IMF Reform and the International Financial Institutions Advisory Commission
Released: 2001-01-05T00:00:00

The IMF and the Evolving International Economy

The International Monetary Fund, conceived at the Bretton Woods conference in 1944, is the institutiondesigned tosupport global trade and economic growth by helping maintain stability in the international financial system. Initially, theIMF served primarily industrialized countries by supporting currency convertibility and providing them withshort-termfinancing when needed to defend their pegged exchange rates. With the demise of the fixed exchange-rate systemin 1973,and the huge growth and liberalization of the private international capital markets, industrial countries soon foundlittleneed to draw on the Fund. At this point, the IMF increased its assistance to developing countries, some of whichwerefinding themselves increasingly embroiled in financial problems. (1)

Most IMF lending draws from the Fund's permanent assets (some $283 billion), provided by member countries (the capitalsubscription or quota) as part of their commitment when they join the fund. In addition to being the financialresources ofthe Fund, the quota is important because it determines a country's voting power and borrowing capacity. The IMFmaintains two borrowing arrangements with selected member countries, as well, for times when the Fund may notbesufficiently liquid to meet all borrowing needs. The General Arrangements to Borrow (GAB) is a $23 billion creditlineestablished by 11 industrialized countries in 1962. The New Arrangements to Borrow (NAB) was establishedfollowing the1994-95 Mexican peso crisis as a supplemental line of credit by 25 member countries, adding another $23 billionofcurrency borrowing authority.

IMF lending involves providing hard currencies to member countries with balance of payments problems based on need,willingness to adjust policies, and ability to repay. Three types of financing facilities are available under the generalresources account: 1) the stand-by arrangement; 2) the extended arrangement (these two constitute most IMFassistance);and 3) special facilities. Two programs created since December 1997, the Supplemental Reserve Facility (SRF) andtheContingent Credit Line (CCL), amount to special access policies to stand-by and extended arrangements underextenuatingcircumstances. As part of the IMF's evolving sense of mission, it has developed lending facilities to address theneeds ofthe poorest developing countries: the Poverty Reduction and Growth Facility (PRGF) - renamed in November 1999fromthe Enhanced Structural Adjustment Facility (ESAF); and the Heavily Indebted Poor Countries (HIPC) initiative.

Although the IMF has operated for over half a century in an evolving and at times volatile global economy, it was theseverity and frequency of the 1990s financial crises that rekindled the recent debate over its core mission. Manycompetingperspectives have developed, but there are some common starting points to consider. First, since the end of theBrettonWoods era in 1973, the IMF has redirected its attention towards the developing world. Second, IMF arrangementshavegrown in size and maturity, as it has taken on increasingly larger financial "bailouts." Third, the Fund has expandedits roleas a development organization through concessional loan programs to very poor countries. Fourth, short-termbalance ofpayments lending has given way to global financial crisis management.

For roughly the first three decades, total IMF outstanding credit was small by historical standards, peaking at SDR (2) 13.7billion in 1977, much of the increase related to financing severe, but temporary balance of payments deficits of oilimporting countries during the mid-1970s oil price shocks. Data for the past two decades point to two additionaldistinctperiods documenting the IMF's elevated exposure to broader global financial troubles. First, the debt crisis in LatinAmerican during the 1980s required vastly greater resources as the IMF took the lead in coordinating the responseamongthe private banks, multilateral financial institutions, and individual bilateral creditors to avoid massive default. TheIMF'sexposure is clearly visible in its increased lending, peaking at SDR 37.6 billion in 1985 (nearly three times theprevioushigh in 1977).

Second, beginning in 1995, a series of individual country financial crises resulted in unprecedented IMF lending. First, theMexican peso crisis unfolded abruptly in December 1994. As Mexico's problems began to wind down, a largerAsianfinancial crisis erupted in 1997, with Russia and Brazil following on its heels in 1998 and 1999, respectively. Theseincidents collectively drained IMF funds, with total credit outstanding rising over six fold from SDR 10 billion in1980 toSDR 67 billion in 1999. Liquidity concerns, along with new policies developed to make access quicker and pleasforadditional resources (in both the quota and borrowing limits), pushed the IMF debate to center stage. (3)

During the 1990s, the concentration of IMF lending was particularly evident. Table 1 shows the percentage of total IMFpurchases (draws) to the major crisis countries since 1995. It includes those made through the SupplementalReserveFacility after 1997 and comprises roughly 90% of the SDR value of IMF purchases for any given fiscal year. (4) As may beseen, Russia has been a significant user of IMF funds since 1995. In 1995 and 1996, when the Mexican peso crisishit,Russia and Mexico together accounted for 56.8% and 67.4% of IMF purchases, respectively. In fiscal 1997, Russiawas theonly major borrower, constituting 42.6% of total draws. With the advent of the Asian and Brazilian problems, themajorcrisis countries collectively accounted for 89.8% and then 82.9% of IMF purchases during fiscal 1998 and 1999,respectively.

