IMF love for exchange rate management: a passing fade? (August 2010)

Rethinking Bretton Woods | Fri, Sep 3, 2010

By Aldo Caliari


A few months ago the IMF was issuing a staff paper “Rethinking Macroeconomic Policy.” (IMF 2010).

Most of the attention drawn by the paper was related to what was considered a dramatic departure from Central Bank orthodoxy. This was the possibility of accepting the targeting of inflation at 4, rather than 2 percent—generally on the grounds that having a higher inflation would give policy-makers more room to cut rates in a recession, before the rates hit zero.

The press characterized it as a big change of heart in the IMF, even though, as  any “staff paper,” it born a clear disclaimer that it did not represent the views of the institution.

The paper, however, was significant in a less visible and, yet, important respect: its mention of exchange rate-targeting as a tool some countries could resort to in order to avert sudden exchange rate movements.

A longstanding demand of civil society groups has been the need for broader room for exchange rate management in developing countries. This is in account of these countries’ greater reliance on trade and their position as net “takers” rather than “makers” of global monetary trends. 

In the words of the IMF paper: 

“Large fluctuations in exchange rates, due to sharp shifts in capital flows (as we saw during this crisis) or other factors, can create large disruptions in activity. A large appreciation may squeeze the tradable sector and make it difficult for it to grow back if and when the exchange rate decreases.”

Granted, along the lines of the rest of the paper, this not very bold assertion came as sort of an oblique reference. The reference was found in a place where the paper’s main argument was that central banks argued they were targeting inflation. The paper said that this was, indeed, the case in advanced economies, but that in “small open economies” the evidence suggested central banks “also” intervened to smooth the volatility of the exchange rate.

So exchange rate–targeting was presented more as something possible and a fact of life, and, not to be forgotten, as accompanying, not substituting, a policy of inflation-targeting, rather than as a policy prescription. Further, the usefulness of that practice seemed, in the eyes of the IMF, and also in a one-size-fits-all fashion, confined to “small open economies.”

Nonetheless, the fact that the IMF also characterized the actions of these central banks as “more sensible than their rhetoric“ may have allowed hopeful readers to see a change in its approach to this practice. Let us not forget that only three years ago, the IMF had reviewed its Decision on Bilateral Surveillance policy that had been in place for thirty years to make it all more difficult to keep “misaligned” – that is, not floating—exchange rates. (Caliari 2007) Though the Guidance Note for implementing this Decision was eased last year, the policy itself as revised in 2007 stays in place. (Caliari 2009)

Hopeful readers were up for a disappointment, though.

A more recent paper called “Central Banking Lessons from the Crisis” (IMF 2010a) – this one made official and submitted to Board discussion, so it can be said to represent an institutional position— has chosen to avoid making exchange rate-targeting the subject of any significant finding or recommendation. Its only reference to the practice is the purely factual assertion that exchange rate stability is one of the policy objectives Central Banks take into account (Ib. at 6-7 and footnote 38).

In all fairness, those really hopeful readers might still wait further for another paper, as this one seems focused on the need to include financial stability – not just price stability—as a major policy objective in Central Banking. But do not hold your breath on it. The conclusive title suggests there are no more lessons for Central Banking the IMF intends to draw from the crisis.

In fact, even the controversial statements that made the February paper famous also seem to have been replaced by a more sober return to the “basics” generally accepted.

“Monetary policy should continue to focus on price stability as its primary responsibility” says the paper, before stating that price stability “has typically meant an average inflation rate of about two percent, although definitions vary across countries.” (IMF 2010a, 20-21)

The potential way out from low inflation targets identified in the February paper – namely, giving room to Central Banks to cut interest rates in a recession—is dismissed now: “On rare occasions, a severe crisis may cause policy interest rates to reach the zero lower bound. However, such severe crises usually stem from conditions that also make interest rates relatively ineffective… “ In other words, yes, there is a risk that policy-makers might run out of space to use interest rate easing as a tool, but this only in situations where such easing is useless, anyway. (Ib.)

Maybe the practice of targeting exchange rates is so controversial that the recognition that “sometimes it happens” is all that can be realistically expected in the foreseeable future. But the IMF‘s most recent statement of position furthers a huge divide on this issue between the IMF, on one hand, and the reality and growing body of support for the practice, particularly for trade-dependent economies, on the other.

In a recent study reviewing the historical experience of Latin American countries, Frenkel and Damill come to the conclusion that

“Probably the most important conclusion that can be drawn from our analysis is that the level of the RER has had a significant influence in the macroeconomic performance of Latin American countries. In particular, the experiences reviewed suggest that an excessively appreciated RER can lead to disastrous outcomes affecting short and medium term growth.” (2010:42)

In an environment where the space for industrial policy has been dramatically reduced, exchange rate management remains one of the few tools that governments can employ to diversify a trade profile away from purely primary production.

Another economist, Mr. Dani Rodrik, has gone as far as saying that “a credible, sustained real exchange rate depreciation may constitute the most effective industrial policy there is.” (Rodrik 2004)

The idea of influencing relative prices to promote development of non-traditional export sectors is one recently favored by another renowned mainstream economist, Mr. Barry Eichengreen. In a seminar recently held at the World Bank in Washington DC, he stated: 

“It’s beyond the capacity of governments to identify specific industries and activities, like green growth, to which subsidies ought to be targeted but it’s not beyond their capacity to identify the kind of broad regularities between different sectors like manufactures, and agriculture, and services, and to try to influence the policy mix and relative prices to get the appropriate balance between broad sectors…” (2010)

The financial crisis has shown the need to diversify the export base is a particularly urgent one for developing countries, whose main damage in the crisis did not come from what were relatively strong financial sectors, but as a result of the trade shocks the crisis triggered. In a context where most tools governments used to be able to apply to this purpose have been lost to a number of trade and investment agreements, the macroeconomic policy tools such as exchange rate management become even more critical. But using them requires Central Banks breaking away from “conventional wisdom.” It does not help that the “conventional wisdom” in the Central banking community finds mutually-reinforcing channels with the lack of open debate of new research findings in the IMF.



Caliari, Aldo 2007. Closing all Paths to Trade-led Development? The IMF Revises Guiding Principles on Surveillance.

Caliari, Aldo 2009. IMF backtracks on constraints to trade-led development –but how much?

Eichengreen, Barry 2010. Statement at Managing Openness: Outward-Oriented Growth Strategies after the Crisis, event held at the World Bank, May 10 2010. (See Video recording of the full event)

Frenkel, Roberto and Martin Rapetti 2010. A Concise History of Exchange Rate Regimes in Latin America. February.

IMF 2010. Rethinking Macroeconomic Policy. IMF Staff Position Note by Olivier Blanchard and Giovanni dell’Ariccia and Paolo Mauro. February 12. SPN/10/03.

IMF 2010a. Central Banking Lessons from the Crisis. Prepared by the Monetary and Capital Markets Department. Approved by José Viñals. May 27, 2010

Berg, Andrew and Yanliang Miao. 2010. The Real Exchange Rate and Growth Revisited: The Washington Consensus Strikes Back? Working Paper No. 10/58.

Rodrik, Dani 2004. Growth Strategies. Harvard University