Speech

The IMF at 60: What Role for the Future?
Anne O. Krueger
First Deputy Managing Director
International Monetary Fund
Lecture at the Central Bank of Iceland
Reykjavik, June 24, 2004

Thank you, Minister, for that kind introduction. I am delighted to be here today. This is my first visit to Iceland. It is particularly apt that I should be speaking here today, on the eve of the sixtieth anniversary of the Bretton Woods Conference. The delegates gathered in the now-famous hotel in New Hampshire in July 1944.

The timing of my visit is also apt because of recent events that I could not have anticipated when I accepted the invitation to come here. As you know, we have a new Managing Director. Hörst Kohler is now President-elect, and shortly to be President of the German Federal Republic. Rodrigo de Rato, formerly Spain's finance minister, arrived a couple of weeks ago as our new Managing Director. And a strategic review of the Fund's role is currently under way by some of our shareholders.

My theme today is forward-looking: to ask what role the Fund might have in the future. I want to try to answer that question in part by examining how we carry out our responsibilities today, and to put that in context by saying something about the Fund's development over the past sixty years.

Iceland and the IMF

But I want first to say something about Iceland's role in the Fund. I don't need to remind anyone here that Iceland was one of the original twenty-nine signatories of the Articles of Agreement at the ceremony in Washington in December 1945. Throughout the past sixty years, Iceland has been a much-valued and stalwart supporter of the Fund's work. The contribution that you and your predecessors have made, Mr. Governor and Mr. Minister, and the quality of the staff seconded to your Executive Director's office at the Fund, has been, and is, appreciated. It is an example of how a small country can punch above its weight in terms of influence and advice.

Icelandic membership of the Fund is mutually beneficial. Let me explain why. In the first place, it is important that the Fund retain the broadest possible membership. We are an inclusive organization, and must be seen to be so. That means listening to the concerns and views of all our members, however small they may be relatively to our larger member countries.

But it is also important to the Fund to have member countries who are staunch supporters of the multilateral economic system established at Bretton Woods. Iceland may be a small country, but its commitment to the principles agreed sixty years ago is an important bulwark in the Fund's work—in the Board policy discussions, of course. But it matters too because it is valuable to have exemplars—member countries that demonstrate the rewards of adhering to sound macroeconomic policies, and I include a commitment to free trade in that.

And Fund membership is important for Iceland. The multilateral framework is vital for the continued prosperity of a small open economy. There is no scope here for underestimating the significance of an interdependent global economy. So Iceland has a clear interest in ensuring that the Fund continues to work to underpin the multilateral framework that has served the global economy so well over the past sixty years.

The past sixty years

Given the pace of change in the modern global economy—a direct consequence, remember, of the rapid pace of growth in the post-war period—both the Fund and the international system in which it plays a central role have proved durable and adaptable.

That the post-war economic order has survived and flourished owes a great deal to those far-sighted delegates sixty years ago and their political masters. They grasped what was needed and were willing to confront the political and technical challenges that might have discouraged lesser figures.

But understanding what was required was only half the story. The framework established at Bretton Woods has survived for so long and has been so successful in large part because its design allowed the system to evolve.

The core principles adopted in 1944 remain intact, of course. The promotion of economic growth through the expansion of trade, all underpinned by the stable international financial system: these are as important to us today as they were to the foresighted founders of the Bretton Woods system.

Central to the framework is its multilateral character. The extent of international interdependence was explicitly recognized by Henry Morgenthau at the opening of the Bretton Woods Conference. Morgenthau, then the Secretary of the United States Treasury, was appointed Permanent President of the Bretton Woods Conference; and in his speech at the inaugural session he emphasized that economic growth and poverty reduction were not a zero-sum game.

The two principal architects of the system adopted at Bretton Woods, America's Harry Dexter White and Britain's John Maynard Keynes, had attached great importance to full employment and growth in their long deliberations. They assumed—rightly—that poverty reduction would result from sustained economic growth.

While much remains the same, much has changed, of course. Iceland was one of twenty-nine countries at the original signing ceremony in 1945: today we have 184 members. White and Keynes were mainly focused on the economic policies of industrial countries, whereas now we cover policies for a wide variety of countries—industrial, emerging market, economies in transition, oil exporting countries, low income countries, and so on. Much of what we do is very different from the way the Fund operated in those early years. It has to be. The world economy has changed beyond recognition. But we still apply those same core principles. International financial stability and the prevention of crises are at the heart of our work.

Indeed, there is a strong case for arguing that global financial stability has become even more important as the years have gone on. It has delivered rapid economic growth. Globalization—which, in its most fundamental sense, I take to be the rapid integration of the world economy—has made stability crucial for growth and prosperity. A stable, well-functioning international financial system helps all countries exploit the benefits that globalization has already brought. It also enables policymakers in both developed and developing economies to adapt to the changes that globalization brings. And that in turn means their citizens can continue to gain from the more rapid growth and rising living standards that only the multilateral framework makes possible.

