The last few months in Europe have put economic historians, economists, and political economists back in business – especially those fascinated by studying financial crises. The focus now seems to be on gauging the politico-economic crisis unfolding after an intense round of negotiations between a debt-ridden Greece and its creditors (including Germany). However, the deal finally made may even lead to worsening of the economic situation in Greece. The entire process of how Greece has been made to accept some tough reform proposals and conditions for a bailout fund has been painful to watch especially because of the role played by Germany along with other members of European Union, and institutions like the IMF and European Central Bank (ECB).
Amidst all the hue and cry on what was so inherently wrong with the Greek economy, I want to raise a simple yet perplexing question: to what extent is the Troika (consisting of the European Union, European Central Bank and the IMF) responsible for this? Or, perhaps more importantly,what has the IMF done to prevent this from happening?I focus here on the second part to the question, particularly questioning the role of the Fund. It is beyond me how an international financial institution such as the IMF, mandated and set up to surveil, mitigate, and end financial crises of such a nature, has yet again been unsuccessful in doing these effectively. There is enough evidence from the recent past of this, including crises such as the 1997-98 East Asian crisis, 2002 Dot-Com Bubble burst and the 2007 U.S. Sub-Prime crisis, which the IMF also failed to mitigate.
When evaluated for its role as a central institution of global monetary cooperation, the IMF seems hardly prepared to meet the great macroeconomic challenges that lie ahead. For example, in the case of the current Eurozone crisis, we still do not know if there is a clear recovery plan proposed by the IMF to deal with the impact of a Greek default on the Euro members and other similarly debt-ridden countries such as Italy, Spain, and Portugal.
Let me briefly highlight two central issues stanching the IMF’s performance with regard to its mandated goals of surveillance and crisis lending, which are at the heart of its inability to identify rudimentary causes of today’s financial crises.
Surveillance: Morris Goldstein, in a paper written a decade ago, addressed the structural problems related to a central, but often neglected, issue of the IMF’s role in surveillance, in particular over members’ exchange rate policies. The Bretton Woods Conference created a post-World War II international monetary system based on fixed exchange rates that sought to avoid ‘beggar thy neighbor policies’ that had undermined the global economy. However, time and time again, the Fund has fallen down on the job as the umpire of the exchange rate system. As an example, Goldstein cites the classic case of China’s manipulation of their exchange rates to prevent global balance of payments adjustment.
A fallacy needs to be debunked with respect to exchange rate manipulation. If a country’s rate is fixed against another country’s currency, the country cannot be manipulating that rate. Passive intervention in defense of a fixed rate is not manipulation even if it is heavy – a country may be justified in maintaining an undervalued rate for domestic economic reasons. It is the real exchange rate that matters and in due course inflation will take care of any nominal undervaluation.
To restore the IMF to its proper role in this area, some valuable reform proposals have previously been offered but ignored. These proposals include one in which the Fund should use a system of providing semiannual or quarterly estimates of reference rates, and a second proposal for the IMF to issue its own semiannual report on exchange rate policies for its member nations. If we analyze these two proposals on their merit, the Fund indeed will benefit by implementing these and identifying practices of potential currency manipulation involving central banks of member nations. The reference rates can become a basis for IMF surveillance over exchange rate policies of members and can be revised periodically
Another problem that has imperiled trust in the IMF is its inability to deal effectively with regional monetary arrangements which includes the dealing with the European Monetary Union (EMU). In an earlier article, I mentioned that it was a grave mistake to allow for a monetary union to be established in Europe without effectively bringing the members into a fiscal union. The absence of a fiscal union among the EU members has landed the entire region in a fiscal mess today. This is the type of situation where the IMF should have played a key role before giving its consent for the Euro to be used as a single currency in the region.
Crisis Lending & Conditionality: The IMF’s crisis lending mechanism too, in my opinion, is inefficiently designed to fulfill the role of providing effective liquidity assistance or act as alender of last resortin case of a contingency. Liquidity crises need immediate response, leaving no time for crisis countries and the Fund to be involved in protracted negotiations. As Charles W. Calomiris mentions, “The current IMF formula of taking weeks or months to negotiate terms and conditions for liquidity assistance, and then offering that assistance in stages over a long period of time simply is a non-starter if the goal is to mitigate or prevent liquidity crises.”
The Fund has in the recent past also managed to transfer resources to debtor countries during severe economic crises, along with other development bank lending (which entails substantial subsidies to borrowing countries); however, most of the transfers do not seem to improve financial markets or increase growth levels. Joseph Stiglitz, in one his recent articles, has critiqued the series of austerity measures unleashed on the Greek economy to no avail. He says: “the economics behind the program that the “troika” (the European Commission, the European Central Bank, and the International Monetary Fund) foisted on Greece five years ago has been abysmal, resulting in a 25% decline in the country’s GDP. I can think of no depression, ever, that has been so deliberate and had such catastrophic consequences: Greece’s rate of youth unemployment, for example, now exceeds 60%.”
I have previously argued that because of such reasons, confidence in the older Bretton Woods framework of economic governance – that the IMF is modeled on – seems to be rapidly waning, especially when looked from the lens of developing countries that are in need of more surveillance and capital. This waning confidence is giving rise to new regionally designed multilateral institutional frameworks such as Asian Infrastructure Investment Bank (AIIB) by China and New Development Bank (NBD) set up by Brazil, Russia, India, China, and South Africa (BRICS).
While deciding the process of financial lending, it is prudent to identify goals and take into account factors such as local ownership, private investment, innovation, and multi-stakeholder partnerships, accompanied with the process of institutional development through mutual accountability and transparency. No single change by itself can restore the IMF or institutions like itself as a highly respected international monetary institution. Similarly, any effective reform of the IMF must clearly highlight the priorities in the Fund’s activities, especially with regard to where it should become less as well as more involved.
Effective and expedient surveillance mechanisms (members’ exchange rate management, monetary and fiscal policies) and more prompt and reasonable policies in crisis lending (and the conditionality attached) for me are the two most important institutional functions that the Fund should involve itself in if it is to uphold its existence as a transnational pecuniary organization.