Surveillance in its present form was established by Article IV of the IMF’s Articles of Agreement, as revised in the late 1970s following the collapse of the Bretton Woods system of fixed exchange rates. Under Article IV, member countries undertake to collaborate with the IMF and with one another to promote exchange rate stability. For its part, the IMF is charged with (i) overseeing the international monetary system to ensure its effective operation, and (ii) monitoring each member's compliance with its policy obligations under Article IV, Section 1.
In June 2007, the legal framework for surveillance underwent a major update with the adoption of the Decision on Bilateral Surveillance over Members’ Policies. The Decision clarifies that country surveillance should be focused on assessing whether countries’ policies promote domestic and external stability. This means surveillance should mainly focus on monetary, fiscal, financial, and exchange rate policies and assess risks and vulnerabilities. It also provides guidance to members on how to conduct exchange rate policies in a way that is consistent with the objective of promoting exchange rate stability and avoiding manipulation.
In his original proposal for a post-war international monetary system, British economist John Maynard Keynes envisaged a global bank (the International Clearing Union or ICU), which would issue its own currency (bancor), based on the value of 30 representative commodities including gold, exchangeable against national currencies at fixed rates. All trade accounts would be measured in bancor, while each country would maintain a bancor account vis-à-vis the ICU (expected to be balanced within a small margin), and also have an overdraft allowance vis-à-vis the ICU. When countries experienced large trade deficits (more than half of the bancor overdraft allowance), they would pay interest on their accounts, undergo economic adjustments (possibly also capital controls) and devalue their currencies. Conversely, countries with large trade surpluses would also be subject to a similar charge and required to appreciate their exchange rates. Keynes expected that this mechanism would bring in a smooth symmetry of adjustments across countries and avoid global imbalances.
The IMF's assessment of member’s compliance with their policy obligations under Article IV, Section 1 is implemented through the regular monitoring of economies and the associated provision of policy advice. Bilateral surveillance is intended to identify weaknesses that are causing or could lead to financial or economic instability.
The IMF’s Executive Board is responsible for conducting bilateral surveillance, and establishes both the legal framework and priorities of IMF surveillance.
See also: surveillance and multilateral surveillance.
An explanation for global imbalances first proposed by Dooley, Folkerts-Landau and Garber. It refers to the unilateral actions by emerging markets, especially in east Asia, to manage their exchange rates with reference to the US dollar. In particular, the authors noted that differing economic priorities (export-led growth in EMEs and financial liberalization in advanced countries) ensured that the present international monetary system would be a mixed system of fully floating and managed exchange rates. The authors further contend that the system is robust, though others disagree. Cooper has also noted that the deeper and more sophisticated financial system in advanced countries (in particular, the US) and its more favourable demographics naturally favour such a mixed system.
The name “Bretton Woods II” aims to signal parallels between the unilateral actions of some countries at the present time and the earlier (multilateral) compact that characterised the original Bretton Woods system.
Refers to the international monetary system in operation in the post-war period until the end of the gold exchange standard in 1971. The name comes from the agreements put in place at Bretton Woods, New Hampshire, where delegations from 44 countries gathered to construct a post-war global monetary and financial architecture, including creating the IMF and the World Bank.
The system was characterized by a system of adjustable pegs to the US dollar, which in turn, was pegged to gold at $35 an ounce. Countries could adjust their currency values in consultation with the IMF and their partners. While the system largely prohibited restrictions on current account transactions, capital controls were explicitly allowed, and indeed seen as a means of ensuring the system’s stability.
By the late 1960s, a fundamental tension arose whereby the domestic macroeconomic policy imperatives in the United States were at odds with the need to maintain the stability and smooth functioning of the international monetary system. This spurred an effort to find a new reserve asset that could act as a substitute for the dollar or any other national currency, thereby addressing this flaw, which led to the creation of the SDR. The system came to an end when the United States dropped the link between the dollar and gold due to a need to regain monetary independence and the fiscal expenditures related to, among others, the war in Vietnam.
