Monetary Structure: IMF and World Bank

Seminar Questions

• Discuss whether SDRs or another global currency (cryptocurrency) created by the IMF should replace the U.S. dollar as the international reserve currency.

• Describe the main criticisms of the IMF and the World Bank and their future opportunities.

Learning Objectives

• Understand the history and purpose of the IMF.

• Describe the IMF's current role, major challenges, and opportunities.

• Understand the history and purpose of the World Bank.

• Describe the World Bank's current role, major challenges, and opportunities.

International Monetary System

• 1930s: The Great Depression

  • Failing economies led to increased trade barriers.

  • Countries devalued currencies to compete for export markets.

  • Usage of foreign exchange was curtailed, leading to:

    • Declining world trade.

    • High unemployment.

    • Plummeting living standards.

• 1944: Bretton Woods Agreement

  • Established a new international monetary system.

  • Created the International Monetary Fund (IMF) and the World Bank.

• The World Bank and the IMF are intergovernmental pillars supporting the world's economic and financial order.

• Both institutions have expanding roles due to the absence of a single global monetary agreement.

IMF vs. World Bank: Similarities

• Owned and directed by member nation governments.

• Almost every country is a member of both.

• Concerned with economic issues.

• Focus on broadening and strengthening member nation economies.

• Hold joint annual meetings.

• Headquartered in Washington, D.C.

• Share joint task forces, sessions, and research efforts.

IMF vs. World Bank: Differences

• World Bank: Primarily a development institution.

• IMF: A cooperative institution that maintains an orderly system of payments and receipts between nations.

• Differences include:

  • Purpose.

  • Structure.

  • Funding sources.

  • Categories of members assisted.

  • Goals.

  • Methods.

International Monetary Fund (IMF): History and Purpose

• Visionaries: John Maynard Keynes and Harry Dexter White.

• Objective: Oversee the international monetary system, exchange rates, and international payments to enable countries to buy goods and services from each other.

• Ensure exchange rate stability.

• Encourage member countries to eliminate exchange restrictions hindering trade.

• Establishment: Officially came into existence in December 1945 with 29 original member countries.

• First Borrower: France in 1947.

• Membership Expansion:

  • Increased over the next 30 years, including African countries in the late 1960s.

  • Soviet bloc nations did not join until the fall of the Berlin Wall in 1989.

  • Russia joined in the 1990s and was placed on the IMF's executive committee.

• Current Status: 187 member countries, with 24 represented on the executive board.

Purposes of the IMF

• Promote international monetary cooperation through a permanent institution.

• Facilitate the expansion and balanced growth of international trade.

• Contribute to the promotion and maintenance of high levels of employment and real income.

• Promote exchange stability and maintain orderly exchange arrangements.

• Assist in the establishment of a multilateral system of payments and the elimination of foreign exchange restrictions.

• Give confidence to members by making the general resources of the fund temporarily available to them under adequate safeguards.

• Shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members.

Key Terms

• Special Drawing Rights (SDRs)

• Triffin Paradox

Special Drawing Rights (SDRs)

• International monetary reserve asset created in 1969 by the IMF in response to the Triffin Paradox.

Triffin Paradox

• The more U.S. dollars used as a base reserve currency, the less faith countries had in the U.S. government's ability to convert these dollars to gold.

• The initial expectation was that SDRs would replace the U.S. dollar as the global monetary reserve currency.

• The Bretton Woods system collapsed a few years later, but the concept of an SDR solidified.

• Today, the value of an SDR consists of the value of four of the IMF's biggest members' currencies: U.S. dollar, British pound, Japanese yen, and European Union's euro.

• The currencies do not hold equal weight.

• SDRs are quoted in terms of U.S. dollars.

• The basket of currencies is reviewed every five years by the IMF executive board based on the currency's role in international trade and finance.

• Current weights:

  • U.S. dollar: 44%

  • Euro: 34%

  • Yen: 11%

  • British pound: 11%

• The SDR is not a currency but a form of IMF currency.

• It does not constitute a claim on the IMF, which only serves to provide a mechanism for buying, selling, and exchanging SDRs.

• Countries are allocated SDRs, which are included in the member countries' reserves.

• SDRs can be exchanged between countries along with currencies.

