Global Financial Turmoil, the IMF, and the New Financial Architecture

CRS Report for Congress
Global Financial Turmoil, the IMF, and the New
Financial Architecture
Updated November 15, 2001
Dick K. Nanto
Specialist in Industry and Trade
Foreign Affairs, Defense, and Trade Division

Congressional Research Service ˜ The Library of Congress

Global Financial Turmoil, The IMF, and the New
Financial Architecture
The economies of the world appear to be heading into a simultaneous slowdown
and possible global recession that could bear significant consequences for U.S. and
world employment, government finances, stock markets, international trade, and
capital flows. The poor economic outlook has been clouded even further following
the terrorist attacks on September 11, 2001. There has been a sharp curtailment of
activity in industries such as travel and tourism, a drop and slow recovery in stock
markets, and sagging consumer confidence not only in the United States but in
numerous other countries.
Unlike the Asian financial crisis of 1997-99 when economic strength in the
United States and Europe offset weakness in Asia, Russia, and Brazil, this time all
major economies seem to be slowing at the same time. The U.S. response to this
global downturn has entailed and may require additional action by the U.S. Federal
Reserve, the Bush Administration, and the Congress in concert with the International
Monetary Fund (IMF) and other multinational organizations.
Congressional interest in this issue is related to: (1) the effects of global
economic turmoil on the U.S. economy, (2) operations of the International Monetary
Fund, (3) U.S. responses to globalization, and (4) U.S. policies to stimulate the
economy. Among these policy issues, this report will focus on the spread and effects
of the economic turmoil with a focus on Asia.
In seeking a new world financial architecture, policymakers are trying to
improve the international monetary and financial system, to reduce the risk that
systemic crisis will recur, and to ensure that, when isolated country crises do happen,
there are early warnings, effective policy tools, adequate resources, and broad support
to help nations withstand difficult external conditions.
Several studies have examined the role of the International Monetary Fund in
financial crises. The IMF, itself, also has been reviewing its policies and operations
in light of severe criticism from various quarters. It has begun to take more
preventative measures, has increased transparency, and is working with nations to
improve their standards, economic policies, and measures to prevent financial crises
from occurring.
Since the United States is the largest economy in the world, global economic
conditions depend greatly on the state of the U.S. economy. As the nascent recession
in the United States has pulled down other economies, a strong recovery could do
much to lift the economies in the rest of the world. This can be pursued primarily
through monetary and fiscal policies – both domestic and coordinated with those of
other nations – and international trade policy being pursued to increase global market
efficiency and to ameliorate the adverse effects of foreign unfair trade practices.

In troduction ......................................................2
Declining Economic Growth Rates....................................3
Contagion in World Financial Crises...................................4
Causes of Financial Crises, The Case of Asia............................7
Securities Markets................................................10
The International Monetary Fund ....................................12
Criticism of the IMF..........................................17
The IMF Response and New Financial Architecture..................20
U.S. Economic Policy.............................................22
Appendix: Archive of News Topics..................................24
List of Figures
Figure 1. Growth Rates in Real GDP for Selected Countries and Country
Groups for 2000 and Forecast for 2001 and 2002.....................3
Figure 2. Indexes of Currency Values With Respect to the Dollar
for Japan, Thailand, South Korea, Brazil, Russia, and Indonesia,
July 1997-October 2001 ........................................8
Figure 3. Indexes of Stock Market Values for the United States, Japan,
Russia, Hong Kong, and Indonesia during the Asian Financial Crisis
July 1997-June 99............................................10
Figure 4. Indices of Stock Market Values for the United States, Japan,
South Korea, Russia, and Hong Kong, September-November 2001......11
List of Tables
Table 1. IMF Lending from Its General Resources Account
Under Stand-by Arrangements and Extended Fund Facilities
As of August 31, 2001........................................15
Table 2. IMF Support Packages During the Asian Financial Crisis..........16

Global Financial Turmoil, The IMF, and the
New Financial Architecture
Most Recent Developments1
!JAPAN The government revised the real GDP data for the second
quarter, now showing a 2.9% annual rate decline – a slight
improvement over the first estimate, which showed a 3.2% drop.
Nominal GDP still fell at a 10%-plus rate. (Nov. 13, 2001)
!EURO ZONE The European Central Bank lowered its main
interest rate by 50 basis points to 3.25%, its first move since its 50
basis point cut on September 17. Central banks around the world are
reducing interest rates to counter the potential major adverse global
economic and financial-market implications of the September 11
terrorist attacks on the United States.(Nov. 8, 2001)
!ARGENTINA Facing default on its debt, Argentina unveiled a
debt-swap plan to exchange $60 billion in existing government
bonds for new ones carrying lower interest rates. Bond-rating
agencies on Wall Street considered this a “selective default” on its
$132 billion debt and downgraded its rating to junk bond status.
(Nov. 6, 2001)
!UNITED STATES Real GDP growth fell 0.4% in the third quarter
(annualized), following a 0.3% increase in the prior quarter. On the
positive side, this decline is less dramatic than expected. On the
negative side, this will probably mark the first quarterly dip in the
economy, with another decline to follow in the fourth quarter. The
last two economic contractions were in the first quarter of 1993
(0.1%) and the first quarter of 1991 (2.0%). (Oct. 31, 2001)
!APEC OUTLOOK The Asia Pacific Economic Cooperation forum
released its 2001 Economic Outlook which concluded that prospects
for the year remain weak, as the negative impact of the global
cyclical downturn rippled through and dampened business and
consumer confidence. APEC had lingering concerns about the
inventory adjustment in the information technology sector, more
difficult financing conditions in some emerging economies,
weakening corporate profitability and downward adjustment in
equity prices, slower than expected recovery in the U.S., continued

1 See the Appendix for an archive of these developments.

slow growth in the euro area, and a possible slip back of the
Japanese economy. The report asserted, however, that a reasonably
good prospect existed for an early rebound in growth in 2002.
(October 18, 2001)
!UNITED STATES Consumers’ desire to spend came to a standstill
in September following the terrorist attack. Households were glued
to their television sets for news updates after the attack occurred and
never recovered their interest in shopping. Retail sales plummeted
2.4% following a 0.4% increase in August. Purchases of big-ticket
items were hurt most. Auto sales fell 4.6%; excluding auto, retail
sales were still down by 1.6%. (October 12, 2001)
!CAPITAL FLOWS The Institute of International Finance
projected net private capital flows to emerging market economies to
fall sharply from $167 billion in 2000 to about $106 billion in 2001
as a result of the terrorist attacks, global slowdown, and earlier crises
in Argentina and Turkey. (September 20, 2001)
The economies of the world appear to be heading into a simultaneous slowdown
and possible global recession that could bear significant consequences for U.S. and
world employment, government finances, stock markets, international trade, and
capital flows. The poor economic outlook has been clouded even further following
the terrorist attacks on September 11, 2001 in the United States, even though
industrialized nations around the world have taken action to ease monetary policies
in an attempt to forestall further declines in economic growth rates. There has been
a sharp curtailment of activity in industries such as travel and tourism, a drop and
slow recovery in stock markets, and sagging consumer confidence not only in the
United States but in numerous other countries.
Unlike the Asian financial crisis of 1997-99 when economic strength in the
United States and Europe offset weakness in Asia, Russia, and Brazil, this time all
major economies seem to be slowing at the same time. The U.S. response to this
global downturn has entailed and may require additional action by the U.S. Federal
Reserve, the Bush Administration, and the Congress in concert with the International
Monetary Fund (IMF) and other multinational organizations.
Congressional interest in this issue is related to: (1) the effects of global
economic turmoil on the U.S. economy, (2) operations of the International Monetary
Fund, (3) U.S. responses to globalization, and (4) U.S. policies to stimulate the
economy. Among these policy issues, this report will focus on the spread and effects
of the economic turmoil with a focus on Asia. For information on globalization, see
CRS Report RL30955, The Issue of Globalization – an Overview, by Gary J. Wells
and CRS Report RL30891, Global Markets: Evaluating Some Risks the U.S. May
Face, by Craig K. Elwell. For information on the IMF, see CRS Report RL30635,
IMF Reform and the International Financial Institutions Advisory Commission, by

