Tuesday, October 28, 2008

The Coming IMF Controversy

. Tuesday, October 28, 2008

The IMF is suddenly relevant again, having already agreed to a loan for the Ukraine while similar loans to Hungary and Iceland are on the way. So it should be expected that criticisms of the agency will also come back to the fore. While everyone hopes and prays that the agency learned some lessons from its missteps in Russia and Asia in the 1990s, it also worth recalling Kenneth Rogoff's response to Joseph Stiglitz's criticisms of the IMF in Globalization and Its Discontents:

Let's look at Stiglitzian prescriptions for helping a distressed emerging market debtor, the ideas you put forth as superior to existing practice. Governments typically come to the IMF for financial assistance when they are having trouble finding buyers for their debt and when the value of their money is falling. The Stiglitzian prescription is to raise the profile of fiscal deficits, that is, to issue more debt and to print more money. You seem to believe that if a distressed government issues more currency, its citizens will suddenly think it more valuable. You seem to believe that when investors are no longer willing to hold a government's debt, all that needs to be done is to increase the supply and it will sell like hot cakes. We at the IMF—no, make that we on the Planet Earth—have considerable experience suggesting otherwise. We earthlings have found that when a country in fiscal distress tries to escape by printing more money, inflation rises, often uncontrollably. Uncontrolled inflation strangles growth, hurting the entire populace but, especially the indigent. The laws of economics may be different in your part of the gamma quadrant, but around here we find that when an almost bankrupt government fails to credibly constrain the time profile of its fiscal deficits, things generally get worse instead of better.

Joe, throughout your book, you condemn the IMF because everywhere it seems to be, countries are in trouble. Isn't this a little like observing that where there are epidemics, one tends to find more doctors?


The whole thing is worth reading, if only because policy disagreements are rarely so theatrical. But there are also serious arguments here. As described by Rogoff, Stiglitz is essentially advocating a Keynesian response to currency crises: stimulate aggregate demand through fiscal and monetary policy, and expect that to bring the economy back to full employment which will in turn stabilize the currency. Indeed, Stiglitz expressed this sort of pure-Keynesianism in an article this week. Rogoff is saying that that response is either insufficient or has already been tried and has failed. If you inject more cash through stimulus or debt-spending, the result will likely be more inflation, a less-valuable currency, and further shattering of confidence. It's bad to introduce that trifecta when an economy is performing well; when an economy is in free-fall, it can be disastrous.

The IMF response has traditionally been to propose a bitter pill: slash government spending and raise interest rates in exchange for a bail-out. As critics of the IMF are quick to point out, this spreads the virus which is already plaguing a local economy. Proponents of the IMF note that the chances of the economy healing itself without such actions are virtually non-existent, so it's better to get pain over with all at once in the hopes of speeding up the recovery. IMF critics see IMF prescriptions as a disease; IMF proponents see the same policies as an antibiotic.

There's one more aspect to this which may be familiar to students of social science: often a needed policy may be difficult or impossible to enact because of domestic political constraints. So a policy-maker may intentionally choose to cede decision-making power to an outside institution as an end-around maneuver. In this way, the veto points in the system may be bypassed, and the political consequences of making an unpopular decision are mitigated, all while the needed policy is carried out. IMF actions aren't always explained by this model of course, but the theory is still worth considering.

For more, see this from Megan McArdle, and Dani Rodrik advocating strong and swift action from the IMF.

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The Coming IMF Controversy
 
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