing poverty.1 This article provides an overview of this research.
India achieved considerable fiscal consolidation during the first half of the 1990s, but subsequent policy slippages, at both the central and state government levels, resulted in the consolidated public sector deficit ballooning to over 11 percent of GDP and public debt rising to 80 percent of GDP by the end of the decade. These developments have naturally raised questions about whether the country's recent strong economic performance can be sustained without fiscal policy adjustment. IMF staff research has focused both on the reasons for the deterioration in the fiscal position and on the sustainability of current fiscal policies.
Muhleisen (1998) assessed the revenue impact of tax reforms implemented by the central government during the 1990s.2 He found that, while elasticity estimates point to a small improvement in the revenue-generating capacity of the tax system, overall tax revenue declined relative to GDP due to the substantial cuts in tax rates. Muhleisen concluded that the disappointing revenue performance reflected the partial nature of the reforms. Regarding the sustainability of fiscal policies, Reynolds (2001) used a simple growth model to show that, despite the high deficits incurred in recent years, India has been able to avoid a fiscal crisis largely because of the favorable differential between real interest rates and overall economic growth rates.3 However, Reynolds's simulations suggested that a continuation of recent fiscal policies would risk putting India on an explosive debt path.
An alternative approach to assessing Indian fiscal policy was followed by Cashin, Olekalns, and Sahay (1998) who used an intertemporal model to demonstrate that policy has been consistent with tax-smoothing behavior.4 They also found, however, a significant bias toward deficit financing—which has led to excessive government borrowing, as well as the resorting to seniorage and financial repression—and government debt was estimated to be in excess of levels considered optimal or consistent with intertemporal solvency. Muhleisen (1997) looked at determinants of saving in India and found that improving public saving was one of the keys to raising national saving.5
With regard to India's external sector, Cerra and Saxena (2000) examined the causes of the 1991 balance of payments crisis.6 Since this crisis, India has maintained a sustainable external position, and a number of papers have looked at the factors behind this success. Towe (2001) assessed the factors that helped insulate India from the turmoil of the Asian financial crisis, attributing the success to effective exchange rate management, generally sound macroeconomic fundamentals, and the presence of capital controls.7 Tzanninis (1998) looked at exports and competitiveness in light of the currency realignments in the Asian region during the financial crisis.8 Using several statistical and econometric techniques, he found no evidence to indicate that the rupee was overvalued relative to its fundamentals. Callen and Cashin (1999) used a number of methodologies to analyze external sector developments in India since independence.9 They found that, while models of external sustainability raised questions about India's external position prior to the 1991 balance of payments crisis, these models have not highlighted significant risks since then.
In the area of monetary policy, the Reserve Bank of India (RBI) shifted away from a broad-money target to a multiple-indicators approach to policymaking in the late 1990s. Callen and Chang (1999) assessed the forecasting ability of single-equation models of the inflation process and a series of vector autoregressions to identify which of the many available indicators provide the central bank with the most reliable and timely guides of future inflation developments.10 They found that developments in monetary aggregates continued to provide the most useful information, but that the long lags between money and inflation suggested the need for a broader set of indicators for policymaking.
The financial sector has also been a key focus of the reform agenda in recent years. Callen (1998) compared the financial performance of the public sector banks during the 1990s with those of the domestic and foreign private sector banks.11 He found that, both in terms of interest spreads and cost structure, the public sector banks fared worse than their private sector counterparts, but he also noted that there was a significant divergence between the performance of "strong" and "weak" public sector banks. Two other papers—Mohanty (1998) and Ilyina (2001)—explored issues relating to the mutual fund and nonbank financial company (NBFC) sectors, respectively.12 Both sectors have faced recent difficulties that highlighted weaknesses in their regulatory environments; the papers assessed the reforms that have been undertaken by the authorities to strengthen these sectors and made recommendations for further action. These recommendations include further strengthening of financial sector regulation and supervision, reductions in problem loans, steps to increase competition among institutions, and measures to reduce the role of the government in the financial sector.