Refers to the process of removing or eliminating restrictions that govern the movement of capital across national borders. While the IMF Articles of Agreement do not, with very limited exceptions, impinge on members’ ability to regulate capital flows, there has been a general tendency to greater capital account liberalization over time, including in emerging markets. In theory, capital account liberalization can enhance long-term growth prospects through allowing: (i) access to finance for investment at lower cost; (ii) consumption-smoothing in the face of adverse shocks; (iii) diversification of assets and liabilities across countries; (iv) “technology transfer” from foreign banks; and (v) greater discipline on macroeconomic policy.
However, the empirical evidence is mixed, with some studies suggesting considerable gains while others pointing to a weak or even negative relationship between liberalization and growth. It also appears that not all capital is equal: foreign direct investment is generally seen to be beneficial while short-term debt is seen to carry greater risk. In view of this, most commentators, including the IMF, have advocated a cautious and sequenced liberalization framework embedded in a larger program of macroeconomic and financial reforms.
In the late 1990s, an effort was made to enshrine capital account liberalization as part of members’ obligations, with safeguards and transitional arrangements, under the IMF Articles of Agreement. This effort was not successful, however, following the onset of the Asian financial crisis. Nevertheless, agreements leading to greater liberalization continue to be concluded through a variety of vehicles including bilateral agreements (e.g., free trade and investment guarantee agreements), regional treaties (e.g., the Treaty on the Functioning of the European Union) and other agreements (e.g., the OECD Code of Liberalization of Capital Movements).
Refer to the measures affecting capital flows into and out of a country. The IMF Articles of Agreement do not, with very limited exceptions, impinge on members’ ability to regulate capital flows, and most countries do maintain some controls on certain aspects of capital flows.
On occasion, countries have temporarily imposed capital controls as a means of creating policy space to enact countercyclical monetary policies and, in the face of persistent and large inflows, mitigate the build up of risks. Recent work by IMF staff suggest that these tools could have a role, especially in the face of large and potentially destabilizing inflows, but that these need to be anchored in an appropriate macroeconomic policy framework.
The IMF surveys countries to ascertain the measures in place that restrict capital flows. The results are reported in the Fund’s Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER). The AREAER forms the basis for the various measures of financial integration and openness including the well-known ones compiled by Chinn and Ito, Quinn, and Schindler.
An investment strategy whereby an investor borrows in a currency that carries a low interest rate and invests in assets in another economy where rates of return are higher. In most cases, a large and persistent interest differential seems to determine carry trade flows, though conceivably other aspects of returns (expectations of exchange rate appreciation, differing growth and profit outlook) may also play a part. Initially, it was used to describe how leveraged investors in Japan behaved (borrowing in yen cheaply to invest in high yielding assets, mainly in Asia and the Pacific) but has now also come to describe investor behavior in the eurozone and Switzerland in the run up to the crisis, and potentially from the US to faster growing emerging markets in the post-crisis period.
In the present IMS, countries have wide latitude to choose exchange rate frameworks, ranging from a fully free-floating currency with minimal intervention, to completely adopting the currency of another country. Currently, the IMF
classifies a country as having one of 4 regimes based on the degree of flexibility and the existence of formal or informal commitments to exchange rate paths. These are: exchange rate anchors such as currency boards, full dollarization, pegs, and bands; monetary aggregate targeting; inflation targeting; and others.
Recent work by IMF staff suggests that, with floating exchange rates among systemic countries, the system can support more active exchange rate management at the periphery, but as emerging markets increasingly migrate to the core, potential systemic instability arises. Further, even with floating exchange rates, an important concern is that countries at the core of the system need to maintain macroeconomic discipline to foster confidence in their reserve assets, while those that are non-systemic need to anchor their policies on sound fundamentals and prudent policies.
Coined by the then-Finance Minister of France, Valéry Giscard d'Estaing, the term refers to the greater macroeconomic space accorded to a country issuing a major reserve currency (especially the United States) by virtue of the greater liquidity of its markets, ability to borrow in its own currency abroad at lower cost, as well as the seigniorage earned from issuing an internationally used currency (distinct from, but associated with, its role as a reserve asset). Owing to the reliance of the IMS on the quality of policies in the centre country, some have spoken of an “exorbitant responsibility” or “exorbitant duty”, especially if no likely alternative is apparent.