Table 1. IMF Purchases by Major Crisis Countries, 1995-99 (percent of total IMF purchases or draws by fiscal year)

Source: International Monetary Fund, Annual Report , various years.

* Includes all Supplemental Reserve Fund commitments beginning in 1998; does not include PRGFconcessional loanfacility data.

If the mission of the IMF were to be defined by its lending portfolio, table 1 would suggestthat its primary purpose is tolend to countries with major currency crises rather than those with short-term, non-crisis balance of paymentsproblems. Among the fundamental questions that have arisen from this global posture of the IMF are: is the Fund "succeeding"inmeeting its core mission of supporting international financial stability, and does the expectation that crisis lendingwilloccur contribute to the possibility of future runs on currencies?

The Meltzer Commission Report

In appropriating funding in the fall of 1998 to increase the U.S. quota in the IMF, Congress required that anindependentcommission be created to evaluate the international financial institutions, giving particular attention to the IMF. TheInternational Financial Institutions Advisory Commission (hereafter the Meltzer Commission) was given six-monthstopresent a detailed report to Congress. Professor Allan H. Meltzer of Carnegie Mellon University, historically astaunchcritic of the IMF, was named commission chair. (5)

The final report reflects the overarching view that the IMF has overstepped its mission of supporting international financialstability by increasingly undertaking large bailouts of countries in severe economic and financial crisis. Not allcommissioners agreed, as reflected in the split 8-to-3 vote approving the final report and in its publication withdetaileddissenting opinions. There was consensus on two issues, however, both pointing to reducing the size and scope oftheFund. First, the Commission proposed that the IMF restrict its lending to only short-term liquidity needs of membercountries and eliminate its role as a long-term lender, particularly for purposes of reducing poverty or promotingdevelopment. Second, the IMF, the World Bank, and the regional development banks should write-off all the debtfrom theso-called Heavily Indebted Poor Countries (HIPCs). (6)

Foundations of the Argument

The Meltzer Commission report builds its case for redefining the IMF mission based on the following arguments:

1. Since the IMF's creation in 1944, its core mission of supporting global financial stability remains, but an internationalfinancial system based on a gold/dollar standard of pegged but adjustable exchange rates and capital controls nolongerexists. Since 1973, most industrial countries have adopted flexible exchange rates and strengthened their centralbanks(lenders of last resort), effectively eliminating their need for IMF assistance;

2. The IMF, in response, adjusted its mission by turning to the developing world, where it has made increasingly large andlonger-term loans to crisis countries, and in some cases, has provided concessional loans to the poorest developingcountries. According to the report, "mission creep" has led to requests by the IMF for additional financial resourcesandpowers;

3. IMF assistance and conditionality have led to an "unprecedented" amount of influence for a multilateral institution overborrowing countries and fostered their increased dependence on the Fund. Overall economic and developmentresults,however, have been disappointing;

4. The IMF has proven to be poorly suited to anticipate financial crises, slow in dispensing financial assistance, and proneto pushing pro forma policy advice that can compound rather than alleviate problems. The severity and recurrenceof theseproblems suggests that the preventative and coping mechanisms as currently practiced by the IMF are not adequate;

5. The most significant problem related to IMF programs, particularly since the Mexican bailout in 1995, has been the riseof moral hazard, or the over commitment of particularly short-term financing by private investors and lenders todevelopingcountries in part because of an expectation, based on previous experience, that the IMF will provide the foreignexchangeliquidity that will allow them to exit the country in time of crisis and without bearing their full losses (Russia is themostprominent example);

6. The report lists a number of other problems internal to the IMF including: failure to enforce IMF conditions uniformly;poor transparency; political manipulation of the IMF by G-7 countries; lack of independent oversight; and overlapofmission with other international financial institutions. (7)

Meltzer Commission Recommendations

The Meltzer Commission makes the case for restructuring the IMF to as part of a more targeted and much reduced mission,with redefined obligations for members of the Fund, as well. At the heart of the proposal is a strong conviction thatdeepstructural reforms, particularly of developing country financial systems, would go a long way toward reducing thepotentialfor currency crises and the related need for large, costly IMF bailouts. Specific report recommendations are groupedbelow.