The impact of economic reforms on interstate growth, income disparities, and poverty have been taken up in a number of studies. Cashin and Sahay (1996) looked at the role of internal migration and grants from the central government to the states in influencing the growth performance of the states.13 Aiyar (2001) found that the per capita income gap between states has widened in recent years and that differences in literacy and private investment rates across states were part of the reason for the lack of convergence.14 Lastly, Aziz (2001) looked at trends in interstate differences in rural poverty and found that, while economic growth has been strongly positive for the poor and a force of convergence in the post-1991 reform period, nongrowth factors have widened interstate poverty differentials.15
1Tim Callen, Patricia Reynolds, and Christopher Towe, eds, India at the Crossroads: Sustaining Growth and Reducing Poverty (Washington: International Monetary Fund, 2001). Earlier research was summarized in Ajai Chopra, Charles Collyns, Richard Hemming, Karen Parker, Woosik Chu, and Oliver Fratzscher, India: Economic Reform and Growth, IMF Occasional Paper No. 134, 1995.
2Martin Muhleisen, "Tax Revenue Performance in the Post-Reform Period," in India—Selected Issues, IMF Staff Country Report No. 98/112, October 1998.
3Patricia Reynolds, "Fiscal Adjustment and Growth Prospects in India," in India at the Crossroads: Sustaining Growth and Reducing Poverty, ed. by Tim Callen, Patricia Reynolds, and Christopher Towe (Washington: International Monetary Fund, 2001).
4Paul Cashin, Nils Olekalns, and Ratna Sahay, "Tax Smoothing in a Financially Repressed Economy: Evidence from India IMF Working Paper 98/122," , 1998.
5Martin Muhleisen, "Improving India's Saving Performance IMF Working Paper 97/4," , 1997.
6Valerie Cerra, and Sweta Saxena, "What Caused the 1991 Currency Crisis in India," IMF Working Paper 00/157, 2000.
7Christopher Towe, "India and the Asia Crisis," in India at the Crossroads: Sustaining Growth and Reducing Poverty, ed. by Tim Callen, Patricia Reynolds, and Christopher Towe (Washington: International Monetary Fund, 2001).
8Dimitri Tzaninnis, "Exports and Competitiveness," in India—Selected Issues, IMF Staff Country Report No. 98/112, October 1998.
9Tim Callen and Paul Cashin, "Assessing External Stability in India," IMF Working Paper 99/181, 1999.
10Tim Callen and Dongkoo Chang, "Modeling and Forecasting Inflation in India," IMF Working Paper 99/119, 1999.
11Tim Callen, "The Financial Performance of Public Sector Commercial Banks in India," in India—Selected Issues, IMF Staff Country Report No. 98/112, October 1998.
12Nirmal Mohanty, "Nonbank Finance Companies in India: Developments and Issues," in India—Selected Issues, IMF Staff Country Report No. 98/112, October 1998; Anna Ilyina, "The Unit Trust of India and the Indian Mutual Fund Industry," in India at the Crossroads: Sustaining Growth and Reducing Poverty, ed. by Tim Callen, Patricia Reynolds, and Christopher Towe (Washington: International Monetary Fund, 2001).
13Paul Cashin and Ratna Sahay, "Internal Migration, Center-State Grants, and Economic Growth in the States and India," IMF Staff Papers, Vol. 43, No. 1 (March 1996), pp. 12371.
14Shekhar Aiyar, "Growth Theory and Convergence Across Indian States: A Panel Study," in India at the Crossroads: Sustaining Growth and Reducing Poverty, ed. by Tim Callen, Patricia Reynolds, and Christopher Towe (Washington: International Monetary Fund, 2001).
15Jahangir Aziz, "India's Interstate Poverty Dynamics" forthcoming IMF Working Paper.
About 25 percent of world merchandise trade consists of primary commodities. Both long-term trends and short-term fluctuations in commodity prices are, therefore, key determinants of developments in the world economy. Indeed, many developing countries continue to rely on a few commodities for the bulk of their export earnings and fiscal revenue. Commodity price fluctuations (particularly in fuel and energy) can also transmit business cycle disturbances across countries and can affect national rates of inflation.
The IMF's Research Department maintains a database of spot prices for about 80 primary commodities, with annual, quarterly, and monthly prices. The commodities covered include items in the general categories of food, beverages, agricultural raw materials, metals, fertilizers, and energy. This database, IMF Primary Commodity Prices, is updated monthly and is available in table format (for the period from 1990 on) at http://www.imf.org/external/np/res/commod/index.asp and through the monthly publication, International Financial Statistics.
