Can the IMF save the world?

Barry Eichengreen, 7 October 2008

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As the financial crisis has unfolded, the International Monetary Fund has been noticeable mainly for its absence. This will now change – at least temporarily – as its Governors assemble for their annual meeting and the kleg lights are turned on. The question is whether those Governors and the management to whom they entrust the Fund’s operation can restore its relevance for more than a weekend.

If not now …

If this is not a set of circumstances that call for the Fund, it is hard to know what is. While recent problems affecting institutions like Fortis and Dexia have been adequately handled by a handful of governments, containing a run on a much larger British, German, or Swiss bank will require wider international cooperation. The managing director, Dominique Strauss-Kahn, should urge governments to get their ducks in a row. He should urge them to move together when raising deposit insurance limits and extending other guarantees in order to avoid draining funds from one another’s financial systems. He should call for coordinating interest rate cuts and fiscal stimulus to prevent the world from sliding into depression. For consciousness-raising purposes if nothing else, the Fund should be issuing an urgent call to action, not maintaining radio silence.

Multilateral Consultation on the crisis: Too little, too late

No doubt Mr. Strauss-Kahn will also call for an IMF-directed Multilateral Consultation bringing together the US, European Union, and others to discuss the credit crisis. But cross-Channel and Transatlantic crisis management will not be arranged through a Multilateral Consultation or more generally through the IMF. Central bankers are already in continuous communication. The relevant regulators meet under the aegis of the Basel Committee of Banking Supervisors. European finance ministers meet as the Ecofin Council, and if they need to reach Mr. Paulson they know his number. They do not need a Multilateral Consultation to bring them together.

And having Mr. Strauss-Kahn and his deputies orchestrating their meeting is unlikely to produce a different outcome. Reflecting diplomatic niceties, the IMF’s first Multilateral Consultation on global imbalances stretched over the better part of a year. This does not exactly match the timing of a financial panic. Any Multilateral Consultation focusing on immediate management of the crisis will quickly become irrelevant.

Focus on regulatory reform: Better ideas needed

Better would be to focus the next Multilateral Consultation on regulatory reform and preventing the next crisis. Here, however, the IMF must first demonstrate that it is a better orchestrator of these discussions than the Bank for International Settlements (BIS) or the Financial Stability Forum. Establishing this means offering better ideas. And so far the novel ideas for regulatory reform – capital insurance, countercyclical capital requirements, forcing over-the-counter trading into an organised exchange – have come from other quarters.

To advertise the 2007 decision strengthening its surveillance of currencies, the Fund will also want to say something about exchange rates. Under current circumstances, however, the less said the better. Notwithstanding the lemming-like rush of investors into US treasury bills, the dollar will have to fall over the medium term as capital flows into the United States diminish, reflecting the reluctance of foreigners to accumulate more toxic assets. Dollar depreciation may make life difficult for other exporting countries, but it is unavoidable and should not be resisted. It is not clear that there is anything constructive for the Fund to say about this.

Aiding middle-income countries

Where the Fund should have a role is in aiding middle-income countries caught up in the crisis. Countries with large current account deficits and relying on foreign capital to finance them will find their position unsustainable as growth slows, undermining their ability to export, and as foreign investors, cash-strapped and in a state of high anxiety, hesitate to commit.

In present circumstances, anyone with a large current account deficit depending on foreign capital inflows is at risk. This includes, of course, the United States, although America is not a client of the Fund, since it can effectively print international reserves (the dollar remaining the dominant reserve currency). But in many smaller countries with even larger current account deficits relative to the size of their economies, corporate borrowing, home mortgages, and even auto loans are denominated in foreign currency. For them, flooding the markets with liquidity and letting the currency depreciate, as the US does, is no solution. Indeed, it will only make matters worse.

Helping countries in this pickle has long been the IMF’s bread and butter. But even here it is not clear that the crisis will allow the Fund to reassert its relevance. Eastern Europe crisis countries may be bailed out by the EU and the ECB, while their East Asian counterparts may receive swaps and credits through the Chiang Mai Initiative. Once again the Fund may end up being sidelined unless it demonstrates that it has a better idea, in this case about how to link emergency lending with policy adjustment.

It is sometimes said that the crisis is a reminder of why we have the IMF. If the Fund doesn’t come up with some new ideas for how to handle it, the crisis may only remind us why we can forget it.

Editors’ note: This column first appeared on http://www.eurointelligence.com/.

Topics: Financial markets, Global economy, Macroeconomic policy
Tags: global financial crisis, IMF, subprime crisis

Professor of Economics and Political Science at the University of California, Berkeley; and formerly Senior Policy Advisor at the International Monetary Fund. CEPR Research Fellow

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