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The world in 1945

In a practical sense, the IMF was born out of the famous conference at Bretton Woods, New
Hampshire, in July 1945. It was there that the representatives of 45 countries, led by America's
Harry Dexter White and Britain's John Maynard Keynes, agreed on a form of international
economic cooperation in the postwar world that was unprecedented in its scope and ambition.
Bretton Woods was concerned primarily with issues relating to international financial stability. In
addition to the International Monetary Fund another new institution was established: the
International Bank for Reconstruction and Development, later the World Bank. This latter was
charged with channeling investment funds, particularly at first to those countries ravaged by war.
The Bank was intended to perform the role played by private international capital flows in the
nineteenth century. No-one at the time seriously expected such private flows to play any
significant part in the postwar global economy.
But it was also understood by those shaping the new postwar framework that trade liberalization
would have to be a key component. The General Agreement on Tariffs and Trade was signed in
1947 with precisely that objective and was succeeded by the World Trade Organization in 1995.
The two Bretton Woods institutions came into being in 1946.
The role of the Fund
The Fund envisaged by its founders wasand isan institution imposing obligations on, and
providing benefits for, its member countries. Members buy shares in the Fund, according to a
quota system; and they undertake to abide by the Fund's rules, including, for instance, the
principle of non-discrimination in their treatment of other members.
In return, they know that other members will also abide by the same rules and so they benefit
from the stable international financial environment that the IMF helps foster and from the global
economic expansion that stability makes possible. Non-members gain from this, too, of course.
But members also benefit from the Fund's surveillance work and from the technical assistance
the Fund provides.
Fund members also have access to the Fund's financial resources when they need temporary
assistance to deal with balance of payments problemsthat is when current account deficits
increase to the extent that a country is at risk of being unable to meet its international payments
obligations. Fund financial support is intended to give member countries breathing space: time to

make adjustments in their economic policies that will ease the pressure on their balance of
Providing temporary financial support in this way was intended to reduce the likelihood of
disruptions to the international system by countries in balance of payments difficulties resorting
to unilateral measures to solve their problems. But it was clear from the outset that in return for
temporary support governments would have to undertake whatever policy adjustments were
necessary; such as reducing domestic demand for exports or, in cases of fundamental
disequilibrium, adjusting their exchange rates in consultation with the Fund and its members.
The rules of the system of which the IMF is guardian have been adapted to reflect the changing
nature of the world economy. And some aspects of the Fund's lending activities have changed,
mainly to enable the Fund better to meet the needs of its changing membership structure.
An evolving system
The framework established at the end of the Second World War has turned out to be both durable
and extraordinarily successful. Most people in most countries are far better off, far healthier and
have a better quality of life than seemed possible at the end of World War II. The world as a
whole has experienced unprecedented economic growth and there has been no repetition of the
depression of the 1930s.
The Fund's role as guardian of international financial stability has, as its architects foresaw, been
absolutely central to this explosion of prosperity. The establishment of a rules-based system for
international financial relations, coupled with financial resources that enable the Fund to lend to
member countries with balance of payments problems, has provided a solid foundation for the
growth of global trade and GDP.
But from its inception the IMF has faced some formidable obstacles in pursuit of its goals.
The first challenge was the economic chaos in Europe at the end of the Second World War. So
great were Europe's economic problems that the American government was obliged to intervene,
launching the Marshall planthe European Recovery Programin 1947 to help kick start the
European economies. The economic challenges confronting most Western European
governments encouraged them to delay making their currencies convertible, as required by IMF
rules. Until 1958, only ten member countries maintained full convertibility.
The Fund sought to accelerate the move towards convertibility by providing support to countries
with balance of payments problems. As the European economies grew stronger and the
international payments position improved, the excuses for postponing convertibility weakened.

