MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/DECEMBER 2002

New International Financial
Arrangements
Keynote Speech by Allan H. Meltzer

The paper addresses three related issues about monetary institutions.
First, acting alone countries cannot achieve price and exchange ratestability. Large economies—the United States, Japan, the European
Union—can provide the public good of price stability. Doing sowould permit all countries that chose to do so to fix their exchange
rates and achieve both benefits. In turn, the large economies would
benefit from fixed exchange rates and domestic price stability. Second,
to respond to the increased size of capital flows, the International
Monetary Fund (IMF) should be changed from a command andcontrol institution into an institution that works to stabilize
international financial markets by increasing incentives for stability.
Third, recent discussion of international bankruptcy, collective action
clauses, and debt rescheduling proposals suggests that reform ofinternational financial institutions has attracted new attention. The
paper discusses three proposals.
Key words: Exchange rates; International monetary system; Debt
restructuring; Sovereign bankruptcy

Carnegie Mellon University and the American Enterprise Institute
I am grateful to Adam Lerrick for many helpful comments.

11

I. Introduction
New research, new policy proposals, new problems, and new policy officials have atlast moved the organization of the international monetary system to the center ofcurrent attention. The Bank of Japan is to be congratulated for forecasting thesedevelopments when it chose exchange rate regimes as the topic at the time it beganplanning this conference 18 months ago. I have been asked by the organizers to
broaden the topic to include the role of international institutions, itself a subject ofrecent interest to policymakers.
The paper begins by summarizing and extending comments I made at an earlier
Bank of Japan conference and elsewhere proposing a policy rule for an open economy(Meltzer [1984, 1997]). Then I discuss reform of the IMF and the recent proposals fordebt default and restructuring. International financial institutions have moved a longway in the past three years from excessive concentration on large loans and conditional
lending to structural reforms that reduce risk and improve market operations.

II. Exchange Rate Systems
Keynes (1923) set out the basic problem of international monetary arrangements.
No country acting alone can achieve both price and exchange rate stability. Acting
alone, a country must choose one outcome or the other. If it fixes its currency to thecurrency of another country, it loses control of its price level and rate of inflation,and may experience real costs of appreciation or depreciation, as in Chile in the
1970s and early 1980s or in Argentina recently. If it chooses domestic price stability,
the market sets its nominal exchange rate.
Some institutional arrangement or international agreement such as the gold
standard resolves this problem by permitting countries to fix exchange rates andimport low inflation. A metallic or fixed exchange rate standard, however, makes
prices move procyclically.
Efforts to avoid either fully fixed or flexible exchange rates using some typeof fixed but adjustable peg contributed to major crises. As Fischer (2001) noted,
intermediate exchange rate systems—those that are neither fixed permanently nor
floating—lost much of their appeal in the 1990s. At the end of the decade, only
34 percent of the countries reporting to the IMF had an intermediate system, downfrom 62 percent in 1991.1 Some type of floating, usually a managed float, is now themost common system.
Standard economic theory does not give explicit answer to the question: What is
the optimal exchange rate system? It depends on country size, degree of openness,international capital mobility, and other factors. Many recent policy discussions conclude that, with capital mobility, pegged exchange rates (including adjustable pegs
and adjustable bands) are not durable. Breakdown has often occurred in a crisis, after
1. Fischer’s data include an additional 26 countries in 1999, so the sample size changes. Fischer (2001, pp. 3–5)
discusses the classification problems.

