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Fiscal Discipline at the Root of Brazil’s Growth and Falling Inflation

The past decade or so has been a particularly challenging one for the International Monetary Fund, a period of rapid and far-reaching change for the global economy, as the process of globalization accelerated.

National and international policymakers, including the IMF, have had to adapt to keep pace with these changes. Crises in Asia, Russia and Latin America from the mid-1990s onwards taught us all important lessons about the impact of globalization on economic policy and about the significance of the sharp rise in private international capital flows. Some rapid reassessments were required.

As a consequence of what we learned, the Fund has made important and far-reaching adjustments to the way it works. Now is an appropriate moment to assess what we have done and to consider what further changes need to be made.

There will, of course, always be a need for change: the world is constantly evolving and so must we at the Fund if we are to continue to fulfill our central purpose: the maintenance of international financial stability. Indeed, the Fund’s history, like that of the international economic policy community as a whole, is one of adapting to change. Success in meeting some challenges inevitably brings fresh ones in its wake. We are proud to be a learning institution.

I want to look at the way the Fund’s work has changed, and how we are adjusting to serve the needs of our member countries and the international economy as a whole. I want to put our work in historical perspective and in the context of the modern global economy.

The world in 1945

In a practical sense, the IMF was born out of the famous conference at Bretton Woods, New Hampshire, in July 1945. It was there that the representatives of 45 countries, led by America’s Harry Dexter White and Britain’s John Maynard Keynes, agreed on a form of international economic cooperation in the postwar world that was unprecedented in its scope and ambition.

Yet the genesis of this postwar economic framework was much earlier – indeed we need to go right back to the nineteenth century to appreciate what its architects had in mind. The rapid spread of industrialization in the nineteenth century owed much to the relatively free flow of goods and capital. Private international capital flows, in particular, provided the investment capital needed for economies to industrialize.

A stable international financial framework facilitated economic growth in the industrializing economies and re-establishing this was an important motivating factor in the deliberations leading up to Bretton Woods. The world had learned at first hand what happened when multilateral economic co-operation broke down.

The start of the Great Depression in the US in 1930 and the enforced abandonment of the Gold Standard by the UK in 1931 marked the beginning of a damaging fragmentation of the international financial system and an unprecedented collapse both of commodity prices and of world trade. Between 1929 and 1932 the world price index, measured in gold values, fell by 47.5 percent. In the same period, the gold value of world trade fell by 63 percent.

As each country sought to defend itself against these huge deflationary pressures it became a free-for-all, where the actions of each individual economy made things worse for every other economy – and for the world economy as a whole. This was the era of beggar-thy-neighbor policies. Exchange rates were devalued as a way of protecting export opportunities at the expense of others. Exchange restrictions were introduced by many countries, as were systems of multiple exchange rates. Tariffs among the main industrial countries rose sharply.

The spillover effect of national policy actions led to a downward spiral: the depression deepened and spread worldwide. International capital flows fell sharply. The participants at Bretton Woods understood that a repetition of this destructive era had to be avoided.

They sought to replace chaos with stability and recognized that this required a multilateral approach. So the negotiations centered on the establishment of a well-functioning and stable international financial system, one that replaced the competitive devaluations of the 1930s with a system of fixed exchange rates with rules to prevent unilateral adjustment.

Discriminatory exchange control restrictions were to be outlawed and the emphasis would be on a multilateral system of trade and payments to promote international financial co-operation and so foster world trade and investment. The new rules-based system, with its emphasis on stability and multilateralism would, in turn, pave the way for a restoration of full employment and economic growth.

Bretton Woods was concerned primarily with issues relating to international financial stability. In addition to the International Monetary Fund another new institution was established: the International Bank for Reconstruction and Development, later the World Bank.

This latter was charged with channeling investment funds, particularly at first to those countries ravaged by war. The Bank was intended to perform the role played by private international capital flows in the nineteenth century. No-one at the time seriously expected such private flows to play any significant part in the postwar global economy.

But it was also understood by those shaping the new postwar framework that trade liberalization would have to be a key component. The General Agreement on Tariffs and Trade was signed in 1947 with precisely that objective and was succeeded by the World Trade Organization in 1995.

The two Bretton Woods institutions came into being in 1946. Next month is the sixtieth anniversary of the first meeting of the IMF’s Board of Governors in Savannah, Georgia, attended by representatives of the 38 countries that had either already joined or did so during the meeting.

The role of the Fund

The Fund envisaged by its founders was – and is – an institution imposing obligations on, and providing benefits for, its member countries. This balance remains at the heart of our work. Members buy shares in the Fund, according to a quota system; and they undertake to abide by the Fund’s rules, including, for instance, the principle of non-discrimination in their treatment of other members.

