1. The course take-away: Institutions matter… The ways countries interact in the international arena partly depends on their institutional context. What is an institution? –A set of rules (structures/constraints/mechanisms) that govern the behavior of a given set of actors in a given context. –An equilibrium?

2. What do international institutions do? Informational role? –E.g., trade agreements Lock-in –E.g. Human rights agreements –Ulysses & the sirens –(Lock-in works for democracies, what about dictatorships?) Obfuscate –dirty laundry, scapegoat, dark knight? Solve collective action problems? –Pool reserves in case of financial crises?

3. Why was the IMF created?

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

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

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

7. Why?

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

9. Growth of democracy (minimalist definition) 1870 (7):1884 (8):1897 (12):1911 (17): United StatesNorwayNetherlandsSweden Canada1885 (9):1901 (14):Portugal FranceUnited KingdomAustralia1912 (18): Switzerland1890 (10):DenmarkArgentina GreeceLuxemburg1909 (15): Orange Free State1894 (11):Cuba New ZealandBelgiumChile (lost OFS – 1902)

10. http://freedom.indiemaps.com/

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

12. 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

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

14. 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!

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

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

17. Stylized history Late 19 th century: –Mobile capital, authoritarian governments Interwar years: –Mobile capital + democracy  beggar-thy-neighbor Bretton Woods (1944-1971/3): –Capital controls + democracy Post Bretton Woods: –Floating exchange rates

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

19. Problem Keynes Plan called for contributions totaling $26 billion (with $23 billion from the US) The White Plan called for only $5 billion (with $2 billion from the US) Compromise: –$8.8 billion, with just $2.75 billion from the US The US would only provide Marshall Plan assistance to countries that did not seek additional assistance from the IMF On the eve of the current crisis: –instead of having reserves approximating half of the value of global imports, the IMF holds on reserve a total of less than 2 percent of global imports

20. IMF Arrangements http://www.imf.org/external/np/exr/map/lending/index.htm http://www.imf.org/external/np/exr/map/lending/index.htm Iceland Turkey Seychelles Pakistan Georgia Mongolia

21. What is the International Monetary Fund? Based on: Vreeland, James Raymond, The International Monetary Fund: Politics of Conditional Lending (Routledge, January 2007).

22. 1944: 44 countries signed the Bretton Woods agreement –International Monetary Fund (stability) –World Bank (development) The “Bretton Woods” Institutions.

23. The IMF was given 2 tasks: 1.Surveillance. 2.Lending. The IMF has mainly focused on the latter function – so we will too… But I’ll touch on surveillance at the end.

24. Why lending? Gold standard – each currency’s value was ultimately backed up by gold. A balance of payments deficit could lead to a depletion of gold reserves  Lowered confidence that the government can really back up the value of the currency  Run on the currency… hyperinflation, breakdown of economic order! Governments close up trading!

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

26. The world shifted away from the Bretton Woods-gold standard in the 1970s The old exchange system collapsed. The IMF faced a crisis of purpose. But the IMF was already involved in the developing world. Expanded this role – not just lending for stability, but also to promote development. The shift?

27. Was there really a shift?

28. Who is the IMF? Where do the resources for “loans” come from? Stepping back a moment…

29. Currently 185 members. (Non-member independent countries: Andorra, Liechtenstein, Nauru, Taiwan, Cuba, and North Korea) Members have “votes” according to the size of their subscription to the IMF… Who is the IMF?

30. Where do the resources for “loans” come from? Members provide a contribution called the member’s quota (held on reserve). The size of the quota is a function of the country’s economy: GDP current account transactions official reserves Largest: USA (SDR 37,149.3 million). Smallest: Palau (SDR 3.1 million).

31. Quotas Determine “voting power” at the IMF. –US: 17% –G5: 38% These guys call the shots! An issue we’ll get back to…

32. 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.”

33. Solution? If the IMF determines that the need for an IMF loan is due to bad policy, The Fund imposes policy conditions in return for the loan. This arrangement of conditions for loans is known as “Conditionality.” Note that the loan is not provided upfront, but disbursed in “tranches,” subject to reviews of compliance with conditions.

34. Policy conditions usually entail: 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.

35. La loi LETTER OF INTENT Drafted (by whom?)… signed by finance minister, central bank president, and/or chief executive. Sent to the Executive Board for approval 1 st “tranche” of loan released.

36. Recidivism is the norm Extreme examples from around the world: South Korea spent 13 years under consecutive agreements from 1965 to 1977. Zaire 14 years straight (1976-1989). Liberia 15 years (1963-1977). Peru participated in consecutive agreements from 1954 to 1971 (18 years). Panama from 1968 to 1987 (20 years of consecutive agreements) After a stint of seven years (1961 to 1967), Haiti entered into agreements again from 1970 to 1989, for a total of 27 out of 29 years.

37. Review of background on the IMF: Similar to a credit union (access to pool of resources). Can lend from this pool to countries in crisis. Moral hazard: lowers the incentive to avoid bad policies. Thus, Conditionality – force the country to follow “good” policies in return for a loan. So, you can think of an IMF program as having 2 components: loan + conditions.