Monitoring economic policies

These days one reads a lot about "reform" of the international monetary system. That system is, of course, the sum of its component countries' various systems and what many often seem to forget is that if, at some point in time, say after the G20 summit for which the IMF's entrè has been an even much lower world GDP growth forecast, some hypothetical agreement to change the elements of the system results, then the inevitable first thing that the IMF will seek would have to be how the same IMF will be monitoring countries' economic policies.

Last August, the IMF published new procedures on how it planned to start monitoring these policies and the main thrust of the new procedures were exchange rate issues and their impact on the global economy. The announced new procedures were, in fact, intended to facilitate implementation of a landmark decision adopted by the executive board in 2007.

That decision strengthened the IMF's surveillance of member countries' economic policies by placing external stability at the heart of IMF surveillance. At its core, IMF surveillance is based on a view of what bilateral surveillance is all about. Even if, with Malta's entry into the eurozone, nobody in Malta seems to speak about exchange rates any longer with the same width of interest as in the past, the fact remains that, as a eurozone member, Malta still has a strong interest in, in fact, seeing that the eurozone as a whole avoids manipulating exchange rates or the international monetary system to prevent balance of payments adjustment, or gain unfair competitive advantage over other IMF members.

Constant dialogue is now the leit motif for effectiveness of IMF surveillance, particularly at this time of increasing strains in the global economy, with fluctuating (often at a high level) commodity prices, slowing world growth and continuing global imbalances.

Discussions, in terms of article IV of the IMF's Articles of Agreement, between its mission teams and member governments are now much better focused on how members' economic policies impact the stability of their economies and of their partners.

But this has not always been the case. There were times in the past where, even after intensive discussions would have taken place between IMF staff and management and certain member countries, clear pictures about the appropriateness of exchange rate levels and regimes would still not be drawn out.

Because such discussions would have taken place outside the IMF's executive board, the Fund's executive directors and the member countries they represent would not have had a chance to listen to the arguments of the country concerned or present their own points of view.

Mark Allen, director of the IMF's Policy Development and Review Department, is very clear on this aspect.

He maintains that "it should be the membership as a whole - through the executive board - that engages with the member (country) in determining whether a problem is of such magnitude that the IMF needs to take a formal view on it and in persuading the member of policy changes that may be needed".

So the IMF's clarification in the latter half of 2008 on how it would be thenceforth monitoring countries' economic policies lays out precisely the procedures formalising such a more intensive dialogue with member countries. In particular, the IMF proposed the use of "ad hoc consultations" as a complement to regular article IV consultations whenever the IMF has significant concerns that a member country may not be observing one or more of the four principles spelled out in the 2007 Decision on Bilateral Surveillance or that its exchange rate may be fundamentally misaligned - even if such misalignment does not stem from the active use of exchange rate policies (say, when the rate is floating).

Are there advantages to this procedure, which sets out the steps for initiating an ad hoc consultation? Certainly it should ensure that the voice of the international community is also heard (through the involvement of the IMF's board), that the nature of the discussions is well understood and that the process is conducted in an even-handed manner.

Secondly, it provides a clearer opportunity for member countries to frame and present their own views comprehensively and, if they deem it desirable, to adjust their policies.

Thirdly, it will help the IMF reach final conclusions on specific findings (whether a country's exchange rate is in fundamental misalignment or whether a member is in non-observance of one or more of the principles that should guide members in the management of their currencies' exchange rates).

Ad hoc consultations do not in any way prejudge final IMF conclusions on a country's exchange rate policies. According to Mr Allen: "The exchange rate must be seen against the background of the entire economic situation of a country and against the evolving global and regional backdrop; and misalignment can often be just a signal of policy inconsistency that is best resolved without a change in the exchange rate".

What the IMF may yet actually come up with on the exchange rates front in the wake of the G20 meeting on the world economic crisis is, of course, still a closed book.