When the IMF was created in 1944, its well‐defined purpose was to enforce the rules in a fixed exchange rate system about altering a country’s exchange rate when fundamental adjustment was needed, as well as to provide temporary resources to deal with a country’s balance‐of‐payments problems. With the collapse of that system in 1971, the IMF lost its purpose. The switch to floating exchange rates eliminated its exchange‐rate regulatory role and changed the character of balance‐of‐payments problems. Since the early 1970s, the IMF has been seeking to reinvent itself. Until the 1995 Mexican bailout, it had pretty much decided that it would promote its purpose as providing advice and information to its members, which number more than 180 countries. That, however, proved to be only an interim stop on the road to acquiring a new identity.
The IMF’s role in the 1995 Mexican bailout planted the idea that the fund should serve as an international lender of last resort. The problem with this program is that its advocates have little understanding of the meaning of a lender of last resort.
Central banks have the capacity to serve as their banks’ lenders of last resort. They can create high‐powered base money (currency in circulation plus reserves), they can act quickly, and they can decisively stem a banking panic. The IMF lacks each of those features. It cannot create high‐powered money. It can issue Special Drawing Rights to central banks that can monetize the SDRs in their national currencies. But the IMF cannot issue SDRs without authorization by its membership. It cannot act quickly. The decisions of its executive board are subject to the votes of executive directors who consult their national authorities. To provide money to a borrowing country, the IMF first engages in lengthy negotiations of a reform program. A national central bank can promptly provide liquidity to the money market without prior external approval. Moreover, a national lender of last resort rescues solvent banks temporarily short of liquidity. It does not rescue insolvent institutions. The IMF has no such inhibition.