J.F. Hornbeck; CRS Report 98-987, Brazil’s Economic Reform and the Global
Financial Crisis, by J.F. Hornbeck, and CRS Report RL30467, IMF and World Bank
Activities in Russia and Asia: Some Conflicting Perspectives.
Declining Economic Growth Rates
Following the 1997-99 Asian financial crisis, most countries seemed to be on
the path toward recovery and sustained growth. The dip in economic growth rates
was short-lived, and except for Indonesia, countries in Asia which had been the
hardest hit by the crisis began recovering relatively quickly. In 2000, world
economies grew by an average of 4.0% with strong growth in gross domestic product
(GDP) in the Former Soviet Union (7.8%), North America (4.1% in the U.S., 4.6%
in Canada), Asia/Oceania (4.0%), South America (3.3%), and Western Europe
(3.5%). For 2001, world growth is slowing. The growth rate in global GDP is
expected to drop by more than half. The Economist Intelligence Unit forecasts 1.7%
for the year, while DRI-WEFA projects 1.4% (both are econometric forecasting
firms). Anything below 2% is considered to be recessionary for the world. This
would be the most rapid deceleration in world economic growth since the 1974 oil
price shock and includes truly recessionary economic conditions for many countries.

Figure 1. Growth Rates in Real GDP for Selected Countries and
Country Groups for 2000 and Forecast for 2001 and 2002
6.9 7.2 72001
4.1 4.6 4
3.1 3.33.34
2 2
1.51 1.3 1.8 1 1.41.32
S.adapan (a)xico (b)inaorld
U.anJa-4e. 7ChW
CropeM Am
. E
Source: DRI-WEFA. a. Fr, Ger, It, UK. b. Arg, Brzl, Chile, Colum, Ecuadr, Peru, Venez.

As shown in Figure 1, according to DRI-WEFA, world economic growth is
forecast to drop from 4.0% in 2000 to 1.4% in 2001 and then to recover somewhat
to 2.0% in 2002. The drop in growth in 2001 is expected to be slightly greater in the
United States (1.0% growth in GDP in 2001), Canada (1.3%), and in Japan where
growth is expected to drop into negative territory (-1.2%). In Western Europe, the
average growth rate for the Big Four – France, Germany, Italy, and the United
Kingdom – combined is expected to drop to a sluggish 1.8%. For Latin America,
Mexico’s growth rate likewise is dropping from 6.9% in 2000 to an expected 0.1%
in 2001, while the average for seven South American countries (Argentina, Brazil,
Chile, Columbia, Ecuador, Peru, and Venezuela) also drops from 3.3% in 2000 to
1.0% in 2001. The middle-income countries of Asia are dominated by India and
China. Beijing and foreign investors are pumping enough money into the economy
to keep China at 7.2% growth in 2001, while India’s growth is holding at about 5.0%.
Among other Asian countries, growth in Hong Kong is expected to plummet from
a phenomenal 10.5% in 2000 to -0.3% in 2001. Taiwan is in similar straits as growth
is dropping from 6% in 2000 to a recessionary -2.1% in 2001. The economic growth
rate in South Korea also is plunging from 8.8% in 2000 to 2.0% in 2001.
During the 1997-99 Asian financial crisis, the United States served as an export
market of last resort. In 1998, countries in Asia were able to begin recovery largely
by exporting to the booming U.S. market. This time, however, the slowdown in the
United States is being spread to many of the countries in Asia that depend on exports
to the U.S. market. Particularly in information technology, as the bust in U.S.
information technology markets has proceeded, some of the first suppliers to be cut
off have been those overseas. Taiwan, in particular, is dropping into recession partly
because its exports to the United States of electrical machinery (including integrated
circuits) and computers are down. As other countries have slowed, moreover, their
demand for imports from the United States also has turned sluggish. Even though
overall U.S. exports are declining only slightly, over the first eight months of 2001
U.S. exports to Taiwan dropped 23% and to South Korea fell by 19%. Some of this
is attributable to the strong U.S. dollar, but deteriorating growth abroad is a major
cause. This is combined with declining consumer confidence and problems still
unresolved from the previous financial crisis. Still, the drop in U.S. imports because
of the weak U.S. economy is more than offsetting the decline in U.S. exports to cause
the overall U.S. balance of trade to improve somewhat.
Contagion in World Financial Crises
How does a financial crisis in one country, such as Thailand in 1997, set off
global responses, destroy billions of dollars in wealth, throw millions of people into
poverty, and even set off events leading to changes of governments? In the current
economic scene, how does economic weakness in one country get transmitted across
borders to bring down economic activity in another? What are the roads of contagion
for economic conditions?
Economies always have interacted with each other, but globalization has added
a new dimension to the international pathways among them. Financial markets today
are international in scope and are more linked, volatile, leveraged, and of greater size