In return, they know that other members will also abide by the same rules and so they benefit from the stable international financial environment that the IMF helps foster and from the global economic expansion that stability makes possible. Non-members gain from this, too, of course. But members also benefit from the Fund’s surveillance work and from the technical assistance the Fund provides.

The Articles of Agreement that still govern the Fund’s work explicitly recognized the need for a period of transition after the war. There was provision for member countries to delay implementing some of the key membership requirements, particularly those in Article VIII that oblige member countries to have freely convertible currencies: that is, permit non-residents freely to exchange their earnings from current transactions in those currencies into any other currency at the prevailing official rate. Article VIII also prohibits the use of multiple exchange rates and the imposition of discriminatory or other payment restrictions.

Fund members also have access to the Fund’s financial resources when they need temporary assistance to deal with balance of payments problems – that is when current account deficits increase to the extent that a country is at risk of being unable to meet its international payments obligations. Fund financial support is intended to give member countries breathing space: time to make adjustments in their economic policies that will ease the pressure on their balance of payments.

Providing temporary financial support in this way was intended to reduce the likelihood of disruptions to the international system by countries in balance of payments difficulties resorting to unilateral measures to solve their problems. But it was clear from the outset that in return for temporary support governments would have to undertake whatever policy adjustments were necessary; such as reducing domestic demand for exports or, in cases of fundamental disequilibrium, adjusting their exchange rates in consultation with the Fund and its members.

The rules of the system of which the IMF is guardian have been adapted to reflect the changing nature of the world economy. And some aspects of the Fund’s lending activities have changed, mainly to enable the Fund better to meet the needs of its changing membership structure.

I will shortly say more about how the Fund operates nowadays. But it is important at this point to note that the main elements of the Fund’s current activities can be traced back to the original Articles of Agreement. Access to financial assistance from the Fund was central to the decisions taken at Bretton Woods.

And surveillance, essentially the monitoring of national economies and arguably now the Fund’s most important activity, was seen from the outset as a way of ensuring that members abided by the rules of the system. Annual consultations with members, known since the 1970s as Article IV consultations, started in 1952.

From a more specific focus on exchange rate issues, these consultations have gradually acquired more breadth: Fund staff, and the Fund’s Executive Board, now discuss pretty much every aspect of macroeconomic policy with each member government. The aim nowadays is to advise governments on policy adjustments that both head off potential difficulties, and enhance macroeconomic stability and growth.

And regional and global surveillance, monitoring the world economy as a whole and watching out for systemic risk, has become more formal and systematic over time. A modest version of the exercise we now know as the semi-annual World Economic Outlook, or WEO, was first conducted in 1969, and the first WEO was published in 1980.

As the world economy has become more integrated, so it has become increasingly important to prevent crises whenever possible. Identification of systemic risks is crucial: some countries may pursue economic policies that may result in difficulties not just for them but for their trading partners and we need to be alert to this.

Even technical assistance, now accounting for about a third of the Fund’s activities, got off to an early, though very low-key, start in the late 1940s.

An evolving system

Over the past six decades, the Fund’s membership has grown dramatically. From those 38 members at the March 1946 meeting, the membership had grown to 68 in 1960; today we have 184 members.

But the framework established at the end of the Second World War has turned out to be both durable and extraordinarily successful. Most people in most countries are far better off, far healthier and have a better quality of life than seemed possible at the end of World War II. The world as a whole has experienced unprecedented economic growth and there has been no repetition of the depression of the 1930s.

The Fund’s role as guardian of international financial stability has, as its architects foresaw, been absolutely central to this explosion of prosperity. The establishment of a rules-based system for international financial relations, coupled with financial resources that enable the Fund to lend to member countries with balance of payments problems, has provided a solid foundation for the growth of global trade and GDP.

But from its inception the IMF has faced some formidable obstacles in pursuit of its goals.

The first challenge was the economic chaos in Europe at the end of the Second World War. So great were Europe’s economic problems that the American government was obliged to intervene, launching the Marshall plan – the European Recovery Program – in 1947 to help kick start the European economies.

The economic challenges confronting most Western European governments encouraged them to delay making their currencies convertible, as required by IMF rules. Until 1958, only ten member countries maintained full convertibility.

The Fund sought to accelerate the move towards convertibility by providing support to countries with balance of payments problems. As the European economies grew stronger and the international payments position improved, the excuses for postponing convertibility weakened. In December 1958, ten West European countries made their currencies freely convertible for current transactions.

