Saving the IMF

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Ashoka Mody is Visiting Professor of International Economic Policy at the Woodrow Wilson School of Public and International Affairs at Princeton University and a visiting fellow at Bruegel, the Brussels-based economic think tank. He is a former mission chief for Germany and Ireland at the Internatio… read more

Saving the IMF

Since the start of the Great Recession in mid-2007, the IMF’s actions have mostly served the interests of its major shareholders. When finance ministers and central bank governors meet in Washington, DC, next week for the Fund’s annual meeting, will they have the energy to push for greater independence and credibility?

APR 9, 2016 0

IMF go-home sign

PRINCETON – Critics have long contended that the International Monetary Fund mainly serves the interests of its major shareholders. In fact, at its best, the Fund has helped crystalize global consensus on macroeconomic policy and coordination. But, since the start of the Great Recession in mid-2007, its actions have mostly confirmed the detractors’ critique.

Whether in assessing global risks, promoting international policy coordination, dealing with Europe’s intractable problems, or creating a viable regime for sovereign-debt restructuring, the Fund either played second fiddle or was swayed by European and US interests. When finance ministers and central bank governors meet in Washington, DC, next week for the IMF’s annual meeting, will they have the wisdom to make the Fund more independent and credible? Or will it be business as usual?

Serial Optimists

The IMF’s one shining moment in the last decade followed the collapse of Lehman Brothers in September 2008. As I later wrote, “At the end of 2008, when the scale of the impending economic destruction was not yet apparent, [IMF chief economist] Olivier Blanchard boldly called for a global fiscal stimulus,” repudiating the Fund’s usual emphasis on “fiscal retrenchment and public-debt reduction.”

Today, there is little doubt that the coordinated fiscal stimulus of 2009 played a crucial role in preventing the “deflation, liquidity traps, and increasingly pessimistic expectations” that Blanchard rightly feared would lead to a second Great Depression. Governments worldwide were panicking, and their interests were perfectly aligned: Everyone could see that failure to act would lead to catastrophe.

Ben Bernanke, Chairman of the US Federal Reserve at the time, having aggressively lowered US interest rates, led the way in October 2008 by coordinating rate reduction by major counterparts, including the stodgy European Central Bank. Even so, many observers called for more monetary and fiscal stimulus. As Thomas Palley put it: “If implemented now, steep rate cuts can still have a significant positive effect. If delayed, their effect is likely to be minimal.” And Nouriel Roubini insisted, “The measures adopted by the US and Europe are a start. Now they must finish the job.”

They didn’t. In November 2009, when the IMF prematurely declared victory, Nobel laureate Robert J. Shiller criticized its self-congratulatory tone. But the Fund, following the lead of its major shareholders, remained giddy about recovery. Over the next six years, it produced one optimistic global forecast after another, helping to justify a policy shift to fiscal austerity, in line with political sentiment in the United States and Europe.

The IMF’s forecast errors, I noted in November 2012, were particularly glaring inasmuch as they stemmed from areas of its core competence: “underestimation of the ‘fiscal multipliers’ (the size of output loss owing to fiscal austerity); and neglect of the ‘world-trade multiplier’ (the tendency for countries to drag each other down as their economies contract).” But the errors continued. Even in 2015, the Fund was still revising down its growth forecasts.

The IMF should have pushed for more aggressive measures to accelerate global recovery, as some had counseled early on and others continued to reiterate. Instead, it endorsed the politically convenient view that fiscal austerity and structural reforms would revive growth. Not surprisingly, the IMF became marginalized.

Coordination Problems

In September 2010, Nobel laureate Michael Spence called for renewed effort to elevate the IMF as a coordinator of national policies. “The G-20,” he warned, “can say the right things about cooperation. But, to perform this function, it needs a knowledgeable, credible, and effective secretariat. That is the IMF.”

