International Monetary Fund (IMF)

Background

During the run-up to the Great Depression and World War II, many governments with severe trade deficits faced a difficult choice between raising interest rates and cutting fiscal deficits or devaluing their currencies and erecting barriers to trade. The latter was more politically expedient, but, as more countries followed this beggar-thy-neighbor path, economic catastrophe ensued. The idea of the IMF was that governments would pool resources, holding them on deposit with the organization, which could loan to countries facing financial problems. Such loans could “soften the blow” of necessary policy adjustments, allowing governments to adjust policies gradually, while remaining open to international trade. U.S. negotiators, led by Harry Dexter White, were concerned, however, that IMF loans might lower governments’ incentives to adjust policies at all (a problem called “moral hazard”).

Gradually, the IMF developed the concept of “conditionality”—where loans are provided as quarterly disbursements subject to governments following prescribed policy adjustments. The conditionality debate concerns how much lending should be provided in return for what policy reforms. Creditor states generally prefer more reform and less lending, whereas borrower states prefer the opposite. Sometimes conditionality helps borrower governments push through their own reform agendas, but governments often find conditionality politically unpalatable because it can be viewed as infringing on national sovereignty. International politics also plays a role: Countries that are strategically important to the major vote-holders of the IMF receive more loans with fewer policy conditions. Some critics question the effectiveness of IMF “programs” of economic reform, arguing that they have failed to promote economic development, although they disagree about whether the failure stems from the loans, the conditions, or both. Evidence of IMF effectiveness in promoting stability is more favorable.

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