Category Archives: IMF

The IMF’s Position in a Fragmented Global Economy

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Ten years ago Cambridge University Press published my book, The IMF and Global Financial crises: Phoenix Rising? I had written a series of journal papers on the IMF and used the format of a book to summarize what I had learned about the Fund. I also made some evaluations and projections about the IMF and its reputation; a decade later, how has the IMF done?

The book reviewed the history of the IMF from its founding at Bretton Woods through the global financial crisis. One of the theses of the book was that the IMF had paid a high price for its handling of the Asian financial crisis. The Fund had formulated programs for Indonesia, South Korea, and Thailand that proved to be controversial. Among the charges levied against the Fund was:

  • Condemnation for imposing harsh macro policies in the conditions of the programs;
  • Criticism for including inappropriate structural conditions;
  • Blame for indirectly precipitating the crisis through its support of capital decontrol.

In the aftermath of the Asian crisis as well as subsequent crises in Russia, Turkey and Argentina, the global economy entered a period of steady real growth and moderate inflation rates. The demand for the Fund’s assistance declined, and the IMF used the occurrence of relative stability to undertake post-mortem reviews and changes in its recommended policies. These included a retreat from its advocacy of full capital decontrol, and a reassessment of the purposes and scope of conditionality.

When the global financial crisis of 2008-09 occurred, it was an opportunity for the IMF to show that it had learned the lessons of the previous crisis and could adapt its playbook.  The IMF set up 17 Stand-By arrangements during the period of September 2008 through the following summer. The policy conditions attached to these programs were based on an understanding that the contractions in economic activity in the program countries were the result of falling international trade that followed the financial collapse in the advanced economies. Subsequent reviews of the programs found that credit was disbursed more quickly and in larger amounts than in past crises.

In addition to providing financial resources, the IMF called for a coordinated response to the crisis and the use of fiscal stimulus to offset its effects. The Fund’s economists completed its turnaround in its position on capital account regulation and acknowledged that capital controls could mitigate financial fragility. The IMF’s activist stance was acknowledged by the newly formed Group of 20, which approved an increase of the IMF’s financial resources, and called upon it to institute surveillance of their economies.

The IMF, therefore, came out of the global financial crisis with its reputation as a crisis manager restored. The whimsical subtitle of my book came from a line in Don Quixote that referred to a phoenix that rose from the ashes of a fure.  How the IMF used its reputation and handled new crises, however, could only be revealed with the passage of time.

The IMF does much more than serve as a crisis lender. The results of its surveillance of the global economy are published in reports such as the World Economic Outlook, and updates to its economic forecasts are widely reported. The IMF’s Managing Director, Kristalina Georgieva, has a high public profile, and speaks out a range of global issues. The research of its economists has grown to include work done on income inequality, gender and climate change.

The next major challenge the IMF faced was the Greek debt crisis, when it joined the “troika” of the European Central Bank and European governments in arranging a resolution. The loans extended to Greece were controversial because of the conditions the Greek government had to implment. As the crisis deepened, the IMF differed from its troika partners in advocating for debt relief. Greece eventually repaid its loans from the IMF two years earlier than planned, but in retrospect the IMF’s inclusion in the troika constrained its ability to set sustainable debt levels.

More recently, during the pandemic the IMF was active in providing financial assistance to its poorest members. Some of its funds were given through new facilities, such as the Rapid Credit Facility and the Rapid Financing Instrument, with (at most) minimal conditionality. Brad Setser of the Council of Foreign Relations pointed out that lending from the IMF and the World Bank to lower middle-income countries rose just as private credit flows fell. Setser observed:

“Such a surge made financial sense, and was a moral imperative as well. The Bank and the IMF, and thus President Malpass and Managing Director Kristalina Georgieva, deserve credit for making it a reality. The system, in a sense, worked. Low income countries had to struggle through the pandemic, but they didn’t lose access to new financing at the same time.”

But not all agree that such lending by the IMF is consistent with its core missions. Kenneth Rogoff of Harvard, who was chief economist at the IMF from 2002 to 2003, points out that the Fund, unlike the World Bank, is not an aid agency. It uses conditionality in part to ensure that it is repaid so that it can continue to lend.  He also argues that “forceful IMF conditionality is essential to establish financial stability and ensure that its resources do not end up financing capital flight, repayments to foreign creditors, or domestic corruption.”

More recently the IMF has become involved with a number of developing nations that can not meet their debt obligations, including Egypt, Sri Lanka and Pakistan. According to The Economist, this work is likely to escalate:

“Debt loads across poorer countries stand at the highest levels in decades. Squeezed by the high cost of food and energy, a slowing global economy and a sharp increase in interest rates around the world, emerging economies are entering an era of intense macroeconomic pain… All told, 53 countries look most vulnerable: they either are judged by the imf to have unsustainable debts (or to be at high risk of having them); have defaulted on some debts already; or have bonds trading at distressed levels.”                                                 The Economist, 7/20/2022

The Fund recently published a Staff Discussion Note on “Geoeconomic Fragmentation and the Future of Multilateralism.” The authors of the Note point out that the pace of globalization slowed notably after the global financial crisis, and geopolitical tensions have led to a reversal of economic integration. They examine the consequences of fragmentation on international trade, the diffusion of technology and the international monetary system.

Could the IMF be replaced? It is difficult to imagine how a new global organization could be organized. On the other hand, regional blocs may become more widespread. For example, the IMF’s Note on fragmentation notes that global liquidity has four sources: central bank reserves, bilateral swap agreements, regional financial arrangements, and the IMF. Bilateral swap lines and regional arrangements have grown rapidly, leaving  the Fund as the only provider of universal coverage. Further growth of regional arrangements based on geopolitical blocs would increase their coverage, but it would be uneven across blocks and could be inadequate to deal with large shocks.