12 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/DECEMBER 2002

New International Financial Arrangements

large expenditure for defense of the peg, as in Mexico, Korea, Thailand, Indonesia,
Russia, and elsewhere.
Three important caveats are in order. First, the remaining choices of exchange rate
systems are often described as corner solutions. That overstates the choice problem.
Many countries that float intervene to adjust the exchange rate. Political pressures
to do so are real, often strong and continuing, even if undesirable. Second, there arefew freely floating currencies. Those that do are mainly currencies of large economies
like the dollar and the euro. Third, floating is not a fully specified policy until there isa rule for money growth such as inflation targeting, Taylor’s rule, or some otherrestriction on the actions of the monetary authority.
To complicate matters, a country may have a pre-announced inflation target
but intervene in the exchange market to achieve the target. In what sense should
these purchases or sales be described as managing the exchange rate? Does it matterthat the central bank achieves the pre-announced target by purchasing foreignexchange instead of domestic securities? My answer is that if foreign exchange
purchases do not change anticipated money growth or anticipated inflation, theyshould have no effect on relative prices including the exchange rate. These purchases
are a way of achieving the designated monetary policy, the target interest rate, money
growth, or inflation rate.
In relating exchange rate systems to policy rules, there are two lessons that havebeen noted for centuries but are often forgotten. First, exchange rate systems cannot
achieve stability unless policies are stabilizing. Both fixed and floating exchange rates
are sustainable if monetary and fiscal policies are disciplined. Neither works well if
policies are destabilizing, but countries that inflate must have either floating or
adjustable rates or exchange controls. Second, the choice of exchange rate system isa decision about the adjustment process. If the exchange rate is fixed, nominal
prices and wages must adjust to restore equilibrium. Floating the exchange rate is analternative means of achieving the equilibrium real exchange rate.
My earlier statement of a monetary policy rule proposed that the major central
banks or governments should supply a public good that would permit all othercountries to have both reasonable price stability and a fixed exchange rate. If thesecurrencies adopt and achieve a common, low rate of inflation—zero to 2 percent or–1 to +1 percent—countries that choose to fix their exchange rates to one of the
major currencies (or to a basket containing all of them) would achieve both internaland external price stability. And, if many countries choose to fix their exchange rates,
the major countries also get the benefit of more stable prices of traded goods andservices. As an alternative, any country, small or large, could allow its currency tofloat and could adopt the common inflation target if it chose to do so.
Of course, adopting either policy rule restricts budget deficits. There is a limit
to the amount that countries can borrow. The limit is not a fixed amount or fixed
percentage of GDP or exports. It depends on the saving rate, growth rate, export
growth, and other factors that influence the country’s real exchange rate. It depends
also on the availability of loans from international financial institutions.
If major countries adopted the common inflation target and the market believedthat each would achieve its target consistently, changes in real exchange rates would

13

be the main source of exchange rate changes. Exchange rates would adjust to differences in productivity, tax rates, monopoly power, regulation, and other real events.
For example, if innovation increases productivity in one country and tax rates andwelfare state benefits reduce incentives to work in another, the real exchange ratewould adjust. Countries with fixed exchange rates would experience price levelchanges to adjust their real exchange rates.
A tripartite agreement on a common rate of inflation for the dollar, the euro,
and the yen would achieve a major benefit at modest cost. Central banks that
follow my proposed rule, or a Taylor or McCallum rule, or set an inflation target
would operate as before, substituting the agreed common rate of inflation into
their rule. Small, open economies could adopt one of the principal currencies or establish a currency board to retain seigniorage. Other countries could choose a hard
fixed rate or set an inflation target equal to the common inflation rate adopted by
the principal currencies.
The common policy rule, if adopted by many countries, would reverse the early
postwar error of creating scores of central banks. Many former colonies wanted tocreate their own money as evidence of their independence. The benefit of having acentral bank proved illusory and costly for countries that experienced high rates ofinflation and enlarged public sectors financed by printing money. In many countries,
a central bank was far more likely to create problems than to solve them.

III. Role of the International Monetary Fund
What role would remain for the IMF? Countries that adopted the common
monetary system, either by fixing firmly to a major currency or adopting thecommon inflation target, would be more stable. They would have to discipline theirfiscal policy to avoid excessive borrowing and to maintain the monetary rule, if the
IMF did not provide loans to sustain budget deficits.
The International Financial Institution Advisory Commission, which reported to
the U.S. Congress in March 2000, proposed major changes in international financial
institutions. In the commission’s view, the IMF’s two principal tasks would be
providing the public good of increased economic and financial stability and greatly
increasing the quantity, quality, and timeliness of information about its member
countries. The commission concluded that most severe crises occurred in countries
with weak banking systems and adjustable pegged exchange rates. There are manyreasons for the weakness of banking systems in developing countries, but three arevery common.
First, the banking or financial system is often used to support a development plan,a subsidy system, and social transfers by lending at below market interest rates tofavored sectors or firms. China is currently an example, but there are many otherssuch as Korea or Indonesia. Second, many developing countries are too small to offer
local banks broadly diversified loan portfolios, if banks lend only to domestic
borrowers. Korea is the world’s 11th largest economy, but its GDP is about the same
size as the GDP of Los Angeles County. We know from theory and from the history