In December 1958, ten West European countries made their currencies freely convertible for
current transactions.
1958 thus marked an important point in the development of the modern international system. But
as significant progress was made towards liberalizing the international payments system, the
system of fixed exchange rates began to come under serious strain, not least because of the
resumption of private international capital flows in the 1960s onwards.
Under the Bretton Woods system, exchange rates were supposed to be "fixed but adjustable"
with adjustment limited to cases of fundamental disequilibrium. Countries could, with the Fund's
agreement, adjust their par values to reflect their changing economic circumstances relative to
other countries. The aim was to prevent unilateral adjustments of the kind seen in the 1930s and
over the years, many exchange rate values were altered.
Although increasing strains in the system became evident during the 1960s, the Bretton Woods
exchange rate regime, combined with trade liberalization, had enabled the industrial countries in
particular to grow rapidly in the postwar period.
From the late 1940s to the early 1970s, growth rates among the major industrial countries made
the achievements of the nineteenth century seem modest. America saw average annual growth in
real GDP per capita of 2.4 percent between 1950 and 1973; the comparable figure for Germany
was 5 percent. For Japan the figure was more than 8 percent. Inflation rates were a little higher
than we have grown accustomed to in recent yearsbut only a littlewhile unemployment was
much lower than even America or the U.K. have recently managed.
But the Bretton Woods system hinged on the continued willingness of the US authorities to
maintain the so-called gold windowthe right of anyone to convert their dollars into gold at the
fixed rate of $35 per ounce. For much of the postwar period, large US capital account deficits
had been offset by current account surpluses. But as the overall balance of paymentsthe
current account combined with long term capital movementsmoved into deficit; and as the US
economy came under pressure from the struggle to finance rapid rises in domestic spending
programs and the cost of the war in Vietnam, the US government decided it could no longer
underpin the international financial system. In August 1971, President Nixon announced that the
gold window would be closed and by 1973 the system of fixed exchange rates had been
Many feared that the collapse would bring the period of rapid growth to an end. Growth did slow
temporarily in most industrial countries after the first of the 1970s oil prices shocks: but this was
mainly a result of inappropriate policy responses to the rise in energy prices. In fact, the
transition to floating exchange rates was relatively smooth and it was certainly timely: flexible

exchange rates made it easier for economies to adjust to dearer oil. Floating rates have facilitated
smoother adjustments ever since.
The 1970s marked an important turning point for the Fund in other ways. This brought to an end
the period during which the industrial countries were the Fund's largest borrowers, as they had
struggled to maintain domestic growth and external payments balance.
The Fund and the developing world
Right from the start, the Fund had developing country members, though initially these were
relatively few and the scale of financial support provided to them in the Fund's early years was
relatively small. At the end of the Second World War, the world was broadly divided into two
groups of countries, aside from those in the Communist bloc in Eastern Europe. There were the
haves and the have-nots: the rich industrial and rapidly-growing economies, and the developing
countries which had been on the sidelines during the rapid growth in the industrial world in the
nineteenth and early twentieth centuries.
In the early postwar period, many developing countries sought to accelerate growth by adopting
policies that depended on considerable government involvement in the economy. Instead of
pursuing the economic opportunities afforded by multilateral trade liberalization, the focus was
on government control of the economy, protecting domestic industries and attempting to
substitute domestic production for foreign imports in a misguided belief that this was the route to
growth and prosperity. For some countries, such policies did bring brief periods of growth, but
such spurts were, as always, unsustainable as fiscal deficits soared and growth petered out.
All developing countries benefited, at least to some extent, from the rapid growth of world trade
in the postwar period. But by the 1960s, these countries began to diverge from one another. Some
remained stuck with protectionist policies and government intervention that stymied their growth
prospects and hampered poverty reduction. But a few developing countries started to implement
more effective pro-growth policies, against the backdrop of a stable international financial
environment and the multilateral liberalization of world trade, with the concomitant growth of
world markets.
The results were dramatic. Before long, the remarkable postwar growth rates in the industrial
countries began to seem unexceptional, as the newly industrializing countrieswhat we now call
emerging marketstook off.
The most spectacular performance was in Asia. Growth accelerated rapidly in Korea, Hong Kong
and Singapore, the first members of the group known as the Asian tigers. In 1960, Korea
embarked on a radical program of economic policy reform, including opening the economy up to
trade. Korea's per capita income increased roughly twelve fold between 1960 and 2005. In any

