1. The IMF Part 1: History and Background
Vreeland, James Raymond The International Monetary Fund: Politics of Conditional Lending. New York: Routledge. HG I58 V CHAPTER 1, CHAPTER 6, & Conclusion

2. Today is about:
A triangle
Trade imbalances
IMF to the rescue… or not

3. Why was the IMF created? To answer this, we need…
a little historical perspective…

4. The Inconsistent/Unholy Trinity Or “Trilemma”
BUT FIRST…
The Inconsistent/Unholy
Trinity Or
“Trilemma”

5. a country can only have 2 out of 3 of these
Free Capital Flow
Inconsistent/Unholy
Trinity Or
“Trilemma”:
a country can only have 2 out of 3 of these
Fixed Exchange Rate
Sovereign Monetary Policy

6. The Trilemma

7. Fixed Exchange Rate

8. Sovereign Monetary Policy

9. Open Capital Flows

10. Why would you want… Free Capital Flow? Fixed Exchange Rate?
Draw on the savings of the rest of the world
Investment opportunities abroad
Fixed Exchange Rate?
Reduce uncertainty in trade
Sovereign Monetary Policy?
Address inflation/unemployment

11. Eurozone countries Switzerland PRC Fixed Exchange Rate The Trilemma
Open Capital Flows
Sovereign Monetary Policy

12. a country can only have 2 out of 3 of these
Free Capital Flow
USA
PRC
Inconsistent/Unholy
Trinity Or
“Trilemma”:
a country can only have 2 out of 3 of these
Fixed Exchange Rate
Sovereign Monetary Policy

13. Fixed Exchange Rate
Open Capital Flows
Sovereign Monetary Policy
Trilemma

15. Fixed Exchange Rate
The Trilemma
Open Capital Flows
Sovereign Monetary Policy

16. Why did we ever need the IMF? A puzzle
Degree of global capital mobility
Fixed exchange rates +
Capital controls
Floating exchange rates +
Open capital flows
1944
1971-3

17. Conclusion:
Cannot maintain (global) fixed exchange rates in the presence of high capital mobility…?

18. Why did we ever need the IMF? A puzzle*
Degree of global capital mobility
Fixed exchange rates +
Capital controls
Floating exchange rates +
Open capital flows
1870
1944
1971-3

19. A puzzle: Why were countries able to maintain fixed exchange rates with high capital mobility in the late 19th century?
Fixed exchange rates +
Open capital flows
Degree of global capital mobility
Fixed exchange rates +
Capital controls
Floating exchange rates +
Open capital flows
1870
Interwar period
1944
1971-3

20. GLOBAL FINANCIAL INTEGRATION (World external assets as % of GDP)
Source: WEO 9/02, 4/05 and 10/07

21. Why?

22. Answer: Democracy Few democracies Growing #’s of democracies
Fixed exchange rates +
Open capital flows
Degree of global capital mobility
Fixed exchange rates +
Capital controls
Floating exchange rates +
Open capital flows
1870
Interwar period
1944
1971-3

23. Growth of democracy (minimalist definition)
1870 (7):
1884 (8):
1897 (12):
1911 (17):
United States
Norway
Netherlands
Sweden
Canada
1885 (9):
1901 (14):
Portugal
France
United Kingdom
Australia
1912 (18):
Switzerland
1890 (10):
Denmark
Argentina
Greece
Luxemburg
1909 (15):
Orange Free State
1894 (11):
Cuba
New Zealand
Belgium
Chile
(lost OFS – 1902)

24. Under democracy, The “pocketbook voter model”
people vote according to changes in their income

25. Of course, for the US don’t forget the electoral college institution!

28. Nixon ends Bretton Woods

29. Why?
So, why do fixed exchange rates pose a problem for democracies in the face of highly mobile capital?

30. Pure gold standard Country A imports from Country B
Gold moves from A to B (re-coined/minted)
Less money in A  lower prices
More money in B  higher prices
 Country B imports from Country A
Balance is restored

31. With paper money Central Banks intervene by adjusting interest rates
So gold doesn’t actually flow
Gold Standard  strict discipline!

32. What is “discipline”? What do “lower prices in Country A” mean?
Supply of money down
More expensive to borrow
Jobs cut!
People don’t eat!

33. Under authoritarianism:
People don’t eat
Under authoritarianism:
Let them eat cake
Under democracy:
Incumbents lose elections

34. Hazard Rate over Time for Democracies (Solid Line) & Dictatorships (Dotted Line) – Time in years

36. Fixed exchange rates + Open capital flows
No problem under established authoritarianism
(no problem for governments)
Big problem under
Democracy
Labor Unions

37. Stylized history Late 19th century: Interwar years:
Mobile capital, authoritarian governments
Interwar years:
Mobile capital + democracy  beggar-thy-neighbor
Bretton Woods ( /3):
Capital controls + democracy
Post Bretton Woods:
Floating exchange rates

39. What was the IMF supposed to do?
Soften the blow
Lend to “Country A” deficit-countries so that adjustment can be gradual

40. What is the International Monetary Fund?

41. 1944: 44 countries signed the Bretton Woods agreement
International Monetary Fund (stability)
World Bank (development)
The “Bretton Woods” Institutions.

42. The IMF was given 2 tasks:
Surveillance.
Lending.
The IMF has mainly focused on the latter function – so we will too…
But I’ll touch on surveillance at the end.

43. Why lending?
Soften the blow of adjusting to trade imbalances

44. IMF lending as insurance
A loan from the IMF enables a country to survive a temporary balance of payments deficit.

45. So…as an international lender,
If a country gets into a balance of payments crisis, or for whatever reason, has a shortfall in its foreign reserves,
The IMF can provide a loan (lest this country enter into destructive policies).
Problem: This “bailing out” option lowers the incentive to pursue sound policy.
 “Moral Hazard.”

46. What is the IMF solution to Moral Hazard?
CONDITIONALITY!
Quid pro quo
Loans in return for policy change
How does it work?
Letter of Intent – describes policy changes
Loan comes in disbursements (“tranches”)
If policies have not been changed, no new “tranche” (maybe)

47. Policy conditions have traditionally entailed:
Fiscal austerity
cutting government services and increasing taxes
Tight monetary policy
raising interest rates and reducing credit creation
Currency devaluation
What are the goals of IMF programs?
Economic stability 
Economic growth

48. Stepping back a moment…
Who is the IMF?
Where do the resources for “loans” come from?
Tune in next time!

49. Thank you WE ARE GLOBAL GEORGETOWN!