INTERNATIONAL ECONOMICS

International Economics

International Economics

Introduction

The need for an organisation like the IMF became evident during the Great Depression that ravaged the world economy in die 1930s. Most of people are familiar with that era through dramatic photographs of farms eroding away in duststorms and of lines of jobless men waiting to enter soup kitchens. The Depression was devastating to all forms of economic life.

Several international conferences convened during the 1930s to address world monetary problems ended in failure. Partial and tentative solutions were clearly inadequate. What was required was co-operation on a previously untried scale by all nations in establishing all innovative monetary system and an international institution to monitor it. Fortunately, a happy coincidence, two bold and original thinkers. Harry Dexter White in the United States and John Maynard Keynes in the United Kingdom put forward almost simultaneously in the early 1940s proposals for just such a system, to be supervised not by occasional international meetings but by a permanent co-operative organisation.

The system, reacting to the needs of the times, would encourage me unrestricted conversion of one currency into another, establish a clear and unequivocal value for each currency, and eliminate restrictions and practices, such as competitive devaluation, that had brought investment and trade to a virtual stand still during 1930s(Baldwin, 2007).

Major problems that countries face in developing a new international monetary system

Eligibility for IMF credit depends on a country's BOP--primarily the level or trend of its foreign currency reserves--and governments are primarily responsible for their BOP problems.14 A government can induce a fall in its currency reserves by maintaining an overvalued exchange rate or an excessive rate of money growth. Neither policy indicates an emergency situation, but each can prompt IMF assistance. An unpublished 2001 IMF study concludes that over expansionary fiscal and monetary policy is the primary cause of BOP problems in borrowing countries; exogenous factors are least important. Unsound domestic economic policies, not temporary external shocks, explain the persistent demand for IMF assistance(Bergstrand, 2005).

Furthermore, the fund's implicit guarantee of subsidised bailouts reduces the cost of fiscally irresponsible, yet politically rewarding, policies, which encourages even greater recklessness. Economists call this behavioural response moral hazard. In private insurance markets, moral hazard is constrained by deductibles. In private credit markets, moral hazard is constrained by market interest rates and loan conditions such as pledging adequate collateral. Neither interest rates nor loan conditions effectively constrain moral hazard in IMF financing programs(Hashemzadeh, 2007).

Government Moral Hazard: The Russian Experience

Moral hazard was evident in July 1998 when Russia promised to implement key economic policies in exchange for an $11.2 billion IMF loan commitment. Even though Russia had reneged on several previous agreements and IMF staff in Moscow advised against additional assistance, the executive board approved the loan. Less than one month after receiving the first instalment of $4.8 billion--which was wasted propping up the rubble long enough, in the words of one fund official, "to let the oligarchs get their money out of the country" the Yeltsin government abandoned its commitments, ...