A brief history of International Monetary Institutions
The International Monetary Fund (IMF)
The International Monetary Fund (IMF) based in Washington, D.C., was established in 1945. The IMF was established in order to oversee the gold exchange standard system of fixed exchange rates, and provide advice and financing to countries experiencing acute balance of payments crises. When the Bretton Woods system of fixed exchange rates broke down in 1971-73, the IMF evolved into a lender of last resort to countries facing macroeconomic and financial crises, and has been involved in many episodes including those of the Latin American debt crisis of 1980s, the Mexican Peso crisis of 1994, The South East Asian and Russian crises of 1997 and1998, the Turkish crisis in 2001 and the Argentinean collapse of 2002. More recently, it has become increasingly involved with debt problems of developing countries. The IMF has often come under criticism for the conditionality of its support to member countries. Although it has not always been prefect in its recommendations, the problems it has been called upon to solve originated with unsound economic but populist entitlement policies that governments have offered their population to buy their vote. When these policies fail, governments are powerless to go back on their word and solve the problems they have created and they blame the international investment community and capitalists for their ills. When their financial systems collapse, then they carry out the necessary reforms under the excuse that they are imposed on them from the IMF in exchange for the badly needed financing.
The World Bank (WB)
The World Bank (WB), based in Washington, D.C, established in 1946. The World Bank has three main branches: the International Bank for Reconstruction and Development (IBRD), the International Development Agency (IDA) and the International Finance Corporation (IFC). It aims to promote economic development in the world’s poorer countries through technical advice, project financing, long-term lending at rates below market interest rates averaging around $30 billion a year and spread over 100 countries.
The World Trade Organization (WTO)
The World Trade Organization (WTO), based in Geneva, established in 1995, that has succeeded the General Agreement on Tariffs and Trade (GAAT), based in Geneva, established in 1995. The WTO was established following the Uruguay Round of multilateral trade negotiations, that were concluded in 1993. This organization should have come to life in the 1940s along with the other two, under the name International Trade Organization (ITO). The US Congress failed to ratify the agreement so the organization never came to life, rather the less formal Secretariat of the GATT was created instead. The WTO is the institution that governs international trade, setting international standards and the rules of trade. Started with 132 members it now has 150 following the admission of Vietnam in January 2006.
The Bank for International Settlements (BIS)
The Bank for International Settlements (BIS) was established in 1930, is based in Basel, Switzerland and serves as a bank for central banks and international organizations. The BIS is the oldest international financial organization established originally following the end of the First World War to facilitate the war reparations payments of Germany. In addition to being a clearing house for central banks, the BIS conducts research and facilitates the coordination of central bank policies and standards. The BIS is the author of the 1988 Basel Capital Accord and the Basel II revision. These accords establish minimum risk adjusted capital adequacy requirements (Tier I and Tier II capital) that internationally active banks should follow to reduce the risk of bank failures and enhance the resilience of the global banking system.
Asian Development Bank
The Asian Development Bank (ADB) is a regional development bank established on 22 August 1966 to facilitate economic development of countries in Asia. The bank admits the members of the United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP, formerly known as the United Nations Economic Commission for Asia and the Far East) and non-regional developed countries. From 31 members at its establishment, ADB now has 67 members - of which 48 are from within Asia and the Pacific and 19 outside. ADB was modeled closely on the World Bank, and has a similar weighted voting system where votes are distributed in proportion with member's capital subscriptions.
By the end of 2012, both the United States and Japan hold the two largest proportions of shares each at 12.78%. China holds 5.45%, India holds 5.36%
Financial crisis of 2007–08
The financial crisis of 2007–2008, also known as the Global Financial Crisis and 2008 financial crisis, is considered by many economists the worst financial crisis since the Great Depression of the 1930s. It resulted in the threat of total collapse of large financial institutions, the bailout of banks by national governments, and downturns in stock markets around the world. In many areas, the housing market also suffered, resulting in evictions, foreclosures and prolonged unemployment. The crisis played a significant role in the failure of key businesses, declines in consumer wealth estimated in trillions of U.S. dollars, and a downturn in economic activity leading to the2008–2012 global recession and contributing to the European sovereign-debt crisis. The active phase of the crisis, which manifested as a liquidity crisis, can be dated from August 9, 2007, when BNP Paribas terminated withdrawals from three hedge funds citing "a complete evaporation of liquidity".
