The IMF’s Half Step

BOSTON – “What used to be heresy is now endorsed as orthodox,” John Maynard Keynes remarked in 1944, after helping to convince world leaders that the newly established International Monetary Fund should allow the regulation of international financial flows to remain a core right of member states. By the 1970’s, however, the IMF and Western powers began to dismantle the theory and practice of regulating global capital flows. In the 1990’s, the Fund went so far as to try to change its Articles of Agreement to mandate deregulation of cross-border finance.

With much fanfare, the IMF recently embraced a new “institutional view” that seemingly endorses re-regulating global finance. While the Fund remains wedded to eventual financial liberalization, it now acknowledges that free movement of capital rests on a much weaker intellectual foundation than does the case for free trade.

In particular, the IMF now recognizes that capital-account liberalization requires countries to reach a certain threshold with respect to financial and governance institutions, and that many emerging-market and developing countries have not. More fundamentally, the Fund has accepted that there are risks as well as benefits to cross-border financial flows, particularly sharp inward surges followed by sudden stops, which can cause a great deal of economic instability.

What grabbed headlines was that the IMF now believes that countries could even use capital controls, renamed “capital flow management measures,” if implemented alongside monetary and fiscal measures, accumulation of foreign-exchange reserves, and macroprudential financial regulations. Even under such circumstances, CFMMs should generally not discriminate on the basis of currency.