In addition, price baselines for nonfuel primary commodities—some 35 series are included in the IMF's aggregate index—are prepared by the Research Department in collaboration with the World Bank. These detailed baselines, generated for internal use, provide a common basis for the short- and medium-term projection of export earnings and import expenditures in the balance of payments work of the IMF and the World Bank. Aggregate price indices derived from the baselines for individual nonfuel commodities are published in the IMF's World Economic Outlook and in the World Bank's World Development Report.
IMF research on commodity prices has focused on understanding the stylized facts of commodity-price movements. The cyclical properties of commodity-price cycles have been examined, with the broad finding that price slumps last longer than price booms, but that prices typically rise faster in short-lived booms than in long-lived slumps.1 Moreover, while there are small, long-run, downward trends in real commodity prices, this trend movement is of little practical policy relevance as it is small when compared with the large variability of commodity prices.2 Shocks to commodity prices are also typically long lasting, which is important information for policymakers seeking to design institutional arrangements to ameliorate the economic effects of such shocks.3In addition, there is little evidence to support the hypothesis that the prices of unrelated commodities move together on world commodity markets.4 The macroeconomic determinants of the behavior of nonoil commodity prices have also been examined, as have the important effects of climate variability on world commodity prices and economic activity.5 Finally, given the importance of oil to the world economy, IMF research has also focused on the economic effects of oil price shocks, and on factors influencing the volatility of world oil prices.6
1Paul Cashin, C. John McDermott, and Alasdair Scott, "Booms and Slumps in World Commodity Prices," IMF Working Paper 99/155, 1999.
2Carmen Reinhart and Peter Wickham, "Commodity Prices: Cyclical Weakness or Secular Decline?" IMF Staff Papers, June 1994; Paul Cashin and C. John McDermott, "Long-Run Commodity Prices: Small Trends and Big Variability, " IMF Working Paper, forthcoming.
3Paul Cashin, Hong Liang, and C. John McDermott, "How Persistent Are Shocks to World Commodity Prices?," IMF Staff Papers, Vol. 47, No. 2, 2000.
4Paul Cashin, C. John McDermott, and Alasdair Scott, "The Myth of Co-moving Commodity Prices," IMF Working Paper 99/169, 1999.
5Eduardo Borensztein and Carmen Reinhart, "The Macroeconomic Determinants of Commodity Prices," IMF Staff Papers, June 1994; Eduardo Borensztein, Mohsin Khan, Carmen Reinhart, and Peter Wickham, The Behavior of Non-Oil Commodity Prices, IMF Occasional Paper 112, August 1994; Allan Brunner, "El Niño and World Commodity Prices: Warm Water or Hot Air?" IMF Working Paper 00/203, 2000.
6See the IMF Research Department special study, "The Impact of Higher Oil Prices on the Global Economy," December 2000, available online at http://www.imf.org/external/pubs/ft/oil/2000/index.htm; Benjamin Hunt, Peter Isard, and Douglas Laxton, "The Macroeconomic Effects of Higher Oil Prices," IMF Working Paper 01/14, 2001; and Peter Wickham, "The Volatility of Oil Prices," IMF Working Paper 96/82, 1996.
on Exchange Rate Regimes
The IMF Institute hosted a high-level seminar on Exchange Rate Regimes during March 1920, 2001, to discuss optimal exchange rate systems for emerging market economies. The main conclusion was that optimal regimes vary across countries and through time as country circumstances change. Polar regimes—hard pegs and pure floats—can be equally viable alternatives if other policies and factors consistently support the exchange rate system, and, under specific circumstances, the middle ground may be a feasible option. The seminar agenda and a brief summary of the proceedings follow.
Round Table Discussion: Hard Peg
or Free Floating?
Exchange Rate Policy in Chile:
Mexico's Experience with a Floating
From Fixed to Floating: The Case
The Asian Countries Before and
After the Crisis
Argentina: The Experience with
Kong's Experience in Operating the Currency
Hard Peg or Free Floating? The
Case of Estonia
The seminar on exchange rate regimes opened with an address by Horst Köhler, who stressed the importance of understanding better how the different regimes work—and what conditions are needed for them to work—in today's highly integrated world. In briefly reviewing the recent experiences of several industrial and emerging market economies, he emphasized how different are the circumstances that each country group faces, and concluded that no single system can work for all countries at all times.