The extent to which this privilege (and resulting responsibility) is significant is the subject of some disagreement, with some commentators arguing it is trivial, and others contending that a large benefit accrues to the U.S.
Refers to the global network of crisis financing instruments. This network encompasses self-insurance (reserves); bilateral arrangements (e.g., swap lines between central banks during periods of stress); regional arrangements such as those in Asia, Europe and Latin America where members stand ready to support one another; and a multilateral system with the IMF at its centre. An important part of the IMF’s reform agenda is to weave these elements of the safety net more closely together so that they are complementary and comprehensive. In recent discussions with regional financing arrangements from Asia, Europe, Latin America and the Middle East, it was agreed that the ultimate objective should be to strengthen surveillance and the effectiveness of co-financing mechanisms for countries vulnerable to crises. This could be done through a variety of means including IMF involvement in surveillance, such as being done with Asia; and exploring co-financing arrangements during crises, as being carried out in Europe.
Refers to the phenomenon whereby some major systemic countries—most notably the US – run large and persistent current account deficits, which are mirrored by large surpluses in a number of countries, especially export-oriented economies in east Asia, and the oil exporters. They also refer to savings/investment balances, where countries have an excess of saving versus investment opportunities. The lack of an automatic mechanism for dealing with global imbalances was seen as a key flaw in the international monetary system, and thus became a key concern of the international community, leading the IMF to convene multilateral consultations to discuss the issue in 2006. The worry was these imbalances were unsustainable and could lead to a disorderly adjustment caused by a collapse in the value of the US dollar.
Nevertheless, many remain concerned that allowed to persist, these imbalances would derail the recovery by stymieing the needed adjustment in deficit countries. Some commentators also point to the potential for the large capital flows engendered by these imbalances to contribute to asset price bubbles and sow the seeds for further instability.
A global monetary system whereby countries anchored their currencies to gold. While there are variations of the system, in all of them, it was expected that surplus countries would eventually experience domestic inflation, which would erode their competitiveness while deficit countries would see their competitiveness restored through disinflation or even deflation. In practice, the system was not able to function as expected as adherence to the standard often removed the prospect of allowing domestic monetary policy to adjust to demand conditions. While proponents point to this as a mechanism that forces discipline on governments and central banks, others have noted a number of problems including that the supply of gold changes slowly and often unpredictably leading to deflation in the long run, and hoarding of specie by surplus countries that may cause disproportionate contractions in other countries in the short term.
Most commentators have concluded that adherence to the gold standard was, at the very least, not helpful in the face of the Great Depression in the early 20th Century, though disagreements remain on how central the system was in causing and propagating the downturn.
Formed in 1999, the G-20 brings together finance ministers and central bank governors from 19 countries and the European Union (represented by the President of the European Council and the European Central Bank). The heads of governments of the G-20 nations began meeting periodically from 2008, in the wake of the global financial crisis. While an informal group with no permanent secretariat, the G-20 has become a key forum, bringing together the key advanced countries of the G-7 (Canada, France, Germany, Italy, Japan, the US and the UK), Australia, and 11 major emerging markets (Argentina, Brazil, China, India, Indonesia, Korea, Mexico, Russia, Saudi Arabia, South Africa, and Turkey). Leadership of the G-20 rotates, with France holding the chair in 2011.
More information on the IMF’s relationship with the G-20.
Refers to the rules and institutions for international payments. Less abstractly, it refers to the currency/monetary regimes of countries, the rules for intervention if an exchange rate is fixed or managed in some way, and the institutions that back those rules if there is a problem (through official credits, controls, or parity changes). After the collapse of the Bretton-Woods system, the present system has evolved in an ad hoc fashion with the key currencies floating against one another, and currencies of economies on the periphery
largely managed in some manner against these core currencies (often the US dollar), leading some to dub the arrangements a “non-system”. A key notion in this setup is that of reserve asset: countries, even those with floating currencies, will need to have access to foreign currency assets that can be used to intervene in markets during periods of stress. This is even more so if a country fixes or manages its exchange rate. Since the demise of real assets like gold as monetary anchors, the U.S. dollar has been the world’s principal reserve asset, with the euro playing an important role. Other important reserve currencies include the British pound and the Japanese yen.
