Institutional reform and sovereign debt crises.

• Author: Rajan, Raghuram G.

In this brief article, I want to offer some ideas for reforms of the International Monetary Fund (IMF). This subject is complicated, and it is very difficult to do justice to in the space available, but I will try. Let us start with a brief review of what the IMF does.

Surveillance, Lending, and Technical Assistance

The IMF is mainly concerned with three activities: surveillance, crisis prevention/crisis resolution, and technical assistance. I will leave out technical assistance, as that speaks for itself, and focus on the other two functions. Surveillance has always been an important motivation for the IMF--even if a country has the best economic expertise at its command, its policies affect other countries, and there is a need for someone to speak out if these policies create problems for other countries. Traditionally, the Fund's policy focus, in the Bretton Woods era, was in the area of exchange rates and trade, primarily because of the destructive consequences of the policies followed during the 1930s and the attempt to avoid repeating those mistakes. Today, even though many of our members have become sophisticated and do not depend on our macroeconomic policy advice to the extent they did in the past, surveillance continues to be an important function of the Fund because the world is so much more interconnected through trade and capital flows.

Even the domestic policies of countries have large international effects, especially if the countries are important players in the global economy. Developed countries have a big responsibility, not just in helping to solve crises, but also in helping to prevent them. After all, movements in developed countries' interest rates, and the attendant movements of capital, are often the starting point for crises in developing countries. The IMF can play a role in drawing attention to the international consequences of developed country policies, and in helping to improve them.

A big problem, of course, is that the IMF can speak, but others need not listen. When we go to large developed countries and tell them, "Your fiscal deficit is 5 percent of GDP and increasing, and it needs fixing," they are apt to say, "Thank you very much. We know it. What's new?" Certainly, for developed countries, the Fund has minor influence unless it can use leverage. One source of leverage is peer pressure--being an impartial arbiter, the Fund can point fingers without appearing biased, and it has the weight of the community of nations behind it in pressing upon a country to alter its policies. A second potential source of leverage is the cross-country expertise the Fund brings to the table. A few countries have sophisticated analysts and researchers who can draw lessons from international experience for themselves. For the rest, the Fund can distill the lessons from its varied experience and still add value through its advice.

That said, both these sources of leverage are increasingly threatened. Private analysts are quite capable of reaching impartial assessments of a country's macroeconomic policies. Also, the number of bilateral, regional, and multilateral venues in which experience is shared is multiplying. It is therefore essential for the IMF to stay ahead of the curve by being perceived as being more impartial and more expert than the alternatives. Going forward, it is important that the Fund continue to recruit high quality economists, maintain a high degree of independence, as well as improve the quality of its analysis and its information base, so that it continue to remain relevant.

Surveillance, of course, is closely linked to the other main function we perform, which is crisis prevention and crisis resolution. (Indeed, one of the aims of surveillance is crisis prevention.) A key purpose of the IMF in the era when private capital flows were limited was essentially to assist countries that did not have market access to weather temporary adverse shocks without the need to incur tremendous costs in adjustment. Countries...