Leland B. Yeager

This selection was excerpted from Leland Yeager's book International Monetary Relations: Theory, History, and Policy, published in 1976. Leland Yeager is the Ludwig von Mises Distinguished Professor Emeritus of Economics at Auburn University and Paul Goodloe McIntire Professor of Economics Emeritus at the University of Virginia.

The IMF resulted from lengthy discussions of separate American, British, Canadian, and French proposals drafted during World War II. The British "Keynes Plan" envisaged an international clearing union that would create an international means of payment called "bancor." Each country's central bank would accept payments in bancor without limit from other central banks. Debtor countries could obtain bancor by using automatic overdraft facilities with the clearing union. The limits to these overdrafts would be generous and would grow automatically with each member country's total of imports and exports. Charges of 1 or 2 percent a year would be levied on both creditor and debtor positions in excess of specified limits. This slight discouragement to unbalanced positions did not rule out the possibility of large imbalances covered by automatic American credits to the rest of the world, perhaps amounting to many billions of dollars. Part of the credits might eventually turn out to be gifts because of the provision for canceling creditor-country claims not used in international trade within a specified time period. The rival American plan took its name from Harry Dexter White of the U.S. Treasury. White rejected the overdraft principle and the possibility of automatic American credits in vast and only loosely limited amounts. Instead, he proposed a currency pool to which members would make definite contributions only and from which countries might borrow to tide themselves over short-term balance of payments deficits. Both plans looked forward to a world substantially free of controls imposed for balance of payments purposes. Both sought exchange-rate stability without restoring an international gold standard and without destroying national independence in monetary and fiscal policies. According to the usual interpretation, the British plan put more emphasis on national independence and the American plan on exchange-rate stability reminiscent of the gold standard. The compromise finally reached resembled the American proposal more than the British.

The Articles of Agreement of the International Monetary Fund (and also the articles of its sister institution, the International Bank for Reconstruction and Development ;obthe World Bank;cb) were drafted and signed by representatives of forty-four nations at Bretton Woods, New Hampshire, in July 1944. By the end of 1945, enough countries had ratified the agreement to bring the fund into existence. The board of governors first met in March 1946, adopted bylaws, and decided to locate the fund's headquarters in Washington, D.C. One year later the fund was ready for actual exchange operations.

According to its Articles of Agreement, the purposes of the International Monetary Fund are to promote international monetary cooperation, facilitate the expansion of international trade for the sake of high levels of employment and real income, promote exchange-rate stability and avoid competitive depreciation, work for a multilateral system of current international payments and for elimination of exchange controls over current transactions, create confidence among member nations and give them the opportunity to correct balance of payments maladjustments while avoiding measures destructive of national and international prosperity, and make balance of payments disequilibriums shorter and less severe than they would otherwise be.

Recognizing that these goals could not all be achieved promptly, Article XIV of the agreement provided for a postwar "transitional period" during which the member countries might violate the general ban on exchange controls over current account transactions. No definite length for the transition period was stated, but countries maintaining exchange controls more than five years after the start of fund operations (that is, beyond 1952) were expected to consult the fund about them every year. Actually, consultations about general economic policies have become an annual routine with all members, not just with members in violation of the standard decontrol obligations. Such consultations, requiring voluminous documentation, have even become the main activity of the fund, the one using up the most man-hours.

The "purposes" just mentioned are vague. More specifically, the fund provides drawing rights (in effect, loans) to help its members meet temporary deficits without resort to exchange controls, exchange-rate adjustments, or internal deflation. Member countries are supposed to "live with" or "ride out" purely temporary deficits, drawing on the fund when necessary to supplement their own accumulated reserves of gold and foreign exchange. The fund is not meant to use up its resources, however, hopelessly palliating "fundamental disequilibrium." A country faced with a "fundamental" deficit in its international transactions may be expected to seek a remedy in devaluing its currency. An opposite situation of "fundamental" balance of payments surplus would presumably call for upward revaluation. Such adjustments were expected to be infrequent.

Balance of Payments Deficits and IMF Adjustment Programs A description of the conceptual role of IMF financing programs in the context of balance of payments accounts.

Source: Lawrence J. McQuillan is a research fellow at the Hoover Institution at Stanford University. He is coeditor of The International Monetary Fund--Financial Medic to the World? A Primer on Mission, Operations, and Public Policy Issues, March 1999.

The balance of payments (BOP) account is a statistical record of the economic transactions during a given year between residents (individuals, businesses, and governments) of one country and residents of the rest of the world. The BOP account consists of the current account, the capital account, and foreign currency reserves. The current account primarily records a country's net exports of goods and services. The current account is the cash flow element of the BOP account. If a country exports more than it imports, the current account is in a surplus position and the country has a positive cash flow. If a country imports more than it exports, the current account is in a deficit position and the country has a negative cash flow--the country's residents are not earning enough foreign currency through their exports to pay for what they buy from other countries. Countries, like people, can spend more than they take in only if they draw down their savings or borrow funds. A current account deficit, therefore, must be financed either by drawing down a country's foreign currency reserves or by borrowing funds from abroad. The capital account records a country's foreign borrowing. When a bond is sold to residents of another country, the payment, a capital inflow, is entered as a credit in the capital account. If a country's total receipts (exports plus capital inflows) fall short of its total payments (imports plus capital outflows), it has a BOP deficit and must draw on its foreign currency reserves to meet its obligations for the remaining payments. Persistent current account deficits eventually exhaust a country's credit and foreign currency reserves, just as a persistent negative cash flow for consumers eventually exhausts their credit cards and savings account.

If a country, say Brazil, has a BOP deficit--for example, U.S. dollar receipts from abroad are less than U.S. dollar payments due abroad--Brazil can, for a time, draw on its dollar reserves. Alternatively, Brazil can borrow dollars from the IMF by exchanging Brazilian reals for U.S. dollars. The IMF uses an analytic framework, known as financial programming, to determine the amount of the loan and the macroeconomic adjustments that are needed to eventually establish BOP equilibrium. Typically, the amount of the loan is equal to a country's upcoming foreign debt obligations and the macroeconomic adjustments are intended to reduce imports and increase exports to enable the country to earn sufficient foreign exchange in the future to pay its bills, including the newly incurred IMF debt.

Conceptually, therefore, IMF loans come at the price of "conditionality," the policy adjustments that IMF officials believe will correct a recipient's country BOP deficit. The usual strategy for correcting a BOP deficit is to reduce domestic demand, and thus imports, through the imposition of credit ceilings, reductions in government spending, and tax increases. In addition, the IMF calls for the removal of export barriers. Currency devaluations are also used to promote net exports. For example, reducing the exchange rate for one Brazilian real from $4 to $2 reduces imports by making U.S. goods twice as expensive in local real prices and increases exports by making Brazilian goods half as expensive in U.S. dollars. Conceptually, IMF adjustment programs seek to rapidly correct BOP deficits.