Question

Question # 03 (04 + 03 + 03 Marks)

Today's world economy looks dramatically different from that of 20 years ago, primarily due to the evolution of international capital markets.

i)-Discuss and compare the role of International Monetary Fund with that of World Bank.

ii)- Differentiate sterilized foreign exchange intervention from unsterilized intervention.

iii)- What steps should an international lender of last resort take to limit moral hazard?

Answer 1

i) The International Monetary Fund has the primary task of overseeing the world's monetary system and the balance of payments in particular. On the other hand, the World Bank's goal is to reduce poverty from the countries by offering various types of assistance and providing support to middle and low-income countries. The IMF keeps a track of the global economy with the help of economists who monitor IMF member countries' economies. IMF provides an economic assessment and assists countries plan their fiscal policy and tax legislation. Also, IMF lends to countries when they face balance of payment problems along with a set of measures to be undertaken to improve the economic situation of the country. The world bank on the other hand focuses on long term aid for economic development and reducing poverty in third world countries. The world bank itself consists of various other organizations such as IBRD, IDA etc which assists world bank in achieving its objectives.

ii) A sterilized foreign exchange intervention takes place when a sale or purchase of foreign currency is undertaken by a central bank of a country to influence the exchange rate of the domestic currency without changing the monetary base of the currency. This is carried out by purchasing or selling of domestic currency along with an open market operation for the purchase or sale of the government securities of similar size. Conversely, in an unsterilized intervention, there are no open market operations, then the intervention is unsterilized foreign exchange intervention because this increases the net amount of money.

iii) The lender of the last resort should ensure that the country is genuinely suffering from a crisis. For this, independent experts must assess the country's finances along with the fiscal situation prevailing. Need is to check if the willing borrower has adopted fraudulent practices or have intentionally taken an undue risk for aid. Once this check is done, the lender must chalk out a strict action plan and comprehensive compulsory steps to be carried out by the borrower to ensure that the economic situation is improved in the borrowing country. Also, need is to carry out the lender of last resort function only in emergency times and not frequently.