IMFSurvey Magazine: In the News
GLOBAL ECONOMIC CRISIS
IMF Key to Crisis Policy Response, Strauss-Kahn Says
IMF Survey online
April 24, 2009
- Global recession requires coordinated economic policies
- IMF has helped contain crisis and propose policy responses to it
- Strauss-Kahn says IMF adapts to demands of global crisis
Stronger coordination is needed among economic and financial sector policymakers around the world during the global recession and the IMF is well placed to help bring countries together to tackle their joint problems, Managing Director Dominique Strauss-Kahn said.
In a broad-ranging speech that examined the role of the 65-year-old IMF in fostering the multilateralism essential to restoring global prosperity, Strauss-Kahn examined the role of the Fund during the crisis as a financial firefighter helping nations in economic distress, as a policy adviser to its 185 member countries, and as a provider of early warnings about problems developing in the international economic system.
A modest recovery
The global crisis is far from over. The latest IMF estimates show further economic deterioration. In an address to a conference at Johns Hopkins University’s School of Advanced International Studies, Strauss-Kahn said the forces pushing down economic conditions are stronger than those pushing in the other direction. As a result, 2009 will be a “horrible year,” he said. But the corrective policies governments are putting in place should help spawn a modest recovery in 2010, provided those policies continue in the right direction—especially efforts to clean bad assets off bank balance sheets..
The IMF has changed some of its approaches to give it more flexibility to aid in recovery, to get funds out quickly to countries that are pursuing sound policies but have been caught by the recession, he said. Member countries have pledged to increase its resources to help it lend on both an emergency and preventive basis. And uppermost in the IMF’s goals is to protect the poorest and most vulnerable from the ravages of the recession.
IMF role is key
The IMF—established in the wake of the Great Depression and World War II—remains “as central as ever” to macroeconomic and financial sector policy coordination, but it “took the worst financial crisis since the Great Depression for this to be manifest,” Strauss-Kahn said.
When the former French finance minister took over the multilateral institution in November 2007, it “was facing a progressive loss of relevance and legitimacy” and many questioned the need for the organization, he said. But 18 months later, after a crisis that has spread from a tiny part of the U.S. housing market to almost the entire world, it became clear that a global crisis demanded a multilateral solution and the IMF was perfectly placed to address financing and liquidity problems at the global level and conduct candid, independent, and evenhanded surveillance of global economic developments.
At its summit earlier this month, the Group of Twenty (G-20) industrial and emerging market economies reaffirmed that role. It not only called for a vast increase in IMF resources—from $250 billion to $750 billion—to enable it to assist with the growing financial requirements of member countries, but emphasized the need for the global monitoring that the IMF provides.
Fighting financial fires
The IMF, which will hold its Spring Meetings in Washington on April 25 and 26, has been thrust back into its role as financial firefighter, providing emergency assistance to countries in economic distress. Firefighters may seem “useless” in good times, Strauss-Kahn said, but the crisis has shown “they have a major role to play when things turn sour.”
The IMF has been active among all types of economies. It has helped emerging markets, especially in Eastern Europe, cope with the sudden stop in capital flows. It has extended help to advanced countries such as Iceland.
Strauss-Kahn: IMF-supported programs can succeed only if country owns them. “We have to be seen as doctors, not as cops” (IMF photo)
Strauss-Kahn made a special plea for low-income countries that were first buffeted by food and fuel price shocks, then, as the recession widened, by a collapse in trade and remittances from nationals working abroad who lost their jobs. Millions of people will be thrown into poverty, 3 million more children could die by 2015, and social unrest, political instability and even civil war could ensue if the financial needs of low-income countries are not met. The G-20 has asked the IMF to provide $6 billion in concessional resources to low-income countries over the next two to three years, which it will do, he said.
The Fund also has made changes in the way it does business. It doubled the amount of money it is willing to lend any member, “to give confidence to countries that we can meet their needs.” It plans to more than double its capacity to make concessional loans. Moreover, he said, because it is “better to prevent fires than to fight them,” the IMF has established flexible credit lines that allow countries with a proven track record of good performance to borrow large amounts quickly and without preconditions.
Those flexible lines fill in a gap in the global financial architecture. Because countries now know there are resources available to help them, they will no longer have to self-insure by building up large buffers of foreign reserves. Mexico, Poland, and Colombia have already sought such flexible lines.
