New Research in Economics: The IMF and Global Financial Crises; Phoenix Rising?

This is from Joseph P. Joyce, the author of The IMF and Global Financial Crises; Phoenix Rising?, which was published last year by Cambridge University Press. The book examines the evolution of the policies and programs of the IMF with respect to the global financial markets and crises in these markets:

Among the many surprising features of the global financial crisis of 2008-09 was the emergence of the International Monetary Fund (IMF) as a leading player in the response to what has become known as the “Great Recession.” The news that the IMF was “back in business” was remarkable in view of the deterioration of the IMF’s reputation after the crises of the late 1990s and the decline in its lending activities in the succeeding decade. The IMF had been widely blamed for indirectly contributing to the earlier crises by advocating the premature removal of controls on capital flows, and then imposing harsh and inappropriate measures on the countries that were forced by capital outflows to borrow from it. Moreover, the IMF initially had no direct role in dealing with the crisis. The IMF was relegated to the sidelines as government officials in the advanced economies coordinated their responses to the crisis.

All this changed in the fall of 2008, however, when the collapse of the financial system led to an economic contraction that spread outside the original group of crisis countries. World trade fell and capital flows slowed and in some cases reversed, as nervous banks, firms and investors sought to reallocate their money to safer venues. In response, the IMF provided loans to a range of countries, including the Ukraine, Hungary, Iceland, and Pakistan. In addition, the IMF restructured its lending programs, cutting back on the policy conditions attached to its loans and increasing the amount of credit a country could obtain. The Fund also introduced a new credit line without conditions for countries with records of stable policies and strong macroeconomic performance. Moreover, the IMF pledged to work with national governments and other international organizations after the crisis receded to continue the economic recovery and improve the regulation of global financial markets. Consequently, many commentators hailed the rejuvenated IMF as a “phoenix”.

The IMF’s response to the Great Recession marked a significant break from its policies during previous global financial crises. These had taken place during an era when the IMF’s membership was stratified by income and whether or not a country borrowed from the Fund. In addition, the IMF had actively encouraged the deepening and widening of global finance. The IMF’s previous responses to financial crises, therefore, reflected the dominance of its upper-income members as well as an ideological consensus in favor of financial flows.

The crisis hastened the end of those conditions. The shock to global financial markets and economies originated in the upper-income countries, and the recovery of many of these nations has been relatively sluggish. The emerging economies, on the other hand, rebounded from the global economic contraction more quickly, which in turn contributed to the recovery of the developing nations. Moreover, the crisis demonstrated that financial instability can be a systemic condition, confirming the need for prudent oversight and the regulation of financial markets and capital flows.       

 But while the Great Recession provided the IMF with an opportunity to demonstrate that it has learned the lessons of its past mistakes, there are fundamental economic and political transformations underway which will affect the ability of the IMF to counter future financial instability. The replacement of the dominance of the G7/8 by the G20 should lead to a more equitable governance structure within the IMF, but inertia has slowed the pace of reform. Moreover, the European debt crises pose new challenges to the IMF. The Fund is caught in the crossfire among Eurozone governments and their citizenries over how to deal with insolvent sovereign members. New fiscal challenges will arise in other advanced economies with aging populations and mounting health care and public pension costs, and the IMF’s response will be scrutinized by its emerging market members who are concerned about the scale of its lending.