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International Financial Policy: Essays in Honor of Jacques J. Polak International Financial Policy Essays in Honor of Jacques J. Polak INTERNATIONAL FINANCIAL POLICY Edited by Jacob A. Frenkel and Morris Goldstein International Monetary Fund De Nederlandsche Bank 1991 © 1991 International Monetary Fund The article by Richard N. Cooper, "What Future for the Interna­ tional Monetary System?" appeared in The Evolution of the Interna­ tional Monetary System: How Can Efficiency and Stability Be Attained? edited by Yoshio Suzuki, Junichi Miyake, and Mitsuaki Okabe (Tokyo: University of Tokyo Press, 1990) and is reprinted with permission. This book was designed and produced by the IMF Graphics Sec­ tion; photograph by Denio Zara. Library of Congress Cataloging-in-Publication Data International financial policy : essays in honor of Jacques J. Polak I edited by Jacob A. Frenkel and Morris Goldstein. P· em. Published in association with De Nederlandsche Bank. Includes bibliographical references. ISBN 1-55775-196-X 1. International finance--<::ongresses. 2. International Mone­ tary Fund--Congresses. I. Frenkel, Jacob A. II. Goldstein, Morris, 1944- III. Polak, J. J. Qacques Jacobus), 1914- HG203.1573 1991 332' .042-dc20 91-46087 CIP Price: US$30.00 Please send orders to: International Monetary Fund, Publication Services 700 19th Street, N.W., Washington, D.C. 20431, U.S.A. Tel.: (202) 623-7430 Telefax: (202) 623-7201 Preface In recognition of Jacques J. Polak's outstanding contributions to international economics and his distinguished service at the Interna­ tional Monetary Fund, the IMF and De Nederlandsche Bank jointly sponsored a conference to honor him. The conference was held in Washington, D.C., on January 13-15, 1991. In the course of his association with the IMF, which spans over forty years, Jacques J. Polak has served the IMF in various capacities, including Economic Counsellor and Director of Research, and member of the Execu­ tive Board representing Cyprus, Malta, the Netherlands, Romania, and Yugoslavia. In these positions-as well as through his writings-Jacques Polak has had a major influence on the shape of the postwar international monetary system and on the IMF' s role in that system. The papers included in this volume were prepared for the confer­ ence by a group of eminent scholars-friends and former colleagues of Jacques J. Polak. The papers deal with a variety of subjects, ranging from the future of the international monetary system to the sequencing of reforms in Eastern Europe. Through publication, it is hoped to disseminate to a wider audience some of the foremost thinking on a number of the major policy issues of the day. Special thanks are due to W.F. Duisenberg and his colleagues at De Nederlandsche Bank for their ideas in planning the conference and for their generous support. The editors are extremely grateful to the authors for their contributions and for their cooperation in preparing the papers for publication. They also wish to thank Jonathan Ostry for assisting with the scheduling, Roberto Brauning and Patricia Kane of the External Relations Department for super­ vising the logistics of the conference, and Adriana Vohden for sec­ retarial assistance. Finally, Esha Ray of the External Relations Department did her usual masterful job in editing the volume for publication. v vi PREFACE The views expressed in the papers are those of the authors and do not in any way represent those of the IMF, De Nederlandsche Bank, or the organizations with which the contributors are associated. }ACOB A. FRENKEL MoRRIS GoLDSTEIN Contents Page Preface v Contributors xiii PART ONE. OVERVIEW AND REFLECI'IONS Chapter 1. Major Themes in the Writings of Jacques J. Polak JacobA. Frenkel, Morris Goldstein, andMohsin S. Khan 3 I. International Spillovers of National Economic Policies · 12 II. The Monetary Approach to the Balance of Payments · 20 III. The Functioning of the International Monetary System · 27 IV. Oosing Remarks · 37 Annex I. Jacques J. Polak-A Bibliography, 1937-91 • 39 Annex II. Depreciation to Meet a Situation of Overinvestment, by Jacques J. Polak · 46 Chapter 2. The Early Years of the International Monetary Fund EdwardM. Bernstein 58 PART TWO. THE INTERNATIONAL MONETARY SYSTEM Chapter 3. Changing Perspectives on the International Monetary System Robert Solomon 67 I. Balance of Payments Adjustment-Then 68 II. Balance of Payments Adjustment-Now 72 III. International Liquidity-Then · 74 vii viii CONTENTS IV. International Liquidity-Now · 76 V. Concluding Comment · 77 Chapter 4. Monetary Integration in Europe Andrew Crockett 78 I. The Costs and Benefits of Monetary Union · 80 II. Transitional Issues · 88 III. The Hard ECU Proposals · 92 IV. Criticisms of the HECU Proposal · 98 Chapter 5. Some IMF Problems After the CommiHee of Twenty