Constantly evolving

After the disastrous economic policies of the 1930s, and then the ravages of war, restoring global economic growth would in itself have been a major achievement. But the framework put in place at Bretton Woods set the stage for something far more spectacular. The global economy was, truly, transformed with sustained growth rates far above those ever before realized.

Impressive though the 1948-73 performance seemed at the time, it was only a foretaste of what was to come. Korea and the other so-called "Asian tigers" had set world records in the 1960s and 1970s with growth rates of real GDP of 8, 10 and even 13 percent a year. By the mid-1980s, most of the other Asian economies followed with annual rates of 7 percent, 8 percent or more. China averaged GDP growth of more than 10 percent a year between 1985 and 1994, according to the official statistics.

The post-war surge in economic growth, to levels that have no historical parallel, owed much to the Bretton Woods system. It is clear that between 1946 and 1973 the system of fixed exchange rates established at the original conference served the world economy well, in spite of occasional bouts of turbulence. This was what many people still refer to as the golden age.

Yet the switch to floating exchange rates among the industrial countries from 1973 onwards was, in its turn, far more successful than many anticipated, and has also contributed to sustained economic growth. The oil price shocks of the mid and late 1970s were disruptive, of course: but much less than they might have been, because of the flexibility that floating exchange rates provided.

The oil shocks are sometimes seen as a turning point in post-war economic history. As oil prices rise again today, we see some people wondering if history is about to repeat itself. But the rise in oil prices in the 1970s was related to the worldwide surge in inflation in the late 1960s and early 1970s. Dearer oil certainly brought important changes in the nature of the Fund's work, because it was in this period, and after, that developing countries became the IMF's biggest customers. Britain was the last major industrial country to borrow from the Fund, in 1976.

But in the context of the recent rise we have seen in oil prices, it is important to remember that the price rises of 1973 and 1979 were supply shocks; the latest oil price increases mainly reflect the impact of rising demand. When dearer oil is a consequence of accelerating growth in the United States and elsewhere there are economic benefits from that higher growth that largely offset the rise in oil prices.

When oil prices shot up in 1973, 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 in 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.

Of course, the 1980s now seem very remote—and in terms of the global financial system, they are. Official capital accounted for the bulk of international capital flows at that time. But there were some important lessons learned that still resonate today.

It was during this period that the degree to which sound policies mattered first became apparent. Policymakers in East Asia succeeded in implementing macroeconomic policies that fostered growth to a much greater extent than Latin America, for example, where inflation and inward-looking trade policies persistently undermined economic performance in several countries.

And with higher export to GDP ratios, Asian economies (which are highly dependent on oil imports) were able to maintain and even accelerate growth while Latin American economies foundered.

Another clear example of the extent to which policies mattered more than natural resources was the performance of the oil exporting developing countries: they generally grew less rapidly than oil importing developing countries where policy adjustments had been more urgent and, in many cases, more radical.

The 1990s

The 1990s were a decade of profound change in the global economic and political system. The changes we witnessed posed for the Fund some of the biggest challenges it has yet faced. But the 1990s were a period that saw remarkably rapid growth, not least in the United States.

And the decade as a whole was, ultimately, an enriching period for the Fund. Meeting those challenges—and in doing so confounding our critics—has left the Fund a stronger institution. Many of our members benefited directly from this.

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 the Fund a large number of new members, all urgently needing our help. They needed financial support, 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 just joined the European Union. And some of the Baltic countries, I know, are developing closer economic ties with Iceland as part of the move towards closer relations among the Nordic countries.

Towards the end of last year, the IMF recognized the extent of the progress made when we closed the department known as European II, which had housed the CIS transition economies, and merged its responsibilities into other Fund departments. We concluded that those countries once under the yoke of Communism have made sufficient progress that they no longer need a special department of their own.

But the former Comecon countries weren't the IMF's only preoccupation during the nineties. One crucially important development was the rapid growth in private international capital flows that followed the deregulation of capital markets in many countries. Some of the biggest crises the Fund has ever dealt with erupted over the past decade or so. The Mexican debt crisis in 1994; the Asian crises of 1997-98, Russia in 1998, Brazil in 1999,Turkey in 2000 and 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 mostly capital account crises, rather than the current account crises that the IMF had been used to handling. Capital account crises are distinctive: they can occur rapidly; they occur because holders of a country's debt are concerned about its ability and/or willingness to service it; and because there are doubts about underlying macroeconomic policies to enable sustaining debt service in the future.

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—usually, I have to say, with reason. Given current macroeconomic policies and debt levels, debts and debt service costs will increase very rapidly.

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.

Lessons learned

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 do better at identifying weaknesses that might lead to crisis; and then to determine how best 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, as I shall describe in a moment—though as I have already pointed out, the learning process is continuous as we adapt to new information and developments.

We now know how important debt sustainability is in judging whether a country has sound economic policies that will deliver lasting economic growth. And we have also learned that many more fundamental reforms are needed if emerging market countries are to benefit from greater economic stability.

