Helping the Global Economy Stay in Shape

• Author: Carlo Cottarelli and Isabelle Mateos y Lago
• Position: Deputy Director/Deputy Division Chief in the IMF's Policy Development and Review Department
• Pages: 48-51

Page 48

The IMF adopts a new framework for monitoring countries' economic performance

FROM An economic perspective, no country is an island. The policy decisions of one country often have consequences for neighboring ones. And when it comes to the policies of large countries, an entire region or even the whole world may be affected. This is more true today than ever. Trade links have increased, and capital markets are now able to magnify and transmit shocks across borders at extraordinary speed. Often, these dynamics are benign. But in the late 1990s, the Asian crisis showed us how powerful economic forces have the ability to wreak havoc across borders, with a crisis in one country spreading like wildfire to other economies that had been perceived as sound until then. Although awareness of these global dynamics is growing, national policymakers are inherently ill equipped to deal with them.

This is where the IMF comes into the picture. The IMF was set up in the wake of the Second World War-an event that many historians consider rooted, in part, in the Great Depression-to help ensure global monetary stability. The founding fathers were particularly keen to avoid competitive devaluations, which had worsened the crisis and helped make it global. While this basic goal remains the same today- exchange rates have again become the subject of often-heated international debate-the way the IMF goes about promoting global economic stability has evolved in response to the new landscape of international trade and finance.

In recent decades, the IMF was often seen as a global financial firefighter or aid catalyst. But providing financial assistance to countries in need has always been a means to an end. Today, the IMF's business model is undergoing a wide-ranging reexamination to ensure that it can continue to fulfill its core mandate of promoting international financial stability.

A universal code of conduct

In 1945, the emphasis was on avoiding the competitive devaluations that had marred the 1930s. Under the Bretton Woods system, this objective was achieved through fixed but adjustable exchange rates-a key pillar of the original code of conduct that countries were encouraged to follow when they joined the IMF. Changes in exchange rate parities exceeding 10 percent could take place only with the IMF's approval. When the United States broke the dollar's link to gold in 1971, this system broke down. As a result, a new code of conduct had to be agreed upon. The Page 49 outcome of those deliberations was a revision of Article Iv of the IMF's Articles of Agreement, which became effective in 1978 and is still in force.

Under the revised Article IV, countries pledged not to run their policies in blind pursuit of their own short-term interests, disregarding the effects of their policies on neighbors or indeed on their own longer-term stability. In particular, the new code of conduct encouraged member countries to promote economic growth while maintaining reasonable price stability and orderly financial conditions. It also directed member countries not to manipulate their exchange rate for balance of payments purposes, for instance to gain an unfair competitive advantage, and called on them to pursue exchange rate policies that were compatible with domestic and external stability.

As for the IMF's own obligations, the revised Article Iv mandated the organization to assess whether country policies were consistent with the code of conduct and to provide advice on economic policy. This process has come to be known as country, or bilateral, surveillance, and it applies to all member countries regardless of size and economic health. Article Iv also requires the...