than at any time in history. The economies of the world have become more
interconnected not only through trade in goods and services but through flows of
investment capital, speculative financial activities, and bank loans. These extensive
linkages have combined with rapid communications to make currency and stock
markets more volatile and easily influenced by events and economic conditions in
other countries. Financial investments also have become more leveraged with
borrowed funds. When markets suddenly turn, these highly leveraged positions can
generate enormous losses (or gains).
The magnitude of the flows of capital among countries also has become huge
and unprecedented. A study by the Bank for International Settlements indicates that
the volume of foreign exchange transactions in 43 markets has exploded to an
estimated $1.5 trillion per day (after making corrections for double counting) — or
about 60 times as great as world trade in goods and services.2 Private capital flows
have grown to the extent that many countries no longer can maintain adequate
foreign exchange reserves to handle sudden outflows or to keep such outflows from
pushing down exchange rates. Between 1990 and 1998, the assets of mature market
institutional investors more than doubled to reach $30 trillion – about equal to world
gross domestic product. In 2000, net inflows into the United States, the world’s
largest recipient of capital flows, exceeded $400 billion. This included a record level
of foreign portfolio investment in U.S. equities and corporate bonds.
These increased levels of trade and investment provide the pathways by which
business cycles are transmitted from one economy to another. The extent to which
foreign economic conditions can affect a particular economy, however, depends on
how large the economy is, how large the foreign sector is relative to the rest of the
economy, and whether domestic monetary and fiscal policies as well as economic
activity go counter to or complement that which is happening in other economies of
the world. Each country will experience economic shocks that can be purely
domestic, such as the crash of the information technology market in the United
States. Other economic shocks can be global, such as a spike in oil prices or a
simultaneous downturn in Europe and Asia.
The larger an economy, the less it is likely to be affected by international
economic fluctuations. In a world economy of $31 trillion, the economies of the
United States ($9.8 trillion GDP), the European Union ($7.8 trillion), and Japan ($3.4
trillion) are large enough that their domestic economic conditions tend to affect other
economies more than they are affected by them. Still, they are not immune to
international economic conditions, and international commodity prices, such as that
for petroleum, are transmitted to them directly.
For particular countries, the larger its international trade flows relative to the
size of its economy, the greater the role trade is likely to have in transmitting effects
of foreign business cycles. In the United States and Japan total trade (imports and
exports of goods and services) accounts for about 20% of GDP. In major European
countries, total trade accounts for more of GDP (about 50%), but much of this is

2 Bank for International Settlements. Central Bank Survey of Foreign Exchange and
Derivatives Market Activity 1998. May 1999. P. 1-4.

trade within the European Community. Canada’s trade dependence at about 70% of
GDP is quite dependent on trade – particularly with the United States, while smaller,
export-oriented countries, such as Singapore, in which trade may account for more
than 100% of GDP, are heavily dependent on trade and quite susceptible to
fluctuations in external economic conditions.
Over the past three currency crises — the European crisis in 1992, the Mexican
Peso crisis in 1994, and Asia financial crisis in 1997 — the best predictor of the path
of contagion has been along trade lines. Currency crises have tended to be regional
— among those countries that trade the most with each other or trade with similar
markets.3 The major reason that currency crises spread along trade lines is that once
a country devalues its currency, its neighbors suffer a competitive disadvantage in
export markets and in selling to that country.

3 How Do Currency Crises Spread? Federal Reserve Bank of San Francisco Economic
Letter, August 28, 1998. On the Internet at
[ ht t p: / / www.f r bsf .or g/ econr sr ch/ wkl yl t r / wkl yl t r 98/ el ml ] .

Causes of Financial Crises, The Case of Asia
How do financial crises begin? In the case of the 1997-99 Asian case, the global
economic turmoil can be traced to many factors – most of them problems with either
the financial system or activities by actors in the system. First, there were foreign
exchange rates in Asia tied to the appreciating U.S. dollar and too inflexible to adjust
to changing trade and capital flows. Second were bankers and corporations who
borrowed short-term on international markets to finance long-term investments –
some of dubious value – in booming local economies. Third were emerging markets
without developed financial infrastructure and with insufficient regulation and
market discipline in which the allocation of capital and resources was influenced
excessively by personal connections and politics (cronyism). Fourth were highly
confident businesses that overbuilt manufacturing capacity and office buildings in
Asia and began to default on bank loans. Fifth were real estate and stock market
bubbles by which excess liquidity was poured into land and corporate equities
creating a euphoria as prices rose but also generating huge losses as prices fell.
Some of the above problems have been corrected as part of the reforms
following the Asian financial crisis, but some are so deep-rooted in economies that
they remain today. The most progress has been made with exchange rate regimes.
Countries now rely on a variety of exchange rate regimes that allow for more
flexibility. Some countries, such as China/Hong Kong, Argentina, Estonia, and a
number of smaller nations still peg their exchange rate against a single or composite
of currencies. Most large economies allow their currencies to fluctuate either freely
or within specific crawling bands.

Figure 2. Indexes of Currency Values With Respect to the Dollar
for Japan, Thailand, South Korea, Brazil, Russia, and Indonesia
July 1997-October 2001
Japanese Yen
S. Korean
WonThai Baht
Brazilian Real
1997 1998 Rupiah1999 2000
5 17r 11r 22t 7 18 30r 24y 5t 20c 1r 29y 10t 25c 6r 11y 23t 17 14
Jul 2ug 13ep 24NovcJan 28MaApJun 3Jul 15ug 26OcvcFeb 10MaMaJun 16Jul 28Sep 8OcDeJan 12Feb 23MaJun 21Aug 2ep 13OcDeJan 17Feb 28ApJul 4ug 15ep 19Ocv
A S De A No De Ma S Ma A S No
Source: Data from PACIFIC Exchange Rate Service
Figure 2 shows the value of the Thai baht, Indonesian rupiah, South Korean
won, Japanese yen, Brazilian real, and Russian ruble relative to the U.S. dollar. The
currency depreciation that began in Thailand in July 1997 rapidly spread across
southeast Asia and affected other currencies as well. The dramatic fall in the value
of the ruble did not occur until August 1998. By March 2000, the South Korean won
and Thai baht had recovered to about 80% and the Brazilian real to about 60% of
their pre-crisis values. The Indonesian rupiah was at about 32% and the Russian
ruble at about 20% of their 1997 values, while in 1999-2000 the Japanese yen had
appreciated to a level higher than its pre-crisis level.
Following the September 11, 2001 terrorist attacks, most of these currencies
dipped momentarily before recovering. Despite the direct attack on the United
States, the lowering of U.S. interest rates, and the prospect that the Federal
Government could return to deficit spending, the value of the dollar has been rising.
The Japanese yen, in particular, has declined in value. Still, there have been no
precipitous drops in exchange values, except that of Brazil, whose rate declined and
then recovered. The most precarious situation in late 2001 was in Argentina. It must
chose between devaluing its currency, fully dollarizing its economy (adopting the
dollar as its domestic currency), or taking similar drastic action.