What sort of reforms do I have in mind? Our experience in the former Communist countries is relevant here. This underlined the importance of properly functioning judicial systems; enforceable property rights; accountable and transparent public institutions; efficient tax systems; and modern and effective public expenditure management. Their absence impedes everyday economic activity.

All these issues are now an essential part of the Fund's work. We regularly examine the economies and the economic policies of all our members, in our Article IV surveillance work. In addition, we now pay far more attention to the stability of and the regulatory framework for the financial sector in the Financial Sector Assessment program, or FSAP. This is aimed at looking more closely at how banks and other financial institutions are regulated and supervised. This does not involve examining individual banks but the regulatory system as a whole.

We also help countries adopt internationally established Standards and Codes. We provide technical assistance to countries that need help in implementing some of the reforms I've mentioned. And of course we continue to provide advice on macroeconomic policy.

Low income countries

One area of increasing importance to the Fund's work is what we do to help low income countries. Some years ago, the Fund concluded that it had a clear and important role, working in close cooperation with the World Bank. Hörst Kohler, during his tenure as Managing Director of the IMF until March this year, put considerable emphasis on this aspect of our work; and our newly-arrived Managing Director, Rodrigo de Rato, has wholeheartedly endorsed this.

It takes no more than a moment's reflection to see why this makes sense, and why our work with poorer countries is wholly in line with our central mission. Low income countries share the same economic objectives as middle income and rich countries. They want rapid, sustainable growth, since that brings rising living standards and falling poverty rates.

And in many respects the solutions are the same for all countries. Macroeconomic stability is a sine qua non for the growth hopes of poor countries, just as it is with rich ones. Of course it is true that poor countries have special needs. But these include help to provide better governance, better-functioning financial systems, improved tax collection regimes—just the sort of thing I described earlier as part of our more comprehensive definition of sound and sustainable macroeconomic policies.

Poor countries need more resource transfers, too: but that is not our job. The aid agencies exist to handle development assistance and I know that Iceland does a great deal in this regard at the bilateral level. More aid cannot substitute for sound policies, however; and indeed, better macroeconomic policies are essential to help countries better absorb and exploit the benefits of larger aid flows.

The Monterrey Consensus of 2002 agreed that both rich countries and the poor themselves share responsibility share responsibility for improving the lot of the developing world. Yes, rich countries should provide more bilateral or multilateral aid; but poor countries should undertake the structural and macro reforms that will ensure they can put such aid to good use.

The Monterrey Consensus was specifically targeted at achieving the ambitious Millennium Development Goals. The Fund is wholly committed to doing what it can to help countries make progress towards these goals, which include universal primary education and a large reduction in poverty by 2015.

And the focus on sound macroeconomic performance is beginning to bear fruit. In Africa, several countries that have worked hard to put appropriate policies in place are recording better growth performance, with low inflation.

Crisis resolution

We put so much emphasis on our preventive work because prevention is invariably better than cure. The better the economic policy framework that is in place, the better-equipped a country will be to cope with outside shocks, and the more sustainable and rapid will be economic growth. The more resilient an economy is, the more easily it will weather a global slowdown. And the better-prepared individual economies are, the milder that global downturn will be.

But there will always be crises: I can say that with certainty, though I cannot go beyond that to predict where or when trouble will strike.

Crises have always been part of the Fund's work. The challenge for the IMF is to do as much as possible to prevent them, but, once crises occur, 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. There are many reasons why a government might want to delay acting on external advice or might choose to ignore it altogether. And unless a government seeks financial assistance from the Fund, the staff ultimately has little leverage in persuading reluctant governments to introduce reform.

Failure to heed warnings by the Fund will lead to crisis in some cases. I've already mentioned what we learned about the origins and nature of crises from our experience of the 1990s. But it is important to remember that each crisis is unique. There may be similarities, but each situation will be different—and, of course, the international economy continues to evolve. Trouble might strike because of inadequate macroeconomic policies; or because of weaknesses in the domestic banking system; or because of an unsustainable debt burden. Most crises do not involve default. And each situation requires a different response.

Looking to the future

It is clear that while much has been accomplished, the Fund's agenda remains a full one—and, given the nature of the evolving world economy, it always will. Maintaining international financial stability is an ongoing process: it is not something we can put in place and forget about. The global economy is changing at a more rapid pace than ever before. How we help underpin the multilateral framework that has brought economic growth, rising living standards and poverty reduction needs constant monitoring and adaptation as well.

Just, for a moment, imagine a world without the IMF.

Hard isn't it. How would the lessons of one country's experience be exploited for a wider benefit? How could peer pressure work if there was no forum for debate and discussion? Who would help countries in need of financial support, of technical assistance, or basic policy advice?

If the IMF didn't already exist, it would pretty quickly have to be invented. Of course, we are constantly re-inventing ourselves, as we adapt to changing circumstances. That goes with the territory. But though the world is different from that known to the Bretton Woods founders, the Fund has a clear long-term role in helping to underpin the multilateral framework that brought so much prosperity to the postwar world—and Iceland is a clear example of that. We in the Fund look forward to many more years of fruitful co-operation with you, as one of our founder members.

Thank you.