In the first session, participants at the round table discussed the critical role played by factors such as pass-through coefficients (Robert Flood, Carmen Reinhart); trade policy and the degree of financial integration (Jeffrey Frankel); a country's capacity to issue foreign debt in its own currency (Carmen Reinhart); and its capacity to credibly commit to sound fiscal and monetary policies (Stanley Fischer). These factors explain why some countries, in recent years, have adopted either of the polar systems—hard peg or free float—while others have successfully maintained an intermediate regime. The factors that determine which system works better for a particular country became clear as different country experiences were analyzed and discussed during the seminar.
Chile and Poland were the only countries discussed at the seminar that have adopted free floats. Mexico declared a similar policy, but Alejandro Werner of the Bank of Mexico observed that, at times, the central bank has intervened in the market to smooth out exchange rate fluctuations. However, because these interventions are not targeted at the medium-term exchange rate, some would still characterize the regime as "floating."
Felipe Morandé of Chile and Alejandro Werner both acknowledged that their countries' choices to float their exchange rates were, to a great extent, dictated by the failure of prior monetary systems to deliver stability and sustained growth. In both countries, the last experiences with pegs ended in recession and financial crisis—Chile in 1982-83 and Mexico in 1995.
After 1983, the regime in Chile evolved into a crawling band that targeted the real exchange rate and resulted in a period of high and sustained growth that lasted until the Asian crisis in 1997. During this period, the country successfully introduced inflation targeting, but the increased financial integration and large capital inflows of the 1990s made it difficult to target both the real exchange rate and inflation. Thus, the adoption of a free float in 1999 reflected the recognition that it was impossible to pursue both independent monetary and exchange rate policies. Mexico adopted a free float in December 1997.
In Chile, and to a lesser extent in Mexico, four factors influenced the authorities' hands-off policy after adopting a free float: pass-through coefficients fell rapidly in subsequent years, inflation stayed at relatively low levels, volatility in financial markets did not increase, and the corporate sector showed greater caution in managing its foreign indebtedness.
In Poland, the nominal exchange rate was managed in the early 1990s, to both maintain a competitive edge in the markets and to reduce inflationary pressures. According to Ryszard Kokoszczynski, however, the conflict between these two objectives became evident early on, and the authorities decided in favor of the first objective. The change in the international environment in the mid-1990s led to large capital inflows, a strong current account, and reserves accumulation, thus making the need to maintain a competitive real exchange rate less urgent. These developments allowed the authorities to adopt price stability as the primary objective, adopting in 1995 a crawling, but widening, exchange rate band. After introducing inflation targeting in 1998, the Polish economy, in reality, functioned with two nominal anchors. The adoption of a full float in early 2000 was recognition that a dual nominal system is unsustainable in the medium-term.
Since 1991, Israel has been operating a crawling band under an inflation targeting policy, but inconsistencies between the two objectives have forced the authorities to keep widening the band—as of late 2000, the band width surpassed 35 percent and has kept increasing since then. Gil Bufman and Leonardo Leiderman noted that four factors contributed to the decision to move toward greater exchange rate flexibility. First, the surge in capital inflows during the 1990s made the continuation of the dual nominal system increasingly costly. Second, the increased flexibility did not lead to more market volatility. Third, inflation and the pass-through coefficient both continued falling after exchange rate flexibility increased. And fourth, market participants have shown greater prudence in handling their external borrowing.
Korea, Indonesia, the Philippines, and Thailand all moved toward greater exchange rate flexibility in the postcrisis period, but Peter Montiel and Leonardo Hernández argued that none of these countries can be labeled "true" floaters for two reasons: their significant accumulation of reserves since the crisis and a lesser reliance on exchange rate movements in response to shocks than real floaters like Japan and Germany. The movement toward greater but limited flexibility in these countries can be justified on at least two grounds. First, they may be trying to target an undervalued currency to help the recovery. Second, they may be attempting to accumulate a reserve buffer as insurance against future liquidity shocks in international capital markets. Furthermore, these countries' postcrisis policies could be characterized as second-best policies that are called for in view of market distortions that cause moral hazard and similar problems. The benign market response to these countries' policies in the postcrisis period suggests that, under some conditions, there is still limited room to maneuver in the middle ground.