Raghuram Rajan shares Spence’s goal. As Governor of the Reserve Bank of India, Rajan is particularly worried that the Fed’s policies fuel financial booms and busts in emerging economies. For that reason, he says, “multilateral institutions like the [IMF] should exercise their responsibility for maintaining the stability of the global system by analyzing and passing careful judgment on each unconventional monetary policy (including sustained exchange-rate intervention).”

But such calls for coordination have proven entirely fanciful. After the recent Shanghai gathering of G-20 finance ministers and central-bank governors, Ngaire Woods, Dean of Oxford’s Blavatnik School of Government, noted that Rajan’s question – “Should central banks be attempting to stimulate growth through ‘unconventional’ monetary policies?” – simply went unanswered. Despite Spence’s optimism, as G-20 “secretariat,” the IMF cannot override its political masters.

This is no surprise. The major central banks have little patience for international advice. Simon Johnson, a former IMF chief economist, has underscored the reality: the Fed “will move interest rates based almost entirely on its collective read of US economic circumstances.” The Fund can do little.

The Euro Quagmire

The IMF’s subordination to its major shareholders became painfully clear when it parachuted into the euro crisis in 2010. By September 2011, Harvard’s Kenneth Rogoff scathingly observed, the IMF had “sycophantically supported each new European initiative to rescue the over-indebted eurozone periphery, committing more than $100 billion to Greece, Portugal, and Ireland” and “risking not only its members’ money, but, ultimately, its own institutional credibility.” The problem, Rogoff said, was stunningly lazy analysis: “Only a year ago…senior staff were telling anyone who would listen that the whole European sovereign-debt panic was a tempest in a teapot.”

Rogoff, also a former IMF chief economist, explained that “[W]hat Europe really needed was the kind of honest assessment and tough love that the Fund has traditionally offered to its other, less politically influential, clients.” But the Europeans mainly wanted the Fund’s rhetorical support. Thus, unwilling to stand up to Europe, the Fund got trapped in a zombie strategy – a failure that refused to die. Quoting Harvard’s Larry Summers, I wrote in September 2012, European leaders could do no more than make “the minimum commitments necessary to avoid imminent disaster – offering optimistic rhetoric, but never taking the steps that even they believed could offer the prospect of decisive victory.”

The greatest failure was in Greece, where, rather than forcing a restructuring of debt, the Fund and its European partners relied on ever deeper fiscal austerity. The Fund continued to back the European orthodoxy that austerity in Greece would help to restore growth by reviving investor confidence, even as its own research – including a seminal paper by Blanchard and his colleague Daniel Leigh – showed that austerity was counterproductive.

The Fund never wavered from its basic approach – more official loans for more Greek austerity. True, in 2012, Greece’s private creditors finally took losses. But, it was too little too late. Driblets of relief on official debt payments followed, but continuing austerity made a return to growth impossible. Thus, even as the Greeks cut spending deeply and raised taxes, the debt-to-GDP ratio kept climbing.

Finally, after a prolonged standoff with the Greek government through the first half of 2015, the IMF publicly stated that Greece’s official debt was unsustainable and a large chunk needed to be written off. But the Fund still refused to back off on austerity. Even Blanchard supported the IMF’s insistence on further fiscal consolidation.

James K. Galbraith, among others, wondered what was going on. Likewise, a month after Greece’s embattled finance minister, Yanis Varoufakis, resigned, Mohammed A. El-Erian came to his defense. “[P]olicymakers must recast the country’s austerity program, couple pro-growth reforms with greater social justice, and secure additional debt relief.”

That still has not happened. Instead, having kowtowed so long to its European shareholders and having doled out vast sums to Greece, the IMF appears to have lost all leverage.