14 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/DECEMBER 2002

New International Financial Arrangementsof banking failures that insufficient diversification is a major reason for bank failures.
Third, many developing countries permit their banks to borrow on short-term loans
from money center banks in the developed countries. When several of these loans are
not renewed, the banking system is forced to shrink and the exchange rate depreciates
and may collapse.
The commission proposed four changes, a set of conditions that would permit
countries to pre-qualify for assistance if there were a run on the currency or someother crisis. The IMF would monitor these conditions, as part of its Article IVprocess, and it would report its concerns or approval in much the same way thatprivate rating agencies announce actual or possible future changes. The Article IV
reports would be available to the public, helping investors decide to invest or
lend more or less to the government and the private sector. To reduce reliance on
short-term loans, increase diversification of loan portfolios, and strengthen thefinancial system, foreign banks would be permitted to enter the local market andcompete to service the country’s borrowers and depositors. These banks could
balance their accounts with loans and deposits in local currency and diversify risk byentering many foreign markets. Several banks have done this where it is permitted,
and the World Trade Organization has adopted a protocol requiring members toeliminate prohibitions against foreign banks. Several developing countries have madethis adjustment. In the 1998 Brazilian crisis, foreign banks were a source of stability.
Concerned depositors shifted their assets to foreign banks. The banking system did
not collapse, so it helped to reduce the severity of the crisis.
Second, to strengthen financial systems, the commission majority called forrecapitalization of local banks. The use of subordinated debentures is one way
discussed in the literature. The debentures would be held by a non-governmental
agency. Third, the commission’s majority recommended improved standards forreporting the amount and timing of a country’s foreign obligations.
The fourth recommendation called on the IMF to establish a standard for fiscal
policy to ensure that IMF resources “would not be used to sustain irresponsible
budget policies” (IFIAC [2000, p. 8]).
The IMF welcomed the proposal for pre-conditions. It had earlier proposeda facility called the contingent credit line, or CCL. The design of the CCL and its
failure to attract any members points up some of the problems in moving the IMF
from a command and control manager of many countries to a quasi-lender of lastresort that reduces global risk and instability.2
The IMF has not implemented the CCL. One reason is that IMF staff havebeen unwilling to make the CCL automatic. They want to reserve the right torefuse assistance under the CCL if a member country contributed to the crisis. And
they want to negotiate conditions for assistance. These departures from automaticity
of assistance, if preconditions are met, increase costs for potential members andreduce the benefits. Prompt, automatic assistance reduces uncertainty and the size
2. A quasi-lender of last resort differs from a lender of last resort in that it cannot print money. The commission
majority proposed that the IMF have the right to borrow in capital markets as part of its lender-of-last-resort
responsibilities.