What is the mechanism by which weakness in one currency drives down the
values of other currencies? In order to understand the process, one must recognize
that trade flows no longer dominate foreign exchange markets. In times past, foreign
exchange was bought primarily for use in foreign trade transactions — for the
international buying and selling of goods and services. Now non-trade transactions
dominate foreign exchange markets. Capital flows completely overshadow trade
flows in value and effect on exchange rates. Foreign currencies are bought by
investors seeking higher rates of return, by wealth-holders seeking safety from
political or economic instability, by multinational corporations building
manufacturing or distribution facilities abroad, by speculators betting on movements
in exchange rates, and by others for a variety of reasons. Trade flows remain
important, but they are only one factor in determining foreign exchange values.
Because currencies play such a variety of roles in the world financial system,
their value fluctuates as underlying financial conditions, macroeconomic variables,
investor expectations, and actions of central monetary authorities change. Like stock
markets, there is no sure method of predicting short-term movements in exchange
rates. Many economists have concluded that, while underlying financial and
macroeconomic conditions — such as interest rates, trade deficits, and economic
growth rates — influence exchange rates over the long run, in the short run,
fluctuations are more random and unpredictable in nature.4
For example, in 1997, once Thailand allowed the value of its currency to fall,
Malaysia, the Philippines, and Indonesia — neighboring countries that compete in
similar export markets — suddenly found their exports significantly more expensive
than those of Thailand. Not did this affect their balance of trade, but speculators and
other buyers of foreign exchange placed financial bets that those other countries
would have to allow their currencies to depreciate also. This unleashed tremendous
downward pressures on exchange rates in these countries. In the Asian financial
crisis, the lines of transmission led from Thailand to Malaysia, the Philippines, and
Indonesia, then later to Hong Kong and South Korea. After that, the problem became
more global as it spread to Eastern Europe, Russia and Brazil.
Since underlying macroeconomic conditions affect the long-run exchange rate
of a country, speculators and investors may target certain currencies for devaluation
if their countries exhibit macroeconomic and financial features similar to the country
that has devalued its currency. For example, since Thailand’s main problems in 1997
were its weak banks, a rising current account deficit, and an accumulation of short-
term foreign currency loans, countries with similar macroeconomic and financial
conditions were targeted by speculators. This is one of the reasons that countries
with scanty trade ties with a country in crisis also can find themselves subject to
currency speculation or capital flight by their own citizens seeking a safe haven to
store their wealth. In 1997, for example, as Hong Kong’s currency came under
attack, speculators also descended upon Estonia’s currency. Like Hong Kong,
Estonia also has a currency board. In South Korea’s case, its currency came under

4 Frankel, Jeffrey A. and Andrew K. Rose. Empirical Research on Nominal Exchange
Rates. In Handbook of International Economics, Vol. III, Edited by G. Grossman and K.
Rogoff. Amsterdam, Elsevier, 1995. Pp. 1690-91.

attack because it too had a weak banking system, an accumulation of short-term
international loans, and other economic conditions that resembled those of the
countries of Southeast Asia.
Securities Markets
Fluctuations in currency markets also affect stock and securities markets. The
process is two-fold. First, when a currency depreciates it also reduces the value of
any asset denominated in that currency such as stocks and bonds. If investors (both
foreign and domestic) in national equity markets anticipate a currency depreciation,
they may sell their stocks and convert the proceeds into a foreign currency before the
depreciation or before the currency depreciates further. Second, when a country is
facing a rapidly declining currency, the country’s monetary authorities may raise
interest rates (to stem capital flight) and adopt restrictive fiscal policies (to raise
savings and reassure investors) which may slow economic growth, reduce corporate
profits, and raise the return on bonds or money market accounts relative to stocks.
Both higher interest rates and lower profits tend to reduce equity values. As funds
are moved from a troubled economy to a safer haven (such as the United States or
Europe), equity values or bond prices may well be bid up in those safe-haven

Figure 3. Indexes of Stock Market Values for the United States, Japan,
Russia, Hong Kong, and Indonesia during the Asian Financial Crisis
July 1997-June 99
140U.S. Dow JonesRussianDefault
40Hong Kong
Hang SengSouth KoreaRussia
20SeoulTrading System
18 15 12 10 7 5 2 30 27 27 24 22 19 17 14 11 9 6 4 1 29 26 26 23 21 17
Jul 4Aug 1Oct 24Jan 16Feb 13Mar 13Apr 10May 8Jun 5Jul 3Jul 31Oct 23Jan 15Feb 12Mar 12Apr 9May 7Jun 4
Aug 29Sep 26Nov 21Dec 19Aug 28Sep 25Nov 20Dec 18
Source: Trendlines, Seoul Composite, Tokyo Nikkei 225, Hong Kong Hang Seng,
Russia Trading System & Dow Jones Industrial Indices

During the Asian financial crisis, values on equity markets fluctuated almost as
much as currency values. Figure 3, shows indices of stock market values on
exchanges in the United States, Japan, South Korea, Hong Kong, and Russia over the
period of the worst of the Asian financial crisis – from its onset in July 1997 to June
1999. The similar behavior of the Asian markets as well as both the positive and
negative effects on the U.S. stock market as measured by the Dow-Jones index is
apparent. The market that has recovered the least is the Russian.
As shown in Figure 4, the September 11 terrorist attacks on the World Trade
Center and Pentagon caused U.S. equity values to drop, despite the additional
liquidity provided by the Federal Reserve and reduction in short-term interest rates.
By mid-October, however, major stock markets had pretty well recovered to their
pre-attack levels. Figure 4 also shows that since July 1997, the Dow Industrial
average has risen about 25%. Japan’s Nikkei and South Korea’s composite averages,
however, still are at 75% to 80% of their July 1997 levels, while those on markets in
Russia, Indonesia, and Hong Kong remain at about 50% of their 1997 amounts.

Figure 4. Indices of Stock Market Values for the United States,
Japan, South Korea, Russia, and Hong Kong
September-November 2001
140U.S. Dow JonesAttacks
100South Korea
Seoul Composite
40Hong Kong
Hang SengRussia
Trading System
71421t 15121926920
Sep 3Sep 11OcNov 12001
Source: Financial Times. Seoul Composite, Tokyo Nikkei Industrials, Hong Kong
Hang Seng, Russia Trading System & Dow Jones Industrial Indices

Stock markets can serve as an early barometer and a reflection of the state of
economies. For an individual company, if the outlook for its profits diminish, the
price of its stock relative to expected earnings will rise, making its stock price
expensive relative to other investments such as more secure government securities.
This is reflected in the price-earnings ratio (PER or P/E) for stocks. A PER of 20 is
roughly equivalent to an investment that pays a return of 5%, since a $20 investment
at 5% would generate a $1 return each year. In the case of Japan’s stock market
bubble in the 1980s, PERs reached twice or three times normal levels. For the
NASDAQ until its crash in 2000-01, some PERs were as high as 100 or meaningless
because firms were not generating any profits at all. Their high stock values were
being justified on the basis of future profit potential, much of which never appeared.
In assigning blame for the Asian currency crisis, some pointed the finger at
speculators — even though speculators certainly were not to blame for the underlying
economic conditions that contributed to the perceived overvaluation of the currencies
in the first place. Speculators, often managers of large international investment
funds, generate gains by taking advantage of perceived weaknesses in exchange rates.
They place financial bets on depreciation (or appreciation) based on their perceptions
of underlying forces of demand and supply. They also combine currency speculation
with financial maneuvering in derivatives, stocks, securities, and money markets.
For smaller emerging markets, these financial actions may trigger currency crises and
may be paralleled by similar maneuvering by other investors and businesses engaged
in currency transactions.
The mechanics of currency speculation are complicated. Essentially the process
involves currency buyers and sellers generating profits from fluctuations in exchange
rates by using spot markets (markets for current delivery of foreign exchange),
forward or futures markets (markets for future delivery), currency swaps, loans, and
other financial maneuvers. The key to this process is that when speculators expect
a depreciation in a local currency, they begin short sales (without the currency in
hand) of forward or future contracts to deliver that currency at a future date in the
hope that they will be able to buy the currency at a lower price before they have to
deliver it. They also can speculate in stock market futures by amassing holdings of
a currency to dump on the market in order to elicit a response from monetary
authorities who often will raise interest rates in order to maintain the exchange rate.
The higher interest rates, in turn, cause equity values to fall.
Once a currency begins to show signs of weakening, astute investors and
speculators who profit from volatility in exchange markets take actions to minimize
losses and maximize gains. The ensuing flight from investments in and holdings of
the local currency pushes its value down even further until it often overshoots what
would be considered an equilibrium rate. Recovery may be slow.
The International Monetary Fund
The International Monetary Fund began operations in 1947 and now has 183
countries who are members. Its quotas (financial base) are the equivalent of $272
billion, following a 45% quota increase in 1999. The IMF plays a key role during

