An Institution that Eases Financial Pain, A Commentary By Kenneth Rogoff, Economic Counsellor and Director of the Research Department, IMF
September 27, 2002An Institution that Eases Financial Pain
By Kenneth Rogoff
Economic Counsellor and Director of the Research Department
International Monetary Fund
September 27, 2002
Many people view the International Monetary Fund as an agent of austerity. Indeed, the popularity of this view is surely one reason why left-leaning anti-Fund polemics sometimes sell well in bookshops, even while right-leaning critics call for the IMF to stop interfering with the natural selection process of market forces.
While the "IMF promotes austerity" view has emotional appeal, in reality nearly the opposite is true - and many Fund-supported programmes allow for sizeable budget deficits. Distressed emerging-market debtors come to the IMF precisely because its financial assistance, combined with the policies it supports, generally alleviates austerity rather than intensifying it.
Emerging-market debtors typically come to the IMF only when their finances are under extreme duress - usually through imprudence and bad luck - and other creditors have turned their backs. These countries would otherwise have no choice but to tighten their belts, cutting domestic spending relative to output through a mix of tax increases, expenditure cuts and higher interest rates. An IMF loan typically loosens the belt, both directly via added funds and indirectly by helping to stabilise markets. Saying the IMF causes austerity is like saying doctors cause plagues because you often find them around sick people.
There are some who think misguided IMF policies more than cancel out any good its limited financial resources bring. These critics say that if only the IMF understood its main task to be fighting recessions, it would be prescribing counter-cyclical policies for cri sis countries, not restrictive policies. They claim that what creditors really want to see is growth. Ergo, the best way to defend a currency is by cutting interest rates to expand the economy. Similarly, if a country wants to calm creditors, it should be borrowing more money, not less. They think the resulting growth would allow the country to carry proportionately more debt. Were this true, crisis countries could have their cake and eat it. Indeed, why not just keep stuffing themselves?
Sadly, the clear weight of logic and evidence suggests the opposite. Surely, if it were feasible to fend off a crisis by simply borrowing more money and lowering interest rates, policymakers whose ears are close to markets would have figured it out by now.
Now, there is a real risk in any IMF programme that interest rates might be raised too sharply and the path of fiscal policy set too tight. If so, either the recession will be steeper than it has to be or, perhaps worse, the programme will be politically unsustainable and creditors will keep racing for the doors. Indeed, as the Asian crisis of 1997-98 evolved and it became clear that the economic downturn was worse than initially thought (not only by the IMF but also by just about everyone), the IMF changed its advice to allow fiscal policies to be less restrictive.
On the other hand, if the programme does not embody sufficiently ambitious targets, it will collapse for lack of credibility. In some of the 1990s crisis countries, for example, policies were relaxed prematurely, throwing programmes off course and postponing recovery. Given the delicate balancing act involved in re-establishing credibility after a crisis, it is no surprise that even the best-crafted IMF programme seems too loose to some and too tight to others.
One way the IMF could make its programmes systematically more expansionary is by extending the repayment horizon for its loans, now typically only a few years. Indeed, many purveyors of the austerity view seem to believe that all IMF loans should be for 40 years or more, the price supposedly being paid by rich countries that ought to be giving more aid through other channels anyway. But who would the real losers be? The IMF does not run for profit; it does not pay dividends to private shareholders. Instead, it continually recycles the money repaid by one developing county to help others. If IMF money were recycled only every 40 years instead of every three or four, the Fund's limited resources would quickly be tied up. And who would be around to help countries engulfed in the next emerging market financial crisis?
The IMF is not perfect and it has made mistakes. We need to find ways to improve the trade-off that crisis countries face in the short term between restoring credibility and restoring growth. But the naive view that the IMF goes around advocating austerity where none is called for denies policy trade-offs that are real - and confuses correlation with causation.