A well functioning international monetary system is an essential component of international economic co-operation. Traditionally, its scope was thought of as confined to three functions: (a) Ensuring adequate liquidity for the financing of trade; (b) Maintaining a system for facilitating exchange-rate realignments; (c) Providing short-term finance to countries to assist them in making balance-of-payments adjustments. More recently, its scope has been broadened to include surveillance of the economic policies of major developed market economies, evaluated in terms of their impact on other countries, as mediated, for example, by the level of world interest rates or the pace of world inflation.
The impacts of a poorly functioning international monetary system on the development process are manifold, but three clusters of issues may be singled out. First, when the balance-of-payments adjustment process places more of a burden to adjust on deficit countries than on surplus countries, world economic growth and the growth of deficit countries clearly suffers. Excessive exchange-rate volatility also imposes costs since it tends to reduce the expected gains from producing for external markets and thus discourages investment. Growth also suffers when the finance available to support balance-of-payments adjustment programmes is insufficient, because then adjustment will have to be compressed into a narrower time frame, with greater emphasis placed on demand restraint than would otherwise be the case. There is an obvious and pressing need for an appropriately high level of transitional development finance for countries trying to implement economic reforms to accelerate growth.
Secondly, the provision of liquidity has come to be mediated through commercial banks, which do not take into account the relatively greater needs of developing countries. Creation of special drawing rights was meant to improve the situation, since the rights are allocated in proportion to Fund quotas rather than perceptions of credit-worthiness, but preoccupation with the risk of renewed global inflation has put a halt to further emissions of special drawing rights in the while the principle of the link between such emissions and the need for development finance has been consistently resisted by developed market economy countries. Thirdly, lack of effective means for insisting upon policy changes in developed market economy countries, when their policies lead to excessively high interest rates, has meant the persistence of a high level of interest rates, which has aggravated the debt-servicing difficulties of heavily indebted developing countries and nearly excluded others from access to bank credit.
Furthermore, there is need for a mechanism for linking the functioning of the international monetary system to that of the international trading system, especially as regards the balance-of-payments adjustment process. This could take the form of reviews of the barriers in importing countries to the exports of countries with persistent current account deficits and the establishment of a dual conditionality, binding on both the deficit countries and their major trading partners to ensure that relatively more of the adjustment takes place by expanding exports compared to import contraction than has been the case in the past.