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Saturday, February 25, 2006

Rethinking the IMF (Mervyn King's lecture)

I attended a talk by Mervyn King, who is Governer of Bank of England, in Delhi. The talk, which was organised by ICRIER, was titled Reform of the IMF. The pdf file of appeared on the Bank of England website. It was fun. It was delightful hearing sharp and modern economics from an employee of a government! I admire the human capital that the UK is able to bring into economic policy. The Bank of England reform is amazing, and so are the humans of that story, such as Mervyn King, Charlie Bean, and Charles Goodhart.

As the old job of the IMF (to periodically bail out countries with a pegged exchange rate which get into trouble) has become redundant in a world with floating exchange rates and open capital accounts, many people have started pondering how to do an IMF differently.

One famous set of ideas on IMF reform has come from Charles Calomiris and Allan Meltzer. Mervyn King's ideas are more radical. He envisages an IMF that shifts into tasks of data, research and meetings. As he describes it, the only instruments that the reformed IMF should have should be the powers of analysis, persuasion and ``ruthless truth-telling''. I think it makes a lot of sense. Yesterday's Business Standard had an excellent editorial on this.


  1. You have written in previous posts about the need for the RBI to regain control of monetary policy and give up the idea of pegging the exchange rate to the dollar. This would imply that targeting the excahnge rate will cease to become one of the bank's objectives.
    The question I have is whether there may be legitimate reasons for employing a exchange rate management policy in the first place? Economic theory tells us that the exchange rate is the most important price in an open economy and decides the relative price of tradables (imports/exports) for that economy. So can a floating exchange rate, that can potentially induce a high amount of volatility in the exchange rate, have bad consequences for the real economy under any condition?
    There are people who point out to the benefits of having low volatility of the exchange rate by pointing out to the example of China. They hypothesize that China is currently using a pegged exchange rate (that has been in operation for a very long period of time)to fundamentally alter the structure of its economy, by moving labour out from low productivity agriculture to high productivity industry (export sector). Do you buy this argument?

    So if a country has to enjoy the benefits of both a pegged exchange rate and have the control over monetary policy, it seems that they have to give up openess of their capital accounts! What is the right way for policy makers in india to analyze this problem?

  2. The "impossible trinity" of open economy macroeconomics asserts that you can have only 2 of 3 of the following: open capital account, fixed exchange rate and autonomous monetary policy.

    So if you say you want exchange rate policy, and the capital account is open, that comes at the price of autonomy of monetary policy. The degree of freedom of monetary policy gets "used up" in chasing the currency goal. So countries are down to asking: Is fixing the exchange rate more important, or is a monetary policy that's suited to the domestic business cycle more important?

    Some people like to respond saying that what's nice is : closed capital account + fixed exchange rate + autonomous monetary policy. But this runs afould of the difficulty of closing the capital account. Burma and North Korea can have a closed capital account. A country that has a huge current account, like India, can't enforce a closed capital account.

  3. nice speech(@ stanfy) on the relevant topic:


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