• The SDR serves as the unit of account of the IMF and some other international organizations.

• Countries borrow from the IMF in SDRs in times of economic need.

Governance of the IMF

• Accountable to its member countries.

• Board of Governors: One governor from each member country, meets once a year.

• Executive Board: Guides day-to-day affairs, made up of 24 executive directors.

• Managing Director: Chairman of the executive board.

Membership in the IMF

• Membership is open to other countries as prescribed by the board of governors.

• Terms are based on principles consistent with those applied to existing members.

• Membership is not conditional on membership in any other organization.

• New members should not have permanent rights that differ from those of original members.

• Open to any applicant who is a country within the attributes of statehood defined by international law.

• Must be willing and able to perform the obligations of membership and accept the terms of the membership resolution.

• Domestic legislation is not a valid defense for not observing membership obligations.

• Members can request an interpretation of the articles of agreement.

• Members can voluntarily withdraw with written notice.

• Withdrawal can also be compulsory for failure to fulfill obligations, including suspension of voting rights and a decision by the board of governors with 85% majority.

• Statements are made between the fund and the member upon withdrawal.

IMF Organization Chart

• International Monetary and Finance Committee

• Board of Governors

• Joint IMF World Bank Development Committee

• Executive Board

• Independent Evaluation Office

• Managing Director and Deputy Managing Directors

Board of Governors

• Highest policy-making body of the IMF.

• All powers not conferred directly on the board of governors or the managing director are vested in the board of governors.

• They may delegate powers to the executive board except those directly conferred to them.

• One governor and one alternate governor are appointed by each member.

• Usually finance ministers or heads of central banks.

• Weighted voting based on the number of votes allotted to the member.

• Governors elect one of the governors as chairman.

• Meets once a year at annual meetings.

• May establish committees such as the International Monetary Finance Committee or the Joint World Bank IMF Development Committee.

Executive Board

• Responsible for conducting the business of the IMF and exercising powers delegated by the board of governors.

• Sits in continuous session, meeting as often as required.

• 24 executive directors with the managing director as the chairman.

• Five are appointed by the five members with the largest quotas.

• 19 are elected by the other members.

• Elected directors serve two-year terms.

• The board of governors may increase or decrease the number of executive directors in the second category by an 85% majority.

• Each director appoints an alternate.

• Weighted voting structure where each executive director casts the number of votes allotted to the members they represent.

• Most decisions require a simple majority, but some require 70% or 85% of the total voting power.

• Voting is rare; most decisions are taken by consensus.

Managing Director, Staff, and Independent Evaluation Office

• The managing director is the chairman of the executive board and the chief of the operating staff.

• Selected by the executive board and cannot be selected from among the governors or the executive directors.

• Serves a five-year term but can be fired by the executive board.

• Conducts the ordinary business of the IMF under the direction of the executive board.

• Responsible for the organization, appointment, and dismissal of staff.

• The staff of the IMF are considered international civil servants.

• The Independent Evaluation Office (IEO) conducts objective and independent evaluations on issues relevant to the fund's mandate.

IMF Resources

• The IMF's capital base consists of membership quotas.

• Total quotas amount to about 310,000,000,000.

• Members' quotas are determined by their economic weight in the global economy.

• The member's quota determines its voting power and the size of the loan the country can borrow.

Financial Structure

• Sources of Funding:

  • Members' quota subscriptions (currently about 305,000,000,000).

  • Borrowing to supplement resources available from quotas according to agreements.

  • Income from investments.

• Members' Quotas:

  • Each member is assigned a quota determined by its economic position relative to other members.

  • Economic considerations include the member's GDP, current account transactions, and official reserves.

  • Determines a member's maximum financial commitment, voting power, access to financial resources, and share in any allocation of SDRs.

  • Reviewed every five years to determine if adjustments are needed.

  • Members must pay a subscription equal to their quotas.

  • Up to 25% must be paid in reserve assets specified by the IMF.

  • The balance may be paid in the members' currency.

• Voting Power:

  • Each member has 250 basic votes, plus one vote per 100,000 SDRs of quota.

  • The significance of basic votes has diminished due to quota increases.

  • A member's quota cannot be changed without its consent.

