Institutions are not … created to be socially efficient; rather they, or at least the formal rules, are created to serve the interests of those with the bargaining power to create new rules.

What is the nature and purpose of IMF conditionality, and is it required to safeguard Fund resources? This chapter reviews these issues and then poses some key questions. For example, can program ownership by a country be made compatible with externally imposed conditionality? To what extent is conditionality of the international financial institutions (IFIs) power without responsibility? What, if any, are the consequences for the IMF of imposing programs that fail more often than not? It looks into the reasons for increased conditionality during the 1980s and 1990s and reviews the recent debate on conditionality. As the number of conditions – in particular structural ones – grew rapidly during the 1980s and the 1990s, the rate of compliance with IMF-supported programs saw a parallel and sharp decline. The chapter also presents an analysis that distinguishes between different types of external crises: short-term imbalances that result from excess demand and expansionary policies; mediumterm structural disequilibria such as those resulting from time lags in production (future supply) from investment spending (current demand); and currency and external crises resulting from sudden reversals of capital flows, noting that different types of underlying causes of imbalances call for different sets of policy conditionality. It critically examines the new guidelines on conditionality approved by the Executive Board in September 2000, concludes that they are not much different in substance from the previous ones, and offers some specific suggestions to make them operationally more effective. It also addresses the optimal mix between adjustment and financing. It discusses how the economic and social costs of adjustment may be minimized and find that Fund resources are highly inadequate to enable it to comply with its mandate. Finally, it offers some specific policy suggestions for streamlining conditionality and enhancing program ownership.