international financial crises in coordinating support packages for its member
countries experiencing balance of payments difficulties. These packages include
loans and secondary lines of credit. The IMF was created to promote international
monetary cooperation; to facilitate the expansion and balanced growth of
international trade; to promote exchange stability; to assist in the establishment of a
multilateral system of payments; to make its general resources temporarily available
to its members experiencing balance of payments difficulties under adequate
safeguards; and to shorten the duration and lessen the degree of disequilibrium in the
international balances of payments of members. As of June 30, 2001, the IMF had
credit and loans outstanding to 90 countries worth about $65 billion.
The financial assistance provided by the IMF enables countries to rebuild their
international reserves, stabilize their currencies, and continue paying for imports
without having to impose trade restrictions or capital controls. Unlike development
banks, the IMF does not lend for specific projects. IMF loans are usually provided
under an “arrangement,” which stipulates the conditions the country must meet in
order to gain access to the loan. All arrangements must be approved by the Executive
Board, whose 24 directors represent the IMF’s 183 member countries. Arrangements
are based on economic programs formulated by countries in consultation with the
IMF and are presented to the IMF Executive Board in a letter of intent (with
permission of the borrowing country, letters of intent are posted on the IMF’s Internet
site).5 Loans are then released in phased installments as the program is carried out.6
Financial support packages are initiated by a request to the IMF from the
country experiencing financial difficulty. This request then requires an assessment
by IMF officials of the conditions in the requesting nation. If a support package is
approved, the IMF usually begins with an initial loan of hard currency to the
borrowing nation. Subsequent amounts are made available (usually quarterly) only
if certain performance targets are met and program reviews are completed. During
the Asian financial crisis, the support packages were designed to restore investor
confidence — both international and domestic — in the economies of the recipient
nations. The packages constituted a three-pronged approach to the problems: (1)
immediate efforts to restore liquidity in currency markets, (2) structural reforms
aimed at strengthening financial sectors, and (3) governance issues underlying the
crisis which included improving the efficiency of markets, breaking the “crony
capitalism” links between business and government in several of the distressed
countries, liberalizing capital markets, and providing for more transparency (in
disclosing data on external reserves and liabilities).
The volume of loans provided by the IMF has fluctuated significantly over
time. The oil shock of the 1970s and the debt crisis of the 1980s were both followed
by sharp increases in IMF lending. In the 1990s, the transition process in Central and
Eastern Europe and the crises in emerging market economies led to another surge in
the demand for IMF resources. Over the years, the IMF has developed a number of
loan instruments, or “facilities,” that are tailored to address the specific
circumstances of its diverse membership. Non-concessional loans are provided

5 On Internet at: [].
6 International Monetary Fund. How Does the IMF Lend? A Factsheet, September 2001.

through five main facilities: Stand-By Arrangements (SBA), the Extended Fund
Facility (EFF), the Supplemental Reserve Facility (SRF), the Contingent Credit Lines
(CCL), and the Compensatory Financing Facility (CFF). Low-income countries may
borrow at a concessional interest rate through the Poverty Reduction and Growth
Facility (PRGF).
Except for the PRGF, all facilities are subject to the IMF’s market-related
interest rate (currently about 4%) which is based on short-term interest rates in the
major international markets. The IMF discourages excessive use of its resources by
imposing a surcharge on large loans. Countries are expected to repay loans early if
their external position allows them to do so.
The major facilities used for stabilizing currencies and preventing financial
crises are the Stand-By Arrangements and Extended Fund Facility. The SBA is
designed to address short-term balance-of-payments problems and is the most widely
used facility of the IMF. The length of a SBA is typically 12-18 months. Repayment
must take place within a maximum of 5 years, but countries are expected to repay
within 2-4 years. The EFF was established in 1974 to help countries address more
protracted balance-of-payments problems with roots in the structure of the economy.
Arrangements under the EFF are longer (3 years) and the repayment period can
extend to 10 years, although repayment is expected within 4½ -7 years. Table 1
summarizes the IMF’s Stand-By and Extended Fund Facility loans.
As shown in Table 1, the largest current borrowers are Argentina, Brazil,
Turkey, Indonesia, and the Ukraine. Total Stand-By Arrangements totaled the
equivalent of $37.0 billion, while Extended Arrangements summed to $12.5 billion.
As a result of the Asian financial crisis, the IMF introduced two new facilities
to cope with needs for huge amounts of funds for relatively short terms. Introduced
in 1997, the Supplemental Reserve Facility is designed to meet needs for very
short-term financing on a large scale. Countries must repay the loan after a
maximum of 2.5 years, but are expected to repay one year earlier. All SRF loans
carry a surcharge of 3-5 percentage points.
Also established in 1997, Contingent Credit Lines differ from other IMF
facilities in that they aim to help members prevent crises. They are designed for
countries implementing sound economic policies, which may find themselves
threatened by a crisis elsewhere in the world economy because of “financial
contagion.” The CCL is subject to the same repayment conditions as the SRF, but
carries a smaller surcharge.