I argued in my book that it is crucial to remember that the IMF is an agent for its 190 principals. Its ability to address global challenges depends on the willingness of the sovereign members to use the IMF to organize responses to the challenges. A world that is divided by U.S.-China frictions gives the IMF limited scope to play the role it seeks to have.

The IMF’s Proposed Policies on the Management of Capital Flows

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The IMF’s views on the advantages and drawbacks of capital flows have substantially evolved over time. The Fund reversed its opposition to capital controls in the wake of the global financial crisis of 2007-09, when it adopted the “Institutional View on the Liberalization and Management of Capital Flows.” That framework included capital flows measures (CFMs) as one of the policy measures available to a government facing surges of capital inflows, i.e., large inflows that could destabilize an economy. The Fund has now moved further in the direction of using CFMs, proposing that they can be used in a preemptive manner to avoid future instability.

The IMF had advocated the removal of capital controls before the Asian financial crisis of 1997-98, so that developing economies could benefit from capital flows. That crisis demonstrated the volatility of capital flows and the catastrophic impact of “sudden stops” on economic activity. Subsequently, the Fund refined its position on deregulation, advising governments to implement adequate supervisory and regulatory regimes before liberalizing their capital accounts, and to begin with opening to foreign direct investment before allowing short-term capital. The IMF moved further during the global financial crisis when it allowed Iceland to implement controls. The Institutional View was adopted in 2012, when countries such as Brazil used CFMs to manage the inflows of foreign capital seeking higher yields than those available in the U.S. The CFMs were part of a toolkit that also includes Macroprudential Prudential Measures (MPMs), which are designed to limit systemic risks. CFM/MPMs are measures designed to limit such risk by controlling capital flows.

The IMF’s new proposals are presented in an IMF Policy Paper, “Review of the Institutional View on the Liberalization and Management of Capital Flows.”  The first proposal extends the Institutional View by allowing the preemptive use of CFM/MPMs on foreign currency debt inflows in order to address the systemic risk that could result from foreign exchange mismatches on balance sheets. Such mismatches can occur slowly, and not just following surges. They increase the probability of capital flow reversals and exchange rate depreciations that disrupt economic activity and could not be adequately addressed with conventional policy tools.

The proposal would also allow CFM/MPMs in the case of high foreign investor participation in local-currency debt markets. In these cases, the danger is a “sudden stop” by foreign investors, which would have particularly adverse consequences if there were illiquid capital markets. Other domestic measures may be unavailable, and the CFM is a second-best solution.

The second proposed policy change exempts certain types of capital control measures that are enacted by governments for specific purposes from review. These include: first, measures adopted for national or international security; second, measures based on international prudential standards, such as those related to the Basel Framework on banking; third, measures designed to deal with money laundering and the combating of financial terrorism; and fourth, measures related to international cooperation standards related to the avoidance or evasion of taxes.

The usefulness of preemptive policies has been demonstrated in a new NBER working paper, “Preemptive Policies and Risk-Off Shocks in Emerging Markets” by Mitali Das and Gita Gopinath of the IMF and Sebnem Kalemli-Özcan of the University of Maryland. The authors investigate the impact of preemptive CFMs on the external finance premia in 56 emerging markets and developing economies during the Taper Tantrum and the COVID-19 shocks. The premia are measured by deviations from uncovered interest rate parity. They consider the impact of CFMs on inflows and outflows, as well as the effect of domestic MPMs.

The paper’s authors report that countries with preemptive CFMs on inflows in place during the five-year period preceding the shocks experienced lower premia and exchange rate volatility. They infer that use of the CFMs provide enhanced access to international capital markets during volatile periods. CFMs on outflows, on the other hand, had a positive effect on the UIP premiums, which may reflect the demand by foreign investors for higher returns to compensate for the CFMs in outflows.

The IMF’s capital flow policies under the Institutional View had been reviewed by the IMF’s Independent Evaluation Office (IEO) in its 2020 report , “IMF Advice on Capital Flows.” The report praised the IMF for the changes in its policy stance, and called the adoption of the Institutional View “a major step forward.” The IEO’s report, however, also called for further changes, including revisiting the Institutional View to take into account recent experience with capital flows, building up the monitoring, analysis and research of capital acccount issues, and strengthening multilateral cooperation on policy issues.

Anton Korinek of the University of Virginia, who wrote a briefing paper for the IEO report, Prakash Loungani, assistant director of the IEO and co-leader of the 2020 report, and Jonathan Ostry of Georgetown University, who was at the IMF when it issued the Institutional View, have written a review of the IMF’s latest policy proposals, “The IMF’s Updated View on Capital Controls: Welcome Fixes but Major Rethinking Is Still Needed.” While welcoming the new measures, they bring up several additional issues that should be addressed. These include the use of capital controls for domestic objectives, such as the impact of capital flows on income inequality and also real estate prices. Such a move would in many ways be consistent with the original aims of the Bretton Woods agreements.

The authors point out that the targets for the IMF’s capital policies are the host countries that receive capital inflows. But challenges associated with capital flows should also involve the countries that are the source of the capital flows. Since these are usually the advanced economies which have a major role in the IMF’s governance, such a move would require the cooperation of the IMF’s most influential members.

Korinek, Loungani and Ostry also urge the IMF to investigate the use of controls on capital outflows. The Fund’s current policy stance only approves the use of such measures during crises. Given the current economic and financial situation (see, for example, here), governments of developing countries are concerned about a repeat of the outflows of March and April 2020. The IMF should be working with these policymakers now to minimize the turbulence that large capital outflows would bring.

