The International Monetary Fund (IMF) has released a Pilot External Sector Report in which the organization for the first time has embraced the concept of fundamental equilibrium exchange rates (FEERs) for use in its surveillance activities. The report, issued on July 30, was an important though little-noticed step that could portend progress toward improving multilateral surveillance of the global economy. The FEER, or reference rate, concept has long been associated with the work of John Williamson at the Peterson Institute for International Economics. In my view, John Williamson should take a bow.
In 2006, Williamson wrote that a FEER, or reference rate, is “an estimate of what rate would be consistent with equilibrium in both the domestic economy [of an IMF member] and [its] balance of payments” (Williamson 2006, 158). The IMF staff’s Pilot External Sector Report, whose release was approved by the IMF Executive Board on July 18, provides for the first time a “multilaterally consistent analysis of the external positions of major world economies” (IMF 2012b, 1). The report defines an “external imbalance” for a country as the gap between its actual current account and the value of its current account consistent with the fundamental economic and financial conditions and desirable policies for the country (IMF 2012b, 4). The report also includes estimates of deviations of real effective exchange rates (REERs) from effective exchange rates that would be consistent with such an external imbalance, in other words, deviations from the country’s FEER or reference rate.
For 28 major economies, the report provides estimates of differences between cyclically adjusted current account positions and those consistent with fundamentals and desirable policies. The report also provides estimates of differences between REERs and those consistent with fundamentals and desirable policies (IMF 2012b, 11). For both sets of estimates the report presents its results in ranges. For current account positions, the countries with surpluses with ranges that do not include zero are Malaysia, Germany, Singapore, Sweden, Thailand, China, Korea, Indonesia, and Netherlands—ranked from largest to smallest maximum deviation. Countries with deficits with ranges that do not include zero are Spain, Turkey, Italy, Australia, United States, United Kingdom, Japan, and Canada. These are plausible results with the possible exception of Japan.
For deviations of exchange rates from what can only be called a country’s FEER, the countries with undervalued currencies in terms of estimated ranges that do not include zero are Malaysia, Sweden, China, and Indonesia. These results, again, are plausible with the possible exception of Indonesia, which has only a small current account surplus. The countries with overvalued currencies in terms of estimated ranges that do not include zero are Turkey, Spain, Switzerland, South Africa, Canada, Brazil, Australia, United Kingdom, and Italy. The United States also is overvalued in that its range is from 0 to 10 percent. The result for Switzerland is questionable given that its current account surplus is more than 10 percent of GDP. It is, however, noteworthy that individual euro area countries are included in both sets of estimates.
One can quarrel with these estimates, which are partly based on models and partly based on judgment. Some of the results are far from intuitive, and the report itself is short on explanations. (I understand that the IMF plans to release background information in due course.) However, the report provides the basis for policy conversations between the IMF management and staff and the countries, between the particular country and its partner, and involving outside analysts.
Those dialogues will be facilitated by a companion action on July 18 by the IMF Executive Board—its approval of a decision on IMF bilateral and multilateral surveillance (IMF 2012a). This decision provides a formal framework for integrating the two types of IMF surveillance and, for the first time, establishes procedures for multilateral surveillance. Previously, only bilateral surveillance of individual countries in isolation was covered by a formal decision. Multilateral surveillance, which covers the implications of countries’ policies for the system as a whole, was in procedural limbo.
The decision does not create any new formal obligations on members, which can only be done by amending the IMF Articles of Agreement. However, the members of the IMF through their representatives on the Executive Board have now recognized explicitly that a member’s policies may affect other members and, consequently, the performance of the international monetary system. By agreeing to the decision, each member now implicitly accepts some responsibility in its own policies for global economic and financial stability.
Operationally, the decision gives the IMF staff and management the authority to discuss how a member’s policies may affect the international monetary system and to report on those discussions to the Executive Board and to the public at large. In the past, members could, and did, decline to discuss such matters with IMF staff and management. More important, this type of framework would help to implement Williamson’s long-time recommendations with respect to fundamental equilibrium exchange rates.
Consequently, even if he has reservations about the Pilot External Sector Report, Williamson should take some satisfaction and considerable pride that approaches to improving the international external adjustment process that he has advocated for 40 years are coming closer to fruition. These developments are evolutionary, not revolutionary. Moreover, the key to their success will be how the IMF staff and management implement the new integrated surveillance decision, including in future external sector reports, and how responsive the general membership of the IMF is to that implementation. We are still a long way from a rules-based system of fundamental equilibrium exchange rates that is supported by guidelines with respect to intervention and other policies influencing exchange rates and with sanctions for deviations, as advocated by John Williamson, but we are closer to that objective.
IMF (International Monetary Fund). 2012a. Bilateral and Multilateral Surveillance: Executive Board Decision—July 18. Washington.
IMF (International Monetary Fund). 2012b. Pilot External Sector Report. Washington.
John Williamson. 2006. Revamping the International Monetary System [pdf]. In Reforming the IMF for the 21st Century, ed. Edwin M. Truman. Washington: Peterson Institute for International Economics.