In recent years, the accumulation of reserves by emerging market economies has accelerated, and risks undermining the stability of the IMS.
Multilateral surveillance refers to the process of assessing developments, risks and vulnerabilities of the international monetary system as a whole. The IMF conducts such surveillance through a number of vehicles including reports (World Economic Outlook, Global Financial Stability Reports), vulnerability and early warning assessments (Early Warning Exercise and vulnerability assessments for advanced and emerging market economies, and most recently, low-income countries) and in cooperation with other groups, most notably the G-20 Mutual Assessment Program.
The IMF’s mandate on conducting multilateral surveillance is set out in its obligation to "oversee the international monetary system to ensure its effective operation”.
See also: surveillance and bilateral surveillance.
Refers to an international monetary system that is based on a group of currencies rather than primarily just one currency. In a multiple currency system, it is conceivable that there would be greater discipline on reserve currency issuers as users could shift their holdings from one currency to another. This would also spread the exorbitant privilege currently accruing to the US by virtue of the dollar’s dominance.
At the Pittsburgh Summit in 2009, G-20 Leaders launched the Framework for Strong, Sustainable, and Balanced Growth. The backbone of this framework is a multilateral process through which G-20 countries identify objectives for the global economy and the policies needed to reach them.
The IMF was requested to provide the technical analysis needed to evaluate how members’ policies fit together—and whether, collectively, they achieve the G-20’s goals. Specifically, the G-20 requested that the Fund (1) analyze how the G-20’s respective national and regional policy frameworks fit together, and (2) develop a forward-looking analysis of whether policies pursued by individual G-20 countries are collectively consistent with more sustainable and balanced trajectories for the global economy.
See also: a blog post on the MAP by the Fund’s Economic Counsellor, and an IMF Report on the MAP.
A concept first introduced by Eichengreen and Hausmann in 1999 and subsequently extended by the authors and Panizza in 2002 and 2003, it refers to the inability of some countries (mainly developing countries) to borrow in their own currencies. As such, these countries are forced to borrow in foreign currencies, which, in turn exposes them to currency risk and potentially balance of payments crises. An explanation for the unprecedented accumulation of reserves by emerging markets in recent years is founded on the idea of self-insurance for precautionary purposes when original sin may be an issue.
Following the crisis episodes faced by emerging markets in the late 1990s and the early part of the 2000s, a number of major EMEs started to accumulate significant levels of reserves. By 2009, reserves totalled 13 percent of global GDP, a threefold increase from a decade earlier, with the growth coming from EMEs. This accumulation, while initially understandable, has become a concern in the system because it leads to a paradoxical situation where capital flows uphill to developed countries instead of to emerging markets where the need is greater. Additionally, the scale of these flows may have caused distortions in the pricing of advanced country financial assets.
In general, reserve currencies are those fully convertible currencies that are in wide use in the international monetary system, both because they account for the bulk of reserve assets held by authorities and because they are widely used in current account and financial transactions. Reserve currencies also tend to be characterised by the fact that many countries other than the issuer may have liabilities in these currencies due to the deeper markets in these currencies. Conversely, one of the characteristics of a reserve currency issuer is its freedom from original sin.
The Special Drawing Right (SDR) is an international reserve asset, created by the IMF in 1969 to supplement the existing official reserves of member countries.
The SDR is neither a currency, nor a claim on the IMF. Rather, it is a right to access freely usable currencies from other SDR Department participants in case of balance of payments difficulties.
SDR Department participants can obtain freely usable currencies in exchange for their SDRs in two ways: first, through the arrangement of voluntary exchanges (also available to other holders of SDRs that are not SDR Department participants); and second, in the event of balance of payments difficulties, by the IMF designating SDR Department participants with strong external positions to purchase SDRs from the participant with such balance of payments difficulties. Under the IMF’s Articles of Agreement, participants in the SDR Department also undertake to collaborate with the IMF and other participants to ensure the SDR system functions properly. In addition to its role as a supplementary reserve asset, the SDR serves as the unit of account of the IMF and some other international organizations.
See also details on how SDRs are created, allocated and used.