Table 1. IMF Lending from Its General Resources Account
Under Stand-by Arrangements and Extended Fund Facilities
As of August 31, 2001
(In U.S. Dollars)
MemberDate ofArrangementExpirationDateTotalAmountUndrawnBalanceIMF Credit Outstanding
Stand-By Arrangements
ArgentinaMar 10,00Mar 9, 0321,679,1049,191,02714,491,604
BrazilSep 14, 01Dec 13, 0215,544,83210,840,0868,491,434
CroatiaMar 19, 01May 18, 02256,000256,000138,409
EcuadorApr 19, 00Dec 31, 01290,21496,748193,467
GabonOct 23, 00Apr 22, 02118,502101,58182,814
LatviaApr 20, 01Dec 19, 0242,24042,24026,840
LithuaniaAug 3, 01Mar 29, 03110,746110,746168,360
NigeriaAug 4, 00Oct 31, 011,009,8431,009,8430
PanamaJun 30, 00Mar 29, 0281,92081,92058,624
PeruMar 12, 00Mar 11, 02163,840163,840393,980
Sri LankaApr 20, 01Jun 19, 02256,000123,712132,288
TurkeyDec 22, 99Dec 21, 0219,249,1527,299,02112,412,851
UruguayMay 31, 00Mar 31, 02192,000192,000146,176
YugoslavJun 11, 01Mar 31, 02256,000128,000277,664
Total Stand-by Arrangements59,250,39429,636,76337,014,510
Extended Fund Facilities
Colombia Dec 20, 99Dec 19, 022,504,9602,504,9600
Indonesia Feb 4, 00Dec 31, 024,656,6403,170,8169,869,235
Jordan Apr 15, 99Apr 14, 02163,68677,939452,662
KazakhstanDec 13, 99Dec 12, 02421,248421,2480
MacedoniaNov 29, 00Nov 28, 0330,86729,39836,303
Ukraine Sep 4, 98Aug 15, 022,457,536930,4962,048,539
Yemen Oct 29, 97Oct 28, 0193,31233,79282,740
Total Extended Arrangements10,328,2507,168,64912,489,478
Note: IMF SDRs (Special Drawing Rights) converted to dollars at 1.28 dollars per SDR.
Source: International Monetary Fund
During the 1997-99 Asian financial crisis, the IMF arranged support packages
initially for Thailand, Indonesia, and South Korea and augmented a credit to the
Philippines to support its exchange rate and other economic policies. Later, the IMF
extended support to Brazil and Russia. The five support packages are summarized
in Table 2. The total amounts of the packages are approximate because the IMF
lends funds denominated in special drawing rights (SDRs), and because pledged
amounts often change as circumstances change. The initial support package for

Thailand was $17.2 billion, for Indonesia about $43 billion, and for South Korea $57
billion. The United States pledged $3 billion for Indonesia and $5 billion for South
Korea from its Exchange Stabilization Fund (ESF) as a standby credit that may be
tapped in an emergency. The U.S. Treasury lends money from the ESF at appropriate
interest rates and with what it considers to be proper safeguards to limit the risk to
American taxpayers.
In addition to IMF support, recipient countries during the Asian financial crisis
tapped funds pledged by the World Bank, the Asian Development Bank or, in the
case of Brazil, the Inter-American Development Bank, and by certain industrialized
nations. The World Bank, in particular, played a key role in attenuating the negative
effects of the financial crises on poorer people who are less able to shield themselves
from recessions. In 1998, the World Bank created a Special Financial Operations
Unit (SFO) to help respond to financial sector crises. Working closely with the
country departments, the SFO’s mandate is to provide immediate support to
governments to help them stabilize their financial systems, followed by support for
structural reforms and resolution of non-viable financial institutions.7
Table 2. IMF Support Packages During the Asian Financial
(Amounts in U.S.$Billion)
ThailandIndonesiaS. KoreaRussiaBrazil
Date InitiallyAug. 20,Nov. 5,Dec. 4,July 20,Dec. 2,
Approved 19971997199719981998
Total Initially $17.2$43.0$57.0$22.6$41.5
IMF $3.9$18.6$21.0$11.6*$14.7
World Bank $1.5$4.5$10.0$2.3$4.5
Development Bank$1.2$3.5$4.0$4.5
( ADB) ( ADB) ( ADB) (IDB)
Bilateral $10.6 $24.0 $22.0 $1.0 14.5
Note: ADB = Asian Development Bank. IDB = Inter-American Development Bank. Actual
amounts disbursed by the IMF’s are in SDR’s. Development bank figures are for structural
adjustment and exclude funds for customary projects.
*The IMF cancelled the 1998 program after disbursing $4.8 billion. In July 1999, it
announced a new program worth $4.5 billion to be paid in tranches of about $640 million
each. The first was distributed immediately, but the others have been delayed.
Source: IMF, World Bank, ADB, IDB.

7 The World Bank. The Special Financial Operations Unit. 1998. On Internet at

In Asia, the Association of Southeast Asian Nations plus Japan, South Korea,
and China (ASEAN + 3) have established what is called the Chiang Mai Initiative.
This is a regional financing arrangement to supplement existing international
facilities. The Initiative involves an expanded ASEAN Swap Arrangement for
currencies that would include ASEAN countries and a network of bilateral swap and
repurchase agreement facilities among the participating countries.
Japan has a special interest in the Asian financial crisis since it occurred within
its region and not only affected its close trading partners and competitors but also
threatened bank loans and investments by Japanese companies in the area. Japan has
been providing financial assistance under what it terms the Miyazawa Initiative
(named after their Finance Minister). It includes $30 billion in loans to Thailand,
Malaysia, the Philippines, Indonesia, and South Korea. This was augmented in 1999
with a commitment by Japan to assist Asian nations to mobilize another 2 trillion yen
(about $17 billion) in domestic and foreign private-sector funds for Asia.8
Criticism of the IMF
Following the Asian financial crisis, the IMF came under increased scrutiny and
criticism. Various groups and commissions have recommended changes to the
methods and scope of its operations. For Congress, on March 8, 2000, the
congressionally mandated International Financial Institution Advisory Commission
submitted its report.9 The Commission considered the future roles of seven
international financial institutions: the International Monetary Fund, the World Bank,
three regional development banks, the World Trade Organization, and the Bank for
International Settlements. With respect to the IMF, the Commission made the
following recommendations:
!The IMF should be restructured as a smaller institution with three
major purposes: (1) to serve as a quasi lender of last resort (standby
lender to prevent panics) to emerging economies, but its lending
operations should be limited to the provision of liquidity (short-term
funds) at penalty interest rates (above the borrower’s recent market
rates) to solvent member governments when financial markets close;
(2) to collect and publish financial and economic data from member
countries and disseminate those data in a timely and uniform
manner; and (3) to provide advice (but not impose conditions)
relating to economic policy as part of regular consultations with
member countries.

8 Japan. Ministry of Finance. Resource Mobilization for Asia: The Second Stage of the
New Miyazawa Initiative. May 15, 1999. On Internet at [].
9 International Financial Institution Advisory Commission. Report of the International
Financial Institution Advisory Commission. Allan H. Meltzer, Chairman. March 8, 2000.
The members of the commission included Allan H. Meltzer, C. Fred Bergsten, Charles W.
Calomiris, Tom Campbell, Edwin J. Feulner, W. Lee Hoskins, Richard L. Huber, Manuel
H. Johnson, Jerome I. Levinson, Jeffrey D. Sachs, and Esteban Edward Torres.