15

of the economy’s downward adjustment. Absence of automatic support lowers theattractiveness relative to other IMF programs.
The commission majority viewed a CCL-type program as a way of replacing
the IMF’s command and control programs with an incentive system. Commitment
by a country to a reform program, phased in over a five-year period, and the
IMF’s approval of the program, would mark the country as qualifying for automatic
assistance. Private lenders, who now supply most of the external capital for developing countries, would supply more capital to the country at lower cost, reflecting
lower risk. The country’s government could propose reforms to its parliament as ameans of obtaining additional foreign capital to support development. Instead ofproposing reforms because the IMF required them, the country’s administration
could propose reforms believed to be beneficial to the country.
To strengthen incentives for reform, the majority proposed that countries that
do not meet the standards for the CCL should not receive assistance from the IMF.
If a crisis in one country threatened to cause a global or regional crisis, the IMF
should lend to countries affected by contagion, including countries that did not meet
prudential standards. It should not lend to the country that precipitated the crisis,
unless it met the standards. A credible policy of this type would encourage reform.
Other proposals for reform include the use of penalty interest rates instead of thecurrent practice of subsidizing borrowers and introduction of negative pledge clauses
to prevent governments from subordinating existing creditors to obtain additionalloans. The majority report mentions bankruptcy courts, collective action clauses, andother contractual changes in contracts, but it does not take a position. I return tothese issues below.
These and other majority recommendations are based on several beliefs thatshould be made explicit. The principal role of the IMF and other public international financial institutions should be to improve the operation of markets, reducerisk, increase incentives for reform, and improve the quantity and reliability of
information. Crisis prevention or mitigation without subsidizing risk or introducing
moral hazard is one of its major duties. Reliance in the Commission Report was on
incentives both within the IMF and in the IMF’s dealings with its clients.
Improvements in the quantity, quality, and timeliness of information are anothertype of public good. Given the IMF’s active role in surveillance and the competenceof its staff, publication of its reports strengthens markets.

IV. Crisis and Default Resolution
The third topic in the proposed revision of international financial arrangements
is the resolution of financial crises and restructuring of defaulted sovereign debt.
To facilitate the recycling of oil revenues in the 1970s, the U.S. Congress and theBritish Parliament passed sovereign immunities legislation that encouraged foreign
governments to borrow using the contractual provisions of U.S. or British law.
Among the provisions that have received current attention are the rights of creditorsand debtors, particularly when there is a default (Bulow and Rogoff [1990]).

16 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/DECEMBER 2002

New International Financial Arrangements

For a considerable time, discussion of these issues focused on “bailing in” ofprivate lenders. Eventually, governments and international financial institutions
recognized that if they did not lend into every crisis, banks and other private lenders
could only sell their claims at a price that a buyer was willing to pay. Without
the US$250 billion in crisis loans to 10 sovereign borrowers during the crises of the
1990s, lenders would have been bailed in. Argentina’s default showed that lenders
could sell only at a distressed price. The painful but necessary first step to relate risk
and return on developing country debt is to end IMF bailouts of countries withunsustainable debt, overvalued real exchange rates, or insolvent banking systems.
The IMF appears to have learned part of this lesson. Discussion has now shifted toa different topic: What should be the role of the public and private sectors in resolving
defaults? Krueger (2001, 2002a, b) gave great impetus to the discussion by reviving
interest in a procedure for international bankruptcy by sovereign debtors. Her proposal
initially gave the IMF a major role in deciding the validity of a country’s decision tostop payment of interest or principal. Krueger (2000b) responded to criticism byreducing the IMF’s role.
A proposal by U.S. Treasury Under Secretary John Taylor relies mainly on debtors
and creditors to resolve their problems. Taylor calls for revisions of debt contracts toinclude collective action clauses. These clauses permit a super-majority of creditors
to bind all remaining creditors to the agreement on debt restructuring. Collective
action clauses are recognized generally as desirable and often necessary to avoid
holdouts and holdups. Both occur when an opportunistic investor (sometimes calleda vulture) gains a blocking position in a single issue, refuses the debtor’s settlement
offer, and insists on repayment in full. Opportunistic investors enforce their claim
most effectively by seizing an asset such as a payment by the sovereign debtor in athird country. Collective action clauses would eliminate this problem if applied to alldebt issues and all payments—bonds, loans, commercial paper, and trade credit.3
Krueger’s proposal relies on statutory provisions. She would have the IMF Articles
of Agreement amended to include new provisions relating to a sovereign bankruptcy
court. Any amendment of the IMF Articles is binding on all members once it is
ratified, but some countries stipulate that amendments must be approved by thecountry’s legislature. The United States is one of these. Several members of Congress
have been skeptical of the IMF proposal, and the Joint Economic Committee ofCongress issued a statement opposing the proposal.
Critics of the IMF proposal came from many quarters—banks and investment
funds, economists and legal experts, emerging nations, and the U.S. Treasury. One
common feature of the protests was opposition to an expanded role for the IMF,
whether by the institution itself or by the courts and committees it might control.
And the critics claimed the proposal would increase the uncertainty that leads tovolatility in markets and result in less lending at higher costs for emerging economies.
Some feared that the policy objectives of dominant IMF members would
influence decisions. Some anticipated a conflict of interest, since the IMF and othermultilateral agencies are large creditors that may not be forever immune to sharing in
3. Part of this section is taken from Lerrick and Meltzer (2002a).