Redefine the IMF's Mission. The IMF should be restructured as a smaller organization with three distinctresponsibilities: 1) act as a "quasi-lender" of last resort that would restrict lending to short-term liquidity assistance;2)collect and disseminate country financial and economic data on a timely basis; and 3) provide advice on economicpolicyrather than impose conditions. Loans would be made only to those countries that had met"preconditions" of financialsoundness, except under "unusual" circumstances where stability of the international financial system is at stake. All otherlong-term lending should cease, particularly long-term concessional lending to the poorest countries, to differentiateclearlythe IMF's mission from that of the development banks. As a result, the Commission sees no need to consider anyadditional quota increase in the foreseeable future.

Participation in IMF Programs. All member countries should provide accurate and timely economic and financialinformation for all market participants to use, both private and public. IMF lending would not be extended to largeindustrial countries because Fund resources are inadequate to cover their potential needs; in any case they shouldnot beneeded in countries with flexible exchange rates and the means to act as their own lenders of last resort. Neitherwouldthere be any need to conduct Article IV consultations with developed countries. The IMF could offer policy advice,but theprecondition of prudent standards would theoretically obviate the need for the current elaborate conditions forlending.

Rules (preconditions) for Lending. To become eligible for IMF assistance, member countries would need to meet fourpreconditions or minimum prudential standards: 1) allow entry of foreign financial institutions to deepencompetitiveness,reduce corruption, and diversify risk in the banking system; 2) require that domestic banks be adequately capitalizedtoestablish market discipline; 3) publish the maturity structure of outstanding sovereign and guaranteed debt, andoff-balancesheet liabilities to encourage safe and sound behavior; and 4) meet a "proper" fiscal requirement so the IMF wouldnot beused to support irresponsible budget deficits. The IMF should not lend to salvage insolvent financial institutions. TheCommission believes that adopting higher IMF-set financial standards and discouraging short-term borrowing canreducethe potential for moral hazard.

Terms for Lending. To support the basic mission of liquidity lending, IMF loans should have short maturities (not toexceed 120 days and one roll-over period), a graduated penalty rate (above sovereign yield), and an explicit legalpriorityfor repayment. Defaulting countries would not be eligible for additional lending by any multilateral agency or IMFmembercountries, and credit limits would be clearly defined and strictly observed. The new rules could be phased in overthree tofive years to allow countries time to meet new requirements, with IMF supporting crises in the mean time, but athigh loanpenalty rates. Extraordinary circumstances for borrowing such as natural disasters, political turmoil, or emergencyassistance should be done through the relevant multilateral development institutions (United Nations, World Bank)orbilateral arrangements.

Exchange Rate Policy. To permit the greatest latitude for adjusting to changes in both domestic policy choices andexternal economic events and to avoid costly attempts to stave off devaluations, countries should shun any ofvariousadjustable peg exchange rate systems, relying instead on either a firmly fixed or flexible exchange rate regime. Moreimportantly, countries should be strongly encouraged to adopt appropriate "stabilizing monetary and fiscal policies"toreduce the possibility of economic shocks that might require dramatic adjustment in either the exchange rate(devaluation)or price level (interest rates).

Debt Issues. IMF arrangements historically (e.g. the 1980s Latin American debt crisis and 1994 Mexican pesodevaluation) have kept private lenders and investors from realizing their full losses and having to implement debtrestructuring on their own. Sovereign borrower and lender conflicts should be worked out by the participantswithoutresorting automatically to IMF assistance. In the case of the so-defined Heavily Indebted Poor Countries (HIPCs),however, all IMF (and other) debt should be written off because of their inability to repay "under any foreseeablefuturedevelopments." Debt relief would be contingent upon debtor countries implementing broad reforms and adoptingan"effective" development strategy. (8)

IMF Finance and Accounting Reforms. The Fund's accounting system should be simplified and rationalized to improvetransparency and better approximate standard accounting procedures that reflect assets and liabilities in meaningfulways(such as distinguishing between the usefulness of various currency holdings.) In concert with the proposed reducedrole ofthe IMF, no further quota increases should be considered in the foreseeable future.

Meltzer Commission Dissenting Opinions

Four members of the Meltzer Commission dissented from the report and three formally voted against it,although they wereagreed on the need for IMF reform. They supported the report's call to differentiate clearly the responsibilities ofthe IMFand development banks and its conclusions that stronger banking systems in developing countries are imperative,thatgreater transparency mitigates abuse by all parties, and that the poorest countries need debt forgiveness and grantsfromindustrial countries to help cover basic public goods. The dissenting opinion disagrees, however, with the detailson how toachieve these goals.

