Speech

Welcome Remarks by Mr. Agustín Carstens, Deputy Managing Director, IMF at the 6th Jacques Polak Annual Research Conference

November 3, 2005

Good morning, ladies and gentlemen. I am delighted to welcome you to the 6^th Jacques Polak Annual Research Conference. This yearly event is perhaps the most "academic" conference that the International Monetary Fund organizes. As such, it provides an important bridge between the forefront of research and the policy world.

Many, if not most, influential economic ideas were born from the need to explain real economic events and find policy solutions to problems. There is a fruitful partnership between rigorous economic analysis and the demands of a policy-making institution, and Jacques Polak's long career at the Fund is a great example of the synergy between both. As some of you may know, in the course of his association with the IMF, which spans some 40 years, Jacques Polak was the Fund's first Chief of the Division of Statistics, and later Director of Research, among various other positions. This conference is thus most appropriately named in his honor, and we are here today to continue developing the partnership which he so aptly embodies.

Past conferences were devoted to the classic themes of international monetary economics, to which researchers in the Fund have made important contributions: exchange rates, international capital flows, financial crises. The topic of this year's conference departs somewhat from these classic themes, and is a bit different: reforms. In these remarks I will argue that understanding reforms, what makes them happen, and their consequences is no less central to the daily work of the IMF than understanding the macroeconomics of stabilization.

First, let me explain what we mean by reforms, since the term is used in different ways and in different contexts. By reforms, we refer to far-reaching changes in the "rules of the game" and in the institutions that shape economic activity. Examples of reforms include trade and financial liberalization; the creation of an independent central bank; changes in labor market policies that alter the cost of hiring and firing workers, or the incentives to participate in the labor force.

Reforms can also mean changes in contractual laws and bankruptcy laws. These examples of different kinds of reforms are far from exhaustive. The list can continue, and as we go through it, we realize how many countries have undertaken sweeping reforms in the last twenty years or so. We also realize how often the IMF has played an active role in this process, in the context of program work, of country surveillance, and of technical assistance.

How is it that the IMF, with its traditional focus on short-term macroeconomic stabilization, is so deeply involved in advising countries about reforms? Certainly our key role in supporting the transition to a market economy in the formerly communist countries has been a factor. But at a deeper level, it has been the gradual realization that, in many cases, it is not possible to sustain macroeconomic stabilization without changing how the economy works in some fundamental way. Time and again, countries return to the Fund to seek "emergency room" care. But emergency room medicine is only part of the solution, and cannot be separated from a more comprehensive diagnosis and cure of the underlying problems. When this diagnosis is done, the prescription includes, more often than not, structural reforms.

Let me be more specific, by going over some examples of reforms which can directly reduce macroeconomic vulnerabilities. The first comes from the area of monetary policy. Reforms to increase the independence of central banks from government interference have proven extraordinarily effective at bringing inflation under control all over the world. This is a perfect example of how reforming an institution can provide a durable solution to a macroeconomic problem.

In the area of fiscal policy, short-term macroeconomic stabilization would be greatly facilitated by structural reforms that permanently curbed the tendency of governments to spend more than they can afford. Many countries are experimenting with fiscal frameworks that increase budgetary transparency and accountability, promote long-term budgetary planning, and limit expenditure biases. At the IMF, the fiscal Report on the Observance of Standards and Codes (ROSC) program is an instrument that we use to disseminate best practices about fiscal transparency in our member countries. These reforms may not be as successful as the creation of independent central banks in bringing about fiscal sustainability. This is not surprising. Politicians are less likely to relinquish political control over fiscal policy to an independent agency, than they would, and have done, with monetary policy. Nonetheless, while they may not be a silver bullet, reforms of fiscal frameworks hold the promise to greatly improve the quality of fiscal management and reduce vulnerabilities.

Another area of structural reforms that can bolster short-term macroeconomic stabilization is prudential supervision and regulation of the banking sector. As banking sectors have become more liberalized, and international financial integration has increased, the financial system has expanded and developed, but it has also contributed to financial fragility in some cases. Banking crises have accompanied balance of payments crises, making them more costly to the economy and to the budget. In response to these crises, many members countries have sought to upgrade the prudential supervision and regulation of the banking system. The IMF and World Bank are major actors in this process through their Financial Sector Assessment Program.

Sometimes, the success of short-term stabilization hinges on specific sectoral policies. Over the years, we have learned that in some countries, what holds back growth after a crisis may be lack of adequate infrastructure, or an inefficient energy sector, and factors like these can, of course, threaten the recovery process. In these cases, the Fund cannot ignore sectoral issues in designing a stabilization program, even if they may be quite far removed from the familiar concerns of open economy macroeconomics.

The IMF Managing Director has made globalization the overarching theme of his vision for the Fund in the medium-term. In this vision, helping countries meet the challenges of globalization will become the central focus of our work. This brings us once again to reforms. As globalization progresses, institutions that worked in the past may no longer be adequate. A country's ability to transform and adapt its institutions to present day realities may well be the key determinant in terms of its being able to benefit from globalization rather than suffer from it. The IMF must continue to lead the way in this area.

I hope these examples clarify how the issue of reforms, which will be the subject of the next two days of discussions, is closely connected with our core mandate. I hope they also explain why Fund involvement in structural reforms is not the result of mission creep, empire building, or a penchant for micromanagement. It is just the natural evolution of our work, as we learn from experience how to do it better.

But we should acknowledge that expanding the scope of our work to structural issues has not been an easy process. For one, it has expanded the breadth of expertise required of our economists well beyond standard open economy macroeconomics. As you will see from the contributions of Fund economists to this conference, this expertise is there.

In addition, there is the question of where to stop: where should the boundaries of IMF policy advice and, in the context of programs, of IMF conditionality be set? There is a tendency of wanting to fix everything that appears out of order, and the risk is that in trying to do too much, we end up doing too little. The guiding principle here is that the Fund should be involved only with structural reforms that are key to macroeconomic stability. In applying this principle, there is obviously a great deal of judgment. Nonetheless, it has already helped us streamline and improve structural conditionality in programs. In surveillance, there is still room for improvement, and the Managing Director has indeed called for more focus in his strategic review.

Over the years, while advising countries undertaking ambitious reform programs, we have learned that reform is a difficult process. The benefits of reform must be explained to an often skeptical public. Even when there is agreement on a reform program, interest groups can seek to block the program to protect their rents, and sometimes governments understandably find it hard to sustain the momentum for reforms, even after an initial success. Several of the papers in this conference are careful studies of these issues. The contributions are both theoretical and empirical, and they draw from experiences of individual countries, and from broad cross-sections of countries. We look forward to the insights that these studies will provide, and to the lively debate that they will undoubtedly generate.

I also hope we will learn more about how the IMF can be a more effective agent of reform. I have mentioned the need for defining boundaries and prioritizing our involvement. There is also the question of credibility. The Fund can play an important role in promoting reforms not only because of its technical expertise or financial resources, but because it can play the role of an impartial outsider. Is the IMF as an organization optimally designed to give us the tools and the credibility to perform this delicate task? The Economic Forum will address this question by focusing specifically on the role of the Fund's Executive Board in the organization's governance structure. It should be a most interesting debate.

I would like to express our appreciation to all participants for coming here today. I wish you all fruitful, open, and intellectually stimulating discussions over the next two days. Thank you.