The IMF and the Coronavirus

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A global threat such as the coronavirus should be met with a global response. National governments, however, have generally not coordinated their efforts, with the exception of those that belong to the European Union, and even there the distribution of vaccines has not gone smoothly. International agencies, on the other hand, such as the International Monetary Fund have responded more quickly. Moreover, the IMF has shown a willingness to play an active role in preparing for the post-pandemic world and to take on issues outside its usual remit.

The IMF’s past attempts to resolve financial crises have not always been successful (for an account see here). The IMF’s policy prescriptions at the outset of the East Asian crisis of 1997-98 included contractionary fiscal policy conditions for the governments that adopted IMF programs, as well as higher interest rates. There were  also structural conditions that dealt with the privatization of government-owned enterprises. While such policies may have been appropriate for a crisis that was due to expansionary macroeconomic policies, fiscal and monetary measures did not precipitate the East Asian crisis. Capital inflows had fueled bank lending and asset prices had soared, while central banks were committed to fixed exchange rates. Once foreign investors became alarmed about the exposure of private borrowers to currency and maturity mismatches, they began to exit, provoking a “sudden stop” of capital and currency devaluations.

The IMF faced criticism not only from the East Asian governments but from economists outside Asia. The macroeconomic policy conditions were inappropriate for a crisis that originated in private capital flows, and were based on overly optimistic projections of growth. Structural conditions were viewed as unnecessary and diverted attention from the measures that need to be undertaken. The IMF was also blamed for indirectly provoking the crisis through its advocacy of the removal of capital controls before the crisis. The IMF subsequently relaxed many of its program conditions as the nature of the crisis became more clear, but the damage to its reputation was enormous.

A decade later the IMF again faced a widespread financial crisis, and this time its response was very different. The global financial crisis of 2008-09 showed some similarities in its background with the Asian crisis. Inflows of capital to the U.S. and several European countries had fueled increases in asset prices and distorted expenditures. Once the bubbles in housing prices burst, financial institutions sought to unload mortgage-backed securities, forcing their prices down further. The rapid nature of the collapse in asset values and the lack of liquidity in financial markets exposed the fragility of the financial sector.

While the central banks of the advanced economies coordinated their responses, the IMF assisted emerging market economies that were caught up in the economic downturn precipitated by the financial collapse. The Fund lent to 17 countries, with the largest amounts of credit going to Hungary, Pakistan, Romania, and the Ukraine. Moreover, the policy conditions attached to the programs reflected an awareness of the origin and severity of the global contraction. Fiscal policy in the program countries was utilized to respond to falling private demand, although their governments avoided the large deficits that occurred in the advanced economies. Interest rate increases designed to prevent runs on currencies were limited and exchange rates did stabilize. Moreover, the IMF allowed the use of capital controls. Overall, the IMF received high marks for its initiatives during the global financial crisis.

In retrospect, the post-crisis recovery did not go as smoothly as it should have. Many countries felt compelled to reverse the expansionary policies of the crisis period because of fears of excessive debt. This contractionary trend was exacerbated by a sovereign debt crisis in Greece. Other European governments sought the inclusion of the IMF in addressing the crisis, and for the first time the Fund had partners: the European Central Bank and the European Commission. The initial macro policy changes imposed by this “troika” sought to restore fiscal balance, but their contractionary effects kept tax revenues below their anticipated levels, which led to further cutbacks. The IMF differed with the European governments over the sustainability of Greece’s debt burden and the need for debt forgiveness. Eventually the Greek economy began a recovery, but in retrospect the austerity policies there and elsewhere led to a slower recovery that there could have been.

The IMF has drawn upon these past experiences in formulating its response to the pandemic. The Fund has again responded quickly to assist its members, approving emergency financing  through its Rapid Credit Facility and its Rapid Financing Instrument to 80 countries and assistance under other arrangements to another five nations. It has extended debt service relief to 29 of its poorest members that have obligations to the IMF. The Fund and the World Bank have called on bilateral lenders to suspend debt service payments from the poorest countries, and the governments of the Group of 20  agreed to do so for official debt. The agencies have called for private lenders to implement similar measures.

The IMF has also sought to prepare countries for the post-pandemic world. Kristalina Georgieva, the current Managing Director of the IMF and the first from a East European country (Bulgaria), has supported policy initiatives in areas that traditionally do not fall under the IMF’s purview. She has supported national policies that seek to address different forms of inequality, including income and wealth inequality as well as gender and generational inequality. She has also called for including climate related risk in the IMF’s economic and financial assessments , and using fiscal expenditures to target “…climate-resilient infrastructure and expanding green public transportation, renewable energy, and smart electricity grids.”

Will the IMF be able to engineer such broad changes? The IMF is an agent responsible to 190 principals, the sovereign governments that are the IMF’s members and oversee its activities. Some of these may feel that Georgieva’s policy agenda is too ambitious and/or expensive. There are also disagreements over how to finance the IMF’s assistance to its poorest members. Proposals to issue more Special Drawing Rights (SDRS) have faced opposition from the U.S. On the other hand, differences amongst its principals may allow the IMF more freedom to expand the scope of its mandate. There is also the danger that a wave of debt crises following the wave of public borrowing by emerging maket governments may force the IMF to focus on debt restructuring.

The IMF, and Georgieva in particular, deserve credit for bringing forward issues that traditionally have not been addressed in discussions of international macroeconomic concerns. Monetary and fiscal policies, for example, have impacts on racial and gender inequality that have been overlooked. Climate change will constrain the actions of the governments of the most vulnerable countries. Whether the IMF is successful in actually steering governmental actions towards these areas will depend on the willingness of its members to adopt wider and inclusive approaches in their responses to the coronavirus

[I had the opportunity of interviewing Ms. Georgieva for the Madeleine Korbel Albright Institute of Wellesley College. The transcript of the interview can be found here.]