1958 thus marked an important point in the development of the modern international system. But as significant progress was made towards liberalizing the international payments system, the system of fixed exchange rates began to come under serious strain, not least because of the resumption of private international capital flows in the 1960s onwards.

Under the Bretton Woods system, exchange rates were supposed to be "fixed but adjustable" with adjustment limited to cases of fundamental disequilibrium. Countries could, with the Fund’s agreement, adjust their par values to reflect their changing economic circumstances relative to other countries. The aim was to prevent unilateral adjustments of the kind seen in the 1930s and over the years, many exchange rate values were altered.

Although increasing strains in the system became evident during the 1960s, the Bretton Woods exchange rate regime, combined with trade liberalization, had enabled the industrial countries in particular to grow rapidly in the postwar period.

From the late 1940s to the early 1970s, growth rates among the major industrial countries made the achievements of the nineteenth century seem modest. America saw average annual growth in real GDP per capita of 2.4 percent between 1950 and 1973; the comparable figure for Germany was 5 percent. For Japan the figure was more than 8 percent. Inflation rates were a little higher than we have grown accustomed to in recent years – but only a little – while unemployment was much lower than even America or the U.K. have recently managed.

But the Bretton Woods system hinged on the continued willingness of the US authorities to maintain the so-called gold window – the right of anyone to convert their dollars into gold at the fixed rate of $35 per ounce. For much of the postwar period, large US capital account deficits had been offset by current account surpluses.

But as the overall balance of payments – the current account combined with long term capital movements – moved into deficit; and as the US economy came under pressure from the struggle to finance rapid rises in domestic spending programs and the cost of the war in Vietnam, the US government decided it could no longer underpin the international financial system. In August 1971, President Nixon announced that the gold window would be closed and by 1973 the system of fixed exchange rates had been abandoned.

Many feared that the collapse would bring the period of rapid growth to an end. Growth did slow temporarily in most industrial countries after the first of the 1970s oil prices shocks: but this was mainly a result of inappropriate policy responses to the rise in energy prices.

In fact, the transition to floating exchange rates was relatively smooth and it was certainly timely: flexible exchange rates made it easier for economies to adjust to dearer oil. Floating rates have facilitated smoother adjustments ever since.

The 1970s marked an important turning point for the Fund in other ways. This brought to an end the period during which the industrial countries were the Fund’s largest borrowers, as they had struggled to maintain domestic growth and external payments balance.

The Fund and the developing world

Right from the start, the Fund had developing country members, though initially these were relatively few and the scale of financial support provided to them in the Fund’s early years was relatively small. At the end of the Second World War, the world was broadly divided into two groups of countries, aside from those in the Communist bloc in Eastern Europe.

There were the haves and the have-nots: the rich industrial and rapidly-growing economies, and the developing countries which had been on the sidelines during the rapid growth in the industrial world in the nineteenth and early twentieth centuries.

In the early postwar period, many developing countries sought to accelerate growth by adopting policies that depended on considerable government involvement in the economy.

Instead of pursuing the economic opportunities afforded by multilateral trade liberalization, the focus was on government control of the economy, protecting domestic industries and attempting to substitute domestic production for foreign imports in a misguided belief that this was the route to growth and prosperity. For some countries, such policies did bring brief periods of growth, but such spurts were, as always, unsustainable as fiscal deficits soared and growth petered out.

All developing countries benefited, at least to some extent, from the rapid growth of world trade in the postwar period. But by the 1960s, these countries began to diverge from one another. Some remained stuck with protectionist policies and government intervention that stymied their growth prospects and hampered poverty reduction.

But a few developing countries started to implement more effective pro-growth policies, against the backdrop of a stable international financial environment and the multilateral liberalization of world trade, with the concomitant growth of world markets.

The results were dramatic. Before long, the remarkable postwar growth rates in the industrial countries began to seem unexceptional, as the newly industrializing countries – what we now call emerging markets – took off.

The most spectacular performance was in Asia. Growth accelerated rapidly in Korea, Hong Kong and Singapore, the first members of the group known as the Asian tigers. In 1960, Korea embarked on a radical program of economic policy reform, including opening the economy up to trade.

Korea’s per capita income increased roughly twelve fold between 1960 and 2005. In any single ten-year period between 1960 and 1995, Korean real per capita income grew by more than British real per capita income during the whole of the nineteenth century.

The rapid growth of trade, spurred by the removal of trade barriers, was integral to this. And with rapid export growth – in excess of 40 percent a year over quite a long period – employment and real wages grew rapidly.