single ten-year period between 1960 and 1995, Korean real per capita income grew by more than
British real per capita income during the whole of the nineteenth century. The rapid growth of
trade, spurred by the removal of trade barriers, was integral to this. And with rapid export growth
in excess of 40 percent a year over quite a long periodemployment and real wages grew
Other countries in the region soon followed suit: Malaysia, Thailand, and Indonesia among
others. More recently we have seen high rates of growth over more than two decades in China,
lifting hundreds of millions out of poverty. Indian growth accelerated significantly after
economic reforms were introduced, beginning in 1991.
In many other parts of the world, though, growth tended to be more volatileas in Latin
America, for exampleor much slower, or even negative, as in some parts of Africa.
Increasingly, the Fund sought to help its developing country members both with financial support
and with the process of policy adjustment needed to enable them to achieve financial stability
and higher growth rates.
In the early 1980s, the so-called third world debt crisis led to much larger Fund involvement with
developing countries including, in some cases, the provision of large-scale financial support.
This crisiswhen many governments found themselves unable to service their loanshad its
origin in the surplus revenues accumulated by the oil producers after the sharp rises in the oil
price in the mid and late 1970s. These revenues had been "recycled" by the international banks
who lent funds aggressively to developing economies, usually on floating rate terms.
With hindsight the result of this large scale lending was predictable. Debt sustainability
regarded as a crucial element of macroeconomic policy todaywas at that time an alien concept.
As interest rates rose in the early 1980s, reflecting the efforts of industrial countries to reduce
inflation, economic policy weaknesses were exposed and many developing country borrowers
found themselves unable voluntarily to service their large debts. The Fund played a significant
role in helping to resolve the problems developing countries faced, both by providing temporary
financial support and by helping them to make policy adjustments.
The experience of the 1980s brought a sharp reminder of the importance of economic policies in
helping foster economic growth. Policymakers in Asia continued to implement policies that
created a growth-friendly environmentlow inflation, outward oriented policies that enabled
Asia to continue to grow rapidly even though many countries were heavily dependent on oil
imports. By contrast, in the 1980s many Latin American countries experienced soaring inflation,
fuelled by large fiscal deficits. In addition, higher barriers to trade hampered growth in Latin
America over a long period. And oil exporting countries, in spite of their high oil revenues,
experienced lower growth rates because of weak macroeconomic policies. Instead of using the
oil revenues to develop and diversify their economies, the governments of many oil-producing

countries used the income for unsustainable current spending and unproductive capital
investment while remaining, in many cases, relatively closed to trade.
The 1990s
As I said at the outset, the 1990s brought the Fund its biggest challenges. The institution played a
central role in assisting the countries of the former Soviet bloc to cope with a dramatic change in
their circumstances. These countries needed Fund help both in the form of financial assistance
but, more important in the long term, in managing the transition to become normally functioning
market economies. This was an economic transformation of a kind that had never before been
attempted, and sometimes the going was less than smooth. But most of these countries are
increasingly regarded as normal, with normal problems: indeed, several are now members of the
European Union with high growth rates.
A more far-reaching development for the Fund during this period, however, was the sharp rise in
private international capital flows. The founders of the Bretton Woods system had largely
assumed that private capital flows would never again resume the prominent role they had in the
nineteenth century. The framework that established the Fund and the financial resources
available to provide temporary support for members were therefore focused on current
transactions. The Fund had traditionally lent to members facing current account difficulties.
But a series of financial crises during the 1990s, triggered by sharp changes in the direction of
capital flows, forced both the Fund and national policymakers to revisit these assumptions. The
first capital account crisis erupted in Mexico in 1994. Crises followed in Asia in 1997-98; in
Russia in 1998; and elsewhere. It became clear, as the decade progressed, that these crises were
fundamentally different from earlier ones. All were capital account crises, large in scale, and, like
most financial crises, involved enormous upheaval for the countries involved. Our experience in
this period underlined the extent to which sound economic policies both foster growth and help
prevent crises from occurring in this new world of large private capital flows.
Look, for example, at the Asian crises. Only a relatively small number of countries were directly
affected, with Korea, Thailand and Indonesia the worst hit. For those countries years of
spectacular growth ended in a dramatic series of national financial crises. But they had an impact
well beyond the countries involved, in part because it was shocking to see economies that had
experienced such rapid growth over such long periods suddenly appear so vulnerable; and in part
because there were, for a time, fears that the crises would spread further.
The sharp reversal of capital flows to Asia in the latter half of 1997 sparked the crises. Net
inflows to the Asian crisis countries were over 6 percent of their GDP in 1995, and just under 6
percent in 1996. In 1997, net outflows were 2 percent of GDP, a figure which rose above 5

