Art Nouveau building in Riga: Latvia is an example of a country that succeeded in using internal devaluation to recover from the crisis (photo: Chromorange/Bilderbox)
GLOBAL FINANCIAL CRISIS
By stemming the panic, shoring up confidence, and providing resources, IMF-supported programs helped avoid the global economic and financial meltdown many had feared at the outset, says the report.
The report takes a closer look at the design and effectiveness of IMF-supported programs since the global financial crisis with a view to drawing lessons for subsequent programs. The report is part of the Fund’s ongoing effort to learn from experience, and it follows a series of previous reviews during 2009–12 that assessed program design and outcomes during the surge in IMF-supported programs since 2008.
In an interview, Vivek Arora, Deputy Director of the IMF’s Strategy, Policy and Review Department, discusses the review of crisis programs, which covers 32 IMF arrangements between 2008 and 2013 from across the membership.
IMF Survey: How well did the IMF handle the 2008 global financial crisis and its aftermath, according to the study?
Arora: We argue that the Fund helped the membership avoid outcomes that were much feared at the outset. It is useful to remember the circumstances that prevailed at the time. At the time the crisis broke there was a real fear that it could lead to another great depression, or to a cascading of crises from country to country fueled by contagion as confidence evaporated, or to a meltdown of the global financial system. These outcomes were avoided. IMF support played a role in avoiding them. Admittedly, it is a counterfactual and therefore not known, but we considered the context of the times to be important.
The Fund helped to chart a way through the crisis, using experience to inform future program design and contributing to the strengthening of policy frameworks that allowed array of feasible policy choices to be broadened over time.
Now, the crisis also affected countries through different channels and over different time frames. The programs provided the euro area time to build firewalls that prevented contagion, they supported reforms and confidence in countries in the Middle East and North Africa that sought Fund financial support to address the economic dislocations associated with the Arab Spring in 2011, and they helped emerging economies and small states to handle the collapse of trade and financing flows in the aftermath of the crisis.
So Fund programs played a role in helping the global economy avoid a catastrophe. We also learned lessons for program design.
Crisis Programs
The 27 countries covered in the review include:
• A group mostly comprising European emerging markets that required Fund financial support in 2008–09 when capital flows dried up at the start of the crisis. This group includes Georgia, Hungary, Iceland, Latvia, Ukraine (2008 and 2010), and Armenia, Belarus, Bosnia and Herzegovina, Mongolia, Romania, Serbia, and Sri Lanka (requests in 2009).5 Later arrangement requests from Moldova (2010) and Kosovo (2012) were similar in character.
• Several small highly open economies that had domestic vulnerabilities that were exposed by the disruption they experienced through their trade, tourism, and financial linkages with the United States and crisis-affected countries. These economies were the Seychelles (2008), Dominican Republic, Maldives (2009), Antigua and Barbuda, Jamaica (2010), and St. Kitts and Nevis (2011).
• The euro area crisis countries of Greece (2010, 2012), Ireland (2010), Portugal (2011), and Cyprus (2013) that faced problems partly associated with the global crisis but whose more immediate origin was their public and private balance sheet vulnerabilities and the accumulation of large current account imbalances within the euro area.
• Some Middle East and North African (MENA) countries that faced fiscal and structural vulnerabilities heightened by the global crisis (Pakistan, 2008) or strained by the economic dislocations associated with the 2011 Arab Spring (Jordan, 2012; Tunisia, 2013).
IMF Survey: How did lessons from program outcomes early on help inform the design of later programs?
Arora: Many lessons were learned early on, through the crisis program reviews undertaken between 2009 and 2012, Independent Evaluation Office assessments, ex-post evaluations of the exceptional access programs, and of course the Executive Board’s views as programs unfolded. The policies in subsequent programs adapted to the lessons learned from earlier programs.
One example is with respect to fiscal adjustment. As it became evident that the contractionary effect of fiscal consolidation on output may be larger than envisaged, many programs slowed the pace of consolidation (Armenia, Greece, Hungary, Latvia, Portugal, Ukraine). Another relates to the stronger emphasis programs gave over time to the challenges of achieving internal devaluation and restarting credit intermediation. In the euro area, the program experience helped inform the Fund’s recommendations for strengthening firewalls and developing a banking union.