!The IMF should be precluded from making other than short-term
loans to member countries, particularly long-term loans in exchange
for compliance with conditions set by the IMF.
!The IMF’s Poverty and Growth facility should be closed and its
long-term assistance to foster development and encourage sound
economic policies be the responsibility of a reconstructed World
Bank and regional development banks.
The Commission listed four “pre-conditions” for a country to quality for IMF
assistance: (1) a competitive banking system that allows a greater presence for
foreign financial institutions; (2) the regular publication of information regarding that
nation’s outstanding debts and liabilities; (3) commercial banks that are adequately
capitalized, and (4) proper fiscal policy. The Commission suggested that these rules
be phased in over a five-year period and that they be suspended if necessary for
global stability in the event of a major crisis.
Several members of the Commission dissented from the recommendations of
the report. The dissent with respect to the IMF centered on the constraints placed on
the IMF in combating financial turmoil and on who would qualify for assistance.
The four dissenters, for example, argued that the suggested pre-conditions for crisis
loans would ignore the macroeconomic policy stance of the country in turmoil,
because the IMF would not be authorized to negotiate policy reform. In short, the
IMF might end up supporting countries with runaway budget deficits and profligate
monetary policies. The pre-qualifying conditions also might preclude support for
countries that are critical for global financial stability.10 Other objections by
commission members were that it did not address worker rights or sustainable
development issues and that it might undercut the fight against global poverty.
Other studies in the aftermath of the global financial crisis have made
recommendations similar to those of the Advisory Commission. In June 1999, the
finance ministers of the G7 (Group of Seven Industrial Nations) recommended
reforms in six priority areas:
!strengthening and reforming the international financial institutions
and arrangements;
!enhancing transparency and best practices;
!strengthening financial regulation in industrialized countries;
!strengthening macroeconomic policies and financial systems in
emerging markets;
!improving crisis prevention and management, and involving the
private sector, and
!promoting social policies to protect the poor and most vulnerable.11

10 C. Fred Bergsten, Richard Huber, Jerome Levinson, and Esteban Edward Torres.
Dissenting Statement (to the International Financial Institution Advisory Commission
report). c. March 6, 2000.
11 G7 Finance Ministers. Strengthening the International Financial Architecture, Report of

In February 1999, the G7 established the Financial Stability Forum which has
endorsed a broad range of concrete policy actions to address concerns related to
highly leveraged institutions, volatile capital flows, and offshore financial centers.
The Forum aims to promote international financial stability through enhanced
information exchange and co-operation in financial supervision and surveillance. It
comprises national authorities responsible for financial stability in significant
international financial centers, international financial institutions, international
supervisory and regulatory bodies, and central bank expert groupings.12
A separate study by the Council on Foreign Relations chaired by Carla Hills and
Peter Peterson makes recommendations aimed at altering the behavior of
emerging-market borrowers and their private creditors in ways that would reduce
vulnerabilities in the exchange rate systems of emerging economies; inducing private
creditors to accept their fair share of the costs of crisis resolution; reforming the
IMF’s lending policies; and refocusing the mandates of the IMF and the World Bank
on leaner agendas.13
Treasury Secretary Paul O’Neill, in a statement before Congress, put forth the
following as policy considerations for the IMF:
!The IMF should focus more on its core objectives which are to: (1)
promote sound monetary, fiscal, exchange rate and financial sector
policies, (2) carefully monitor economic conditions, and (3) deal
with critical problems in the international financial system as soon
as they are detected in order to provide greater financial stability and
facilitate trade.
!The IMF should put more effort into crisis prevention, including the
pursuit of sound policies by countries, the development of robust
financial sectors, and the adoption of internationally accepted
standards and codes.
!The IMF needs more transparency, particularly in releasing
information and assessments to the private sector in order to enable
markets to make informed judgements and to give countries strong
incentives to pursue sound policies.
!The IMF should increase its accountability to IMF shareholders and

11 (...continued)
the G7 Finance Ministers to the Köln Economic Summit, Cologne, June 18-20, 1999.
12 Financial Stability Forum (Basle, Switzerland). Financial Stability Forum Endorses
Policy Actions Aimed at Reducing Global Financial Vulnerabilities. Press release No.

7/2000E, March 26, 1999.

13 Council on Foreign Relations. Safeguarding Prosperity in a Global Financial System:
The Future International Financial Architecture. 1999.

!The IMF should not create expectations that reduce the incentives
for countries and for individuals to take policy actions essential to
prevent crises. Expectations of continued or additional financial
support in the case of poor policy decisions in a country reduce the
incentives to make good economic decisions. Moreover,
expectations that countries can and will use IMF financial support
to meet payments on debt instruments held by the private sector
reduce due diligence required to make sound financial decisions.
!The IMF should focus its work on areas in which it has expertise and
responsibility rather than to use conditions on its loans to go beyond
relevant macroeconomic reforms within its expertise.14
The IMF Response and New Financial Architecture
The IMF, along with the World Bank and member governments, have been
addressing the above criticisms and problems in the international financial
architecture. This architecture is the institutions, markets, and practices that
governments, businesses, and individuals use when they carry out economic and
financial activities. The underlying goal is to build a stronger, more stable
international financial system that will make the world less vulnerable to financial
crises, while allowing all countries to benefit from the process of globalization.
To date, the most progress by the IMF has been in:
!the increase in the quality and candor of economic information that
governments and other institutions are making available to the
!the growing implementation of codes of good practices that are
essential to a well-functioning economy; and
!the creation of Contingent Credit Lines (CCL), an IMF facility that
enables the Fund to lend preemptively to help prevent a crisis.15
A fundamental criticism of IMF and governments during the Asian financial
crisis was that insufficient information was available to the public to protect their
investments and to determine what actions the IMF and government were taking.
Some also asserted that the IMF kept information confidential that might have
warned investors of potential problems, although release of such information, itself,
might trigger precisely the financial crisis the country and the IMF would be
attempting to avoid. Governments also were not gathering sufficient data on
financial transactions to assess their exposure to a tightening of credit or financial

14 O’Neill, Paul H. Statement before the House Committee on Financial Services, May 22,

2001. U.S. Department of Treasury, PO-392.

15 International Monetary Fund. Progress in Strengthening the Architecture of the
International Financial System, A Factsheet. July 31, 2000

panic. The IMF now releases (with member government permission) Public
Information Notices and staff reports following consultations (under article IV) with
member countries, Letters of Intent, and other documents. The Letters of Intent, in
particular, provide detail on the actions being required as a condition of loans. The
IMF also is releasing statements of the Chairman of its Executive Board summarizing
the board’s views following discussions of a member’s use of Fund resources. Most
of these documents are available on the IMF Internet site.
The IMF also claims that substantial progress has been made in developing and
assessing internationally accepted financial standards. Standards and codes of good
practices help ensure that economies function properly at the national level, which
is a key prerequisite for a well-functioning international system. In consultation with
others, the IMF has developed Special Data Dissemination Standard; the Code of
Good Practices on Fiscal Transparency; the Code of Good Practices on Transparency
in Monetary and Financial Policies; and guidelines concerning financial sector
soundness. Currently, 47 countries subscribe to the IMF’s Special Data
Dissemination Standard, which encourages member countries to provide detailed and
reliable national economic and financial data.
A third area of focus for the IMF is in financial sector strengthening, particularly
the ability of banks and other financial institutions to improve internal practices,
including risk assessment and management; and upgrading supervision and
regulation of the financial sector to keep pace with the modern global economy. The
IMF and the World Bank have intensified and enhanced their assessment of
countries’ financial systems through joint Financial Sector Assessment Programs
which serve to identify potential vulnerabilities in countries’ financial systems. The
Basle Committee on Banking Supervision also is addressing gaps in regulatory
A strong criticism of the financial support programs coordinated by the IMF
during the Asian financial crisis is that those programs may have created a moral
hazard (causing more risky behavior by reducing the adverse consequence of it). If
lenders know the IMF will “bail out” countries unable to repay international debts,
for example, lenders may extend loans with risks higher than those reflected in the
interest rate and other terms of the loans. The IMF claims, however, that it works
under the basic operating principle that its financing should not relieve debtors or
creditors of their responsibility for the risks they take. Holders of equity incur
financial losses immediately as values on stock markets decline. Holders of loans,
however, may not see immediate losses because IMF loans may provide the foreign
exchange for countries to service foreign loans. In the resolution of financial crises,
therefore, the IMF is to involve the private sector more in the resolution of crises,
particularly lenders and holders of bonds. This may require actions such as debt
restructuring by creditors.
During the Asian financial crisis, the IMF was criticized severely for imposing
conditions on its loans that were viewed as too severe for the countries in turmoil.
Many blamed IMF conditions that resulted in fiscal stringency and high interest rates
for causing economies to turn downward more than was necessary and throwing
millions of people into poverty. A particular complaint was that the IMF tended to
require that central government budgets be balanced or in surplus despite the need