Other countries in the region soon followed suit: Malaysia, Thailand, and Indonesia among others. More recently we have seen high rates of growth over more than two decades in China, lifting hundreds of millions out of poverty. Indian growth accelerated significantly after economic reforms were introduced, beginning in 1991.

In many other parts of the world, though, growth tended to be more volatile – as in Latin America, for example – or much slower, or even negative, as in some parts of Africa. Increasingly, the Fund sought to help its developing country members both with financial support and with the process of policy adjustment needed to enable them to achieve financial stability and higher growth rates.

In the early 1980s, the so-called third world debt crisis led to much larger Fund involvement with developing countries including, in some cases, the provision of large-scale financial support.

This crisis – when many governments found themselves unable to service their loans – had its origin in the surplus revenues accumulated by the oil producers after the sharp rises in the oil price in the mid and late 1970s.

These revenues had been "recycled" by the international banks who lent funds aggressively to developing economies, usually on floating rate terms.

With hindsight the result of this large scale lending was predictable. Debt sustainability – regarded as a crucial element of macroeconomic policy today – was at that time an alien concept.

As interest rates rose in the early 1980s, reflecting the efforts of industrial countries to reduce inflation, economic policy weaknesses were exposed and many developing country borrowers found themselves unable voluntarily to service their large debts.

The Fund played a significant role in helping to resolve the problems developing countries faced, both by providing temporary financial support and by helping them to make policy adjustments.

The experience of the 1980s brought a sharp reminder of the importance of economic policies in helping foster economic growth. Policymakers in Asia continued to implement policies that created a growth-friendly environment – low inflation, outward oriented policies that enabled Asia to continue to grow rapidly even though many countries were heavily dependent on oil imports.

By contrast, in the 1980s many Latin American countries experienced soaring inflation, fuelled by large fiscal deficits. In addition, higher barriers to trade hampered growth in Latin America over a long period.

And oil exporting countries, in spite of their high oil revenues, experienced lower growth rates because of weak macroeconomic policies. Instead of using the oil revenues to develop and diversify their economies, the governments of many oil-producing countries used the income for unsustainable current spending and unproductive capital investment while remaining, in many cases, relatively closed to trade.

The 1990s

As I said at the outset, the 1990s brought the Fund its biggest challenges. The institution played a central role in assisting the countries of the former Soviet bloc to cope with a dramatic change in their circumstances. These countries needed Fund help both in the form of financial assistance but, more important in the long term, in managing the transition to become normally functioning market economies.

This was an economic transformation of a kind that had never before been attempted, and sometimes the going was less than smooth. But most of these countries are increasingly regarded as normal, with normal problems: indeed, several are now members of the European Union with high growth rates.

A more far-reaching development for the Fund during this period, however, was the sharp rise in private international capital flows. The founders of the Bretton Woods system had largely assumed that private capital flows would never again resume the prominent role they had in the nineteenth century.

The framework that established the Fund and the financial resources available to provide temporary support for members were therefore focused on current transactions. The Fund had traditionally lent to members facing current account difficulties.

But a series of financial crises during the 1990s, triggered by sharp changes in the direction of capital flows, forced both the Fund and national policymakers to revisit these assumptions. The first capital account crisis erupted in Mexico in 1994. Crises followed in Asia in 1997-98; in Russia in 1998; and elsewhere.

It became clear, as the decade progressed, that these crises were fundamentally different from earlier ones. All were capital account crises, large in scale, and, like most financial crises, involved enormous upheaval for the countries involved. Our experience in this period underlined the extent to which sound economic policies both foster growth and help prevent crises from occurring in this new world of large private capital flows.

Look, for example, at the Asian crises. Only a relatively small number of countries were directly affected, with Korea, Thailand and Indonesia the worst hit. For those countries years of spectacular growth ended in a dramatic series of national financial crises.

But they had an impact well beyond the countries involved, in part because it was shocking to see economies that had experienced such rapid growth over such long periods suddenly appear so vulnerable; and in part because there were, for a time, fears that the crises would spread further.

The sharp reversal of capital flows to Asia in the latter half of 1997 sparked the crises. Net inflows to the Asian crisis countries were over 6 percent of their GDP in 1995, and just under 6 percent in 1996.

In 1997, net outflows were 2 percent of GDP, a figure which rose above 5 percent the following year. The economic dislocation caused by reversals of this magnitude was huge, and would have been so for any country.

Some have argued that the turnaround in investor sentiment was capricious and unwarranted. But this argument doesn’t hold up: fundamental problems had begun to emerge and they prompted the shift in capital flows. In particular, there had been a huge expansion of credit over a relatively short period of time.