Dissenting commissioners had varied opinions, but the collective dissenting statement challenges the report on its analysis,interpretation, and recommendations regarding the role of the IMF in the international economy. The dissenterssuggestthat the report's analysis mischaracterizes the effects of international financial institutions over the past five decades. Theycontend that the international economy, despite periods of volatility, has performed well since World War II andcountrieswith severe financial problems have all been helped by IMF assistance. These include most of those that facedcrises in the1990s (Indonesia and Russia being the exceptions), which have since "experienced rapid V-shaped recoveries."

The dissenters also point out that while the report criticizes the international financial institutions for underminingdemocracy by dictating policies that should be domestically determined, the past decade has witnessed anunprecedentedtransition to democracy in much of the world. The dissenting commissioners argue that the Commissionrecommendations,if implemented, might actually worsen rather than improve the prospect for global financial stability and therebypotentiallyundermine the fight against poverty and underdevelopment. They also maintain that the recommendations are notwellsupported by evidence in the report.

Promoting Financial Instability. Dissenters argue that the report's key recommendation that the IMF restrict itsoperations only to countries that prequalify for assistance based on reforming their financial systemsand do so without IMFauthority to impose policy conditions is a flawed strategy because: a) the authority to impose policy changes isnecessary toencourage macroeconomic corrections, such as insisting huge fiscal deficits be reduced; otherwise, IMF assistancemightfuel rather than fight the crisis; and b) those countries that would not or could not meet IMF standards would be atevengreater risk of turmoil if a financial problem arose. To the extent that this might include large developing countries,theinternational economy may be at greater risk of systemic financial upheaval.

Dissenters found fault with five of the reports key "lines of analysis." These are listed below, with the dissenters responsefollowing in parentheses:

the main problem is moral hazard, (for which dissenters claim there is little empirical evidence);

"penalty" rates will deter excessive borrowing (dissenters assert that borrowing will not be tempered by higher costs during a liquidity crisis);

the IMF fails to require banking reform in crisis countries (when it actually does);

literature on the effectiveness of IMF "conditionality" has been represented as negative (when actually it is more balanced); and

there is no discussion of what would happen in the absence of IMF assistance (which some argue could lead to worse outcomes).

Undercutting the Fight Against Poverty. The dissenting opinion argued against the report's recommendation toterminate long-term poverty lending at the IMF as it could militate against poverty reduction efforts, as wouldrelying onlyon appropriations from rich countries to fund assistance to poor countries. The IMF's Poverty Reduction andGrowthFacility (PRGF) is represented as helping millions of the world's poorest people and worthy of continued support. Further,the report's recommendation that advanced developing countries rely only on private capital markets for externalfinancecould hurt them during times of financial market volatility or panic.

Unsubstantiated Proposals. Dissenters also criticized the lack of detailed evidence in support of pursuing many of theCommissions' proposals, suggesting that without more thorough documentation, the report presents opinion as muchasreasoned analysis. Other questions were raised regarding the wisdom of: 1) precluding the IMF from assistinghigh-incomecountries; 2) requiring countries to adopt only selected exchange rate systems; 3) insisting on separate new rulesor ideasfor developing country banking systems when the Basel Core Principles have been agreed to and serve the samepurpose.

Dissenters also argued that the report failed to address some key issues, such as: 1) advocating for a better "early warning"system to respond in an anticipatory manner to future financial crises; 2) outlining an adequate role for private sectorburden sharing in times of financial trouble; and 3) giving more attention to detailed exchange rate options.

U.S. Treasury Response

Responding to the Meltzer Commissions recommendations, the U.S. Treasury issued a formal report supportingthe overallmission and effectiveness of the international financial institutions, acknowledging the need for reform, butdisagreeingwith "the bulk of the Commission's reform prescriptions." (9) The Treasury report expresses the need to evaluate IMFreform in the context of how it can be done best to ensure that global economic challenges are met that are "criticalto U.S.interests." This perspective is decidedly different from others regarding how to assess benefits and direction of IMFreform. Although the U.S. Treasury makes its own detailed recommendations, they would not result in anysignificantchanges from the way the IMF operates today based on continuing reform efforts largely designed with U.S.influence.