The IMF’s Flexible Credit Line

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The policy conditions attached to the disbursement of an IMF loan have long been the subject of controversy. In the wake of the global financial crisis, the IMF introduced a new lending program—the Flexible Credit Line—that allowed its members to apply for a loan before a crisis took place. If approved, the member can elect to draw upon the arrangement in the event of a crisis without conditionality, and there is no cap to the amount of credit. However, only three countries—Colombia, Mexico and Poland—have signed up for the FCL, and the lack of response to an IMF program without conditions has been a bit of a mystery. A new paper, “The IMF and Precautionary Lending: An Empirical Evaluation of the Selectivity and Effectiveness of the Flexible Credit Line“ by Dennis Essers and Stefaan Ide of the National Bank of Belgium, provides evidence that helps to explain the muted response.

Essers and Ide deal with two aspects of the FCL: first, the factors that explain the decision to participate in the program, and second, the effectiveness of the program in boosting market confidence in its users. This paper is very well-done, both from the perspective of dealing with an important issue as well using appropriate econometric tools for the analysis, and it received a prize for best paper at the INFINITI conference in Valencia. The authors point out that the views expressed in the paper are theirs, and do not necessarily reflect the views of the National Bank of Belgium or any other institution to which they are affiliated.

The results in the first half of the paper can explain why so few countries have adopted the FCL. On the “demand side,” Colombia, Mexico, and Poland applied for the FCL because they were vulnerable to currency volatility as manifested by exchange market pressure. On the “supply side,” the IMF was willing to accept them into the program because 1—the economies were not showing signs of financial or economic instability, as manifested by lower bond interest rate spreads and inflation rates, and 2—they met the “political” criteria of high shares in U.S. exports and acceptable United Nations voting patterns.

If this line of reasoning is correct, then the adoption of the FCL will always be limited. The authors point out that the “…the influence of the first two variables (EMBI spread, inflation) is in line with supply-side arguments…” The qualifying criteria on the IMF web page that explains the program include:

  • “A track record of steady sovereign access to international capital markets at favorable terms”
  • “Low and stable inflation, in the context of a sound monetary and exchange rate policy framework”

However, lower bond spreads and inflation (and macroeconomic stability) can also be viewed as factors that lower the demand for IMF programs, as would most of the other criteria, i.e., a “sustainable external position,” “a capital position dominated by private flows,” “a reserve position which…remains relatively comfortable,” “a sustainable public debt position,” and “the absence of solvency problems.” My first paper on the economic characteristics of IMF program countries found that countries that entered IMF programs in the early 1980s had higher rates of domestic credit growth, larger shares of government expenditure, more severe current account deficits, and smaller reserve holdings. Therefore, the applicants for the FCL have been countries that do not have the features of those that apply for the standard IMF program, the Stand-By Arrangement, and yet decided to apply for the FCL because of some form of exchange market pressure.

Such a confluence of factors may be relatively rare. If the country is experiencing exchange market pressure, ordinarily we would expect to see increased bond spreads. Moreover, exchange market pressure could be a reaction to domestic macroeconomic instability, which could be linked to rising inflation rates. The three countries were experiencing some combination of exchange rate depreciation and/or a drain on their international reserves, but their bond rate spreads were not rising and domestic inflation was not a concern. In addition, the governments also met the IMF’s (hidden) political criteria.

If such a combination is unusual, then to enhance participation in the FCL, the IMF would have to be willing to relax its official criteria for selection. It would also need to deal with countries that have not always accommodated U.S. foreign policy. This may require some “bargaining” among the major shareholder countries at a time when international agreements and organizations are being looked on with suspicion. The time to promote the program, however, is now, while international financial markets are relatively calm. Unfortunately, there is always a tendency to project current conditions into the future, and to delay adopting precautionary measures. When circumstances force governments to turn to the Fund, they will not qualify for the no-conditions FCL, but for programs with much more stringent criteria.

Greece, the IMF and the Euro

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Talk about possible trade wars with China and the Brexit negotiations has crowded the Greek debt crisis out of the headlines, but a new decision point is approaching. It is possible that this time the beleaguered Greek government will announce a withdrawal from the Eurozone, if only to drive home the point to other European governments that the status quo is not acceptable. But those governments, facing resistance from voters suspicious of foreign engagements, may not offer terms acceptable to the Greek government. Moreover, the IMF does not want to approve the next stage of a bailout agreement that it believes is not credible. Consequently, each side may feel pushed to accept an outcome it knows is not optimal. If that comes to pass, the consequences for the Eurozone will be far-reaching.

Greek economic performance, after years of contraction, has stabilized. The IMF projected that GDP, after stagnating in 2016, would increase in the current year by 2.8%. But the ratio of gross debt to GDP, according to the IMF’s projection in last fall’s Global Stability Report, was 183.4% last year, up from 176.9% in 2015 and 180.1% in 2014. Moreover, a draft report from the Fund projects continuing growth in the debt burden, ultimately reaching a crushing 275% in 2060.

The IMF’s concerns come as European governments are assessing Greek compliance with its current bailout agreement. Greece needs a successful review to qualify for disbursal of about $90 billion, which the government requires for debt repayments. Greece has met its recent fiscal targets, but the agreement calls for a 3.5% primary budget surplus target by 2018. The IMF fears that this is not achievable without a degree of fiscal austerity that would kill off the incipient recovery. Not everyone shares the IMF’s apprehensions, and the agency that administers the European Stability Mechanism has issued a positive assessment. But if the IMF does not approve the next stage of the bailout, at least some European governments will not want to proceed.