for fiscal stimulus to combat recessions and to provide a social safety net for the
growing numbers of unemployed workers.
The IMF still views conditionality as indispensable for safeguarding the Fund’s
resources. It requires certain actions by member governments to ensure that its loans
are used appropriately to promote adjustments considered to be necessary to prevent
future crises. The IMF, however, also claims that it recognizes that countries cannot
carry out major structural changes overnight. The Fund, therefore, asserts that,
henceforth, it intends to focus conditionality on those measures that are critical to the
macroeconomic objectives of country programs. The IMF states that will not weaken
conditionality but make it more efficient, effective, and focused. There also is broad
agreement within the IMF that the Fund must promote good governance in borrowing
countries, both through initiatives – such as the work on standards and codes – and
through specific measures to improve the decision making and administrative
processes in government and the private sector.
In 2001, as world economies have been slipping into recession, the IMF is
taking measures to keep the world economy on track.16 It particularly is working
closely with countries such as Argentina to ensure that slowing world economic
activity does not trigger another international financial crisis. This is a test to see if
the new international financial architecture is able to prevent another global financial
U.S. Economic Policy
Since the United States is the largest economy in the world, global economic
conditions depend greatly on the state of the U.S. economy. As the developing
recession in the United States has pulled down other economies, a strong recovery
could do much to lift the economies in the rest of the world. This can be pursued
primarily through monetary and fiscal policies – both domestic and coordinated with
those of other nations – and international trade policy being pursued to increase
global market efficiency and to ameliorate the adverse effects of foreign unfair trade
practices. With respect to monetary policy, while Congress plays an important
oversight role, actual policy is determined by the U.S. Federal Reserve in accord with
its own assessments. From mid-1999 though most of 2000, inflation remained a
threat, and labor markets were tight. The Fed raised interest rates several times to
ease labor and price pressures and to provide alternative investments to the high-
rising U.S. stock market. As the U.S. economy has slowed, the Federal Reserve has
dropped interest rates aggressively. It lowered, for example, its discount rate (the
interest rate it charges banks) from 6.0% in 2000 to 5.75% in January 2001 and
executed ten more rate cuts until the rate reached 1.5% in November 2001.

16 Köhler, Horst. The IMF in the Process of Change. April 29, 2001. On Internet at
[ ht t p: / / www.i mf .or g/ ext e r nal / np/ omd/ 2001/ st at m] .
17 For information on Argentina, see CRS Report RL31169, Argentina: Economic Problems
and Solutions, by Gail E. Makinen.

With respect to fiscal policy, the 107th Congress has been considering various
stimulus packages. In September 2001, Congress passed a $40 billion emergency
supplemental appropriation (P.L. 107-38) and the $15 billion Air Transportation
Safety and System Stabilization Act (P.L. 107-42). Various tax cuts provided for by
the Tax Relief Reconciliation Act (P.L. 107-16) also are slated to be automatically
phased in on January 1, 2001. On October 24, 2001, the House passed the Economic
Security and Recovery Act (H.R. 3090) which seeks to stimulate the economy
through several tax reductions including changes in capital depreciation deductions,
repeal of the corporate alternative minimum tax, acceleration of the phase-in of the
25% marginal income tax bracket adopted in P.L. 107-16, and a supplemental
income tax rebate for those who did not receive a full rebate under that law.
As for international trade policy, pressures are building in two areas. The first
is in the size of the U.S. trade deficit. The merchandise trade deficit reached a high
of $328.8 billion in 1999 and increased further to a record $436.1 billion in 2000.
The U.S. current account deficit likewise reached $324.4 billion in 1999 and a record
$444.7 billion in 2000. While these deficits currently are being matched by inflows
of capital into the relatively safe U.S. market, the trade imbalance reflects growing
pressures on U.S. industries that export to the troubled economies or compete with
imports. While reducing the trade deficit, itself, is not necessarily an objective of
U.S. trade policy, increasing U.S. exports, enhancing market efficiency through
reducing import barriers abroad, and ensuring that imports into the American market
are traded fairly are U.S. policy goals. The United States can open markets abroad
through trade negotiations, coordinate monetary and fiscal policies to encourage
other nations to stimulate their economies more, and impose import barriers to
protect U.S. industries from unfair foreign trade practices – particularly dumping.

Appendix: Archive of News Topics18
!MEXICO Mexico’s real investment was down 2.9% year over year
(y/y) in the first seven months of the year. On a monthly basis, real
investment contracted 4.8% y/y in July, which is an improvement
from June’s 8.5% drop. July’s relative improvement was due to a
smaller contraction of construction investment (-2.7%). This sector
was hit hard in the first half of the year but currently seems to be
benefitting from lower interest rates and higher public spending.
Meanwhile, investment in equipment and machinery contracted

6.6% y/y in July. (Oct. 9, 2001)

!TERRORIST ATTACKS on the World Trade Center and
Pentagon caused sharp declines in stock values and are expected to
cause consumer confidence to decline and economic activity to slow.
(Sept. 20, 2001)
Ministers meeting stated that the United States could not shoulder
the burden of reversing the global slowdown on its own, and that
other nations must do their share – particularly Japan, which needed
“decisive action” to cure the decade-long economic malaise that has
sapped the economic health of the entire region. (Sept. 7, 2001)
be held in Washington, D.C. on September 29-30, 2001, were
cancelled following the September 11 terrorist attacks. (Sept. 17,


!BRAZIL The IMF approved a 15-month US$15.58 Billion
Stand-By Credit for Brazil in support of the government’s economic
and financial program through December 2002. (Sept. 14, 2001)
!ARGENTINA IMF Managing Director Horst Köhler recommended
that Argentina’s Stand-by Credit be augmented by $8 billion to a
total of about $22 billion. (Aug. 21, 2001)

18 Source: Selected from DRI-WEFA Hot News Topics.