Treasury is sympathetic to the call for developing countries to improve their financial sectors, to become more transparentin reporting financial and economic data, to adopt exchange rate regimes and the related policies that lend credibilityandstability to their economies, and to improve market incentives and avoid undue use of the IMF. Treasury disagreeswith theMeltzer Commission's strategy for achieving these goals. Treasury's central concern is that the recommendationswouldnot allow the IMF to respond to future financial crises adequately, perhaps deepening and protracting their effectsabroadand in the United States, as stated in its summary of the Meltzer Commission report:

The majority report outlines a set of recommendations for reform of the IMF that would fundamentally change the nature ofthe institution. The main objective of the commission's proposals is to limit IMF lending to very short-term,essentiallyunconditional liquidity support for a limited number of relatively strong emerging market economies that wouldprequalifyfor IMF assistance. (10)

The Treasury finds fault with this approach suggesting that: 1) it would potentially restrict the IMF from responding tofinancial emergencies in many large countries that did not prequalify, including the weaker countries that needassistancemost, perhaps aggravating broader systemic problems; 2) prequalification criteria are too narrow, focusing onfinancialsector issues, which alone are not sufficient to "significantly reduce" risk of crisis; 3) prequalified lending couldincreaserather than decrease moral hazard if countries targeted policy reform for the express purpose of meeting only IMFguidelines; 4) eliminating conditions for lending would reduce leverage for policy change, as well as increase thepossibility of financial assistance being misused; 5) very short loan maturities and excessive interest penalties wouldforcerepayment prematurely at excessive cost, worsening borrowing countries already tenuous financial position; and6)eliminating poverty assistance lending would remove IMF and its macroeconomic expertise from the developmentadjustment process involving the international financial institutions.

While recognizing a mutuality of concern between the Treasury's perspective and that of the Meltzer Commission, and thatsignificant progress has been made in reforming the IMF, Treasury proposes a different agenda for altering IMFpolicies toimprove its responses to financial emergencies. The general thrust of these recommendations is in line with manyothers,but differs in detail. There are five major categories of improvement suggested:

1) Improve information flow from governments to markets, not just the IMF "club of nations." Treasury emphasizesimportance of IMF's new Special Data Dissemination Standard (SDDS), with some modifications;

2) Give more attention to financial vulnerabilities, with IMF surveillance emphasizing key liquidity indicators (e.g. debtmanagement guidelines) and identifying unsustainable exchange rate regimes;

3) Use IMF financing facilities more strategically, focusing on crisis prevention and emergency situations in emergingeconomies. Treasury calls for adjusting the Contingent Credit Line (CCL), using a graduated scale of lending ratesbasedon size of the draw to discourage excessively large or extended lending arrangements. It is presented as the bestanticipatory response to crises that would serve better than the narrow prequalification scheme advocated by theMeltzerCommission. The Supplemental Reserve Facility (SRF), which provides IMF financing at higher rates than normalstand-by arrangements, is a successful tool for higher loan pricing and so would encourage early repayment andjudiciousborrowing (Brazil being the most recent case). Treasury would not remove the PRGF from IMF managementbelieving ithas a role to play in helping countries enact necessary macroeconomic adjustment policies in addition todevelopment bankexpertise in other critical policy areas.

4) Emphasize market-based solutions to crises to lessen moral hazard and facilitate return of crisis countries to "normalmarket access." It believes the call for 100% debt relief of HIPC countries is too high to be financed by the IFIs anddeveloped countries. In addition, it would increase potential for moral hazard. The idea behind the HIPC initiativeis toreduce the debt burden of very poor countries to levels of other developing countries. Full debt relief mightencourageincreased indebtedness to qualify as a HIPC country. In addition, funds forgiven are not available for re-lendingto othercountries in need of borrowing, especially from concessional facilities at the World Bank and IMF.

5) Modernize the IMF by establishing a permanent independent evaluation office and create a liaison group of privatefinancial market participants to improve its understanding of global market trends. Other recommendations counterto theMeltzer Commission included leaving future quota increase decisions to the long-established quota review process,requiring all countries to continue undergoing Article IV consultations (to emphasize the "universal nature ofFund"), andsuggesting that the IMF already has priority for repayment among public and private creditor institutions.

Council on Foreign Relations Report

In a separately issued study prior to release of the Meltzer Commission report, the Council on Foreign Relationspresentedthe recommendations of another panel of experts on the global financial system. (11) In agreement that many of the keyproblems identified by the Meltzer Commission exist, this report, the "broad thrust" of which was supported by all29members, takes a complementary overall approach to resolving these concerns. Believing that markets provide theclearestsignals of problems in the international financial system, the Council on Foreign Relations report recommends thatamarket-based approach guide reform efforts in borrowing countries. The "broad thrust," therefore, is to "place theprimaryresponsibility for crisis avoidance and resolution in emerging economies back where it belongs: on emergingeconomiesthemselves and their private creditors, which dominate today's international capital markets." (12)

The Council report also agrees with the Meltzer Commission on some broad policy directions including: 1) strengtheningcrisis prevention management; 2) discouraging pegged exchange rates, to the point of having the IMF refuseassistance tocountries with "unsustainable" pegs; 3) refocusing the IMF toward monetary and financial policies and away fromstructural reform and development needs, which are better handled by the World Bank; 4) enhancing IMFoperationaltransparency, including expanded use of its Special Data Dissemination Standard (SDDS); and 5) ensuring thatindividualcountries take political responsibility for their economic and financial policies and actions. It goes one step furtherincalling for using transparent and nondiscriminatory tax measures as a way to control short-term capital movements,whichare viewed as a potential leading factor of financial instability.

