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The Role of Fiscal Policy in Crisis Situations|
(Response to Point de vue de Joseph E. Stiglitz,
"L'actualité de Keynes," Les Echos, June 3, 2002)
By Flemming Larsen
Director, IMF Office in Europe
June 17, 2002
Prof. Stiglitz's solution to the financial crises that have afflicted emerging market countries in recent years—including the East Asian countries, Russia, and Argentina— is to increase government spending and deficits and print more money. He claims that such a "Keynesian" response would have prevented recessions in the wake of the crises, in contrast to what he calls the IMF's "alternative theory," which supposedly aggravated or even caused the contractions in output.
Unfortunately, Prof. Stiglitz seems to ignore the facts. The truth is that, under IMF-supported programs, many countries did in fact allow public finances to exert a stimulating impact on their economies. This has been true for Mexico in 1994 to South Korea in 1998 to Brazil in 1999. This can be shown by the evolution of budget balances in the crisis countries from the year immediately preceding the crisis to the year immediately following it.
As for Russia, persistently large budget deficits were a major reason for the financial crisis (and default) of 1998. In Argentina, the economic contraction since 1998 was accompanied by a significant deterioration in the budget position, ultimately eroding the confidence of domestic and foreign investors in the government's ability to service its debt, leading to the collapse of the currency board arrangement.
It is correct that the IMF generally advises countries to limit the buildup of public debt in the aftermath of financial crises in order to help restore confidence, and reduce the very high interest rates the country typically has to pay in such a situation. Nonetheless, this advice is tailored to the country's special circumstances and the size of its debt burden. Of course, it is impossible to predict accurately the consequences of a crisis. When key assumptions change, for example if private demand contracts more than expected then the program's fiscal goals are adjusted appropriately. This is exactly what was done at an early stage of the Asian crisis; for example, the budget deficits in Thailand and South Korea were allowed to grow rapidly in the face of deeper-than-expected economic downturns. From all this, it is clear that government budgets in the recent crisis situations have played a stabilizing role.
It also needs to be taken into account the way that IMF-supported programs in individual countries have been adjusted to respond to the needs of the most exposed segments of society, especially the poor. In many countries, social safety nets have been expanded to provide unemployment compensation, targeted food subsidies and other support. In several cases, government budgets also helped finance a needed restructuring of the financial sector. At the same time, the programs allowed for significant shortfalls in budget revenues as tax proceeds declined with the recession. Of course, the programs also sought to reduce unproductive and wasteful public expenditures to help finance priority spending. Many of the specific elements of government budgets thus provided support for the economy while a few elements were contractionary when seen in isolation. Still, the overall contribution of government budgets was supportive.
Should fiscal policy have been even more supportive? Perhaps some further stimulus might have been feasible in some of the cases. However, the fact that relatively solid recoveries did materialize in almost all of these countries would seem to suggest that further fiscal stimulus would not have been justified. Moreover, it is of critical importance to minimize the danger that a government may be perceived to jeopardize medium-term fiscal sustainability as demonstrated by the experience of Russia and Argentina.
It is not only government budgets that help support economic activity in the wake of a crisis. The adoption of a crisis resolution program with the IMF also mobilizes financial assistance from the international community—both through IMF lending, and through bilateral arrangements. By strengthening a country's foreign exchange reserves and enhancing the credibility of the government's policies, the program provides additional support for the country's recovery and limits the depth and duration of the recession that almost always follows in the wake of a financial crisis.
Overall, it is clearly misguided to criticize the IMF for imposing hardship on crisis-stricken countries by pointing to the output contractions that inevitably result from crises. Instead, IMF support has helped the countries avoid much deeper and more protracted recessions and to see renewed growth more quickly. That, of course, is the very purpose of the IMF.
But the crisis response cannot be limited to fiscal (or macroeconomic) policy or to financial support. Financial crises rarely result from inadequate demand alone. Each of the recent crises in emerging market countries has highlighted a unique set of problems associated with structural distortions, resource misallocation, financial strains, etc.. Identifying the core problems and helping the country design the appropriate reforms often present a much greater challenge than getting fiscal policy right.
The IMF welcomes constructive debate and dialogue, including of course with Prof. Stiglitz and other critics. But let us concentrate on the core issues and avoid polemics based on gross distortions of the facts.
IMF EXTERNAL RELATIONS DEPARTMENT