George Papaconstantinou in Game Over has provided an insider’s look at the outbreak of the crisis and the course of negotiations in the early years. Papaconstantinou, who earned a Ph.D. in economics at the London School of Economics, served first as Finance Minister and then Minister of Environment, Energy and Climate Change, in the government of Prime Minister George Papandreou from 2009 to 2012. He faced what he calls a “disconnect” between the demands from European ministers that the Greek government close the fiscal deficit and the realization at home what the abrupt change in the government’s fiscal position meant for the economy. There was a continuous refusal on both sides to address the reality of the situation and to temporize in the unfounded hope that the arrival of another day would deliver a solution—or at least delay any decision that would generate voter unhappiness, either at home or in the European electorate. But postponement only raised the cost of what became three bailout agreements. Among the lessons that Papaconstantinou draws: “time is expensive: the more you delay, the more you pay.”

The IMF was also facing challenges in its involvement in the crisis negotiations, as Paul Blustein recounts in Laid Low. The Fund joined the European Central Bank and the European Commission, representing the European Union, in an arrangement known as the “troika.” The IMF, however, was viewed as a “junior partner,” and had to negotiate with its partners as well as with the Greek government. This was a departure from past practice, and placed the IMF in the position of making compromises that it came to regret.

The principal violation of the Fund’s own practices took place early in the crisis when it approved “exceptional access” credit to Greece, i.e., an unusually large amount of credit. Such approval was supposed to be contingent on a high probability that the debt was sustainable. This condition had clearly not been met in 2010, but the IMF gave itself a loophole when it approved exceptional credit if there is a high risk of international systemic spillovers. The insertion of the systemic exception clause violated any notion of the IMF’s evenhandedness when dealing with members who required assistance, and reinforced the image of the Fund as an agency dominated by its richer members.

The IMF subsequently has sought to recover its reputation as an institution that has extensive experience in macro adjustment and is willing to “speak truth to power.” It eliminated the exceptional access provision in 2016. The Fund now admits that the fiscal policies imposed on Greece in the earlier bailout programs were contractionary. And in a statement it issued on Tuesday, the IMF called for more debt relief by the European creditor governments:

“Most Directors considered that, despite Greece’s enormous sacrifices and European partners’ generous support, further relief may well be required to restore debt sustainability.”

But in a highly unusual public statement, the IMF also announced that the Board was split on the feasibility of the new agreement:

“Most Directors agreed that Greece does not require further fiscal consolidation at this time, given the impressive adjustment to date which is expected to bring the medium-term primary fiscal surplus to around 1½ percent of GDP, while some Directors favored a surplus of 3½ percent of GDP by 2018.”

Could there be a better outcome? Joseph Stiglitz of Columbia University argues that the monetary union is inherently flawed in The Euro. He points out that the euro was justified on the premise that a single currency would facilitate trade and financial flows, and “…the resulting economic integration would improve societal welfare everywhere within the Eurozone.” In fact, there were winners and losers, and the latter were not compensated for their losses. Such a redistribution requires political integration, which does not automatically follow the establishment of economic integration.

Stiglitz does not want to abandon what he calls the “European project,” and offers several structural reforms to rescue the euro. But all of these require political resolution as well intellectual flexibility, and these are not qualities rewarded by voters. Upcoming elections in France and Germany will show whether their citizens approve of the attempts to maintain the viability of the euro. If they follow the examples of the U.S. and British electorates, then the days of the euro may be numbered.

The IMF and the Next Crisis

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The IMF has issued a warning that “increasing financial market turbulence and falling asset prices” are weakening the global economy, which already faces headwinds due to the “…modest recovery in advanced economies, China’s rebalancing, the weaker-than-expected growth impact from lower oil prices, and generally diminished growth prospects in emerging and low-income economies.” In its report to the finance ministers and central bank governors of the Group of 20 nations before their meeting in Shangahi, the IMF called on the G20 policymakers to undertake “…bold multilateral actions to boost growth and contain risk.” But will the IMF itself be prepared for the next crisis?

The question is particularly appropriate in view of the negative response of the G20 officials to the IMF’s warning. U.S. Treasury Secretary Jacob J. Law sought to dampen expectations of any government actions, warning “Don’t expect a crisis response in a non-crisis environment.” Similarly, Germany’s Minister of Finance Wolfgang Schaeuble stated that “Fiscal as well as monetary policies have reached their limits…Talking about further stimulus just distracts from the real tasks at hand.”

The IMF, then, may be the “first responder” in the event of more volatility and weakening. The approval of the long-delayed 14th General Quota Review has allowed the IMF to implement increases in the quota subscriptions of its members that augment its financial resources. Managing Director Christine Lagarde, who has just been reappointed to a second term, has claimed the institution of new Fund lending programs, such as the Flexible Credit Line (FCL) and the Precautionary and Liquidity Line (PLL), has strengthened the global safety net. These programs allow the IMF to lend quickly to countries with sound policies. But outside the IMF, Lagarde claims, the safety net has become “fragmented and asymmetric.” Therefore, she proposes, “Rather than relying on a fragmented and incomplete system of regional and bilateral arrangements, we need a functioning international network of precautionary instruments that works for everyone.” The IMF is ready to provide more such a network.

But is a lack of liquidity provision the main problem that emerging market nations face? The Financial Times quotes Lagarde as stating that any assistance to oil exporters like Azerbaijan and Nigeria should come without any stigma, as “They are clearly the victims of outside shocks…” in the form of collapses in oil prices. But outside shocks are not always transitory, and may continue over long periods of time.

