How the Fund Can Help Save the World Economy

Op-ed in the Financial Times

March 5, 2009

When the leaders of the Group of 20 nations gather in April, they will have one policy instrument available to address the financial crisis cooperatively, concretely, and credibly. They should make a commitment to an immediate, one-time allocation of $250 billion in special drawing rights (SDR) by the International Monetary Fund (IMF) to its 185 member countries.

The summit statement will contain pledges to adopt expansionary policies, avoid protectionism, and mobilize the IMF and multilateral development banks to help the weakest countries. A large, one-time allocation of SDR would do most to address these issues.

Special drawing rights are assets and liabilities of the Fund provided to each member in proportion to its quota share in the institution. A member receiving SDR can transfer some or all of its allocation to another member country and receive credit in a convertible currency to spend on its domestic or international needs. The interest rate on this credit is now about 0.6 percent-a good deal for most countries.

Approval of an SDR allocation requires an 85 percent majority vote of the IMF membership. The US Treasury Secretary can vote for an SDR allocation of up to $250 billion (€199 billion, £178 billion)-or larger, if he consults with key members of Congress 90 days before he casts his vote. Thus, the actual allocation could occur by mid-summer, sooner than other crisis-mitigation measures would take effect.

A one-time SDR allocation would dramatically build confidence in cooperative solutions to the global recession. It would leverage the low current borrowing costs of the major industrial countries to finance the immediate needs of developing countries experiencing a sudden disruption of normal international financial inflows. It would also provide immediate aid, about $17 billion, to the poorest countries-substantially more than their total annual disbursements from the International Development Association, the World Bank's soft-loan window. More than $80 billion would flow to other developing countries that have besieged multilateral development banks for large sums of quick disbursing credits with few economic policy conditions, threatening to distort the banks' normal mode of operations. Industrial countries would benefit by receiving, in return for their intermediation of a flow of credit to countries that use their SDR allocations, an asset backed by the full membership of the Fund.

Equally important, a large SDR allocation would allay a systemic danger posed by countries that may conclude from this crisis that their holdings of international reserves were too small. The risk is that their response would be to try to manage their exchange rates to generate large trade surpluses and build up reserves. Such competitive exchange rate policies cannot be successfully followed by all countries at the same time. However, in the attempt, they can set off trade wars. Some countries may be successful and promote a new build-up of global imbalances, which many people argue was one of the principal causes of this crisis. A large SDR allocation can help meet this demand for reserves.

Backers of an SDR allocation are likely to face some tired, out-of-date arguments. First is that the potential credit would be extended without conditions on recipient countries' economic policies. But that is a plus today. Some countries are not in a position to provide income growth support through monetary and fiscal policies and would use their SDR allocations to do so. In the process, the recent record of economic reforms in many countries would continue because they have less incentive to roll them back.

A second argument against SDR allocations is that they are inflationary. That is not today's problem. The more likely problem is deflation.

A third argument will be that a substantial amount of the SDR allocation may go to countries that do not need and would not use it. This is an empty argument. If a country did not need to do so, it would not mobilize the SDR-based credit. There would be no benefit, but also zero cost. Furthermore, under current uncertain circumstances, no country can be sure it will not need access to official international credit-witness Iceland.

Finally, countries are free to lend their SDR to other countries or use them to support the policies of neighboring countries, as is being contemplated in Western Europe with respect to their partners and neighbors in Central and Eastern Europe.