percent the following year. The economic dislocation caused by reversals of this magnitude was
huge, and would have been so for any country.
Some have argued that the turnaround in investor sentiment was capricious and unwarranted. But
this argument doesn't hold up: fundamental problems had begun to emerge and they prompted
the shift in capital flows. In particular, there had been a huge expansion of credit over a relatively
short period of time. Rapid credit growth is almost always indiscriminate and, therefore,
dangerous. The result had been a sharp rise in the number of bad loans. The rate of return on
capital had fallen and, in consequence, non-performing loans started to rise. Once these problems
became apparent, it was inevitable that international creditors would undertake a rapid
reassessment of the creditworthiness of debtors and loan exposure.
Several factors conspired to make the consequences of this shift in investor sentiment extremely
painful. Fixed exchange rates prevented a more rapid adjustment to the shift in capital flows
and gave speculators the chance to make a one-sided bet. Government assurances that exchange
rate pegs would be maintained had left currency mismatches unrecognized until governments
were forced to devalue. Banks had built up liabilities in foreign currencies and assets in domestic
currency. Devaluation then left financial institutions and businesses facing massive losses, or
insolvency. The weaknesses of domestic banking systems, a result both of the poor quality of
credit assessment and allocation and because of the mis-matches, were revealedas was the
impact on economic performance.
The contraction in GDP that most crisis countries experienced made things even worse, of
course, because the number, and size, of non-performing loans grew rapidly. The further
weakening of the financial sector inevitably had adverse consequences for the economy as a
whole. The crisis economies found themselves in a vicious downward spiral.
The capital account crises in Asia had much in common with each other and with those that
erupted elsewhere in the 1990s. They occurred rapidlyalarmingly so; they occurred because
holders of a country's debt were concerned about its ability and/or willingness to service that
debt; and because there were doubts about underlying macroeconomic policies.
The speed with which capital account crises erupted meant that financial support from the Fund
for countries affected was often urgently neededin days rather than the weeks or months which
Fund programs for current account crises had usually taken to put together. And the support
needed tended to be on a much larger scale than the Fund had customarily provided because of
the scale of the outflows experienced by crisis countries.
Fund programs with financial support were far-reaching. They included a commitment by the
government to rapid fiscal rebalancing, necessary to bring expenditure and revenues more
closely into line and to address underlying weaknesses in banking systems; a switch to floating