The Council report differs from the Commission, however, on how to accomplish specific market-based reform of IMFoperations. First, rather than force countries into a narrowly defined reform structure, the lack of which wouldprohibitreceiving IMF assistance, the Council on Foreign Relations report advocates an incentive system to encourage "goodhousekeeping" ranging from insisting on sound policy decisions such as fiscal responsibility, prudent debtmanagement,and avoidance of overvalued exchange rates, to making deeper structural changes, such as financial sector reform,withparticular attention to developing bank deposit insurance systems. This could be accomplished, the reportconcludes, bylending on more favorable terms to countries that meet these goals rather than forsaking noncomplying countriesalltogether, as recommended by the Meltzer Commission.

Second, IMF assistance should not be used simply to bail out private sector lending and investment. To promote privatesector burden sharing (address the moral hazard issue), borrowing countries should use "collective action clauses"in bondcontracts, for example, to ensure that all parties, public and private, are compensated on the same terms and holdoutscannot impede attempts at orderly debt rescheduling when widely accepted as the appropriate course of action. Where debtrescheduling is considered necessary, the IMF should lend only if "good faith" discussions on rescheduling are beingpursued with private lenders.

Third, the Council report also recommends that the IMF not pursue large bailouts by limiting credit to levels defined inexisting Fund guidelines. (13) Combined withcharging higher rates of interest for riskier loans, limiting lending will reducethe risk of moral hazard. In addition, when a financial crisis threatens the international financial system, the Councilrecommends the IMF use its credit lines (the GAB and NAB) for when countries are largely responsible for theirownproblems. If a country's financial problems are deemed largely externally driven, a separate special "contagionfacility"should be used in place of the CCL and SRF to respond to the threat of systemic crisis. These provisions differsignificantly from the Meltzer Commission's narrower view that only very short-term liquidity lending is neededif reformefforts are embraced. The Council on Foreign Relations anticipates that future speculative financial crises mayrequiredeeper, longer-term assistance, but not to the extent that has been offered in the 1990s.

Reform Proposals Compared

Reducing the number and severity of financial crises is a universally desired goal, but determining how best toaccomplishthis task and defining the IMF's role in this process is a hotly disputed matter. A broad range of solutions are beingproposed to improve IMF operations within the context of a changing and frequently volatile international economy(see appendix 1 for a side-by-side comparison). Most observers support some type of IMF reformincluding clarifying itsmission relative to the development banks, reconsidering how it can emphasize prevention and greater private sectorparticipation in negotiating more orderly workouts of financial crises, and determining how the Fund can best serveas acatalyst for financial reform in developing countries.

There is also broad agreement that the IMF should operate as a monetary institution focusing on fiscal, exchange rate, andmonetary policies and leave long-term structural reform to the development banks. Less agreement exists on thedisposition of the Poverty Reduction and Growth Facility (PRGF). The Meltzer Commission would close it, thedissentersresist this idea, the U.S. Treasury actively supports its continuation, and the Council on Foreign Relations makesnospecific recommendation. Operational changes at the IMF that are widely embraced include promoting greatertransparency in virtually all aspects of information gathering and dissemination including adopting a standardizedpresentation of accounting and financial data to improve market decision-making ahead of potential crises.

Beyond these general considerations, there is much disagreement over specific courses of action. The Meltzer Commissionargues that having the IMF "bailout" countries experiencing large financial crises is a losing proposition. It hasneither thefinancial resources nor the clout to avert a currency run once begun, nor has its conditionality requirements beeneffectivein bringing about the structural reforms in countries that many argue are needed to help avert future crises. Theassuranceof IMF lending further exacerbates the problem by encouraging moral hazard, considered the single most criticalproblemthat can be solved in the public policy process. Its fundamental stand hinges on the belief that reform must precede(if notbe held hostage to) IMF assistance, otherwise the cycle of excessive lending and sudden withdrawal of capital willnot bebroken.