17

losses when debt is restructured. Some opposed reliance on a rigid bureaucracy whose
decisions are imposed by fiat and are difficult to predict.
The IMF revised its proposal several times to develop the idea and meet someof the main criticisms. The most recent version, at the time this is written, argues
that a principal advantage of the “statutory” approach is that it would bind all
creditors in all countries and for all classes of debt—bank loans, bonds, trade credit,
and other types of loans (Krueger [2002b]). This is an advantage. If a rule of thiskind became part of the IMF Articles of Agreement after ratification by its members,
it would provide uniform treatment in all jurisdictions. Currently, debtors issue
obligations in many different jurisdictions and subject to different laws. Krueger(2002b) argues that, without a uniform rule, different jurisdictions may havedifferent interpretations of the same contract.
This is a useful point. The IMF proposal next considers how to respond to amember country’s decision to default. I cannot see why the IMF should make thisdecision instead of leaving it to the debtors, creditors, and the market.
Markets have an exceptional ability to evolve and adapt. Postwar experience,
especially in the 1990s, is dominated by IMF bailouts of creditors claims. When theeasy fix of bailouts was an option, both borrowers and lenders rationally placed
obstacles in the path of restructuring to force a stream of subsidized funds from theindustrialized world that made good capital market losses and glossed over country
policy errors. With bailouts ruled out or reduced in size, scope, and frequency, theprivate sector is confronted with a choice: Accept regulation or find its own solution
to make restructuring work.
For over a century, financial contract law has sought to contain what Francis
Palmer, the English jurist, called the “tyranny of the minority.” Many bonds now
require 100 percent agreement to reduce borrower debt burdens. Opportunistic
investors, who seek to hold the restructuring process hostage and enrich themselves atthe expense of the remaining bondholders, remain the stumbling block in an orderly
resolution of debt claims.
When Taylor opted for a decentralized market-oriented approach, he proposed a
simple answer: A package of protective clauses would be built into all sovereign bonds
going forward, as has been the practice for corporate debt under United Kingdom
law for the past century.
Majority action clauses by which a super-majority of creditors can impose anamendment to the payment terms of debt instruments on a dissenting minority
can resolve the difficulties posed by holdout or opportunistic investors. To be truly
effective, these clauses should not be applied issue by issue but across all debt of thesame priority rank. Otherwise, a vulture investor, who accumulates a blocking
minority position in a single small issue, can attempt to hold hostage the entire
restructuring process. The voting provision should be based upon a super-majorityof all creditors of the same priority, regardless of the instrument held—bond, loan,
or trade credit—as long as the treatment of all individual groups of claims is
non-discriminatory.
The protections provided by a sovereign bankruptcy court can be easily replicatedin debt contracts. Protections include automatic stay of individual creditor litigation