rates or at least more flexible exchange rate regimes; and programs of longer-term reforms aimed
at removing structural rigidities and improving growth potential.
Lessons applied
For the Fund, the most pleasing measure of success is the absence of crises rather than their
effective resolution. Crises will nevertheless occur from time to time. What matters then is how
they are resolved, and two recent examples demonstrate the extent to which national
governments and the international policy community have been able to apply the benefits of our
experience in the 1990s and earlier.
Brazil experienced a major crisis in early 1999 when the government was forced to abandon its
fixed exchange rate regime and introduce wide-ranging reforms. Yet by the middle of 2002,
Brazil was widely seen as being on the brink of another crisis, brought about not by policy
changes but by speculation about the economic policies that might follow the 2002 presidential
election. There was concern in the markets that a new President might not follow the prudent
macroeconomic policies that had helped the Brazilian economy recover from aftermath of the
1999 crisis. Electoral uncertainty led to concerns in particular about the sustainability of Brazil's
large public debt.
A Fund-supported program was agreed during this pre-election period, committing the new
government to maintenance of the existing fiscal, monetary and exchange rate framework, along
with a longer term program of structural reforms. All three major Presidential candidates
undertook to maintain the policy framework should they be elected. In the context of the Fund
program with large-scale financial assistance, the financial markets were rapidly reassured.
The result has been a remarkable transformation in Brazil's economic fortunes. The floating
exchange rate regime, which had already been introduced, has undoubtedly helped smooth the
adjustment process. And prudent fiscal policies have paved the way for more rapid growth and
falling inflation. The country's external financing needs have fallen sharply, and the debt position
has strengthened markedly.
In consequence, Brazilian living standards have risen and poverty has been reduced: in 2004
there were about four and a half million fewer Brazilians living on less than a dollar a day than
there had been only three years earlier.
A great deal has been achieved in Brazil; and we can already see the rewards of a sound
macroeconomic framework in terms of growth and the scope for poverty reduction. There is still
quite a way to go and the government is working on further structural reforms. But at the end of
last year, the Brazilian government repaid all its outstanding debt to the Fund, well ahead of

The work of the Fund today

The Fund's surveillance work gives the institution a unique cross-country perspective. It is, after
all, the only institution that has such a broad membership and that has access to the relevant
information about national macroeconomic policies. Its surveillance work, and the work of
research department, permits comparative insights into economies and economic policies.
Highlighting successful policies is actually as important a part of our work as sounding a note of
caution when there are doubts about national economic policy choices.
Regional surveillance is an increasingly important element of its work, as it monitors the
possible spillover effects of economic policies where groups of countriessuch as those in the
Euro areahave particularly close economic ties.
With emerging market countries and most transition economies, the emphasis is on reducing
vulnerabilities and raising potential long-term growth rates. The two go hand in hand, of course:
the stronger the macroeconomic framework, the higher growth rates will be. Key ingredients of a
strong framework include low, or falling, inflation; sound fiscal and monetary policies;
sustainable debt levels; and policies to remove structural rigidities that hamper growth.
Of course, macroeconomic stability is just as important for low income members: and this has
become increasingly apparent over the years. Most of those poorer countries that have, often
with Fund advice and encouragement, put in place policies to reduce inflation and create the
conditions for growth have experienced higher growth rates. But even in these countries there is
still a considerable way to go before growth rates are high enough to give them a chance to meet
the Millennium Development Goals. Since the Fund is not an aid agency, its role is to help
countries shape their macroeconomic policies in a way that addresses some of the causes of low
Technical assistance
The Fund's technical assistance is a vital part of the work IMF does to help countries implement
reforms that will strengthen their economies and raise their growth potential.
Technical assistance can help countries make their public sectors more efficient. Improving tax
collection procedures, for example, can raise the revenue stream from any given tax rate;
lowering tax rates can also raise revenues by acting as a disincentive for people to participate in
the informal sector of the economy. And by providing expert assistance with pension reforms, TA
can enable countries to manage fiscal policy more effectively, freeing up resources for
infrastructure and more targeted spending without increasing deficits.
Financial assistance

Fund financial assistance was seen as an integral part of the system by its original architects. For
some members, the prospect of temporary support for balance of payments problems remains
important and financial assistance can play a critical role in helping countries overcome
economic difficulties.
Emerging market countries are currently the Fund's largest borrowers, although the currently
favorable global environment means that we have fewer loans outstanding than for some time.
We also provide considerable financial support to low income countries, much of it on
concessional terms. Indeed, we have recently extended the range of facilities available to these
countries. Towards the end of last year, the Fund's Executive Board approved a new facility, the
Exogenous Shocks Facility, which will provide financial support for countries facing shocks,
such as commodity price shocks, or abrupt changes in their terms of trade.
All aspects of the Fund's worksurveillance, technical assistance and financial supporthave a
common goal. It is to enable member countries to ensure that they have in place the policies that
will deliver macroeconomic and financial stability and so lay the foundations for the more rapid
and sustained growth that is the prerequisite for poverty reduction.