March 16, 2018
Countries benefit in various ways from belonging to a currency union—a group of countries that share a single currency. Businesses can trade and invest across borders more easily. Member countries gain access to larger markets without facing currency risk. And in some circumstances, currency unions can help support their members when they are hit by external shocks.
But there are also costs to membership: countries relinquish the independence to formulate monetary policy, which can complicate a country’s adjustment to a shock. At the same time, currency union institutions face their own constraints. Currency unions have a responsibility to serve the interests of all of their members; accordingly, changes to policies with a union-wide impact, like monetary policy, are guided by the needs of the union rather than any one single member.
In a new paper, Program Design in Currency Unions, we review our experience in supporting the economic adjustment of countries that belong to currency unions and, for the first time, propose guidance on how this support should be designed and managed. The guidance clarifies when and how the IMF will seek supportive policy actions from union-level institutions. It does not confer any new authority on the Fund—rather, it simply articulates more clearly how that authority should be exercised in practice.
Why guidance is needed
There are currently four currency unions in the world—the Central African Economic and Monetary Community, the Eastern Caribbean Currency Union, the European Monetary Union, and the West African Economic and Monetary Union—all of which delegate monetary policy and, to varying degrees, exchange rate and financial sector policies to union-level institutions.
Currency unions have long been part of the global financial landscape, but they now account for over 15 percent of the global economy. In the absence of established guidance, our engagement with currency union institutions during past programs has been somewhat ad hoc. By clarifying how adjustment programs should be designed in the future, we hope to foster more robust programs and promote more evenhanded treatment.
Currency unions evolve over time, including with respect to which policies are the responsibility of union-level institutions and which ones remain in the domain of the national authorities. IMF-supported programs will be more robust if there is greater clarity over when and how critical union-level actions should be incorporated into programs so that such programs are effective in helping countries resolve their problems.
The nature of actions a union-level institution may be asked to undertake in support of a member’s program can change over time as the nature of the union evolves. For instance, in 2014 responsibility for bank supervision in the euro area was assigned to the Single Supervisory Mechanism. This change meant that important financial sector supervisory actions required under the earlier Greece, Ireland, Portugal, and Cyprus programs would no longer be under the control of the respective national authorities. Future programs where banking measures are judged to be similarly essential would instead now involve some action by the Single Supervisory Mechanism.
The guidance also helps delineate when union-wide policy settings (such as monetary policy in a recent set of programs with members of an African currency union) may be appropriate. Experience suggests this would only be in truly exceptional circumstances, since in past currency union programs, when action at the union level has been called for, it has almost always taken the form of measures that affect only the program country—bank resolution, for instance.
The new guidance also means that the IMF will seek qualitatively the same level of assurance regarding policy intentions in programs with currency union members as we do for programs in countries outside currency unions. Clearer expectations for when and how union-level policy actions are needed in support of a member’s program will help ensure evenhandedness and consistency across different currency unions.
When to call for action
If a member of a currency union requests our financial support, we will call for policy assurances—that is, voluntary pledges to undertake specific actions deemed critical for the successful completion of the program—from union institutions in the following circumstances:
When national policies are insufficient . The premise is that program design should be based, to the extent possible, on policies under the control of the member’s national authorities. Only where this is not feasible—typically because some essential aspect of policy has been delegated to the union level—will complementary measures be sought from the relevant union institutions.
When the action is critical for program success. The threshold is the same as for policies under the member’s own control: the measure must be deemed critical to program success—meaning that, if the measure were not implemented, the objectives of the program would be jeopardized.
When the actions are consistent with mandates and legal frameworks. As with institutions of individual member countries, the Fund will not ask a union institution to take actions or make commitments that are inconsistent with that institution’s mandate and legal or institutional frameworks.
How to call for action
The value provided by a policy assurance depends importantly on how it is framed and conveyed. The guidance lays out two main requirements in this respect:
Transparency . Assurances should be clear, specific, monitorable, and—where necessary—timebound. This will ensure clarity with respect to the action that is being committed and (in due course) whether it has been implemented as envisaged.
Mode of conveyance . The relevant institution should provide assurances in writing, either in the form of a letter to the Fund or in a public statement—it is recognized that different institutions may have different preferences in this regard. In line with our current policy, assurances could be kept confidential only in a narrow set of circumstances, such as where the announcement of the action may trigger disruptive market movements.
The new guidance approved by the IMF’s Executive Board in February represents an important step towards greater clarity in how the Fund supports members of currency unions undertaking adjustment. This guidance is a natural evolution from our past engagement with currency unions, and should ensure that our lending decisions are robust and evenhanded—while at the same time guaranteeing an approach that takes account of country and union circumstances and protects the independence of currency union institutions.