How has the IMF fared in relation to the crisis? The assessment has to be in relation to the three stages of the crisis: the run-up, clean-up, and follow-up. My assessment would be something like: cock-up in the run-up; thumbs-up for the clean-up, and doubts about the follow-up. Here’s why.
The authorities in the United States—notably the Fed but also others—made a number of macroeconomic and regulatory policy errors in the run-up to the crisis. The IMF’s cock-up was two-fold. First, it was weak and/or ineffective in addressing the problem of global imbalances that contributed to the crisis. It was ineffective in making countries that ran large current account surpluses, notably China, adjust, and equally ineffective in influencing policies in the current account deficit countries, notably the United States. Second, and arguably the bigger failure, was to preside over large capital flows to Eastern Europe despite the lessons that it should have learned from the experience of the Asian financial crisis in the late 1990s. These flows to Eastern Europe were in some cases so large that it did not require hindsight to see the problems that they would lead to. Warnings about the unsustainability of these flows should have been loud and insistent. And they were not.
On the other hand, the IMF’s response—to include the actions of the management of the IMF and that of the G-20 leaders—to the crisis has been commendable. The IMF gets top marks for (1) mobilizing additional resources and lending them out to countries that needed them (the stabilization that occurred in Eastern Europe would have been slower and more costly without extra IMF lending); (2) issuing Special Drawing Rights (SDRs)—the IMF’s funny money—to member countries, which could potentially pave the way for more such SDRs in the future (a proposal originally mooted by my colleague Ted Truman); (3) devoting a lot of effort to overcome the stigma problem of borrowing from the IMF by making the terms of its loans less onerous (lower rates, fewer conditions, quick disbursing); and (4) making the case for a strong fiscal stimulus to counteract the global recession.
Why not an A if this is the record? For one important reason: The IMF’s record, even during the crisis, is not without blemish. Its handling of the Latvian currency issue—allowing Latvia to avoid a currency devaluation in the face of a current account deficit of 24 percent—was probably bad economics. My colleague John Williamson would call this “immaculate adjustment.” But it was almost certainly bad politics in perpetuating the impression that the IMF dealings with member countries are not even-handed and that it is not an International Monetary Fund but a Euro-Atlantic Monetary Fund. (How would a country that was not backed by Brussels or Washington have been treated in a similar situation is a question that many countries have been asking.)
While the crisis has conferred on the IMF a lease of life, this might turn out to be all too brief unless it fundamentally changes itself in two ways: governance and ideology.
First, it must change its governance so that all countries, especially those in Asia, come to believe that it is “their” institution and not a Euro-Atlantic Monetary Fund. Without governance reform, the IMF will not be trusted as an impartial referee, and hence not be conferred the additional powers that it needs to become more effective. And the IMF has a long way to go to be perceived as everyone’s institution. Recall that in the early stages of the crisis, a number of Asian countries were willing to receive liquidity from the US Federal Reserve but would never have gone to the IMF for such liquidity. Note also, that despite the IMF bending backwards to make liquidity come almost completely unencumbered in the form of the new Flexible Credit Line, only three countries have signed up to it. The really big and most meaningful governance reform will be the selection procedure for the next Managing Director of the IMF. But other reforms such as reducing the quotas of Europe, increasing those of China and India, and eliminating the effective veto over decision making that the United States and Europe currently enjoy will also help. The G-20 summit in Pittsburgh offers an opportunity to make strides on this front.
Second, on the intellectual front, the IMF must lead the charge in evolving a new, sensible approach to capital flows based on the experience of this crisis. The policy arsenal against future crises, especially the build-up of asset bubbles, must include “macroprudential” measures. In the case of emerging markets, one important source of asset price bubbles is a surge in capital flows. For them, macroprudential measures must therefore encompass the counter-cyclical management of capital flows. The IMF should be asked to prepare a “best practices” manual for countries on whether, when, and how best to deal with flows that have the potential of creating asset bubbles and financial crises.
Such a manual would allow the IMF to make a genuine intellectual contribution to the still nascent area of appropriate “macroprudential” measures and demonstrate its usefulness to emerging market countries, some of whom are already witnessing a resurgence of capital flows. There would be a large collateral benefit, too. An IMF that is seen to be honestly and disinterestedly engaging on this issue would address its legitimacy problems because in the eyes of many, the IMF’s support (implicit and explicit) for free capital flows reflected the belief system of the rich countries and the interests of their financial sector.