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Tuesday, February 16, 2010

"Changes in Global Governance"

Now that the U.S. is faced with taking the advice it has given in the past, the advice is changing:

When the shoe is on the other foot: Changes in Global Governance, by Jim Vreeland [via]: The Chief Economist of the International Monetary Fund (IMF) has co-authored a paper calling for countries to raise their inflation targets from 2 percent to 4 percent and pursue counter cyclical fiscal policies. ... As the Financial Times reports, this ... represents a dramatic shift away from the standard policy advice of the IMF - stretching back decades.

During the East Asian Financial Crisis of the late 1990s, for example, the Fund imposed economic austerity on countries that received IMF loans - raised interest rates and contractionary fiscal policy. During the Latin American Debt Crisis of the 1980s, austerity was also the answer. Not surprisingly, these policies resulted in lower economic growth, but the IMF preached financial stability first, economic growth to follow.

Of course, during these years, the only borrowers from the IMF were developing countries. ... And as Joseph Stiglitz has observed, the contractionary IMF advice seemed somewhat hypocritical, considering the way advanced industrial countries responded to economic crises - far from following economic austerity, these countries always put together stimulus packages.

The hypocrisy did not go unnoticed by people of the developing world, who grew to hate the IMF, some seeing it as a tentacle of Western imperialism. ... For the first time in a long time, however, its customers include advanced industrial economies. And suddenly, economic austerity isn't looking like the answer. ...

Yet the first reaction of this IMF to the current crisis was indeed a return to the old austerity playbook - this was the advice for Iceland and Hungary, who turned to the IMF in 2008. As the crisis unfolded, however, the IMF softened. Instead of the usual arrangement, where loans are provided in return for ..."conditionality" - the IMF opened a new lending facility, the Flexible Credit Line (FCL). ...

If one takes a broad historical view of the IMF, this policy advice does not seem so heretical. The IMF was the brainchild of Lord Maynard Keynes of "Keynesian" economics. As the world emerged from the Great Depression, he advocated the international pooling of resources to be used in times of economic downturns in a counter-cyclical manner. The problem as seen by the United States - the world's largest creditor at that time - was that the promise of liquidity during economic crises would lower the incentives of governments to avoid those crises in the first place, a problem we call "moral hazard." The solution that developed over time was "conditionality": in return for liquidity, the IMF would require governments to adjust their policies.

But how much liquidity in return for how much adjustment and according to what schedule? The debate over these questions is what has fueled the evolution of the IMF over its history. ...

Change is coming to the IMF. While changes in its voting structure are lagging behind the times, votes are supposed to reflect economic weight in the world. And the emerging markets have arrived. In the coming decade, we will see increasing voice for countries like China, Brazil, India, Korea, Mexico, Indonesia, Turkey, Iran (yes, a member in good standing) and South Africa - many of whom were historically spurned by IMF conditionality. ...

Some things will not change. The debate over conditionality will persist. Creditors with little to gain by the provision of liquidity during a crisis will still worry most about moral hazard and suggest stringent conditionality. Debtors and countries closely tied to the crisis, will advocate the massive provision liquidity to put out the flames of the crisis, eschewing conditionality (see Lipscy's piece on this). Some will preach stability first, growth thereafter. Others will suggest that by priming the pump, we can grow our way out of crisis and debt.

So where's the change?

Global economic power has shifted. ... The United States will remain the "chairman of the board," continuing to hold more IMF votes than any other single country... But it will have to share power, most notably with China. And this will be the real, long-lasting change at the IMF.

See,... for the first time in its history, the IMF will have multiple voices with power, voices with vastly different experiences with development and dramatically different points of view on best economic policy. Importantly, they will also have different ties to different economies - so preferences over liquidity provision and moral hazard may shift depending on where the next crisis hits. ... So, looking decades ahead, we've got to ask ourselves: How will conditionality feel when the shoe is on the other foot?

The IMF's ability to provide liquidity and infuse capital need to be improved. Developing countries in particular had difficulty finding the resources they needed to address the problems the crisis was causing in their countries. As for conditionality, as I've argued before, some judgment has to be made about the source of a country's troubles. It is was due to circumstances beyond their control, they operated in good faith bu the unexpected happened, then the moral hazard worry is not much of a worry. But if the troubles were caused by a country's own poor choices, then I think the conditions need to be tougher.

    Posted by on Tuesday, February 16, 2010 at 11:01 AM in Economics, International Finance | Permalink  Comments (4)


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