What is an International Monetary Fund (IMF)?
The International Monetary Fund (IMF) is the central institution embodying the international monetary system and promotes balanced expansion of world trade, reduced trade restrictions, stable exchange rates, minimal trade imbalances, avoidance of currency devaluations, and the correction of balance-of-payment problems. The IMF's goal is to prevent and remedy international financial crises by encouraging countries to maintain sound economic policies. Because of its size, the IMF is also a forum for discussion of global economic policies.
The IMF is headquartered in Washington, D.C., but has offices in Paris, Tokyo, New York, and Geneva.
How Does an International Monetary Fund (IMF) Work?
The IMF formally came into existence in December 1945 with 29 member countries after it was conceived during negotiations of the Bretton Woods Agreement in 1944. It was originally tasked with establishing exchange rates after World War II through regulation of rates among the member countries.
Between 1944 and 1971, most of the world operated under a fixed exchange-rate system, which required each country to maintain a reserve balance of other currencies in order to weather temporary supply and demand problems. Thus, the IMF required each member country to deposit currency into an interest reserve fund. The IMF then loaned these funds to nations with balance-of-payment problems.
Today, the IMF promotes its objectives through surveillance and consultation with member countries rather than regulation. It still provides short-term loans to member countries having balance-of-payment problems, and countries seeking assistance must meet or exceed certain thresholds related to inflation rates, budget deficits, money supplies, and political stability.
Mechanics of the IMF
The IMF is run by a board of governors, which makes decisions on major policy issues but delegates day-to-day decision making to the executive board. All member countries are represented on the board of governors, which meets once per year. Each member country appoints a governor and an alternate governor to represent it to the IMF. The governors are usually the ministers of finance or governors of their central banks.
The IMF's 24-member executive board is chaired by a managing director. The managing director is selected by the executive board every five years, and three deputy managing directors, each from a different region of the world, report to the managing director.
The executive board meets three times a week, and the IMF's five largest shareholders (the United States, Japan, France, Germany, and the United Kingdom) as well as China, Russia, and Saudi Arabia, each have a seat on the board. The other sixteen directors are elected for two-year terms by groups of countries.
There are several committees within the IMF. The International Monetary and Financial Committee, which is a committee of the board of governors, meets twice per year to evaluate policy issues relating to the international monetary system. The IMF Development Committee, which is composed of members of the boards of governors of both the IMF and the World Bank, advises and reports to the IMF governors on matters concerning developing countries.
The IMF has a weighted voting system that gives more votes to countries with larger economies. However, according to the IMF, most decisions are not made based on formal voting, but by consensus.
The IMF is funded by the subscriptions countries pay upon joining the IMF or when their subscriptions are increased. Members pay 25% of their subscriptions in Special Drawing Rights (SDRs) or in major currencies. The IMF can call on the remaining 75% as needed for lending.
The IMF determines a country's subscription amount based on its relative size in the world economy. The IMF may borrow money to supplement the funds received from subscriptions. Generally, the IMF may borrow money from several countries that participate in one of two standing lending agreements with the IMF.
The IMF monitors economic and financial developments and policies in member countries and at the global level and then gives policy advice to its members based on its observations and experience. IMF advice generally focuses on macroeconomic, financial-sector regulation, and structural policies. To do this, the IMF engages in three types of surveillance: country surveillance, global surveillance, and regional surveillance. During country surveillance, which occurs annually, a team of economists visits a member country to collect data, examine policies, and meet with government and bank officials. The team submits its findings to the IMF executive board, which makes recommendations to the country. The IMF's global surveillance functions center around the publication of the World Economic Outlook and Global Financial Stability reports, which are issued twice a year. Regional surveillance usually occurs within a series of internal IMF discussions about developments in certain regions or within groups of countries.
The IMF also provides technical help and training to the market participants and governments of member countries. This often comes in the form of advice on banking regulation, tax administration, and budget formulation as well as managing statistical data and drafting or reviewing legislation. They also provide training courses for government and central bank officials.
One of the IMF's single biggest functions is lending money to members in need. If a country is unable to make payments to other countries without taking 'measures destructive of national or international prosperity,' such as implementing trade restrictions or devaluing its currency, it may borrow money from the IMF. When the IMF lends a country money, it often requires the borrower to follow a program aimed at meeting certain quantifiable economic goals, which are described in a letter of intent from the borrowing government to the IMF's managing director. IMF loans are not provided to fund particular projects or activities, they are provided to promote a country's overall economic health. The duration, payment terms, and lending conditions vary on a case-by-case basis. The IMF charges borrowers a market-related interest rate and also requires service charges and a refundable commitment fee. Low-income countries pay as little as 0.5% interest per year.
The IMF also lends money to countries dealing with sudden losses of financial confidence, such as after natural disasters or wars, in order to prevent the spread of financial crises stemming from those countries. There are five main facilities from which the IMF makes loans: IMF Stand-By Arrangements (for short-term lending), the Extended-Fund Facility, the Poverty Reduction and Growth Facility, the Supplemental Reserve Facility, and the Exogenous Shocks Facility.
When a country borrows from the IMF, the proceeds are deposited in the country's central bank. The repayment period varies for each loan, but maturities usually extend from six months to up to ten years. The international community places considerable pressure on a borrower to repay the IMF so that those funds are available to other countries, and the IMF in turn is diligent about timely repayment in order to maintain its status as a preferred creditor.
Why Does an International Monetary Fund (IMF) Matter?
The IMF, like the World Bank, is one of the most powerful and controversial legislative bodies in the world. The IMF's objectives focus on macroeconomic performance and policies, while the World Bank focuses on long-term economic development and poverty-reduction issues. The IMF works actively with the World Bank, the World Trade Organization, the United Nations, and other international bodies that share an interest in international trade.
Whether the IMF truly benefits the international economy is the subject of considerable debate. Much of the criticism centers on the IMF's requirements to adopt certain economic policies in order to receive IMF loans, which may encourage poor countries to neglect social concerns in order to comply. Supporters note that the IMF strengthens the economic and financial-integration effects of globalization and helps low-income countries benefit from globalization through the development of sustainable economic policies and debt reduction in the poorest countries. They also state that IMF approval often indicates a country's economic policies are favorable, which may reassure and motivate investors and other governments who might provide additional financing to the country in need. This not only attracts capital, it prevents investors from withdrawing funds from an economy, which could create further distress for that country and possibly for other countries.