IMF funds are SDRs, which are funded internationally not domestically

It is common to talk of the IMF as being an international lender of last resort (LLR), playing a role akin to the one played by central banks in a domestic context. I myself have used this analogy at times and I suspect many of those in this room have done so as well.¶ But the more I have thought about the subject, the more I have realized that the analogy falls short. In reality, while the IMF performs some functions that look like an LLR, it also differs from a domestic LLR in a number of important respects. Indeed, the differences are so fundamental—and so unlikely ever to be eliminated—that it is time we change the terminology of what the Fund really does and should do in the future, assuming it should continue to exist.¶ Central banks within countries typically have three characteristics that enable them to function as lenders-of-last-resort:¶ They can flood a troubled market with liquidity by printing money (which ordinarily lowers interest rates on government securities and thereby makes investments in riskier assets, such as loans, bonds and equity securities, relatively more attractive).¶ They can provide temporary loans to specific solvent institutions, typically banks, that may find themselves short of liquidity in a crisis.¶ They limit moral hazard by regulating potential borrowers (banks), and if they are following Walter Bagehot’s rules, only provide loans at a penalty rate backed by good collateral.¶ The IMF differs from a domestic LLR, however, in the following important respects:¶ First, although it has created a small amount of a kind of “world money” for central banks, or SDRs, the Fund cannot act as the world’s provider of liquidity. The resources of the Fund are limited by the amount of currencies deposited by members. The Fund cannot print money to lend to any worthy borrower like a central bank, but increasingly must husband its scarce resources, a topic I address in greater detail shortly.¶ Second, while the Fund can and does lend to individual countries in need of liquidity, its loans often have effective maturities that last for years.¶ Third, I do not believe the distinction between “illiquidity” and insolvency” is useful in the international context. It is hard enough for a central bank, in the heat of a crisis, to distinguish whether any particular bank is illiquid or insolvent. But what would it even mean to say that a country is insolvent and not merely illiquid?. Sure, governments can and do default on their obligations. But are the countries “insolvent” when they do so, or are political leaders simply unwilling to pay the political and economic price of honoring the country’s debts? Take Russia, as an example. Even though the government there has effectively defaulted on its loans, and caused the banks to do likewise, Russia remains very rich in resources and so is hardly “insolvent”.¶ Fourth, the Fund does not regulate countries preemptively in the same way that central banks (or national supervisors) regulate their potential bank borrowers. To be sure, the Fund has a carrot—money—to persuade countries that want to avoid a crisis by reforming their policies. But until countries ask for money, either in the absence or in the middle of a crisis, the Fund has no ability to regulate their activities.¶ With some exceptions, the Fund does not charge a penalty rate on its loans, and in this sense the IMF looks very much like our Fed. At the same time, the Fund’s conditions on its loans seem to entail more micomanagement of its borrowers than would be the case even for a national bank supervisor of a troubled institution. But the Fund imposes tough conditions because it cannot seize assets of countries, as can private creditors; or overthrow their leaders, as even U.S. regulators can now do in the case of weakly capitalized banks under the new “prompt corrective action” regime (to be precise, U.S. regulators can assume control of a weak, but still solvent bank, and sell it to others who can recapitalize and manage it).¶ Sixth, unlike central banks that have an interest in immediately supplying such funds as may be necessary to stop a deposit run (consistent with prudent lending practices), the Fund dribbles out the disbursement of its assistance in small doses. It does this because the prospect of handing over more money is its only real leverage to ensure that borrowing countries adhere to the Fund’s conditions. But gradualism has its costs as well, since countries can find it hard to stop a currency run when they are short of reserves on hand.¶ Seventh, the IMF is governed by many different countries with different interests and must work by consensus. Its director does not have the power of, say, an Alan Greenspan to move the entire body, although recently the U.S. government (through the Treasury) has been well out in front in leading the IMF. However, the U.S. still only has an 18% vote, and our influence inevitably must wane if we are not willing to provide the IMF with the additional resources it has requested.