Rapid credit growth is almost always indiscriminate and, therefore, dangerous. The result had been a sharp rise in the number of bad loans. The rate of return on capital had fallen and, in consequence, non-performing loans started to rise. Once these problems became apparent, it was inevitable that international creditors would undertake a rapid reassessment of the creditworthiness of debtors and loan exposure.

Several factors conspired to make the consequences of this shift in investor sentiment extremely painful. Fixed exchange rates prevented a more rapid adjustment to the shift in capital flows – and gave speculators the chance to make a one-sided bet. Government assurances that exchange rate pegs would be maintained had left currency mismatches unrecognized until governments were forced to devalue.

Banks had built up liabilities in foreign currencies and assets in domestic currency. Devaluation then left financial institutions and businesses facing massive losses, or insolvency. The weaknesses of domestic banking systems, a result both of the poor quality of credit assessment and allocation and because of the mis-matches, were revealed – as was the impact on economic performance.

The contraction in GDP that most crisis countries experienced made things even worse, of course, because the number, and size, of non-performing loans grew rapidly. The further weakening of the financial sector inevitably had adverse consequences for the economy as a whole. The crisis economies found themselves in a vicious downward spiral.

The capital account crises in Asia had much in common with each other and with those that erupted elsewhere in the 1990s. They occurred rapidly – alarmingly so; they occurred because holders of a country’s debt were concerned about its ability and/or willingness to service that debt; and because there were doubts about underlying macroeconomic policies.

The speed with which capital account crises erupted meant that financial support from the Fund for countries affected was often urgently needed – in days rather than the weeks or months which Fund programs for current account crises had usually taken to put together. And the support needed tended to be on a much larger scale than the Fund had customarily provided because of the scale of the outflows experienced by crisis countries.

Fund programs with financial support were far-reaching. They included a commitment by the government to rapid fiscal rebalancing, necessary to bring expenditure and revenues more closely into line and to address underlying weaknesses in banking systems; a switch to floating rates or at least more flexible exchange rate regimes; and programs of longer-term reforms aimed at removing structural rigidities and improving growth potential.

Lessons learned

These capital account crises were a testing time for the Fund – and indeed for all those involved. The crises brought a sharp reminder of the extent to which the world had changed: and they taught all of us – Fund staff, economists and national policymakers – a great deal.

We came to appreciate just how vital it is to have a sound macroeconomic framework that can deliver macroeconomic stability and sustainable growth. In a globalized world, economies must have monetary and fiscal policies that make possible falling or low inflation, that foster budgetary prudence and that limit public debt at sustainable levels. We also learned to look at the sustainability of fiscal policy in the context of debt dynamics.

Most economists are now agreed that countries need an exchange rate regime that enables an economy to be sufficiently flexible to respond to shocks. Fixed exchange rates pose significant challenges because they mean monetary policy must be subordinated to the exchange rate regime, thus placing much greater reliance on fiscal and structural policies to provide the flexibility needed in the economy.

Another important lesson is the closeness of the link between the financial sector and economic stability and growth: and this has assumed increasing importance in the Fund’s work. Let me explain what I mean.

Banks and the financial sector in general have a vital role to play in fostering economic growth: by providing credit to those investments that offer the highest rate of return, banks contribute to a higher growth rate for the economy as a whole.

But to be effective, banks, even small ones, must develop the ability to assess creditworthiness, risk and returns. They need to be able to assess the likely returns from competing borrowers and so direct resources to those offering the highest rates of return.

As economies grow, they become more complex and interdependent; and the demands placed on the financial sector grow commensurately. Banks grow bigger: they need to in order to meet the demand for investment capital.

They must also grow more sophisticated, and become more diversified in terms of the risks they assume. Continued expansion means that firms need banks able to serve their needs across national boundaries and to provide specialized financing services.

But the financial sector has to meet the needs of the range of economic activity and other sources of financial intermediation – equity, bonds and insurance, for example – are important to provide the necessary breadth and depth. Healthy and sustained growth of firms and economies requires constant innovation as firms seek the best terms and intermediaries become increasingly refined in making risk assessments. Thus, for example, we have seen in recent decades the development of derivatives and, more recently, hedge funds.

Experience has repeatedly shown that high growth rates are sustainable only as the financial sector develops in parallel with the economy as a whole. A weak financial sector can undermine growth. Resources are misallocated, and average returns fall. We all knew that a healthy financial sector was an important ingredient of macroeconomic stability. But the role that weak financial sectors played in the crises of the 1990s made us appreciate even more than before quite how central the financial sector’s role is.