There are many reasons to expect that lower commodity prices may persist. If so, the governments of commodity exporters that became used to higher revenues may be forced to scale down their spending plans. Debt levels that appeared reasonable at one set of export prices may become unsustainable at another. In these circumstances, the countries involved may face questions about their solvency.

But is the IMF the appropriate body to deal with insolvency? IMF lending in such circumstances has become more common. Carmen M. Reinhart of Harvard’s Kennedy School of Government and Christoph Trebesch of the University of Munich write that about 40% of IMF programs in the 1990s and 2000s went to countries in some stage of default or restructuring of official debt, despite the IMF’s official policy of not lending to countries in arrears. Reinhart and Trebesch attribute the prevalence of continued lending (which has been called “recidivist lending”) in part to the Fund’s tolerance of continued non-payment of government debt.

More recently, the IMF’s credibility suffered a blow due to its involvement with Greece and the European governments that lent to it in 2010. (See Paul Blustein for an account of that period.) The IMF ‘s guidelines for granting “exceptional access” to a member stipulate that such lending could only be undertaken if the member’s debt was sustainable in the medium-term. The Greek debt clearly was not, so the Fund justified its lending on the grounds that there was a risk of “international systemic spillovers.” But the IMF’s willingness to participate in the bailout loan of 2010 only delayed the eventual restructuring of Greek debt in 2012. The IMF now insists that the European governments grant Greece more debt relief before it will provide any more financial government.

Reinhart and Trebesch write that the IMF’s “…involvement in chronic debt crises and in development finance may make it harder to focus on its original mission…” of providing credit in the event of a balance of payments crisis. Moreover, its association with cases of long-run insolvency may “taint all of its lending.” This may explain the limited response to the IMF’s programs of liquidity provision. Only Colombia, Mexico and Poland have shown an interest in the FCL, and the Former Yugoslav Republic of Macedonia and Morocco in the PLL.

Even if the IMF receives the power to implement new programs, therefore, its past record of lending may deter potential borrowers. This problem will be worsened if the IMF treats countries that need to adapt to a new global economy as temporary borrowers that only need assistance until commodity prices rise and they are back on their feet. The day when the emerging market economies routinely recorded high growth rates may have come to an end. If so, debt restructuring may become a more common event that needs to be addressed directly.

The IMF and Sovereign Debt

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The continuing inability of the Eurozone economies to break out of their current impasse means that any optimistic projections of declining debt to GDP ratios are unlikely to be achieved. As long as European governments continue to raise funds in the financial markets on favorable terms, the current situation remains sustainable.  But the IMF is thinking ahead to the day when there is a change in the financial climate, and is proposing a change in the rules governing its ability to lend to governments that may need its assistance if they are to continue repaying their debt.

The Fund’s rethinking has been prompted by its concerns over its lending to Greece. The IMF, as part of a “troika” with the European Commission and the European Central Bank, participated in a loan arrangement in May 2010. The IMF’s contribution consisted of a $40 billion Stand-By Arrangement. The Fund had a problem, however: this amount far exceeded the normal amount of credit that the IMF normally provided to its members. Exceptions were allowed, but there were criteria to govern when “exceptional access” was permitted. One of these was a high probability that a government’s public debt was sustainable in the medium term. It was difficult to claim that was true for Greece in 2010, so an alternative criterion was established: exceptional access could also be provided if there was a “high risk of international systemic spillover effects.” This was used as grounds to justify the lending arrangement to Greece.

A restructuring of the Greek debt did take place in 2012. The IMF subsequently issued a review of its own response to debt crises, and found that “debt restructurings have often been too little and too late, this failing to re-establish debt sustainability and market access in a durable way.” The IMF was concerned that its money was used to pay off creditors who would otherwise have been forced to negotiate changes in the debt’s conditions with the Greek government.

The IMF has come back with a new lending framework for governments with problems in paying off their debt. The new option would be relevant for a country that has lost access to the capital markets, and when there are concerns about the sustainability of its debt. The government would ask for a “reprofiling” of its debt by creditors, which would consist of an extension of its maturity without a reduction in the principal or interest, while the IMF offered financial support with a plan for economic policy adjustment. Fund officials claim that “reprofiling tends to be less costly to creditors than debt reduction, less disruptive to financial markets, and hence less contagious.”

The new option would allow the IMF to operate in situations where the sustainability of a country’s debt is ambiguous. Those cases are more common than creditors want to admit. Ireland and Portugal have graduated from their respective IMF programs, and can obtain credit again. But the “good outcome” occurred in part because Mario Draghi, President of the European Central Bank, pledged to do “whatever it takes” to preserve the euro, and market participants took him at his word. To date, no one has called upon Mr. Draghi to back up his pledge, and lending rates to all the Eurozone members have fallen. But it is not too difficult to imagine a scenario in which the ECB’s credibility crumbles, particularly if deflation takes hold. What then happens to perceptions of debt sustainability?

As an agent of 188 sovereign principals (the member governments), the IMF is constrained in what it can do on its own initiative. But any ambiguity of the sustainability of debt gives the IMF some scope for autonomy. In addition, differences in the objectives of the members provide policy “space” for the IMF to maneuver.

Extending the maturity date of an existing bond would lower its net present value of the debt. Lenders, therefore, are unlikely to embrace the IMF’s proposal. But the concerns over the repayment of Argentine debt threaten to extend to other markets (see here), and are another source of uncertainty.  An association of lenders has issued a call for more flexibility in the terms governing collective action clauses, but these take time to implement. Moreover, European finance ministers are preoccupied by other, more pressing concerns.