The value of the SDR was initially defined as equivalent to 0.888671 grams of fine gold—which, at the time, was also equivalent to one U.S. dollar. After the collapse of the Bretton Woods system in 1971, however, the SDR was redefined as a basket of currencies, today consisting of the euro, Japanese yen, pound sterling, and U.S. dollar. The U.S. dollar-equivalent of the SDR, as well as its value against other major currencies, is posted daily on the IMF’s website. It is calculated as the sum of specific amounts of the four basket currencies valued in U.S. dollars, on the basis of exchange rates quoted at noon each day in the London market.
The basket composition is reviewed every five years by the Executive Board to ensure that it reflects the relative importance of currencies in the world's trading and financial systems. In the most recent review (completed in November 2010 and effective January 1, 2011), the weights of the currencies in the SDR basket were revised based on the value of the exports of goods and services and the amount of reserves denominated in the respective currencies that were held by other members of the IMF. The currency amounts for the new SDR basket were announced on December 30, 2010. The next review will take place by 2015.
During periods of strong dollar liquidity growth, calls have been made to diversify reserve assets, including most recently by China. One idea that has been broached is that of a substitution account whereby reserve holders have a transparent method of swapping their short-term dollar assets for other assets. It would involve having the IMF (or some other supranational body) set up an account that would allow central banks to swap dollar assets (typically, short-term U.S. T-bills) for SDRs (alternatively, to boost the number of SDRs, central banks could swap reserves in exact proportion to the components of the SDR basket). The account would in turn convert the U.S. T-bills for longer-term claims on the U.S. Treasury, with the spread between the long-term interest rate and the short-term rate paid to SDR holders helping to cover the exchange rate risk. However, there was no assurance that the exchange rate risk would be covered (e.g., the shift in relative demand could flatten the yield curve and reduce the term premium). Other mechanisms for sharing the exchange rate risk were floated, such as investing in government bonds of the SDR component currencies or using a portion of the IMF’s gold stock to absorb the costs.
All the proposals over the years have not been acted on, in part because countries were never able to settle on a mechanism for sharing exchange rate risk, but also because the dollar’s value recovered and a more sanguine view regarding its prospects re-emerged.
The IMF, through the Executive Board, is tasked with assessing whether members meet their obligations to promote a stable system of exchange rates. The IMF carries out this responsibility by monitoring developments in its member countries, as well as at regional and global levels, to ascertain potential sources of instability, with the aim of fostering international dialogue and cooperation to deal with these concerns. This process is known as surveillance.
The modalities of surveillance vary and include bilateral consultations with members (also known as “Article IV Consultations”), the production of global and regional reports such as the World Economic Outlook, Global Financial Stability Report and the Fiscal Monitor, and exercises to assess vulnerabilities in member countries (Early Warning Exercise, vulnerability exercises for advanced and emerging economies). Other IMF activities, such as the Financial Sector Assessment Program (FSAP) informs surveillance.
The IMF periodically reviews its experience with surveillance through the Triennial Surveillance Review, last conducted in 2008. The next Review will be completed in 2011. Based on the outcome of the Review, the Executive Board will then set out the priorities that will guide Fund surveillance over the medium term in a Statement of Surveillance Priorities.
Key priorities for IMF surveillance include better assessment of tail risks, enhancing financial sector surveillance and real-financial linkages, improved understanding of multilateral perspectives and more effective analysis of risks to external stability. A number of initiatives that would improve this include better and more comprehensive treatment of spillovers in its reports, and better oversight over the financial sector are the goals.
See also: bilateral surveillance, and multilateral surveillance.
Named after economist Robert Triffin who first proposed it, the dilemma refers to what he thought was an inherent tension in the original Bretton Woods system. He noted that the US could not simultaneously supply the necessary volume of high quality reserve assets demanded by faster growing economies, while ensuring parity with gold. At that time, because global trade (and therefore demand for dollars to settle trade) was increasing more quickly than growth in the US, any emissions of US debt would necessarily be domestically inflationary and likely fiscally unsustainable. On the other hand, if the US were to rein in spending and reduce both its fiscal and external deficits, the world would lose its injections of needed dollars and was in danger of slipping into a deflationary spiral. Coupled with this, the US was also confronted with the expenditures related to the war in Vietnam which saw it finally abandon the gold standard in 1971.