The Meltzer Commission believes the IMF should return to short-term liquidity lending, where financial assistance can bedisbursed quickly, unencumbered by extensive conditionality requirements. This is why it strongly advocatescountriesmeeting preconditions for IMF eligibility. If reform has already proceeded to a certain level, conditionality of IMFassistance is unnecessary. In cases where countries either cannot or will not comply with IMF preconditions, theywilleventually be subjected to the unfettered actions of the international capital markets. Experience would instructpolicymakers as to which produces the least desirable outcome. As such, the IMF would have a much reduced mission,eliminating all long-term assistance, particularly for development purposes, and focus on very short (four months),butquickly disbursed lending arrangements at "penalty rates."

The Meltzer Commission dissenters agree with the need for structural reform of developing country financial sectors, thepreference for short-term IMF lending, greater transparency, and the need for debt forgiveness for the poorestcountries. They argue, however, that the role of moral hazard is overplayed and that IMF conditionality can reduce themagnitude of acrisis and is necessary to enforce reform efforts. In this light, dissenters question the specific recommendations oftheMeltzer Commission report, particularly the strong stands on prequalifying for assistance, reducing IMF policyleverage byeliminating conditionality, and lending at very short maturities at above market (penalty) rates, which wouldpotentiallyeliminate assistance to some large countries, "increasing the risk of global economic disorder."

These reservations have been reiterated by both the U.S. Treasury and the Council on Foreign Relations. The Councilreport argues that developing countries should adopt sound economic policies, but rather than make them aprequalifyingcondition for IMF assistance, a graduated lending rate scale should be used to encourage reform. The Council alsosupportsthe use of some type of capital control to discourage over-reliance on short-term investment capital, which is thefirst toleave if economic conditions deteriorate, hastening financial crises. Avoiding large bailouts is possible by adheringto theIMF-imposed lending limits already in existence and by relying more on market discipline to bring in greater privatesectorburden sharing, while restraining IMF assistance if there is no good prospect for resolving a country's balance ofpaymentsproblem.

The U.S. Treasury argues that changes are needed in the IMF to meet new challenges of the global economy, but that theIMF is in the process of addressing many of the concerns that have been raised by the Meltzer Commission. Treasuryasserts that the Commission's specific recommendations, taken together, would deter the IMF from doing its job,whichwould not further U.S. interests. It argues that reform of the financial sector and other areas is critical, but thatmaking itpart of preconditions for IMF eligibility would likely deepen and prolong financial crises for countries not assisted. In itsview, other avenues for encouraging reform are available and IMF conditionality has been a necessary part of theprocess. Limiting loan maturities to four months, when, for the average crisis, it has taken a minimum of eight months torestoreconfidence in the private capital markets, indicates that the Meltzer Commission suggestion is too restrictive. Treasury alsoargues that the Poverty Reduction and Growth Facility (PRGF) has a constructive role to play in assisting thedevelopmentbanks by offering IMF macroeconomic expertise.

The U.S. Treasury presents the IMF's ongoing reform efforts as essentially meeting most of the concerns raised by theMeltzer Commission report. Specifically it points to: 1) transparency goals being met by the increasing number ofIMFdocuments released to the public; (14) 2) crisisprevention improving by the ongoing implementation of the IMF's SpecialData Dissemination Standard (SDDS) and adoption of the "preventative" Contingent Credit Line (CCL); 3)emphasis onimproving country financial standards to Basel Core Principles; 4) enhanced government oversight of IMF resourceuse andother anti-corruption guidelines; and 5) continuing review of IMF operations in light of ongoing criticism.

These specific Treasury recommendations reflect the IMF's perspective rather closely and although the Fund has notaddressed specifically the Meltzer Commission suggestions, it has continued to respond to the internationalcommunity'scritique of its operations. The IMF has acknowledged the need to improve core areas of concern raised by thevariousreports, including: transparency, accountability, unified reporting standards, domestic financial systems, crisispreventionearly warning methods, clearly defined private sector involvement, and internally consistent macroeconomic andexchangerate policies. It has responded with a detailed Code of Good Practices on Transparency in Monetary andFinancialPolicies , which incorporates guides such as the Special Data Dissemination Standard. The current IMFManaging Directorviews this as a "work in progress," however, entailing adapting the Fund to the changing world economy rather thanremaking it from scratch and has not suggested reducing any of its current programs. (15)

Balancing Perspectives

Clearly, there are differences of opinion regarding the best path to achieve IMF reform despite a generalagreement that itshould happen. There are also differences in how to bring about reform of developing country financial systems,despiteuniversal agreement that some level of minimally acceptable standards are needed and that the IMF is unlikely tobesuccessful at managing this on its own. The overall question may become not whether the IMF should exist, buthow it canbest support international financial stability along with a host of other official and private sector organizations.