The bursting of the U.S. housing bubble, which peaked in 2006, caused the values of securities tied to U.S. real estate pricing to plummet, damaging financial institutions globally. The financial crisis was triggered by a complex interplay of policies that encouraged home ownership, providing easier access to loans for subprime borrowers, overvaluation of bundled sub-prime mortgages based on the theory that housing prices would continue to escalate, questionable trading practices on behalf of both buyers and sellers, compensation structures that prioritize short-term deal flow over long-term value creation, and a lack of adequate capital holdings from banks and insurance companies to back the financial commitments they were making. Questions regarding bank solvency, declines in credit availability and damaged investor confidence had an impact on global stock markets, where securities suffered large losses during 2008 and early 2009. Economies worldwide slowed during this period, as credit tightened and international trade declined. Governments and central banks responded with unprecedented fiscal stimulus, monetary policy expansion and institutional bailouts. In the U.S., Congress passed the American Recovery and Reinvestment Act of 2009. In the EU, the UK responded with austerity measures of spending cuts and tax increases without export growth.
Many causes for the financial crisis have been suggested, with varying weight assigned by experts. The U.S. Senate's Levin–Coburn Report asserted that the crisis was the result of "high risk, complex financial products; undisclosed conflicts of interest; the failure of regulators, the credit rating agencies, and the market itself to rein in the excesses of Wall Street".The 1999 repeal of the Glass-Steagall Act effectively removed the separation between investment banks and depository banks in the United States. Critics argued that credit rating agencies and investors failed to accurately price the risk involved with mortgage-related financial products, and that governments did not adjust their regulatory practices to address 21st-century financial markets. Research into the causes of the financial crisis has also focused on the role of interest rate spreads.
In the immediate aftermath of the financial crisis palliative fiscal and monetary policies were adopted to lessen the shock to the economy. In July 2010, the Dodd-Frank regulatory reforms were enacted to lessen the chance of a recurrence.
Major Causes of Crises
§ Subprime lending
§ Growth of the housing bubble
§ Easy credit conditions
§ Weak and fraudulent underwriting practices
§ Predatory lending
§ Deregulation
§ Increased debt burden or over-leveraging
§ Financial innovation and complexity
§ Incorrect pricing of risk
§ Boom and collapse of the shadow banking system
§ Commodities boom
§ Systemic crisis
Identify the performance criteria of the IMF program
Poverty Reduction Strategy Papers (PRSPs) are documents required by the International Monetary Fund (IMF) and World Bank before a country can be considered for debt relief within the Heavily (HIPC) initiative. PRSPs are also required before low-income countries can receive aid from most major donors and lenders.
The IMF specifies that the PRSP should be formulated according to five core principles. The PRSP should be country-driven, result-oriented, comprehensive, partnership-oriented, and based on a long-term perspective. The PRS process encourages countries to develop a more poverty-focused government and to own their own strategies through developing the plan in close consultation with the population.[ A comprehensive poverty analysis and wide-ranging participation are vital parts of the PRSP formulation process. There are many challenges to PRS effectiveness, such as state capacity to carry out the established strategy. Criticism of PRSP includes aid conditionality, donor influence, and poor fulfillment of the participatory aspect.
Interaction between monetary and fiscal policies
Fiscal policy and monetary policy are the two tools used by the State to achieve its macroeconomic objectives. While the main objective of fiscal policy is to increase the aggregate output of the economy, the main objective of the monetary policies is to control the interest and inflation rates. The celebrated IS/LM model is one of the models used to depict the effect of interaction on aggregate output and interest rates. The fiscal policies have an impact on the goods market and the monetary policies have an impact on the asset markets and since the two markets are connected to each other via the two macro variables — output and interest rates, the policies interact while influencing the output or the interest rates.
Traditionally, both the policy instruments were under the control of the national governments. Thus traditional analyses made with respect to the two policy instruments to obtain the optimum policy mix of the two to achieve macroeconomic goals as the two were perceived to aim at mutually inconsistent targets. But in recent years, owing to the transfer of control with respect to monetary policy formulation to Central Banks, formation of monetary unions (like European Monetary Union formed via the Stability and Growth Pact) and attempts being made to form fiscal unions, there has been a significant structural change in the way in which fiscal-monetary policies interact.
There is a dilemma as to whether these two policies are complementary, or act as substitutes to each other for achieving macroeconomic goals. Policy makers are viewed to interact as strategic substitutes when one policy maker's expansionary (contractionary) policies are countered by another policy maker's contractionary (expansionary) policies. For example: if the fiscal authority raises taxes or cuts spending, then the monetary authority reacts to it by lowering the policy rates and vice versa. If they behave as strategic complements, then an expansionary (contractionary) policy of one authority is met by expansionary (contractionary) policies of other.
The issue of interaction and the policies being complement or substitute to each other arises only when the authorities are independent of each other. But when, the goals of one authority is made subservient to that of others, then the dominant authority solely dominates the policy making and no interaction worthy of analysis would arise. Also, it is worthy to note that fiscal and monetary policies interact only to the extent of influencing the final objective. So long as the objectives of one policy are not influenced by the other, there is no direct interaction between them.