Argentina, Estonia, Hong Kong, and Malaysia adopted hard pegs, although for different reasons. Malaysia was the only one among the Asian crisis countries not to move toward greater flexibility after the 1997-98 turmoil. Peter Montiel argued that this policy was probably motivated by the authorities' decision not to resort to an IMF-sponsored adjustment program, which made the credibility issue vis-à-vis financial markets a pressing one. He noted that the authorities signaled a very strong commitment to price stability by pegging their currency, and resorted to capital controls in order to have some "breathing space" to implement monetary policy. Again, the benign market response postcrisis suggests that the policy mix has been adequate given the specific circumstances.
Argentina, Hong Kong, and Estonia operate currency boards, which indicates a much greater commitment to the peg. Argentina adopted its currency board in 1991 in an effort to escape hyperinflation after a long history of failed stabilization programs. The currency board succeeded in stabilizing prices and bringing about a period of prosperity when foreign capital flooded in, but the board also acted as a straightjacket when external conditions changed. Nevertheless, Guillermo Escudé argued that the currency board remains the cornerstone of Argentina's nominal exchange rate stability, and abandoning it could have serious consequences because of large currency mismatches and high dollarization in the economy.
Hong Kong adopted a currency board as a response, not to hyperinflation, but to a confidence crisis and high market volatility in the early 1980s. Also, the underlying economic conditions there are significantly different from those in Argentina, which is probably why Hong Kong had a quick turnaround after the Asian crisis. Furthermore, the high foreign exchange coverage of the monetary base implies that the Hong Kong Monetary Authority can effectively act as a lender of last resort, thus reducing the risk of a systemic liquidity crisis. Having a lender of last resort does not detract from having strong and sound financial institutions. Priscilla Chiu documented that Hong Kong banks maintain capital and liquidity ratios of 18 and 40 percent, respectively, well above the recommended standards of 8 and 25 percent.
In the final country presentation, Peter Lohmus argued that, although inflation in Estonia in the early 1990s was still high, the decision to adopt a currency board was mainly political. After independence, the country needed to quickly implement reforms, but many of the institutions needed to effectively operate a more discretionary policy were missing. The currency board, along with sound macroeconomic policies, has sheltered Estonia from external shocks.
Proceedings of IMF conferences and seminars, including agenda and papers, can be obtained through the "Conferences, Seminars, and Workshops" link at http://www.imf.org/external/np/exr/seminars/index.htm.
on Macroeconomic Policies and Poverty
A workshop held at the IMF on
April 1213, 2000, considered the
effects of macroeconomic policies, economic
crises, and IMF-supported programs on
income distribution and poverty in various
countries. Several studies of work in
progress were presented by IMF economists
and then opened for discussion by experts
from academia, the World Bank, and other
research institutions. These studies
will be revised, taking into account
the points made in the discussions, and
many will be issued later this year as
working papers or policy discussion papers
and posted on the IMF's website. A list
of the workshop papers along with brief
summaries of their preliminary findings
Transitional Growth with Increasing
Inequality and Financial Deepening
India's Interstate Poverty Dynamics
The Impact of Public Education Expenditure
on Human Capital, Growth, and Poverty
in Tanzania and Zambia: A General Equilibrium
The Economic Consequences of HIV/AIDS
in Southern Africa
The Gender Gap in Education in
Migration, Human Capital, and
Poverty in a Dual-Economy Model of a
Financial Crises and Poverty
How Volatile and Predictable Are Aid
Flows, and What Are the Policy Implications?
Changes in the Structure of Earnings
During a Period of Rapid Technological
Change: Evidence from the Polish Transition
Debt Relief, Poverty, and Income
Hiccups for HIPCs
Panel Discussion on Macroeconomic
Policies and Poverty Reduction
Studies that use longitudinal microeconomic data (household income and expenditure surveys) for one country to measure the impact of macroeconomic or structural adjustment and economic crises on households' living standards:
Studies that use panels of countries or regions within countries to examine the impact of macroeconomic developments on poverty:
Studies that apply calibration, computable general equilibrium, or theoretical models to macroeconomic and poverty issues in developing countries:
Volume 48, Issue 1
Threshold Effects in the Relationship
Between Inflation and Growth
A Peek Inside the Black Box: The
Monetary Transmission Mechanism in Japan
Recapitalizing Banks with Public Funds
A Critical Look at the Stylized Facts
Income Inequality: Does Inflation
Welfare Effects of Uzbekistan's Foreign
Crash-Free Sequencing Strategies for
Financial Development and Liberalization
Dynamic Gains from Trade: Evidence
from South Africa
IMF Staff Papers, the IMF's scholarly journal, edited by Robert Flood, publishes selected high-quality research produced by IMF staff and invited guests on a variety of topics of interest to a broad audience, including academics and policymakers in IMF member countries. The papers selected for publication in the journal are subject to a rigorous review process using both internal and external referees. The journal and its contents (including an archive of articles from past issues) are available online at http://www.imf.org/external/pubs/ft/staffp/index.htm.