As long as debt markets remain calm, “reprofiling” will be considered as an interesting policy proposal, which will be sent off for further study. But once the interests of the major stakeholders—which continue to be the G7 countries—are involved, then there will be an assessment based on the financial interests at stake. The response to the Greek debt crisis demonstrated that the European countries are quite willing to rewrite the rules governing the IMF’s policy options when they see an advantage for their national interests. But the response to a similar situation in another part of the world could be very different. And it is precisely that perception of unequal treatment that is driving dissatisfaction with current arrangements at the IMF.

 

Protesting the IMF’s Madame Lagarde

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The protests at Smith College that led to the withdrawal of Christine Lagarde, Managing Director of the International Monetary Fund, as this year’s commencement speaker have been widely denounced as a manifestation of intolerance. They also demonstrate a lack of understanding of the IMF and the many changes that have taken place at that institution in the last decade, as well as Ms. Lagarde’s own record. The IMF adjusted its policies in response to the criticisms it received after the crises of the 1990s, but apparently its critics are mired in the past.

A petition signed by several hundred Smith students and faculty (but not supported by many Smith faculty, including members of the Economics Department) explains the grounds for their opposition to Lagarde’s appearance on their campus:

“By having her speak at our commencement, we would be publicly supporting and acknowledging her, and thus the IMF. Even if we give Ms. Lagarde the benefit of the doubt, and recognize that she is just a good person working in a corrupt system, we should not by any means promote or encourage the values and ideals that the IMF fosters. The IMF has been a primary culprit in the failed developmental policies implanted in some of the world’s poorest countries. This has led directly to the strengthening of imperialist and patriarchal systems that oppress and abuse women worldwide.”

This statement exhibits the “vagueness and sheer incompetence” that George Orwell cited as characteristics of modern English prose, particularly political writing. In addition, the assignment of responsibility to the IMF for the “imperialist and patriarchal systems” is a contemporary example of the “staleness of imagery” that Orwell deplored. Holding the IMF responsible for global poverty reveals a lack of knowledge about the decline in global poverty in recent decades as well as a gross misunderstanding of the IMF’s role.  The IMF long ago retreated from the structural adjustment policies that were criticized as inappropriate, and ceded the lead role in addressing poverty to the World Bank. More recently, the IMF was active in responding to the global financial crisis. The Fund in 2008-09 provided large amounts of credit relatively quickly with limited conditionality, and the IMF’s programs contributed to the recovery of global economic activity (see here for more detail).

Blaming Lagarde for global poverty is particularly unjustified in view of her acknowledgement of this issue. She has spoken eloquently about the combined impact of the economic crisis, the environmental crisis and the social crisis that reflects a widening gap in income distribution. To tackle the latter, she has supported more spending on health and education, and the development of social safety nets. Lagarde has also been a strong spokeswoman for gender equality (see also here). The change in the IMF’s position on the use of capital controls predates Lagarde’s tenure, but she has encouraged the continuing intellectual evolution of its Research Department under Olivier Blanchard.

And then there is the irony of students at a prestigious women’s college protesting the invitation extended to a woman who has been a pioneer in raising the professional profile of women. In the male-dominated world of international finance she was the first female finance minister of a member country of the Group of 8, and is the first female head of the IMF. The top position at the IMF became available when her predecessor at the IMF, Dominique Strauss-Kahn, resigned after being charged with sexual assault at a New York hotel. Ironically, the controversy over Lagarde arose as a movie about Strauss-Kahn was being shown at Cannes.

If protestors want to do something to improve the position of the world’s poorest countries, they should aim their ire at those members of the U.S. Congress who are blocking reform at the IMF. The politicians have been stalling passage of the required authorization of changes at the IMF, which would increase the representation of emerging market countries at the Fund. In a rare act of (muted) public criticism, the government of Great Britain has publicly urged the U.S. Congress to ratify the required measures. Reforming the IMF would be a more effective response to global inequality than protesting against someone who has sought to lessen that inequality.

The IMF and Ukraine

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The International Monetary Fund last week announced an agreement with Ukraine on a two year Stand-By Arrangement. The amount of money to be disbursed depends on how much other financial support the country will receive, but will be total at least $14 billion. Whether or not this IMF program will be fully implemented (unlike the last two) depends on the government’s response to both the economic crisis and the external threat that Russia poses. There is also the interesting display of the use of the IMF by the U.S., the largest shareholder, to pursue its international strategic goals even though the U.S. Congress will not approve reforms in the IMF’s quota system.

Ukraine’s track record with the IMF is not a good one. In November 2008 as the global financial crisis intensified, the IMF offered Ukraine an arrangement worth $16.4 billion. But only about a third of that amount was disbursed because of disagreements over fiscal policy.  Another program for $15.3 billion was approved in 2010, but less than a quarter of those funds were given to the country.

The recidivist behavior is the product of a lack of political commitment to the measures contained in the Letters of Intent signed by the government of Ukraine. Ukraine, like other former Soviet republics, was slow to move to a market system, and therefore lagged behind East European countries such as Poland and Romania in adopting new technology. Andrew Tiffin of the IMF attributed the country’s economic underachievement to a “market-unfriendly institutional base” that has allowed continued rent-seeking. Promises to enact reform measures have been made but not fulfilled.

Are the chances of success any better now? Peter Boone of the Centre for Economic Performance at the London School of Economics and Simon Johnson of MIT are not convinced that there has been a change in attitude within the Ukrainian government, despite the overthrow of President Viktor Yanukovych (see also here). Consequently, they write: “There is no point to bailing out Ukraine’s creditors and backstopping Ukrainian banks when the core problems persist: pervasive corruption, exacerbated by the ability to play Russia and the West against each other.”