Key to improved financial sector performance, and key to the improved governance that makes possible improved macroeconomic performance in general, is the issue of transparency. We have learned that at the sectoral, the national and the global level the more openly individuals, firms and institutions go about their business, and the more open to public scrutiny they are, the more effectively they will perform.

The IMF has taken a lead in this: we are now one of the most transparent institutions in the world. Some have gone so far as to argue that transparency will prove to be the most important and durable lessons of the past decade.

Lessons applied

For the Fund, the most pleasing measure of success is the absence of crises rather than their effective resolution. Crises will nevertheless occur from time to time. What matters then is how they are resolved, and two recent examples demonstrate the extent to which national governments and the international policy community have been able to apply the benefits of our experience in the 1990s and earlier.

As you may know, Brazil experienced a major crisis in early 1999 when the government was forced to abandon its fixed exchange rate regime and introduce wide-ranging reforms. Yet by the middle of 2002, Brazil was widely seen as being on the brink of another crisis, brought about not by policy changes but by speculation about the economic policies that might follow the 2002 presidential election.

There was concern in the markets that a new President might not follow the prudent macroeconomic policies that had helped the Brazilian economy recover from aftermath of the 1999 crisis. Electoral uncertainty led to concerns in particular about the sustainability of Brazil’s large public debt.

A Fund-supported program was agreed during this pre-election period, committing the new government to maintenance of the existing fiscal, monetary and exchange rate framework, along with a longer term program of structural reforms.

All three major Presidential candidates undertook to maintain the policy framework should they be elected. In the context of the Fund program with large-scale financial assistance, the financial markets were rapidly reassured.

The result has been a remarkable transformation in Brazil’s economic fortunes. The floating exchange rate regime, which had already been introduced, has undoubtedly helped smooth the adjustment process. And prudent fiscal policies have paved the way for more rapid growth and falling inflation. The country’s external financing needs have fallen sharply, and the debt position has strengthened markedly.

In consequence, Brazilian living standards have risen and poverty has been reduced: in 2004 there were about four and a half million fewer Brazilians living on less than a dollar a day than there had been only three years earlier.

A great deal has been achieved in Brazil; and we can already see the rewards of a sound macroeconomic framework in terms of growth and the scope for poverty reduction. There is still quite a way to go and the government is working on further structural reforms. But at the end of last year, the Brazilian government repaid all its outstanding debt to the Fund, well ahead of schedule.

There are many similarities with the situation in Turkey where crisis erupted at the end of the 1990s. Inflation had been a chronic problem, having been above 60 percent a year from the late 1980s, in large part because successive governments had failed to tackle the problem of large fiscal deficits.

Reforms that had been implemented earlier – such as trade liberalization in the early 1980s – had delivered less than they might otherwise have because of macro instability. The consequence was an economy that lurched from crisis to crisis. Short-lived booms were followed by busts.

The economic crisis, that started in 1999 and came to a head with a banking crisis in 2000-1, led to wholesale economic reforms. Here, as in Brazil, reforms were supported by a Fund program; here, too, a floating exchange rate has been an important factor in making rapid adjustment possible; and here, too, successive governments have displayed impressive commitment to the reform program. As a result, recent progress has been remarkable.

Strengthened fiscal policy has been a cornerstone of Turkey’s macroeconomic framework, just as it has of Brazil’s. In both cases, fiscal discipline has played a critical role in creating the conditions for rapid growth and falling inflation. In addition, the Turkish government has undertaken a number of critical structural reforms, especially in the banking sector, that strengthen the domestic financial system and which helped lay the groundwork for recovery.

Inflation has fallen from more than 70 percent just three years ago to below 8 percent in 2005 – the first time since the 1960s that Turkish inflation has been in single digits. It is expected to fall further, to 5 percent, this year. And tightening fiscal policy was accompanied by accelerating growth, as it was in Brazil.

So Turkey, too, has achieved much and reforms continue. Last year, the Fund agreed a new $10 billion standby arrangement, in support of a program aimed at sustaining growth, delivering price stability and continuing with structural reforms.

The work of the Fund today

Our experience with countries like Brazil and Turkey serves to underline the extent to which our work, though not our purpose, has changed over the years. It is inevitable that that our work on the management and resolution of such crises attracts the most attention: and it is, of course, important. By their nature, when they do occur, crises inevitably absorb huge amounts of the time and energies of the Fund’s senior officials.

But such periods are, thankfully, rare and a much greater part of our day-to-day work is preventive. Crises can teach us much about prevention and enable us to assist our members achieve sustained rapid growth through the implementation of sound macro and other economic policies.

