Division of Labor

ESF and Federal Reserve swaps are analogous to two separate fire crews working under the direction of the same fire department. Although each crew has the same broad goal—that of putting out fires within the jurisdiction—each has an area of expertise and a traditional clientele. Residential fires get one crew, commercial fires the other. Similarly, the Federal Reserve and the Treasury’s ESF each have their own specialties that they bring to bear when confronting an international financial conflagration. In a statement before Congress at hearings on the ESF in 1976, Federal Reserve Chairman Paul Volcker summed up the division of labor between the two American ILLR mechanisms as follows:

The Federal Reserve, in time of need, can bring very substantial resources to bear . . . . The ability to marshall [sic] large amounts of resources in one currency or another through these Federal Reserve swap arrangements at a time of need remains important in dealing with specific problems as they arise . . . The ESF, although its resources are much smaller, can respond in a greater variety of ways to contingencies not envisaged in guidelines for Federal Reserve operations. The ESF can, for instance, engage in transactions with countries that may not be included in the [Federal Reserve] System’s overall swap network . . . The ESF can respond more flexibly to unusual or special circumstances attaching such conditions and specifications to these financings as may be appropriate with each operation . . Because of

some of these differences, the flexibility with which the U.S. could approach a particular situation has sometimes been enhanced by having both the System and the ESF participate in its own way.[1]

The Federal Reserve’s most important asset is its theoretically unlimited pool of financial resources. The Fed’s ability to create liquidity in US dollars renders its capacity to respond to systemic global financial crises unparalleled by any other actor in the world. In circumstances when the IMF faces the problem of resource insufficiency, the Federal Reserve is generally best equipped to step in and fill the ILLR role on its own. Historically, its lending has substituted for IMF credits. However, a downside of the Fed’s swap lines is that the US monetary authority has typically been very reluctant to extend swap lines to nonindustrialized countries. The Fed is quite circumspect with respect to the countries with which it is willing to transact. This is at least in part due to the institution’s informal "red line,” whereby it will only extend credit to countries that are signatories to Article VIII of the IMF’s Articles of Agreement.[2] Article VIII, in short, requires that countries make their currencies convertible for current account transactions.[3] Since it was not until after 1993 that even a majority of IMF members had signed Article VIII, this red line precluded most countries from receiving a bailout via the Federal Reserve for the majority of years considered here.[4] As such, advanced industrial countries have been the typical Fed swap line recipient.[5]

By comparison, what the ESF lacks in resources, it makes up for in flexibility and agility. Unlike the Federal Reserve, the ESF has no informal restrictions regarding which countries it will lend to. In practice, this has meant that the ESF tends to serve a different population ofborrowers than the Fed does. Historically, ESF credits have been extended almost exclusively to developing or emerging market economies. Moreover, because the ESF’s resources are limited, its financial rescues have almost always complemented IMF lending. On many occasions, it has aided Fund lending by quickly providing bridge loans while IMF programs are negotiated. On other occasions, it has aided Fund actions by providing supplemental credits aimed at increasing the overall size of the financing package.

Figure 2.5 presents a spatial map of ILLR capability based on Bagehot’s classical conception of a mechanism that can automatically provide

Figure 2.5

Spatial Map of ILLR Capability

unlimited liquidity. Both axes are theoretically conceived of as continua. Moving up the y-axis signifies that the mechanism’s aggregate lendable resources are closer to the "unlimited” liquidity ideal. Moving to the right on the x-axis signifies that the mechanism’s responsiveness to borrower needs is more proximate to the “automaticity” ideal. Thus, the closer the mechanism is to the upper right corner of the figure, the closer it is to the ideal-type ILLR. Although the specific points depicted do not correspond to a precise measure on either scale, the figure is meant to depict the various strengths and weaknesses of the IMF, ESF, and Federal Reserve as potential ILLR mechanisms. By virtue of its ability to independently open swap arrangements with foreign central banks and its capacity to create liquidity in US dollars, the Federal Reserve most closely approximates an ideal-type ILLR mechanism. Although the ESF’s lendable resources are quite limited, its ability to complement IMF lending through (l) providing supplemental resources (point a) or (2) swiftly providing bridge loans while longer-term credits are being worked out (point b) has the effect of moving the combined response closer to the ILLR ideal point. Thus, although the United States prefers that the IMF assume the ILLR role, its shortcomings may under some circumstances threaten vital US interests. When faced with such situations, the United States’ unilateral ILLR actions are designed to protect its economy from harmful spillovers by making international financial crisis management more effective.


Using Bagehot’s classical conception of the lender of last resort, upon which Kindleberger’s concept of an ILLR was based, I have explained why the IMF’s effectiveness in this role has been consistently limited by the problems of resource insufficiency and unresponsiveness. These shortcomings are embedded in the Fund’s DNA. The United States relies on two institutions to execute unilateral ILLR actions: the Federal Reserve’s ability to open reciprocal currency swap arrangements with partner central banks and the Treasury’s ability to open similar swap arrangements with foreign governments by using ESF resources. The remainder of the book presents historical, empirical analyses of US ILLR actions in an effort to further uncover the motives behind these efforts.

  • [1] US House of Representatives 1976, p. 82.
  • [2] Federal Reserve Chairman Paul Volcker mentions this during a 1982 Federal OpenMarket Committee (FOMC) meeting where the group discusses the possibility of extending a swap line to either Argentina or Brazil. At one point in the conversation, Volcker notes,"Argentina is an Article VIII country, which is one place where we draw the ring aroundswap agreements. Brazil is not” (FOMC 1982c, 62).
  • [3] Or, to put it differently, Article VIII prohibits countries from imposing restrictions onpayments and transfers for current international transactions.
  • [4] IMF 2006, 7. By 2005, this percentage had jumped to nearly 90 percent.
  • [5] There are a few exceptions to this rule, however. Most notably is Mexico, which hasbeen the beneficiary of Fed swaps in 1982, 1990, 1995, and 2007-2008. Furthermore,Mexico has enjoyed a permanent swap line with the Fed since 1967; since 1994 a $3 billion swap line has been maintained as part of the North American Framework Agreement(NAFA), a financial agreement between Canada, Mexico, and the United States that preceded the more famous trade agreement by a similar name.
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