Putting the wheels on. Action needed on three fronts to prevent recession turning into a global depression (Photo: zumaphotos)
Financial crisis
In a wide-ranging speech at a conference at the Spanish central bank in Madrid to celebrate the 50th anniversary of Spain's membership of the International Monetary Fund, Managing Director Dominique Strauss-Kahn said that action is needed on three fronts to prevent the current recession turning into a global depression.
• Coordinated government intervention in financial markets to get credit flowing and support bank recapitalization
• Fiscal measures to offset the abrupt fall in private demand
• Liquidity support for emerging market countries to reduce the adverse effects of the widespread capital outflows triggered by the financial crisis.
In some of the starkest language he has used since the crisis erupted, Strauss-Kahn said governments around the world have endorsed this agenda, most recently at the November meeting of the Group of 20 (G-20) industrialized and emerging market countries in Washington. "Many have begun to implement it. But the actions taken so far are not enough. We need more," he said, according to the text of remarks as prepared for delivery. The event was also attended by former IMF managing Directors Michel Camdessus and Rodrigo de Rato.
According to the most recent IMF forecast, the major advanced economies are expected to contract by ¼ percent on an annual basis in 2009, marking the first annual contraction in the post-war period for this group of countries. But, with the effects of the crisis spreading rapidly, IMF First Deputy Managing Director John Lipsky has said that the Fund is likely to revise downward its global forecast when it announces new numbers next month.
Restoring financial market stability
Government intervention in the financial markets should be clear, comprehensive, and cooperative between countries, Strauss-Kahn said. "Government action needs to have a clear objective so that effective oversight of how public money is used is possible. This is still not always the case, and this lack of clarity goes some way to explaining the `bailout fatigue' which is a major political risk at the moment."
To be comprehensive, national plans must contain guarantees to depositors and assurances to creditors that are sufficient to ensure that markets function. The plans should also provide liquidity and support bank recapitalization as well as encouraging banks to recognize the losses they have made. And they should promote the removal of distressed assets from banks' balance sheets. The IMF's experience with past crises underlines that both recapitalization and loss recognition are key.
Action should be coordinated at the global level and when appropriate at the regional level. The euro zone has been coordinating actions at the regional level, and the comprehensive program that the G-20 has initiated will help further promote global coordination. "I am somewhat worried about these plans. A lot has been announced but I sincerely believe that the follow up doesn't go fast enough," Strauss-Kahn said.
Fiscal stimulus to revive growth
Another priority is to support aggregate demand through fiscal stimulus in the face of what now looks to be a dramatic fall in consumer demand.
"We are facing an unprecedented decline in output, we have evidence of substantial uncertainty limiting the effectiveness of some fiscal policy measures, and we anticipate that the negative growth effects will last for some time. For all of these reasons we are calling for stimulus measures that are large and diversified, and that will last longer than one or two quarters," said Strauss-Kahn, while recognizing that not all countries would have the capacity for a fiscal stimulus.
Explaining the ways in which fiscal stimulus can be effectively applied, he said a key criterion was to maximize the multiplier effect of different fiscal measures. Actions could include help for troubled sectors such as housing and finance; transfers to low-income households through greater provision of unemployment benefits, increased tax benefits for low-wage earners, and expansion of in-kind benefits covering basic needs such as food; and spending on major projects—particularly those that are already planned and could be implemented quickly.
Temporary reductions in personal income and sales taxes could also be envisaged. But the IMF would not recommend reduction in corporate tax rates, dividends and capital gains taxes, or special incentives for businesses. "These are likely to be ineffective and difficult to reverse," Strauss-Kahn said.
Financial support to crisis-hit countries
Providing financial support to countries hit by shocks to cushion their impact and hasten recovery is a traditional responsibility of the Fund. Strauss-Kahn noted the IMF has provided prompt and very substantial support for Hungary, Ukraine, Pakistan, and Iceland, and said help for other countries would be provided.
"We are also closely monitoring the fallout from the global downturn on our low-income members and stand ready to provide additional financial support," he added. Malawi and the Kyrgyz Republic have become the first two nations to tap the IMF's revamped borrowing program known as the Exogenous Shocks Facility (ESF), designed to help low-income countries cope with emergencies caused by events beyond their control. Several more African nations are expected to request loans in the near future, according to IMF officials.
The revamp of the IMF's shocks facility for low-income countries is part of an effort by the IMF to improve its lending toolkit. In October, the IMF said it was launching a new short-term lending facility to channel funds quickly to emerging markets that have a strong track record, but that need rapid help during the current financial crisis to get them through temporary liquidity problems. For other countries where policy frameworks need strengthening, the IMF has been providing member governments access to traditional lending facilities over longer periods, but on an accelerated basis.
The IMF has launched a review of its financing role in member countries, to make sure it has the right instruments to meet countries' needs in a world characterized by growing—and increasingly complex—cross-border financial flows.
Additional resources needed by IMF
Strauss-Kahn said if the global economic crisis gets worse, the world would need to supply much more liquidity to affected countries. This may mean the IMF would need additional resources. "We have enough resources for now, but this can change quickly. The commitment of the G-20 to support Fund lending capacity is helpful, as is Japan's generous offer of $100 billion to add to the resources of the Fund," he said.
"I would urge other countries with large reserves to follow Japan's example. Now is the time for the world community to get together and provide the Fund with the means to address the challenges arising from the financial crisis. I would also urge the major advanced economies to cofinance Fund loans—either directly or through balance of payments support in conjunction with Fund programs."
Strauss-Kahn also discussed ways of avoiding future crises, including suggestions for improving financial market regulation, understanding the linkages better between the real economy and financial markets, and creating early warning systems for looming problems.
The priority areas for regulatory reform are outlined in an article in the December issue of the IMF's Finance & Development magazine, "Preventing Future Crises."
Comments on this article should be sent to imfsurvey@imf.org