IMF Survey: Could you say a bit more about external adjustment and internal devaluation?
Arora: Program countries generally entered the crisis with large initial external imbalances—larger, in fact, than was typically observed in previous program episodes. But the nominal exchange rate adjusted by much less than in previous episodes. Internal devaluation—that is, seeking to adjust domestic wages and prices rather than the nominal exchange rate as a way to restore competitiveness in tradable sectors—is a challenging strategy. It requires large macroeconomic adjustment and deep structural reforms sustained over a relatively prolonged period, can be costly in terms of employment and output, and can require large and sustained financing.
A few countries did achieve substantial adjustment through this route. Latvia is an often-cited case. There, unit labor costs fell 25 percent in a single year, followed by a strong supply response as new firms entered the traded goods sectors amid flexible labor and product markets, and output recovered thanks to rising exports. But the configuration of circumstances was somewhat unique to Latvia. In a few program cases in the euro area, as well, unit labor costs fell substantially. But the supply response was relatively muted and so, overall, was output.
IMF Survey: Was the IMF sufficiently mindful of the potentially adverse effects of fiscal adjustment? How did experience influence the IMF’s thinking in this area?
Arora: Overall, the review notes that program design did pay attention to the individual circumstances of each member, and it did adapt in response to experience. In the fiscal area, program objectives were influenced by the levels of public debt, which were different across countries. Where the debt was higher, more consolidation was needed.
But the pace of consolidation matters. If the consolidation is very large and very rapid, it can contribute to a reduction in output that is costly socially and raises the debt-to-GDP ratio relative to program objectives.
With that experience in mind, many programs that had significant consolidation needs adapted and moved to a slower—but still appropriate—pace of fiscal consolidation. Examples include Cyprus, Ireland, Greece in its 2012 program, and Jordan.
It is noteworthy that the recent programs paid special attention to strengthening social safety nets and protecting the poor and vulnerable, and that program outcomes were generally in line with these objectives.
IMF Survey: What did the study reveal about structural reforms in the period following the crisis?
Arora: Structural reforms were an important part of the program strategy. They are important for helping countries raise competitiveness and potential growth, and the Fund is paying increasing attention to the appropriate role of such reforms as well as analytical frameworks for thinking about them.
This review focuses more on the implications for program design, and makes two general points. First, while structural reforms are very important from a longer term perspective, the evidence from recent programs suggests that in the short term their effects on growth may be relatively modest. Program design should, therefore, be prudent about how large a growth payoff to expect from structural reforms in the short term. If program design builds in very large payoffs, that may prove to be overly optimistic.
Our review also highlights the need to avoid overburdening authorities’ implementation capacity. Recent programs saw an increase in structural reforms across the membership. This increase was warranted, among other things, by the emphasis on domestic price adjustment for restoring competitiveness. So there were grounds for more structural reforms. But we found that countries with longer programs, or with successor programs, had weaker implementation of structural reforms. These observations are consistent with reform fatigue.
IMF Survey: What lessons does the study draw about IMF collaboration with regional financing arrangements?
Arora: Regional financing arrangements (RFAs) are an increasingly important feature of the global economy. They are an important complement to the IMF in the global financial safety net, and they can bring valuable understanding of regional policy challenges and help foster ownership of programs. We need to determine, therefore, the most effective way of interacting with regional financing arrangements.
The review considered that it would be useful to establish more operational guidelines for IMF-RFA interaction, building upon the principles the G20 endorsed in 2011. Such guidelines could help clarify the respective roles of the different institutions as well as ensure the cumulative conditionality faced by the member is well aligned with implementation capacity. Of course, they would need to take into account the significant differences between such arrangements across the membership.
IMF Survey: What do you see as the value of this type of reflective exercise?
Arora: We have to serve our membership and provide the best policy advice possible. This type of exercise is complementary to ex post evaluations, the Independent Evaluation Office assessments, reviews of conditionality, and other efforts to improve our advice.