In considering the merits of these reports, (16) much can be learned from a historical analysis of financial crises. Mostretrospective discussions of the IMF begin with its creation at Bretton Woods in 1944. Financial crises, both in theUnitedStates and abroad, however, have a much longer history. One study points to the lessons from past financial crises,comparing the troubled nineteenth and early twentieth century period with the1990s. The author documents howtheUnited States endured a financial crisis on average every eight years before making sweeping changes to its financialoperations, such as creating the Federal Reserve System in 1913. Further serious banking reform was delayed untilafterthe Great Depression hit. This experience points to the difficulty in making such deep structural reform that manydeveloping countries now face, which they often resist, as did the United States a century ago, and the apparentseriouslevel of motivation, both politically and economically, needed to spur such change. (17)

Three insights emerge from this study. First, financial sector reform is not needed for capital to return to a country that hasundergone some type of financial crisis. Financial capital, for various reasons, has repeatedly found its way backtotroubled countries, including the United States in the nineteenth century, despite numerous setbacks. The need forfinancialsector reform, however, may be more compelling because of this trend; that is, financial sector reform is necessarynotbecause capital will fail to return to crisis countries, but precisely because it will return and hence be a disincentiveforreform, setting the stage for the next crisis. (18) Thissupports the universal call for financial sector reform, but notnecessarily the Meltzer Commission's implication that market discipline can force it.

Second, the IMF is not the cause of financial crises. Crises were a part of the financial landscape long before BrettonWoods, when capital moved relatively freely among countries and in similar volumes relative to the size ofeconomies atthe time, and continued through history regardless of the international monetary system in place. Whether the IMFhasbeen an agent aggravating financial crises is less clear, but this research suggests that solutions, such as closing theIMF,would appear to have little effect on deterring future financial crises in and of themselves. (19) There is some evidence thatinternational "bailouts" may have some effect on hastening recovery in financially troubled countries, which canbe thoughtof as a "benefit" to counter the "cost" of moral hazard. (20) Still, there is broad preference to find a better, more orderly, wayto manage crisis situations.

Third, in comparing the exchange rate problems of the 1990s with those of a century earlier (the gold standard), it hasbecome clear that there are solid benefits associated with firmly fixed exchange rates. Such fixing, however,requires acommitment to policies that will support the exchange rate. In today's world of pegged exchange rates with less thancredible promises given the proclivity of governments to reverse policy when international pressures mount, itappearsthere is little reason to believe that any of various alternatives to floating exchange rates or some extreme form offix(dollarization) is possible. This is in keeping with most current exchange rate analyses.

In light of these insights, if there is a central conclusion that can be gleaned from the varied approaches to IMF reformdiscussed in this report, it may be that it is too much to ask the Fund to tame an international financial system wherecapitalmoves freely and speculatively, capable of causing severe macroeconomic problems. The Council on ForeignRelationsidea that limited capital controls be reconsidered, for example, may garner broader support in this context. This isnot todeny the benefits of increased oversight of the IMF, of continuing to emphasize adopting changes already in progressat theIMF, or of more stringent Fund advocacy for improving borrowing country policies. It may suggest, however, thatbecausemany players with far more resources and clout than the IMF are involved (governments and financial institutions),thatreform of more than the IMF may be needed to improve the prospect for greater stability to the internationalfinancialsystem.

In particular, there is a growing body of literature seeking to find a middle path between continuing large IMF bailouts andleaving financially troubled countries to be disciplined by panicked capital markets, both of which frequently resultinturmoil. One thrust argues for changing lending rules to include specific contractual obligations that requirecreditors topursue a collective orderly debt workout if a crisis hits. This might diminish the frequency of future crises byincorporatinga more appropriate level of risk into lending arrangements and thereby reducing the amount of capital flowing intodeveloping countries. It could also lessen the depth of crises by reducing the amount of capital that could leave thecountryat the IMF's expense. The IMF could serve as an active proponent of this approach through its consultation andconditionality efforts, as well as, by lending into arrears as a support mechanism for keeping all parties to the debtrenegotiation table. (21)

It appears that oversight actions by the U.S. Congress and institutions representing the international community have beencritical in fostering the many changes that are taking place within the IMF. Congress has its most leverage,however, whenconsidering appropriations legislation involving IMF funding increases. Since the quota review occurs only onceevery fiveyears and does not always result in a recommendation for an increase, in the interim, Congress must rely on thepublicforum and exerting policy pressure through U.S. representation at the IMF as its primary options for making itsvoice heard. Continued oversight surely will be necessary to keep the reform process moving, but more time may be needed tosort outprecisely which policy options will suit the collective, but competing needs of the IMF member countries and otherconstituents of the global economy.

Appendix 1. Selected IMF Reform Proposals