Sovereign Debt Muddle

In June 2013, the Fund recognized that the decision not to impose losses on Greek creditors in May 2010 was a mistake. Meanwhile, as US courts struck down key provisions of Argentina’s unfinished debt restructuring of the early 2000s, the importance of reform was becoming increasingly apparent. In June 2014, Anne Krueger, a former World Bank chief economist and IMF First Deputy Managing Director, reported an overwhelming consensus among academics and policymakers in favor of easing the restructuring process, which would lighten distressed sovereigns’ debt burden and discourage reckless lending by creditors.

But the formidable Geithner-Trichet doctrine – the insistence by former US Treasury Secretary Timothy Geithner and former ECB President Jean-Claude Trichet that creditors would panic and financial markets would freeze if debt were restructured during a crisis – has continued to prevail. “Geithner,” Johnson explained in early 2011, “remains the senior public official worldwide who is most in thrall to the self-serving ideology of big banks.”

The IMF has not helped by insisting on inserting itself into this process. As has been the case with its past proposals, the latest also crucially relies on the Fund’s judgment. The basic idea – that debt payments to private creditors should be halted when a country’s debt exceeds some threshold – is a sensible one. The problem is that the Fund wants the authority to trigger the standstill on payments when a country approaches it for financing.

As Joseph E. Stiglitz and Martin Guzman argue, “regulation of sovereign-debt restructuring cannot be based at the [IMF], which is too closely affiliated with creditors (and is a creditor itself).” In addition, countries typically approach the Fund for help only when they are under acute stress. By then, prodded by its shareholders, the temptation for the Fund would be to invoke the threat of contagion. The Fund now does recognize that if debt restructuring is essential and threatens financial contagion, a global pool of funds should be used to repay creditors: The debtor’s unsustainable burden would be relieved and the contagion risk eliminated. In the latest proposal, this wishful thinking has been extended by increasing the range of possibilities for avoiding temporary payment standstills with the help of concessional official funds.

It is easy to anticipate how the next potential restructuring will unfold. The debtor government will seek help too late; the Fund will agonize about whether the country’s debt burden is sustainable; another official source will be sought to pick up the tab; and, in the meantime, the threat of financial panic will force matters to a familiar climax: repayment of private creditors or default.

The Fund Must Succeed

Most proposals to reform the IMF would make its ownership more representative of the world economy. This requires, as El-Erian has described, greater voting rights for emerging-market countries, and also, as Jeffrey Frankel has emphasized, that Europe lose its de facto monopoly on the IMF’s Managing Director’s position.

But as long as shareholders can influence the Fund’s operations, the necessary shift in voting rights will change only which countries wield influence, and to what end. Real reform requires replacing the Fund’s Executive Board, which represents shareholders, with a board of independent, professional directors, in the manner of the Bank of England’s Monetary Policy Committee.

At the same time, Berkeley’s Barry Eichengreen has rightly argued that the Fund must use “its bully pulpit to warn of risks created by large-country policies,” a task it has shied away from, “wary of biting the hand that feeds it.” With its “universal membership” and “expert staff,” the Fund, Eichengreen says, is the natural candidate for this task.

It is time, therefore, for the IMF to put away its growth forecasts and focus on risk profiling. Global fault lines and their implications should be presented to a committee of finance ministers and central bank governors, preferably in public hearings, just as central bank chiefs report to their parliamentary committees.

Likewise, on sovereign debt, Eichengreen makes the case for privately negotiated “contingent convertible” debt contracts with measurable triggers that automatically pause repayments. Thus, instead of seeking the authority to pull the standstill triggers, the Fund should promote the use of such contingent instruments. It can require its borrowers – soon, hopefully, it will be time for Greece – to issue new bonds on this basis.

In its 70 years, the Fund has adapted only within the confines of its post-World War II structure. The convulsions of the past decade revealed that this is not enough: The IMF’s technocratic strengths are easily undermined by political pressures. At every critical juncture, powerful national interests weighed in and skewed policy. Continuing on this path will lead to institutional atrophy. For their own sake – and that of an institution that is needed today more than ever – the Fund’s major shareholders must leave the building.