Conditionality is not abandoned
He said that although the new flexible lines are available without preconditions, they are only available to countries that are already following good economic policies but were caught in a financing crisis through no fault of their own.
But conditionality, the changes in policy required of countries receiving IMF resources, is still important, he said. Bad economic policies remain in place in many countries—especially on the spending side—and they must be remedied as part of any IMF programs. Nevertheless, Strauss-Kahn said, the IMF will not overreach with conditions, as it has been accused of doing in the past. Instead any conditions it attaches to loans will be focused on what needs to be fixed, not on other challenges facing the country.
The IMF seeks to protect the poor when deficit cutting does occurr. Many recent programs call for sizeable increases in social spending in the midst of serious efforts to cut deficits. In Latvia, social spending is set to increase by 1½ percent of GDP and by ½ percent in Pakistan.
Such safeguards are critical. IMF-supported programs can succeed only if the country owns them. “We have to be seen as doctors, not as cops,” Strauss-Kahn said.
As the crisis evolved, the IMF was among the first to pinpoint the policy responses that have now become part of the conventional wisdom, Strauss-Kahn told the Johns Hopkins conference. In making the case for fiscal stimulus and restructuring banking systems burdened by a high level of toxic assets, “the IMF got it right,” he said.
Since January 2008 the IMF has been recommending that countries that can afford it should boost spending to help compensate for a decline in demand that was both large and expected to be long lasting. It was, he noted, something novel from an institution associated with fiscal “belt-tightening.” He said that the IMF recommended that such stimulus be on the order of 2 percent of gross domestic product, an amount that countries delivered with an “unprecedented degree of international coordination.” It is not yet clear whether the stimulus countries plan for next year will be enough, he said.
But unless the financial sector gets moving again, which requires that bank balance sheets are cleansed of toxic assets, no amount of stimulus will be successful, he said, and 2010 will be another bad year. There are several ways to deal with the bad assets, such as the subprime mortgage loans that were the initial source of the crisis. But countries are not moving as quickly here as they are with stimulus packages.
He noted that it is politically easier to get support for stimulus spending than for aiding the banking system, which many blame for the crisis. He also warned advanced countries against urging their domestic banks to repatriate capital from emerging markets, which he called a new form of protectionism. “There can be no purely domestic solutions in today’s world,” Strauss-Kahn said.
The IMF was less successful in predicting the crisis than it has been in helping countries cope or giving sound advice, Strauss-Kahn acknowledged. “We failed to pay enough attention to factors like excess leverage, systemic risk, credit booms, and assets prices,” he said. And when the IMF did give warnings, they were often not loud enough, and tended to be overly cautious and nuanced, and as a result ignored by policymakers.
Since the crisis began, however, Strauss-Kahn said the IMF has been quite accurate in predicting the course of both the real and financial sectors. And the IMF plans to produce better early warnings that are real, credible and even handed. When the Fund detects bad behavior, it will say so—not shying away from “naming and shaming.” IMF surveillance will focus on “systemic risks from all quarters” that better integrates macroeconomic and financial sector analysis and monitors policy spillovers from one country to another and how linkages occur across borders.
At the same time, he noted, policymakers are reluctant to listen to negative forecasts during good times. It’s hard to get them to act when the “sky is blue” and the warning is that next year “it will rain.”
Still, if the IMF is to succeed in any of its roles it must establish its legitimacy as a global institution, Strauss-Kahn emphasized. Otherwise, countries won’t come for help until it is too late. The existence of flexible credit lines will not prevent reserve accumulation. No one will listen to policy advice, and early warnings will be ignored.
To enhance its legitimacy, the Fund is increasing the voice of emerging market and low-income countries in making IMF policy, a reform effort that began in 2008. That legitimacy must not only be based in voting power but in the staff. The IMF must diversify its staff—educationally, culturally, and nationally—to ensure that the needs of all its members are met.
The Great Depression of the 1930s showed that lack of cooperation and isolationism make things worse. There remain temptations today to seek purely domestic solutions—such as by protecting domestic banking systems at the expense of neighbors and favoring domestic lending.
Strauss Kahn said that cooperation and multilateralism must win out, with the IMF playing a critical role in managing the international financial architecture. “If countries come together to tackle their joint problems in a cooperative manner, everybody wins,” he concluded.
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