Crisis Lessons to Remember for Europe’s Policymakers

IMF Blog, February 24, 2010

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Author: Marek Belka.
Date: February 24, 2010.
Focus: Lessons from the global economic crisis for Europe’s policymakers, with primary focus on countries outside the eurozone and reflections from the author’s experience as a former policymaker.

The transition from central planning to market-based economies remains an undisputed success.
Market-based economy is described as “the only game in town.”
Social cohesion in emerging market economies is assessed as robust; “for now at least, there is no serious social unrest in sight.”
European integration helped eastern European countries by strengthening institutions and granting access to the EU single market.
Structural funds and the EU balance of payments facility provided support during the global economic crisis.
The EU “halo” that previously shielded emerging markets in borrowing costs is now gone; domestic policy choices matter more.

Good policies and strong institutions matter:
- Countries with unsustainable fiscal policies and weak institutions were the first to fall and had less space for fiscal stimulus.
- Policy quality must extend beyond fiscal and monetary responses to bank regulation, supervision, and public institution quality.
- Examples:
- Estonia kept its budget deficit under 3 percent of GDP during extreme economic decline due to strong institutions and political determination.
- Romania’s independent and well-managed central bank helped the country survive a potential liquidity crisis during the recent presidential campaign.
Good fiscal policies must be built in good times:
- If prosperity is used for consumption rather than saving, fiscal stimulus or automatic stabilizers may not be feasible during downturns.
- Fiscal stabilizers have regained favor; some eastern European countries (notably the Czech Republic and Poland) were able to afford fiscal stimulus.
Watch expenditures:
- Budgets that look strong in boom times can be exposed in busts due to falling tax revenues.
- Policy trade-offs exist between low-tax models and the ability to provide extensive social services.

Capital inflows: supportive if they increase output potential; risky if they merely stimulate demand.
- Prudential regulations may be necessary to curtail unwanted capital flows; capital controls should not be ruled out in certain situations.
Foreign ownership of banks:
- Selling domestic banks to foreigners accelerated the creation of modern and efficient financial sectors.
- Foreign-owned banks generally had long-term investment horizons and showed willingness to maintain exposure during the crisis.
Domestic banks and competition:
- Market opening and competitive pressure helped strengthen domestically-owned banks (examples: Poland’s PKO BP and Russia’s Sberbank weathered the crisis well).
- Some domestically-owned banks faced trouble (examples: Parex in Latvia and OTP in Hungary), where country risk contributed to difficulties.
- Critical determinant: whether banks have a sustainable business model not dependent on short-term wholesale funding.

Self-regulation of the private sector has limits; ultimate responsibility rests with the state.
Bailouts became politically acceptable to avoid social unrest and preserve stability; this implies taxpayers may bear the cost if things go badly.
Policymaking in emerging economies must be pragmatic and increasingly sophisticated as economies advance.
The author notes a sense of betrayal among eastern policymakers at the abandonment of market-discipline rules in the West but stresses the need for refined policy messages tailored to emerging economies.

The IMF is portrayed as responsive and adaptive: “The Fund has listened, learned, and adapted.”
The IMF is characterized as a doctor rather than a bad cop; engagement with the IMF may be uncomfortable but necessary when deeper problems exist.
The Fund has improved its understanding of member countries’ diverse needs.

Marek Belka, February 24, 2010 — Crisis Lessons to Remember for Europe’s Policymakers