IMF Surveillance

Author(s): Michael Mussa

Source: The American Economic Review , May, 1997, Vol. 87, No. 2, Papers and
Proceedings of the Hundred and Fourth Annual Meeting of the American Economic
Association (May, 1997), pp. 28-31
Published by: American Economic Association

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 IMF Surveillance

By MICHAEL MUSSA *

Surveillance, it is often said, is the Interna- and (iii) should avoid manipulating the inter-
tional Monetary Fund's most important re- national monetary system in order to prevent
sponsibility. But, what is IMF surveillance? effective balance-of-payments adjustment or
What does it seek to achieve? What does it to gain unfair competitive advantage.
actually accomplish, for good or ill? To carry out surveillance, the IMF conducts
Conceptually, the IMF 's responsibilities for annual "Article IV consultations" with each
surveillance derive from its original role as the member. Staff missions meet with key gov-
overseer of the Bretton Woods system of ernment officials to review economic perfor-
fixed-but-adjustable exchange-rate parities. mance and policies. These missions prepare
That system collapsed in the early 1970's. But, confidential reports for careful review by the
views of skeptics notwithstanding, the IMF IMF's 24-member Executive Board, which
has survived. Indeed, the membership has con-represents the general membership through a
sistently reaffirmed the value it sees in the IMFweighted voting system broadly based on the
by, among other things, periodically author- economic importance of members. (A sum-
izing substantial increases in the Fund's mary of key Board discussions is provided in
resources. the IMF Annual Reports.) The IMF staff also
In the function of surveillance, the IMF's prepares semi-annual reports on the World
responsibilities were substantially redefined Economic Outlook which are reviewed by the
by the second amendment of the Articles of Executive Board and form the basis for
Agreement in 1977. Specifically, Section 3 of ministerial-level discussions in the IMF's In-
Article.IV defines three important and related terim Committee. A variety of other staff
areas for Fund surveillance: (i) general over- reports, such as the annual reports on Inter-
sight of the international monetary system to national Capital Markets, are also part of the
ensure its effective functioning; (ii) oversight surveillance process. Confidential communi-
of the compliance of members with the obli- cations concerning surveillance issues occur
gations specified in Section 1 of Article IV; frequently between national authorities and
and (iii) firm surveillance over members' IMF management and staff, including in such
exchange-rate policies. In practice, the main forums as the G-7 and APEC.
focus of IMF surveillance has been on mem- In fulfilling its surveillance responsibilities,
bers' economic policies which, in turn, influ- the IMF faces two critical limitations. First, in
ence the international monetary system and the seeking to provide good policy advice, the
behavior of exchange rates. According to Sec- IMF is limited by the accumulated wisdom of
tion 1 of Article IV, members' economic and the economics profession, which is continually
financial policies which are subject to Fund advancing and being revised. The economics
surveillance (i) should endeavor to foster or- profession has not discovered the magic for-
derly economic growth with reasonable price mula that assures rapid and steady economic
stability, (ii) should seek to promote orderly growth, low inflation, financial stability, and
underlying economic and financial conditions social progress. However, based on experience
that do not tend to produce erratic disruptions, across many countries, a consensus has
emerged about the broad guidelines for poli-
cies that serve these goals.
Policies need to support an appropriate mac-
* International Monetary Fund, 700 19th St., N.W.,
roeconomic and microeconomic environment,
Washington, DC 20431. The opinions expressed in this
paper are my own and do not necessarily reflect the views
but achieving high rates of sustainable eco-
of the International Monetary Fund, its staff, its manage-nomic growth depends primarily on private-
ment, or its Executive Board. sector activities. Market-oriented economic
28

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VOL. 87 NO. 2 THE INTERNATIONAL MONETARY FUND 29