  • If a member consents to a reduction, the fund shall pay the member an amount equal to the reduction within sixty days.

Criticism and Challenging Areas for the IMF

• The IMF supports many developing nations by helping them overcome monetary challenges and maintain a stable international financial system.

• Despite its defined purpose, the execution can be complicated and have wide repercussions.

• The IMF has both critics and supporters.

• Challenges center on operating efficiencies and the global political environment.

• The IMF has been subject to criticisms focused on the conditions of its loans, lack of accountability, and willingness to lend to countries with bad human rights records.

• Conditions for Loans:

  • Loans are conditional on implementing certain economic policies.

  • Typically include reducing government borrowing, higher interest rates, allowing failing firms to go bankrupt, and structural adjustment.

  • Austere policies have worked at times but can extract a political toll.

  • Some suggest loan conditions are based on the Washington consensus.

  • Conditionalities may result in the loss of the state's authority to govern its own economy.

• Exchange Rate Reforms:

  • When the IMF intervened in Kenya, it made the central bank remove controls on flows of capital.

  • Critics argue that this made it easier for corrupt politicians to transfer money out of the economy.

• Free Market Criticisms:

  • Believers in free markets argue that it is better to let capital markets operate without intervention.

  • Attempts to influence exchange rates only make matters worse.

  • Bailing out countries with large debts is morally hazardous.

• Lack of Transparency and Involvement:

  • The IMF has been criticized for imposing policies with little or no consultation with affected countries.

• Supporting Military Dictatorships:

  • The IMF has been criticized for supporting authoritarianism and totalitarianism.

Opportunities and Future Outlook for the IMF

• The 2008 global economic crisis was one of the toughest situations since the Great Depression.

• The IMF was inundated with requests for financial and policy support.

• The IMF's lending capacity tripled to around 750,000,000,000.

• To use these funds effectively, the IMF overhauled its lending policies.

• It created a flexible credit line for countries with strong economic fundamentals and performance.

• These factors enabled the IMF to disperse very large sums quickly.

• The IMF has played a role in helping countries avert widespread financial disasters.

• Flexibility and speed were increased, as with the flexible credit line (FCL).

• Additionally, new IMF requirements are aimed at reassurance rather than reform.

• The fund is positioning itself to be less of an adversary and more of a cheerleader to member countries.

• Adaptability with new loan facilities providing short-term resources to reassure investors.

• The IMF has made efforts to improve its own transparency and continues to encourage its member countries to do the same.

• Some call for replacing the U.S. dollar as the international reserve currency with a new global system controlled by the IMF.

• This would require extraordinary political vision and courage.

• China is politically and economically motivated to recommend an alternative reserve currency.
  * Expanding the role of special drawing rights were introduced by the IMF in 1969 to support the Bretton Woods fixed exchange rate regime but became less relevant once that collapsed in the nineteen seventies.

Key Takeaways for the IMF

• The IMF is playing an expanding role in the global monetary system.

• Key Roles:

  • Promote international monetary cooperation.

  • Facilitate the expansion and balanced growth of international trade.

  • Promote exchange stability.

  • Assist in establishing a multilateral system of payments.

  • Give confidence to members by making resources temporarily available.

  • Shorten the duration of disequilibrium in international balances of payments.

The World Bank

• Came into existence in 1944 at the Bretton Woods Conference.

• Formally known as the International Bank for Reconstruction and Development (IBRD).

• Its primary purpose is financing economic development.

• First loans were extended to finance the reconstruction of war-ravaged economies of Western Europe.

• Later, it turned its attention to assisting the world's poorer nations.

• The World Bank has one central purpose: to promote economic and social progress in developing countries.

• It helped raise productivity so that their people may live a better and fuller life.

• The World Bank provided 46,900,000,000 for 303 projects in developing countries worldwide.

• Aims to help those countries reduce poverty.

• Currently involved in more than 1,800 projects in virtually every sector and every developing country.

World Bank Group

• The World Bank consists of two main bodies:

  • International Bank for Reconstruction and Development (IBRD).

  • International Development Association (IDA), established in 1960.

• The broader World Bank Group consists of five interrelated institutions:

  • IBRD.

  • IDA.

  • International Finance Corporation (IFC), established in 1956.