18 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/DECEMBER 2002

New International Financial Arrangements

through the use of a trust indenture, where the trustee controls all action against the
debtor on behalf of all bondholders; and targeted subordination of outstanding
claims to interim lenders, the equivalent of debtor-in-possession financing, cancontinue debt service in a liquidity crisis. These and other desired elements can be
integrated into new bond issues. Again, voting should be across all creditors of thesame rank regardless of the instrument held. All other debt instruments, such as bankloans and trade credits, would be amended to match the new bond provisions.
The outstanding stock of old debt remains vulnerable to predators. Complex inits variety of issues, distributed among many investors and lacking the protective
provisions, existence of this stock is now the chief argument for an official bankruptcy court. The claim is that, without a formal procedure, an orderly frameworkfor debt restructuring must await the maturity of all bonds—as long as 30 years. One
way to resolve this problem is to exchange all existing debt for new debt that contains
the collective action clause, as Taylor proposes. The IMF proposal for a uniform rule,binding on all sovereign debt, seems more effective.
Nothing in Taylor’s proposal is new. Perhaps by chance, both New York andLondon used the wording in corporate bond contracts when emerging market
bonds reappeared in the 1970s. London contracts required 75 percent of holders toalter the contract; New York required 100 percent. By law, these percentages apply tocorporations, not to sovereigns. Borrowers and lenders have the option of writing
their contracts in London, where collective action clauses are standard. Why havethey not done so? Why do they not rewrite all contracts based on New York (orother) law, so that all contracts have London rules, including collective action
clauses? One possible explanation is that debtors and creditors relied on IMF-ledbailouts, so there was no reason for concern. It would be helpful to know if this istrue. No less important, borrowers could only gain approval of the Securities andExchange Commission to sell bonds in the United States if they operated under U.S.
(effectively New York) law.
Some critics suggest that voluntary arrangements cannot work because debtors insound financial condition have no motivation to embrace change where costs are
incurred up front and benefits seem remote, perhaps at a time when another Ministerof Finance is in office. But there are immediate benefits. Converted instruments
would trade at narrower spreads in the market reflecting the predictability of anorderly restructuring if a crisis should occur. Lower costs of financing on new
borrowing and greater access to funds would result. The weaker the credit, the greater
the immediate gain.
After a small group of countries initiates the process and gains a relative advantage
in financing, the rest would likely follow. If many borrowers execute conversions in
unison, no stigma of imminent trouble can be attached to the reform, and markets
would not penalize the debtor’s cost of funds.
Debtors can be encouraged by the IMF to convert their existing bonds by making
the new provisions a precondition for access to official financing. The “no bailout”
policy should be firmly reiterated to underscore that subsidized official intervention
is no longer forthcoming. The IMF could also consider subsidizing the cost of
conversion for debtors as a global public good. Financing could be generated through19

adjustments to the IMF’s rate of remuneration on credit balances and rate of charge
on loans, as has been done in the past for special programs.
A likely effect of debt restructuring, whether under IMF rules or not, is that theprice of the debt falls far below its price prior to the default. Many institutional
investors must sell the bonds once default occurs. These sales and any panic selling
drive down bond prices and may influence the restructuring negotiations and theperceived risk in sovereign debt. Other reasons for selling include debt that is held on
margin and investment funds that sell to pay off customers. A small volume of sales
in an illiquid market can cause a large price change.
This problem can be avoided if, at the time of default, the government announces(1) a minimum restructured value (or maximum write-down) at which it offers to
restructure its debt and (2) that the IMF has agreed to purchase for cash all debt
offered during the restructuring period at a price equal to 80 or 85 percent of theminimum restructured value. The IMF’s offer expires when the restructuring ends
(Lerrick and Meltzer [2002b, p. 4]).
The IMF’s announcement would have two benefits. It would put a floor under the
price to which the debt would fall and, more importantly, it would increase the demandfor defaulted debt. The reason is that, given the IMF’s guarantee of a floor, the bonds
become the highest-grade collateral for a loan at 90 or 95 percent of the guarantee.
Speculators could earn attractive annualized returns by buying the bonds, using themas collateral for a bank loan and exchanging them for the restructured debt.4
The two principal objections to the proposed floor price are (1) the difficulty of
deciding on the minimum restructured value at a time of default and (2) the riskof adverse or irresponsible behavior by the debtor, or political instability, once the
IMF issues its guarantee. Both events would require the IMF to purchase debt
(IMF [2002]).
The second risk cannot be excluded, because the possibility of political upheaval
is always present. The debtor country may act to reduce the bonds’ price to thefloor guarantee. This is a costly long-run tactic that arises only if a country plays aone-time game.
In a default, the IMF must always project the growth rate, inflation rate, interest
rate, and other determinants of the minimum restructured value. It does not lend
without projecting, formally or informally, the possibility that the program will fail.
The IMF is perhaps at lower risk if a program fails, because it pays out the loan in aseries of steps (tranches) and can stop payment. In fact, it usually resumes payment
after several months.