systems with high levels of competition are on the willingness and capacity of the political
generally more efficient in allocating resources system to pursue appropriate policies. In pure
to meet consumer needs and to support worth- surveillance cases, the IMF is practically lim-
while investment and growth. Openness to in- ited to giving policy advice which the member
ternational trade and investment and to is essentially free to adopt or ignore. The
transfers of information and technology is vital bright side is that if the IMF offers bad advice,
for economic progress. Exchange rates should it need not be followed, especially as alterna-
broadly reflect international competitiveness. tive advice is usually available from diverse
Policies resulting in rapid inflation are gener- sources. The downside is that even generally
ally injurious to economic performance. To good advice may bow before political exi-
maintain reasonable price stability and to gency and often does. Hopefully, things are
counteract unwarranted fluctuations in output getting better in both of these dimensions:
and employment, monetary policies typically Fund advice is improving, along with the gen-
need to respond to (and to anticipate) cyclical eral advance of economic knowledge; and the
developments. The public sector has an es- political effectiveness and acceptability of
sential role in fairly enforcing the rules of a good policies is growing as the benefits of such
competitive market system, in providing ap- policies are increasingly recognized.
propriate assistance to the vulnerable in soci- Given its inherent limitations, how well has
ety, in supporting investment in some key the IMF fulfilled its surveillance responsibili-
areas such as education and health and some ties? In my view, there have been successes
components of infrastructure, and in counter- and deficiencies.
vailing identifiable and significant market It is sometimes said that IMF stands for
failures. Public expenditure needs to be ade- "It's mainly fiscal." Undoubtedly, the IMF
quately financed by equitable and enforceable perceives that fiscal deficits are the root cause
taxes with broad bases and with the lowest fea- of economic difficulties of many of its mem-
sible tax rates. Fiscal deficits often have a de- bers, and it offers consistently vigorous advice
sirabl'e cyclical component reflecting the on the virtues of fiscal probity. In my view,
"automatic stabilizers"; but public-sector def- this is mainly right. As Paul Masson and I re-
icits and debt should be kept within reasonable cently argued at some length (see Masson and
limits lest they unduly mortgage future gen- Mussa, 1995) and as was extensively dis-
erations or contribute to economic and finan- cussed in the World Economic Outlook of May
cial instability. 1996, many countries do face an urgent need
While this consensus does not supply specific to reduce their fiscal deficits and levels of pub-
guidance for policies in particular circumstances, lic debt over the medium term. For most in-
it does provide the broad basis for IMF policy dustrial countries, this urgency is heightened
advice. Thus, leaving room for mistakes in in- by large invisible liabilities for public pensions
dividual instances, if the consensus is right, then and other entitlements, the burden of which
IMF surveillance is generally on a sound foot- will grow as populations age.
ing. If the established policy consensus is wrong The IMF, of course, has not been alone in
in important respects, then Fund advice likely focusing on fiscal problems and urging correc-
suffers from corresponding systematic error. In tive action. And, even if IMF advice did not
this connection, recall that it used to be widely always provide the critical impetus, it is grat-
believed that industrial investment supported by ifying that corrective action is being taken in
subsidies or direct government involvement a number of countries, notably the United
would launch the take-off into sustained States. In this regard, the IMF is beginning to
development, that import substitution was a emphasize "fiscal transparency" as a key for
pro-growth strategy, and that there was an ex- enhancing public understanding of, and polit-
ploitable long-run trade-off between higher in- ical support for, necessary but unpleasant cor-
flation and lower unemployment. rective measures. As Julius Ismael, an
Second, even for program countries seeking outstanding former Executive Director of the
IMF financial support, economic policies de- Fund has argued, "self-surveillance" is gen-
pend largely on the authorities' judgment and erally the most effective form of surveillance.

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 30 AEA PAPERS AND PROCEEDINGS MAY 1997

On the discretionary use of fiscal policy to term economic performance would have been
counter recessionary forces, the IMF has usu- enhanced by policies that generated higher in-
ally not been very sympathetic. Given the flation rates. Of course, now that inflation in
well-known difficulties with discretionary many industrial countries has returned to rel-
fiscal policy (i.e., recognition and imple- atively low rates, the question arises whether
mentation lags and the political problems in policies that deliver zero inflation would be
reversing expansionary policies during recov- superior to policies that accommodate very
ery) and the general need for medium-term fis- low but positive inflation. Inside the IMF, as
cal consolidation in many countries, the IMF 's in the economics profession more generally,
policy stance seems generally appropriate. In- the jury is still out on this question (see the
deed, the IMF has argued that when authorities World Economic Outlook of October 1996).
suffer low credibility, as reflected in large For countries that have achieved acceptably
interest-rate premia, fiscal consolidation that low inflation and are experiencing recession or
helps to restore credibility can positively affect weak growth, the IMF has generally recom-
output even in the relatively short run, as well mended accommodative monetary policies-
as delivering the fiscal bonus from reduced notwithstanding that such policies are not the
government borrowing costs. Finland, Italy, fastest path to even lower inflation. On the
and Sweden are recent examples of this phe- other hand, if an economy were performing
nomenon. On the other hand, IMF fiscal well with zero inflation or a slightly declining
dogma is not so rigid that it fails to recognize price level, I am confident that the IMF would
the general usefulness of the automatic fiscal not recommend easier monetary policy for the
stabilizers. In rare instances, such as Japan sole purpose of raising inflation to low positive
during 1994-1995, the IMF has even ap- rates.
plauded discretionary fiscal expansion to boost For countries with very high inflation (well
prospects for recovery, while noting the need into the double digits or beyond), shifting to
for eventual reversal. sounder financial policies that rapidly reduce
Such flexibility has not been limited to sur- inflation is economically beneficial, particu-
veillance for industrial countries, as illustrated larly in cases of hyperinflation (see Carlos A.
by two recent examples. When a delay in ex- Vegh, 1992). A more difficult issue is what to
pected recovery induced a fiscal shortfall in recommend for countries with histories of
Argentina last year, the IMF agreed to upward moderately rapid inflation that have success-
modification of the deficit target, along with fully reduced annual inflation to the low dou-
strengthened fiscal measures to take effect pri- ble digits. Often the IMF has pressed to reduce
marily in 1997. Similarly, in Russia last year, inflation further. However, several developing
the IMF agreed to accommodate a larger-than- countries have sustained rapid growth with in-
programmed fiscal deficit, while stressing the flation rates running in the 5-15 percent range
need for sustained improvement in revenue or slightly higher; and some countries that ag-
collection. Thus, the IMF hardly fits the image gressively sought further inflation reduction
of single-minded insistence that more fiscal have seen growth suffer and real exchange
consolidation is, always and everywhere, the rates become overvalued.
best policy. Rather, the deficiency has perhaps Exchange-rate policies are supposed to be
been occasional insensitivity to political diffi- subject to "firm surveillance" by the IMF.
culties of sustaining desirable fiscal consoli- Aside from some program cases, however, the
dation in the face of deteriorating economic IMF has not consistently paid intense attention
conditions. to exchange rates as a policy issue (notably,
Another mainstay of IMF surveillance has exchange rates among the systemically impor-
been pursuit of low inflation. As with fiscal tant major national currencies). This primarily
prudence, I find it difficult to fault this generalreflects the current state of economic knowl-
advice. Looking at the experience of the past edge and the dominance of domestic objec-
two decades, there are few if any countries tives in determining national economic
where a consensus of informed professional policies. Arguments by the advocates of "tar-
opinion would seriously suggest that medium- get zones" notwithstanding, no generally ac-