Alexandre Kafka 102 I. The Regulatory Functions of the IMF After the Collapse of the Par Value System · 103 II. The Financial Functions of the Fund · 106 III. How to Strengthen the Fund's Influence · 117 Chapter 6. What Future for the International Monetary System? Richard N. Cooper 106 I. Past International Monetary Systems · 126 II. A Brief Evaluation · 133 III. The Case for Flexible Exchange Rates · 133 IV. Problems with Flexible Rates · 135 V. Proposals for Reform · 139 VI. Evaluation of the Single-Currency Proposal · 145 Chapter 7. Failings of the SDR: Lessons from Three Decades Rudolf R. Rhomberg 150 I. Salient Historical Observations · 151 II. Why Has the SDR Failed? · 162 PART THREE. ROLE OF THE INTERNATIONAL MONETARY FUND Chapter 8. Borrowing by the Fund: Ultra Vires and Other Problems Joseph Gold 173 I. Borrowing by IMF Under Article VII · 173 Origin of Power to Borrow · 173 Contents lx Problems of Interpreting Article VII · 178 Aspects of Practice Under Article VII · 195 ll. Direct Loans by Lenders to Members · 218 Ill. Borrowing Under Article V, Section 2(b) • 221 The Power to Borrow Under Article V, Section 2(b) • 221 Borrowing from Nonmember · 221 Constraints on Power to Borrow · 224 Freedom from Constraints · 233 IV. The Case for Borrowing · 236 Annex I. Original Articles and Present Articles · 240 Chapter 9. Recent Evolution of Fund Conditionality Azizali F. Mohammed 244 I. Basic Conditionality · 244 ll. Evolution in the 1980s · 246 Ill. Adaptations to Eastern Europe · 251 Chapter 10. The Monetary Character of the IMF W.F. Duisenbergand A. Szasz 254 I. The Monetary Character in the Early 1980s · 256 II. The Monetary Character in the Present Situation · 260 III. Concluding Remarks · 264 PART FOUR. CURRENT ISSUES IN THE OPEN ECONOMY Chapter 11. Prudential Supervision and Monetary Policy H. Robert Heller 269 I. Policy Functions · 270 II. Bank Supervisory and Regulatory Functions · 272 III. Competing Interests · 273 IV. Basic Tenets · 274 V. Preserving the Central Bank's Independence 276 VI. The Track Record · 277 VII. The Role of the Central Bank in Supervision 279 Vlll. Conclusion · 280 x CONTENTS Chapter 12. National and International Monetary Policy ]. de Beaufort Wijnholds 282 285 I. National Monetary Policy · 288 II. International Monetary Policy · 295 III. Can International Liquidity Be Controlled? • Chapter 13. Exchange Rate Arrangements, Seigniorage, and the Provision of Public Goods Peter B. Kenen 306 306 I. Introduction · 311 II. The Model · 315 III. The National Currency Case • 322 N. Three More Policy Regimes · 328 V. The Common Currency Case · 335 VI. Summary and Concluding Note • 336 Annex I. The Second-Order Conditions • Annex II. Mapping Solutions for Optimal Output 340 of the Public Good · Chapter 14. How to Warrant a Sufficient Level of Energy Supply to Future Generations Jan Tinbergen 345 345 I. The Problem and Its Core · 346 II. Permissible Consumption and "Optimum Moment" · 346 III. Some Interesting Computations · 347 N. Coal · 348 V. Natural Gas · 349 VI. Conclusion · 349 Annex I. Basic Data Used · Chapter 15. Current Issues in Transition Economics John Williamson 350 351 I. The Scope of Reform · 352 II. Gradualism versus a Big Bang · III. The Minimum Critical Size of Bang 355 366 N. Summary and Comparisons · Contents xl PART FIVE. EXTERNAL ADJUSTMENT AND POLICY ASSIGNMENT Chapter 16. The Design of Macroeconomic Policy in the World Economy: Proposals for Reform Victor Argy 373 I. Introduction and Background · 373 II. Reform Proposals · 377 III. An Evaluation of Some Reform Proposals · 406 Annex I. The Medium-Run Model Underlying the Thesis in the Section on "Labor Market Reforms" · 411 Chapter 17. The Current Account and the Policy Mix Under Flexible Exchange Rates Hans Genberg and Alexander K. Swoboda 420 I. The Current Acount as a Policy Target, Alternative Assignment Rules, and Other Preliminaries · 424 II. The Small Economy Case · 428 III. The Policy Mix in a Multicountry Setting · 434 IV. Evidence on Assignment Rules from Simulation Models · 449 V. Capital Mobility, Fiscal Policy, and Coordination: A Summary · 451 Chapter 18. Does the Current Account Matter? The Old View and the New W. Max Carden 455 I. The Old View · 457 II. The New View · 459 III. Qualifications and Complications · 462 IV. The New View and the Sarro-Ricardo Theorem · 471 V. Conclusion · 475 Chapter 19. The Quantity Theory of Money in an Open Economy: Variations on the Hume-Polak Model 479 Robert Mundell I. Monetary Statics · 482 II. Monetary Dynamics · 491 III. Conclusion · 505 Contributors VICTOR ARGY, Professor of Economics, School of Economic and Financial Studies, Macquarie University, Sydney EDWARD M. BERNSTEIN, Guest Scholar, The Brookings Institution, Washing­ ton, and former Director of Research, International Monetary Fund, Washington
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