I’ve already mentioned our surveillance work which is conducted at the global, regional and national levels. The World Economic Outlook is now well-established as our principal tool for multilateral surveillance. The Fund staff’s latest projections for global and national growth and a series of other economic indicators are accompanied by an analysis of the potential risks that could undermine the central forecast.

At the national level are our Article IV consultations with each member country. Each country has assigned to it a team of Fund officials, which conducts in-depth discussions with the national authorities. The team analyzes the country’s economic prospects and policies, warns of potential risks to the outlook and of potential weaknesses in the economic policy framework, and discusses ways in which prospects could improve.

The Fund’s surveillance work gives the institution a unique cross-country perspective. We are, after all, the only institution that has such a broad membership and that has access to the relevant information about national macroeconomic policies. Our surveillance work, and the work of our research department, permits comparative insights into economies and economic policies. Highlighting successful policies is actually as important a part of our work as sounding a note of caution when there are doubts about national economic policy choices.

Regional surveillance is an increasingly important element of our work, as we monitor the possible spillover effects of economic policies where groups of countries – such as those in the Euro area – have particularly close economic ties.

Surveillance is important for all categories of our membership. We may no longer need to provide financial assistance to our industrial country members, but the dialogue we have with them remains vitally important. We focus on issues that affect their prospects for growth and stability and that, because of the size of these economies, have implications for the world economy as a whole.

With emerging market countries and most transition economies, the emphasis is on reducing vulnerabilities and raising potential long-term growth rates. The two go hand in hand, of course: the stronger the macroeconomic framework, the higher growth rates will be. Experience has taught us that key ingredients of a strong framework include low, or falling, inflation; sound fiscal and monetary policies; sustainable debt levels; and policies to remove structural rigidities that hamper growth.

Of course, macroeconomic stability is just as important for our low income members: and this has become increasingly apparent over the years. Most of those poorer countries that have, often with Fund advice and encouragement, put in place policies to reduce inflation and create the conditions for growth have experienced higher growth rates.

But even in these countries there is still a considerable way to go before growth rates are high enough to give them a chance to meet the Millennium Development Goals. Since the Fund is not an aid agency, our role is to help countries shape their macroeconomic policies in a way that addresses some of the causes of low growth.

But in many low income countries, policies discourage business and enterprise. Property rights are often difficult to enforce and, in many cases, weak judicial systems make contract enforcement virtually impossible.

In recent years we have come to realize such issues need to be addressed if a macroeconomic framework is to be sustainable. Businesses are stifled and foreign investment discouraged if a country does not have an effective judiciary that makes efficient and timely contract enforcement possible.

Firms simply relocate to somewhere that offers them greater legal protection. Similarly, countries that do not offer legally, and easily enforceable, property rights will find it hard to attract and retain investment.

Such shortcomings have always undermined business activity and economic growth: but as the world economy becomes more integrated, business has become more mobile and a climate hostile to business even more damaging.

The Fund, in co-operation with the World Bank, now works actively to promote institutional reform among our members as a vital ingredient in promoting sustained and rapid economic growth. Institutional shortcomings are an issue in some of our emerging market members; but they are far more serious, and widespread, in low income countries.

We aim, as part of our surveillance work, to assess the health of the financial sector. As I noted earlier the breadth of financial instruments is important; as is the transparency of the system which enables more accurate assessments to be made of the asset and risk position of individual institutions. And a strong, effective regulatory regime, following international best practice, is vital.

Much of our financial sector surveillance is done through the Financial Sector Assessment Program, or FSAP, introduced in 1999: and this is done jointly with the World Bank in the case of developing countries.

Member countries request an FSAP: at which point the Fund undertakes a detailed examination of the framework for financial regulation and supervision. The work carried out under an FSAP program involves a broad range of financial experts, many of them from outside the Fund.

Well over 100 of our members have now had, or requested, an FSAP program. The feedback we get is overwhelmingly positive, from both industrial countries with highly developed financial sectors, as well as others. Countries as diverse as Britain, Iceland, Russia and Nigeria have all found the FSAP useful.

We have also worked with the World Bank to develop a system of Standards and Codes – using internationally-recognized standards – that result in Reports on Standards and Codes (ROSCs).

These are an integral part of our work to encourage transparency and cover twelve areas, including banking supervision, securities regulation and insurance supervision. Surveillance of financial sector issues has identified vulnerabilities in many countries that have subsequently been rectified.

Technical assistance

The Fund’s technical assistance is a vital part of the work we do to help countries implement reforms that will strengthen their economies and raise their growth potential.