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 VOL. 87 NO. 2 THE INTERNATIONAL MONETARY FUND 31

cepted body of economic analysis determines sis that erupted in the summer of 1992. The
narrow -ranges for the economically appropriate Article IV report on Mexico discussed in early
levels of major exchange rates and thereby pro- 1994 did note concern with the large current-
vides a firm basis for contradicting market judg- account deficit; and based on the work of
ments in most circumstances. Nor is it realistic Guillermo Calvo and his collaborators, a gen-
to suppose that the main economic policies of eralized warning of adverse consequences
the largest countries would be (or should be) from a slowing of capital flows to developing
diverted from supporting sustainable economic countries associated with rising industrial-
growth with reasonable price stability in order country interest rates was issued later in 1994
to pursue exchange-rate objectives. (see the World Economic Outlook of October
Nevertheless, the perception remains that 1994). However, there was no specific warn-
wide swings in exchange rates generate sig- ing by the Fund of the crisis about to beset
nificant economic disturbances and that such Mexico and spread to other countries through
swings are not always well-justified by eco- the "tequila effect."
nomic fundamentals. Indeed, in a few in- Responsibility for these failures applies to
stances such as the sharp appreciation of the the IMF itself, but also partly to the national
Japanese yen in the spring of 1995, the IMF authorities that own and control the Fund
has concluded that markets have pushed which are not often enthusiastic to hear about
exchange rates beyond reasonable bounds and potential crises that may beset their econo-
that countervailing policy actions were appro- mies. With the denouement of the Mexican
priate. Analytical and empirical work to lay a crisis, however, the IMF's apparent inatten-
firmer foundation for such judgments is a pri- tiveness was sharply criticized. Important re-
ority in the IMF, but I would not expect to forms have been undertaken, including more
discover a formula to provide precise judg- sharply focused surveillance reports and
ments about exchange rates. promulgation of data dissemination standards
Another key task of surveillance is to to be adopted by governments. It remains to
encourage members to foster "...orderly be seen how much the IMF's ability to diag-
economic and financial conditions and a mon- nose potential crises will improve and whether
etary system that does not tend to produce the official appetite for warnings will be
erratic disruptions." Yet according to studies sustained.
prepared by the IMF 's Monetary and
Exchange Affairs Department (see Carl- REFERENCES
Johan Lindgren et al., 1996), during the past
15 years, 133 IMF members have experi- International Monetary Fund. World economic
enced significant banking problems, includ- outlook. Washington, DC: International
ing 41 major banking crises with financial Monetary Fund, various dates.
costs often exceeding 10 percent of GDP. Lindgren, Carl-Johan; Garcia, Gillian and Saal,
This is an area where improvements in IMF Matthew. Bank soundness and macroeco-
surveillance appear feasible and desirable, nomic policy. Washington, DC: Interna-
and work is proceeding along these lines. tional Monetary Fund, 1996.
Finally, significant deficiencies in IMF sur- Masson, Paul and Mussa, Michael. "Long-Term
veillance have been recognized in providing Tendencies in Budget Deficits and Debt,"
specific warning of potential economic crises. in Budget deficits and debt: Issues and op-
Analytic work in the IMF during 1990-1991 tions. Kansas City, MO: Federal Reserve
identified likely pressures within the European Bank of Kansas City, 1995, pp. 5-55.
Exchange Rate Mechanism (ERM) associated Vegh, Carlos A. "Stopping High Inflation: An
with the effects of German unification; but Analytic Overview." IMF Staff Papers,
there was no specific warning of the ERM cri- September 1992, 39(3), pp. 626-95.

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