Chapter 6 IMF and the World Bank

6.1 Global finance

• Global financial markets are as integrated as they have ever been

• Advantages of financial integration:

– Offers investors and businesses access to overseas markets to spur economic growth

– Allows for the possibility of better returns on investment for individuals investing for college tuition and retirement

• Risks of financial integration:

– An economic crisis can quickly spread and lead to a global economic crisis affecting small and large economies alike

▪ What began as trouble in the U.S. housing market ended as a global financial meltdown

International Currency Exchange

• National currencies are valued against each other, not against gold or silver

• Most exchange rates are expressed in terms of the world’s most important currencies

– U.S. dollar, the Japanese yen, and the EU’s euro

– Relative values of currencies at a given point are arbitrary

• Some states do not have convertible currencies

– Holder has no guarantee of being able to trade it for another currency

Exchange rate: The rate at which one state’s currency can be exchanged for the currency of another state. Since 1973, the international monetary system has depended mainly on floating rather than fixed exchange rates. See also convertible currency; fixed exchange rates; and managed float.

Convertible currency: The guarantee that the holder of a particular currency can exchange it for another currency. Some states’ currencies are nonconvertible. See also hard currency.

• Inflation reduces a currency’s value relative to more stable (more slowly inflating) currencies

– Hyperinflation: Extremely high, uncontrolled inflation (more than 50 percent per month)

• Hard currency: money that can be readily converted to leading world currencies (with relatively low inflation)

– States maintain reserves of hard currency, equivalent of the stockpiles of gold in centuries past

• Forms of currency exchange:

– Fixed exchange rates: official rates of exchange

– Floating exchange rates: determined by global currency markets

Hyperinflation: An extremely rapid, uncontrolled rise in prices, such as occurred in Germany in the 1920s and in some third world countries more recently.

Hard currency: Money that can be readily converted to leading world currencies. See also convertible currency.

Reserves: Hard-currency stockpiles kept by states.

Fixed exchange rates: The official rates of exchange for currencies set by governments; not a dominant mechanism in the international monetary system since 1973. See also floating exchange rates.

Floating exchange rates: The rates determined by global currency markets in which private investors and governments alike buy and sell currencies. See also fixed exchange rates.

6.2 The Bretton Woods System

• International regimes and institutions have developed around norms of behavior in monetary relations

– Bretton Woods system: established the International Bank for Reconstruction and Development (World Bank)

▪ Created to reconstruct European economies after World War II

▪ Closely linked to International Monetary Fund (IMF)

• International Monetary Fund

– Coordinates international currency exchange, balance of international payments, and national accounts

– Created the Special Drawing Right (SDR) to replace gold standard (abandoned in 1971)

Bretton Woods system: A post–World War II arrangement for managing the world economy, established at a meeting in Bretton Woods, New Hampshire, in 1944. Its main institutional components are the World Bank and the International Monetary Fund (IMF).

World Bank: Formally the International Bank for Reconstruction and Development (IBRD), an organization that was established in 1944 as a source of loans to help reconstruct the European economies. Later, the main borrowers were third world countries and, in the 1990s, Eastern European ones.

International Monetary Fund (IMF): An intergovernmental organization (IGO) that coordinates international currency exchange, the balance of international payments, and national accounts. Along with the World Bank, it is a pillar of the international financial system. See also IMF conditionality.

Special Drawing Right (SDR): A world currency created by the International Monetary Fund (IMF) to replace gold as a world standard. Valued by a “basket” of national currencies, the SDR has been called “paper gold.”

6.3 IMF and the World Bank

6.3.1 IMF

Founded in 1944

Governed by a Board of governors

The Directors of the Executive Board

Formal voting in the Fund takes place under a weighted system that apportions votes according to countries’ size and economic influence in the international system. (US, Japan, Germany, France, and the UK)

Decisions require 85% percent majorities

Since 1970s, most major economies have abandoned the fixed exchange rates that were required by the BWS, and adopted floating rates.

At the time of its inception, the purpose of IMF was to monitor fixed exchange rates and provide emergency funding of foreign reserves to help maintain those fixed rates.

In today’s world, the purpose is to advise countries on how to maintain stable exchange rates in a world of floating rates and providing emergency lending when capital is fleeing the country so quickly and in such large quantities that it threatens financial and social stability.


1.  Members shall provide the Fund with the information necessary for surveillance;
2.  Members are allowed to request loans from the IMF’s pool of cash reserves.


Compliance with the terms of the loans

General resources; adequate safeguards

By adequate safeguards it means there should be an agreement with the government over how it will change its policies to ensure that the conditions that caused the crisis are improved so that the loan is paid back and the system protected.


For non-compliance with the conditions of a single loan, the Fund uses the threat of withholding future disbursements of the loan.

For non-compliance in repayment, the Fund relies on a combination of institutional and informal pressures, put together out of the assorted currencies of power in the international political economy: political influence, the threat to reputation and credit rating, and above all the suggestion that access to future loans in contingent on correct behavior with respect to present loans.

6.3.2 World Bank


Members are obligated to purchase their shares upon joining the organization and this stock of investment funds the Bank’s lending.

The shares are not tradable on any market.

The mechanics behind the Bank’s lending take advantage of the workings of the international credit rating system.


The core of the Bank’s lending happens through the IBRD (International Bank for Reconstruction and Development), and its operations are limited by the Articles of Agreement to loans “for the purpose of specific projects of reconstruction or development.”


The WB relies on states’ concerns with their future borrowing as the lever to induce them to repay their loans.

6.4 Case study: loan to Argentina