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We face a global economic and financial meltdown that may yet rival the Great Depression. If national economic and financial policies are sufficiently focused and mutually supportive, we can avoid the trade and financial protectionism and competitive exchange-rate devaluations that exacerbated economic distress eight decades ago. The International Monetary Fund (IMF), the World Bank, and what is now the World Trade Organization were established at the end of World War II to mitigate, if not prevent, recurrence of such destructive policies. The question is whether the IMF in particular is up to its assigned task. My answer is that I hope so, but the Fund needs our help.
In my remarks, I will make three major points.
First, the IMF is the principal institution of global economic governance positioned to help deal with the current economic and financial crisis. Unfortunately, the Fund’s legitimacy and relevance has been undermined in recent years. Moreover, even in the best of circumstances, the Fund can only be as successful as its principal members want it to be.
Second, in the near term, the Fund should: (a) lend to countries that have been adversely affected by the crisis, (b) help to establish an agreed approach to global economic and financial recovery, and (c) monitor the implementation of national economic and financial policies, in particular exchange-rate policies, to minimize the negative, spillover effects of one country’s policies on other countries.
Third, in the longer term, the Fund should step up its surveillance of national financial systems and the global system and help to develop a better framework for macroprudential supervision. (There is not even a generally accepted definition of macroprudential supervision. I define it as a concern for the influence of financial system developments on the global economy and, equally important, vice versa.)
Finally, I will sketch some proposals for consideration by the new US administration as it takes over discussions on economic recovery and financial reform with the group of twenty countries in London on April 2.
Before turning to the role of the IMF in the current crisis, let’s remember some historical context. The Fund was established at an international conference in 1944 at Bretton Woods, New Hampshire. The conference was preceded by several years of largely bilateral discussions and conferences involving principally the United States and the United Kingdom. The objective was to prevent the type of competitive exchange-rate adjustments that had characterized the interwar period. The agreed mechanism was a system in which exchange rates were fixed and international permission was required before they could be adjusted. It was recognized that if a country was going to defend its exchange rate from devaluation pressures associated, for example, with a trade deficit, it would be useful to provide international financial assistance, through the IMF, to cushion the process of external adjustment. Domestic macroeconomic policies were to be used primarily to achieve that result. An important subsidiary objective of the IMF was to facilitate the removal of the exchange controls in order to promote the expansion of world trade.
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