Leszek Balcerowicz, a former deputy prime minister of Poland and former head of its central bank, is more optimistic about the country’s chances. The political movement that drove out Yankovich, he claims, is capable of promoting reform. Further aggression by Russia, however, will threaten whatever changes the Ukrainian people seek to undertake.

The “back story” to the IMF’s program for Ukraine has its own intramural squabbling. The U.S. Congress has not passed the legislation needed to change the IMF’s quotas so that voting power would shift from the Europeans to the emerging market nations. The changes would also put the the Fund’s ability to finance its lending programs on a more regular basis. Senate Majority Leader Harry Reid sought to insert approval of the IMF-related measures within the bill to extend assistance to the Ukraine, but Republicans lawmakers refused to allow its inclusion. While U.S. politicians expect the organization to serve their political ends, they reject changes that would grant the IMF credibility with its members from the developing world.

The Economist has called the failure of Congress to support the IMF “shameful and self-defeating.” Similarly, Ted Truman of the Peterson Institute for International Economics warns that the U.S. is endangering its chances of obtaining support for Ukraine. The Europeans, of course, are delighted, as they will keep their place in the Fund’s power structure while the blame is shifted elsewhere. And the response of the emerging markets to another program for Ukraine, despite its dismal record, while they are refused a larger voice within the IMF? That will no doubt make for some interesting discussions at the Annual Spring Meetings of the IMF and the World Bank that begin on April 11.

Speaking Truth to Power

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When the full history of the European debt crisis is related, one important part of the story will be the uneasy relationship of the International Monetary Fund with its European partners in the “Troika,” the European Commission and the European Central Bank. The Fund and the Europeans came to hold different views on the nature of the crisis and how it should be handled soon after its outbreak in 2010. Their disagreements reflect the split in the Fund’s membership between creditors and debtors, and the inherent ambiguity of the position of an intergovernmental organization that serves principals with different interests.

Greece obtained $145 billion from the Troika in May 2010. Of that amount, $40 billion was provided by the IMF in the form of a three-year Stand-by Arrangement. This represented 3,200% of the Greek quota at the IMF, far above the usual access limits. Susan Schadler has drawn attention to the modification of IMF policy that was made in order to allow the agreement to go forward.

The IMF has criteria to be met in deciding whether to allow a member “exceptional access” to its resources. One of these of these is a high probability that the borrowing member’s public debt will be sustainable in the medium-term. At the time of the arrangement, the IMF’s economists realized that there was little probability that Greek sovereign debt would be sustainable within any reasonable timeframe. The IMF, therefore, amended the criteria so that exceptional access could also be provided if there were a “high risk of international systemic spillover effects.” There was little doubt that such effects would occur in the event of a default, but whether this justified lending such large amounts was questionable.

It soon became clear that the two of the other four criteria would not be met. Greece would not regain access to private capital markets while it participated in the Fund program (criterion #3). Moreover, there was little prospect of a successful implementation of the policies contained in the original agreement (criterion #4). By 2011, it was evident that the program with Greece was not viable. Talks began on a new program and a restructuring of the debt, which eventually occurred in 2012. Moreover, Ireland received assistance from the Troika in December 2010, as did Portugal in February 2011.

This was the background when newly-appointed Fund Managing Director Christine Lagarde, a former French finance minister, appeared at the annual gathering of central bankers and financiers at Jackson Hole, Wyoming, in August 2011. Ms. Lagarde voiced her concerns that her fellow Europeans were responding too slowly to the dangers posed by the sovereign debt crisis. (Lagarde also called upon U.S. policymakers to undertake steps to resolve the housing crisis.) But her recommendations for more vigorous actions went unheeded. Her call for a more accommodative monetary policy was ignored by outgoing ECB President Jean-Claude Trichet. And European bankers were displeased by her assessment of their capital base as inadequate and her proposal of public injections of capital if private sources were inadequate.

In retrospect, Lagarde’s judgments look prescient. Trichet’s successor at the ECB, Mario Draghi, came to a very different view of what that institution needed to do to maintain financial stability. The ECB lowered its key interest rate in November 2011, and the following month instituted a longer-term refinancing operation for European banks. European banks, however, are still seen as relatively frail.

The IMF subsequently reassessed the response to sovereign debt crises and reviewed the framework for debt restructuring. Its review found that “debt restructurings have often been too little and too late, thus failing to re-establish debt sustainability and market access in a durable way.” The report’s authors claimed that: “Allowing an unsustainable debt situation to fester is costly to the debtor, creditors and the international monetary system.” The policy review raised the possibility of more involvement of the official sector in debt restructuring.

But the development at the IMF of a proposal to write down unsustainable debt at an earlier stage of a crisis has aroused resistance from German and other policy officials. They see the suggestion of a standstill on debt repayments as an assault on the rights of bondholders. Any mention of delay or reduction of payments is viewed as the first step towards the evasion of borrowers’ responsibilities.

Such a position in the wake of the restructuring of the Greek debt is alarming. Other borrowers will suffer financing problems, and relying on exhortations to repay in full will not improve their circumstances. Moreover, ignoring the costs to the debtor of a (attempted) repayment is self-defeating. The Greek economy may have touched bottom, but even under the most optimistic scenario its debt/GDP ratio will not decline for years.

The IMF is the agent of 188 principals. To be credible, it must  serve the interests of all its members, not just its partners in a lending arrangement. Moreover, the IMF has established more credibility in this crisis than those who have consistently refused to acknowledge its extent. In seeking to improve the process of dealing with debt restructuring,  the IMF is fulfilling its mission to provide “…the machinery for consultation and collaboration on international monetary problems.” (IMF Article of Agreement I(i).) Its members should allow it to meet that mandate.