## 2014 TRIENNIAL SURVEILLANCE REVIEW— EXTERNAL COMMENTARY—CRISES, SHADOWS, AND SURVEILLANCE

## Source details

**Canonical URL:** [2014 TRIENNIAL SURVEILLANCE REVIEW— EXTERNAL COMMENTARY—CRISES, SHADOWS, AND SURVEILLANCE](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2014/_073014l.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2014/_073014l.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2014/_073014l.pdf.json)

---

### INTRODUCTION
- The Fund’s central historical mission is crisis management—originally an emergency lending agency providing foreign exchange with conditionality.
- With large-scale private capital mobility the Fund’s direct financing role diminished, but its "seal of approval" tied to conditionality remains important to private lenders and official financing.
- Crises are more frequent with rising international capital mobility.
- Recovery from crises, even when crisis management avoids major disruption, tends to be slow and incomplete; "contained" crises cast a long shadow over subsequent economic performance.
- Surveillance is needed to reduce the risk, severity, and aftermath damage of crises by offering analysis and advice to countries not, or not yet, in crisis.
- Surveillance faces intellectual and political difficulties, including limited knowledge about causes and costs of crises and constraints on preemptive intervention.

### CRISES AND THE CASE FOR SURVEILLANCE
- Historical perspective:
  - Crises from the Latin crisis of the 80s through the Asian crisis of the 90s to the ongoing euro crisis show firefighting is a poor substitute for prevention.
  - The late-1990s East Asian crisis initially appeared to validate aggressive firefighting with "phoenix miracle" recoveries, but later evidence showed persistent lost output relative to pre-1997 trends.
- Post-2008 findings:
  - Post-mortems suggest crises can quasi-permanently depress potential output.
  - Ball (2014) documents sharp declines in estimates of real potential GDP across the advanced world.
  - IMF spring 2008 WEO predicted potential output growth in major advanced countries at approximately a 2.1 percent annual rate through 2013.
  - The current WEO database (as of the paper) shows potential growth marked down to less than 1.1 percent over the same period, with a large output gap five years after the crisis.
  - These outcomes occurred despite aggressive interventions that avoided large-scale financial system breakdown and markets returning more or less to normal by the summer of 2009.
- Policy lesson:
  - Political and ideological constraints that limited stronger crisis responses (for example, more fiscal offset and debt relief) are reasons to emphasize precautionary measures to make severe crises rarer.

### WHAT DO WE KNOW ABOUT CRISIS PROPHYLAXIS?
- Prediction limits and indicator strengths:
  - Economists have poor records on predicting timing or depth of crises, but may be relatively better at identifying vulnerabilities.
  - Article IV consultations on the eve of crises often identified key risks; example: preliminary conclusions of the 2007 consultation for Spain identified "the large external deficit and related high private sector indebtedness."
  - Current account imbalances and high leverage have played key roles in many crises.
- Nature of leading indicators:
  - Leading indicators typically involve voluntary private-sector actions, complicating policy levers aimed at prevention.
  - Since 1990, major crises have largely been preceded by private-sector overreach rather than obvious public-sector irresponsibility.
  - Attempts to blame public-sector policies (e.g., "Hellenize" the euro crisis or attribute the U.S. housing bubble mainly to government-sponsored lending) overlook the dominant role of private-sector dynamics in many cases.
- Political economy challenge:
  - Precautionary calls often require second-guessing market participants, making such calls hard to sell to authorities enjoying booms financed by private capital inflows.
  - Examples of crises preceded by large external deficits: Mexico 1994, Southeast Asia 1997, Spain 2008—each had outside warnings that were dismissed by local authorities who trusted private investors' judgments.

### LIMITS OF AND POSSIBILITIES FOR IMF ACTION
- Fundamental constraint:
  - The IMF can often identify dangerous configurations (e.g., low public debt with large capital inflows, loss of competitiveness, large external deficit, rapidly rising private-sector leverage) but lacks leverage when countries are booming.
- Political economy of influence:
  - The Fund exercises strong influence post-crisis via conditionality and financing; it has limited influence pre-crisis when countries can "brush off" external advice because they attract capital.
  - Using the "bully pulpit" to burst bubbles is unlikely to be effective and is politically problematic because the Fund cannot legitimately seek to undermine current growth.
- Constructive, realistic role:
  - The IMF can play a discreet, credibility-enhancing role in domestic policy debates by lending analytical weight to domestic actors who have concerns.
  - Key requirements for the Fund to be effective in prevention:
    - IMF work must be clearly of high quality.
    - Analyses must be carefully objective and depoliticized.
    - Governments must accept analyses in the right spirit; pressure on IMF staff to change inconvenient conclusions undermines the Fund’s broader role.
- Overall assessment:
  - The IMF remains primarily a firefighting agency with limited tools for prevention beyond moral suasion and high-quality, objective surveillance aimed at influencing domestic policy debates.
  - Even a restricted, discreet role—highlighting risks and drawing parallels with other cases—can have a significant impact when done credibly.

*Prepared by Paul Krugman; July 30, 2014.*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2014/_073014l.pdf_