  • Multilateral Investment Guarantee Agency (MIGA), established in 1988.

  • International Center for Settlement of Investment Disputes (ICSID), established in 1966.

• The IDA typically provides interest-free loans to countries with sovereign guarantees.

• The IFC provides loans, equity, risk management tools, and structured finance.

• MIGA focuses on improving the foreign direct investment of developing countries.

• The ICSID provides a means for dispute resolution between governments and private investors.

Current Primary Focus of the World Bank

• Poorest countries: poverty reduction and sustainable growth, especially in Africa.

• Post-conflict and fragile states: solutions to special challenges.

• Middle-income countries: development solutions with customized services and financing.

• Global public goods: addressing regional and global issues.

• Arab world: greater development and opportunity.

• Knowledge and learning: leveraging the best global knowledge to support development.

• The World Bank provides low-interest loans, interest-free credits, and grants to developing countries.

• Loans are always with a government or sovereign guarantee of repayment.

• Directed to make loans for projects but never to fund a trade deficit.

• Loans must have a reasonable likelihood of being repaid.

• IDA loans (soft loans) are free of interest, offered for several decades, with a ten-year grace period.

• The IBRD generates funds through the international capital markets.

• Issues bonds typically about 25,000,000,000 a year.

• Bonds are rated triple-A, which is the highest possible rating.

• This enables borrowing at relatively low-interest rates.

• The World Bank charges a fee of about 1% to cover administrative overheads.

World Bank: Current Role and Major Challenges and Opportunities

• The criticisms extend from the challenges faced in the global operating environment.

• Those challenges result from conflict between nations and the global financial crisis.

• Even in 2020, over 3,000,000,000 people live on less than $2.50 a day.

• Almost a billion people cannot read or sign their names.

• Less than 1% of what the world spends each year on weapons would have put every child into school by the year 2018.

• Fragile states face severe development challenges.

Main Criticisms of the World Bank

• Administrative incompetence.

• Rewarding or supporting inefficient or corrupt countries.

• Focusing on large projects rather than smaller local initiatives.

• Negative influence on monetary theory and practice.

• The job dominance of the G7 countries.

• Increasingly scrutinized, with critics asserting the World Bank has shifted from being a lender of last resort to an international welfare organization, resulting in an institution that is bloated, incompetent, and even corrupt.

• Lax lending standards have led to a rapidly deteriorating loan portfolio.

• The bank's lending policies often reward macroeconomic inefficiency in the underdeveloped world.

• The Pacific Tigers have been able to lift themselves out of poverty and into wealth with very little help from the World Bank.

• Many countries in Africa, however, have relied primarily on multilateral assistance from organizations like the World Bank while avoiding fundamental macroeconomic reforms with deplorable but sadly predictable results.

• The World Bank has lent more than 350,000,000,000 over half a century.

• The critics claim that the World Bank loans give preference to large infrastructure projects over projects that would benefit the poor.

• Large projects become targets for corruption by local government officials.

• The World Bank plays a large role in research training and policy formulation.

• Decisions are typically made and policies implemented by leading countries, the G7, because they are the largest donors.

Opportunities for Potential Correctives in the World Bank

• The World Bank is praised by many for engaging in development projects in remote locations around the globe.

• Their praise comes as a result of their project which improve living standards and reduce poverty.

• The World Bank's focus is to help countries achieve the Millennium Development Goals (MDGs).

• The MDGs are eight international development goals established in February at the Millennium Summit.

• Focus on four key issues:

  • Increasing transparency.

  • Expanding social issues in the fight on poverty.

  • Examining improvements in the country's competitiveness and increasing exports.

  • Improving efficiency in diverse industries and leveraging the private sector.

• The World Bank has made progress in response to criticisms over the decades.

• More of the World Bank's decision-making and country assessments are publicly available.

• The World Bank has continued to work with countries to combat corruption at both the country and bank levels.

Key Takeaways from the World Bank Examination

• The World Bank consists of two main bodies: the International Bank for Reconstruction and Development and the International Development Association.

• The World Bank Group includes the following interrelated institutions:

  • IBRD.

  • IDA.

  • Multilateral Investment Guarantee Agency.

  • International Center for Settlement of Investment Disputes.