V. Concluding Remarks
In April 2002, the G-7 nations agreed to encourage countries to amend contracts
to include provision for a standstill in payments and collective action clauses, by
4. In Lerrick and Meltzer (2002a, p. 5), we estimate annualized returns as high as 40 percent depending on themarket price of the bonds and the time to restructuring.

20 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/DECEMBER 2002

New International Financial Arrangements

which a super-majority could bind all debt holders to accept a revision in contractual
terms. The IMF can continue to develop its bankruptcy plan for possible adoption in
the future.
The new arrangements for dealing with default and for assisting countries indefault are important steps away from the policies of the 1990s. Incentives for reform
and market action and discipline have a much larger role; command and control by
the IMF now has a smaller role.
More remains to be done to reduce financial risk. IMF loans to Turkey and debt
forgiveness for Pakistan show that political considerations remain powerful. Perhaps
evidence of increased stability will in the future encourage greater use of incentives
and fewer bailouts even in politically sensitive countries.
One task for the future is to learn about the general equilibrium effects of the newarrangements. New contractual terms, fewer bailouts, and greater reliance on incentives will affect the market’s functioning. Risk on sovereign debt will increase in the
short term if IMF bailouts end or are much less common. Countries will have more
incentive to reform by establishing the rule of law, opening the economy, securing
property rights, and avoiding macroeconomic imbalances. Such changes will change
the amount, duration, and form of capital transfer to developing countries.
Finally, markets work best when relevant information becomes available promptly.
The quantity of information has increased greatly. The quality of information has
lagged behind. One can cite as an example loan losses on bank balance sheets in
Korea, China, and many other countries. Or, one can cite the amount of hardcurrency reserves available at the Argentine and some other central banks. The IMF
still has much work to do to help markets function, to rely on incentives instead ofcommand and control, and to reduce risk to the minimum required by nature andtrading arrangements.

References

Bulow, Jeremy, and Kenneth Rogoff, “Cleaning Up Third World Debt without Getting Taken to the
Cleaners,” Journal of Economic Perspectives, 4, Winter, 1990, pp. 31–42.
Fischer, Stanley, “Exchange Rate Regimes: Is the Bipolar View Correct?” Journal of Economic
Perspectives, 15, Spring, 2001, pp. 3–24.
International Financial Institution Advisory Commission (IFIAC), Report of the Commission,
Washington, D.C.: Government Printing Office, 2000.
International Monetary Fund, “Involving the Private Sector in the Resolution of Financial Crises: A
Staff Note on the Lerrick/Meltzer Proposal,” 2002.
Keynes, John Maynard, A Tract on Monetary Reform, London: Macmillan and St. Martin’s Press for theRoyal Economic Society, 1923 (reprinted 1971).
Krueger, Anne O., “International Financial Architecture for 2002: A New Approach to Sovereign Debt
Restructuring,” speech given at the National Economists’ Club, American Enterprise Institute,
Washington, D.C., November 26, 2001.
———, “New Approaches to Sovereign Debt Restructuring: An Update on Our Thinking,” speech
given at the Conference on Sovereign Debt Workouts: Hopes and Hazards, Institute forInternational Economics, Washington, D.C., April 1, 2002a.
———, “Sovereign Debt Restructuring and Dispute Resolution,” speech given to the Bretton Woods
Committee, Washington, D.C., June 6, 2002b.

21

Lerrick, Adam, and Allan H. Meltzer, “Sovereign Default: The Private Sector Can Resolve Bankruptcy
without a Formal Court,” prepared for the Joint Economic Committee, U.S. Congress, April
19, 2002a (available at www.house.gov/jec).
———, and ———, “Blueprint for an International Lender of Last Resort,” manuscript, Carnegie
Mellon University, 2002b.
Meltzer, Allan H., Overview in Price Stability and Public Policy, Federal Reserve Bank of Kansas
City, 1984.
———, “On Making Monetary Policy More Effective Domestically and Internationally,” in I. Kuroda,
ed. Towards More Effective Monetary Policy, London: Macmillan, 1997, pp. 3–27.

22 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/DECEMBER 2002