Occasional Paper No. 204
Six non-CFA-zone members of the Economic Community of West African States (ECOWAS) have launched an ambitious initiative to set up a second monetary union and common currency area in West Africa by January 2003, as a first step toward wider monetary union among all the ECOWAS (CFA and non-CFA) countries by 2004. Following a survey of the lessons learned from other monetary unions, the paper evaluates whether such a monetary union makes economic sense. Pointing out that monetary union is neither necessary nor sufficient to achieve other aspects of regional integration, the authors urge the ECOWAS countries to invest their energies in the structural policies, instead of trying to meet very short deadlines for monetary union. A looser form of monetary cooperation would help to increase exchange rate stability, would be less costly, could be achieved sooner, and would allow some flexibility in response to the asymmetric shocks to which these economies are susceptible. The paper concludes that full ECOWAS monetary union should await more extensive economic convergence and reinforced political solidarity within the region.
Detailed contents of IMF Occasional Papers are available at http://www.imf.org/external/pubind.htm.
Occasional Paper No. 205
revenues from exploiting large exhaustible
resources such as oil can pose significant
challenges for a country. Nonrenewable
Resource Funds (NRFs)—which can take
various forms including stabilization
and savings funds—are seen as a response
to these challenges. This paper examines
whether NRFs can help countries pursue
good fiscal and other macroeconomic policies
and, if so, how NRFs should be designed
to attain these objectives. Two main
results emerge. First, NRFs should not
be seen as a simple solution to a complex
problem; rather, the question should
be whether they might help improve overall
fiscal policy. Second, it is important
that NRFs be designed carefully to ensure
their effectiveness. Key features of
a well-designed NRF include: coordination
of its operations with those of the rest
of the public sector, effective integration
with the budget, and mechanisms to ensure
full transparency and accountability.
Books from the IMF
the International Monetary and Financial
Following an introductory discussion by former IMF Managing Director Michel Camdessus about international monetary and financial stability as a global public good, various experts consider the most disruptive manifestations of instability in the current system, as well as the appropriate policy responses to them: volatility and misalignments in the exchange rates of the dollar, euro, and yen (Benoit Coeuré and Jean Pisani-Ferry); instability of capital flows to emerging market economies (Michael Mussa, Alexander Swoboda, Jeromin Zettelmeyer, and Olivier Jeanne); consequences of abrupt capital flow reversals for balance of payments adjustment and financing, and for a country's choice of exchange rate regime (Guillermo Calvo and Carmen Reinhart); and private sector involvement in crisis resolution (Barry Eichengreen). The role of the IMF in crisis prevention and resolution is also examined (Takatoshi Ito and David Lipton). Twenty-four substantive comments by prominent academics, policymakers, and other experts are included. Perhaps not surprisingly, the general conclusion of the contributors is that segmented and slower, rather than widespread and radical, reform is the way to proceed.
Full-text versions (or, in some cases, detailed summaries) of books published by the IMF are available online at http://www.imf.org/external/pubind.htm. Follow the link to IMF Publications.
Kosovo, a province of Serbia in the Federal Republic of Yugoslavia, is under temporary United Nations administration. Extensive technical assistance from the IMF has aided the UN authorities in constructing tax and budgetary institutions and in setting up a payments and banking system. This new book provides a macroeconomic perspective on some of the problems Kosovo faces as it tries to rebuild its economy following the conflict in 1999.
The authors provide a first estimate of aggregate income levels (per capita GDP is found to be lower than in neighboring Albania), analyze the budget structure, and examine the conditions for sustainable fiscal accounts in the medium run. While any type of prediction is necessarily a speculative exercise in view of the political uncertainties, the authors conclude that it will take several years before public spending in Kosovo can be fully financed by self-generated revenues—even given the assumption of a fast-recovering economy. Any rapid reduction in donor support to Kosovo would thus produce quite stringent conditions. Meanwhile, the interim UN authorities should not delay in pressing ahead with broadening the tax system and strengthening the legal framework for private enterprise. Reforms such as these will help Kosovo reestablish a stronger economy sooner.
versions (or, in some cases, detailed
summaries) of books published by the
IMF are available online at http://www.imf.org/external/pubind.htm.