Our TA work covers a wide range of activities: from assistance in improving customs procedures or tax administration to the management of monetary policy.

It can help countries increase the benefits from trade liberalization, both through customs reforms and through increasing other tax revenues, through improved administration. Streamlining customs procedures can create a more business-friendly environment and spur trade.

We provide expertise to countries wanting to develop their foreign exchange markets and to improve public expenditure management – for poor countries keeping track of where the money goes can be as difficult as it is important.

Technical assistance can help countries make their public sectors more efficient. Improving tax collection procedures, for example, can raise the revenue stream from any given tax rate; lowering tax rates can also raise revenues by acting as a disincentive for people to participate in the informal sector of the economy.

And by providing expert assistance with pension reforms, TA can enable countries to manage fiscal policy more effectively, freeing up resources for infrastructure and more targeted spending without increasing deficits.

Financial assistance

As I noted, Fund financial assistance was seen as an integral part of the system by its original architects. For some members, the prospect of temporary support for balance of payments problems remains important and financial assistance can play a critical role in helping countries overcome economic difficulties.

Emerging market countries are currently the Fund’s largest borrowers, although the currently favorable global environment means that we have fewer loans outstanding than for some time. We also provide considerable financial support to low income countries, much of it on concessional terms.

Indeed, we have recently extended the range of facilities available to these countries. Towards the end of last year, the Fund’s Executive Board approved a new facility, the Exogenous Shocks Facility, which will provide financial support for countries facing shocks, such as commodity price shocks, or abrupt changes in their terms of trade.

All aspects of the Fund’s work – surveillance, technical assistance and financial support – have a common goal. It is to enable our member countries to ensure that they have in place the policies that will deliver macroeconomic and financial stability and so lay the foundations for the more rapid and sustained growth that is the prerequisite for poverty reduction.

Helping countries achieve stability and growth at the national level enables us to fulfill our mandate of international financial stability and the promotion of growth through the expansion of trade.


Let me briefly conclude.

The world economy has undergone enormous change since the IMF was established at the end of the Second World War. Yet the Fund’s mandate is as relevant today as it was in 1945.

Indeed, in today’s rapidly-integrating global economy, the maintenance of international financial stability is, if anything, even more important than it was in those early days. We have more than five times as many members as when we started out. Our membership is both more diverse than it was then and much more closely interlinked.

Diverse our membership may be: but our members also have much in common. All countries need a strong macroeconomic framework if they are to experience sustained rapid growth, raise living standards and reduce poverty.

All countries benefit from a stable, growing global economy. All countries benefit from the multilateral trade framework that has made possible the rapid expansion of world trade: and trade growth has been a key driver of the rapid growth of the world economy since 1945.

The Fund’s unique cross-country perspective has significant advantages when helping countries address their economic policy needs. We are able to assess what policies are most effective and what means of implementation are likely to work best. And we can look at the reform process in a global context. It is this which equips us to address the needs of all our members.

As the world economy has evolved, so have we. We have all learned a great deal about how economies function and about how best to achieve sustained rapid growth, rising living standards and poverty reduction.

Since the 1990s, in particular, we have attached greater importance to sound fiscal policies and sustainable debt levels. We have come to appreciate the central role that a sound financial sector plays in fostering growth. We know that flexible exchange rate regimes enable economies more easily adjust to shocks.

We recognize that structural reforms, removing rigidities that hold back growth, are a critical element of macroeconomic policy as is an institutional framework that respects property rights and contract enforcement and encourages enterprise.

The international economy will continue to evolve, though we do not yet know how. But there has been, and will be, no revolution, no big bang. Change has to be a continuous process, for national governments as much as the Fund. This in some ways is more difficult: it means we all have to be ready to adapt all the time: we – all of us – are part of a dynamic process.

More difficult, but potentially more rewarding. Given the appropriate policies and the necessary support, all economies have the potential to achieve accelerated growth and the accompanying rise in living standards and reduction in poverty. By working to foster growth in the context of a stable international economic environment, the IMF will continue to have a central role in this evolutionary process.

Thank you.

Remarks by Anne O. Krueger, First Deputy Managing Director, IMF, adressing the International Development Club Graduate School of Business, Stanford University, in Stanford, California on February 23, 2006


  • Show Comments (1)

  • Guest

    A joke this article….
    because it is quite well known that Brazil government is awfull on their tax collection and wealthy Brazilians are known for their tax evasions even by the highest rankings politicians !!!!

    And Brazil has not done structural reforms.but remains with their structural problems !

    Brazil is a medieval country !

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