IMF Working Papers, January–March 2001
Paper No. 01/1
Paper No. 01/2
Paper No. 01/3
Working Paper No. 01/4
Working Paper No. 01/5
Working Paper No. 01/6
Working Paper No. 01/7
Working Paper No. 01/8
Working Paper No. 01/9
Working Paper No. 01/10
Working Paper No. 01/11
Working Paper No. 01/12
Working Paper No. 01/13
Working Paper No. 01/14
Working Paper No. 01/15
Working Paper No. 01/16
Working Paper No. 01/17
Working Paper No. 01/18
Working Paper No. 01/19
Working Paper No. 01/20
Working Paper No. 01/21
Working Paper No. 01/22
Working Paper No. 01/23
Working Paper No. 01/24
Working Paper No. 01/25
Working Paper No. 01/26
IMF Working Papers and other IMF publications can be downloaded in full-text format from http://www.imf.org/external/pubind.htm
The second volume of the International Economic Policy Review, an annual publication, features a selection of 11 policy papers produced by IMF staff, highlights some of the research behind IMF-supported economic programs, and presents a range of policy choices in several economic areas.
The section on economic growth, inflation, and poverty includes papers that examine: the reasons for sub-Saharan Africa's unsatisfactory growth performance, the continuing problem of rural poverty, the low-income-country debt crisis, and the IMF's role in improving governance and combating corruption, and the real effects of high inflation. Capital account liberalization and financial sector vulnerability—areas of increasing concern to the IMF—are covered in the journal's second section, which includes a discussion of trade policy in financial services and a case study of capital flight out of Russia. The final section is devoted to the exchange rate relations of advanced transition economies—those countries that are candidates for membership in the European Union and which will soon face a fundamental question: how best to ensure a smooth transition to monetary union with the euro zone?
Part I. Economic Growth, Inflation,
Rural Poverty in Developing Countries:
Issues and Policies
From Toronto Terms to the Enhanced
HIPC Initiative: A Brief History of Debt
Relief for Low-Income Countries
Improving Governance and Fighting Corruption
in the Baltic and CIS Countries
Real Effects of High Inflation
Part II. Capital Account Liberalization
and Financial Sector Vulnerability
Trade Policy in Financial Services
Capital Flight from Russia
Part III. Exchange Rate Relations
of Advanced Transition Economies
Pros and Cons of Currency Board Arrangements
in the Lead-up to EU Accession and Participation
in the Euro Zone
Michael Bordo; Rutgers University
The IMF has appointed Kenneth Rogoff, Professor of Economics at Harvard University, as the new director of its Research Department. Rogoff will simultaneously hold the position of IMF Economic Counsellor. He succeeds Michael Mussa, who retires at the end of June, after a distinguished decade-long tenure in both positions.
A full listing of external publications of IMF staff in the first half of 2001 will appear in the next issue of this bulletin.
India is featured in this issue's Country Study, coinciding with the publication of a new book which collects together recent IMF research on this country. This issue also contains brief summaries of two recent IMF events—a conference on exchange rate regimes and a workshop on macroeconomic policies and poverty reduction.
This issue introduces a new feature
called Special Topics. The purpose
of these short articles will be to highlight
different types of research output from
the IMF that could also be of use to
outside researchers. Such output includes
datasets, macroeconometric models, and
other analytical tools developed by IMF
staff and made available in the public
domain. The bulletin's first special
topic article contains a description
of the IMF's database on commodity
prices and summarizes recent IMF
research on this topic.
The IMF Research Bulletin (ISSN: 1020-8313) is a quarterly publication in English and is available free of cost. Material from the bulletin may be reprinted with proper attribution. Editorial correspondence may be addressed to The Editor, IMF Research Bulletin, IMF, Room 10-548, Washington, DC 20431 U.S.A. or e-mailed to email@example.com. Subscription requests should be addressed to Publication Services, Box X2000, IMF, Washington, DC 20431 U.S.A.; e-mail:firstname.lastname@example.org.