Noted for February 26, 2013
Liveblogging World War II: February 26, 1943

Tuesday Ten Years Ago on the Internet: Ken Rogoff: The IMF Strikes Back

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The IMF Strikes Back, By Kenneth Rogoff, Economic Counsellor and Director, Research Department, IMF 2003:

Vitriol against the IMF, including personal attacks on the competence and integrity of its staff, has transcended into an art form in recent years. One bestselling author labels all new fund recruits as "third-rate," implies that management is on the take, and discusses the IMF's role in the Asian financial crisis of the late 1990s in the same breath as Nazi Germany and the Holocaust. Even more sober and balanced critics of the institution—such as Washington Post writer Paul Blustein, whose excellent inside account of the Asian financial crisis, The Chastening, should be required reading for prospective fund economists (and their spouses)—find themselves choosing titles that invoke the devil. Really, doesn't The Chastening sound like a sequel to 1970s horror flicks such as The Exorcist or The Omen? Perhaps this race to the bottom is a natural outcome of market forces. After all, in a world of 24-hour business news, there is a huge return to being introduced as "the leading critic of the IMF."

Regrettably, many of the charges frequently leveled against the fund reveal deep confusion…. Other criticisms, however, do hit at potentially fundamental weak spots…. Worse yet, some of the deeper questions… are too easily ignored. Consider the four most common criticisms against the fund: First, IMF loan programs impose harsh fiscal austerity on cash-strapped countries. Second, IMF loans encourage financiers to invest recklessly, confident the fund will bail them out (the so-called moral hazard problem). Third, IMF advice to countries suffering debt or currency crises only aggravates economic conditions. And fourth, the fund has irresponsibly pushed countries to open themselves up to volatile and destabilizing flows of foreign capital. Some of these charges have important merits, even if critics (including myself in my former life as an academic economist) tend to overstate them for emphasis….

The Austerity Myth: Over the years, no critique of the fund has carried more emotion than the "austerity" charge…. Critics must understand that governments from developing countries don't seek IMF financial assistance when the sun is shining; they come when they have already run into deep financial difficulties, generally through some combination of bad management and bad luck…. Policymakers in distressed economies know the fund will intervene where no private creditor dares tread and will make loans at rates their countries could only dream of even in the best of times. They understand that, in the short term, IMF loans allow a distressed debtor nation to tighten its belt less than it would have to otherwise. The economic policy conditions that the fund attaches to its loans are in lieu of the stricter discipline that market forces would impose in the IMF's absence…. Nevertheless, the institution provides a convenient whipping boy…. "The IMF forced us to do it!" is the familiar refrain when governments cut spending and subsidies…. At its heart, the austerity critique confuses correlation with causation. Blaming the IMF for the reality that every country must confront its budget constraints is like blaming the fund for gravity. Admittedly, the IMF does insist on being repaid….

A Hazardous Critique: Of course, in so many IMF programs, borrowing countries must pay back their private creditors in addition to repaying the fund. Yet wouldn't fiscal austerity be a bit more palatable if troubled debtor nations could compel foreign private lenders to bear part of the burden? Why should taxpayers in developing countries absorb the entire blow? That is a completely legitimate question…. Private creditors ought to be willing to take large write-downs of their debts in some instances, particularly when a country is so deeply in hock that it is effectively insolvent. In such circumstances, trying to force the debtor to repay in full can often be counterproductive…. [M]any critics reasonably worry that IMF financing often serves as a blanket insurance policy for private lenders….

Fiscal Follies: Even if IMF policies are not to blame for budget cutbacks in poor economies, might the fund's programs still be so poorly designed that their ill-advised conditions more than cancel out any good the international lender's resources could bring? In particular, critics charge that the IMF pushes countries to increase domestic interest rates when cuts would better serve to stimulate the economy…. [I]t would be wonderful if governments in emerging markets could follow Keynesian "countercyclical policies"—that is, if they could stimulate their economies with lower interest rates, new public spending, or tax cuts during a recession…. [T]he IMF, or anyone else for that matter, can only do so much for countries that don't pay attention to the commonsense advice of building up surpluses during boom times—such as Argentina in the 1990s—to leave room for deficits during downturns…. Reagan's tax cuts during the 1980s did not lead to higher tax revenues but instead resulted in massive deficits. By the same token, there is no magic potion for troubled debtor countries. Lenders simply will not buy into this story….

Capital Control Freaks:… Critics such as Columbia University economist Jagdish Bhagwati have suggested that the IMF's zeal in promoting free capital flows around the world inadvertently planted the seeds of the Asian financial crisis…. However one apportions blame for the financial crises of the past two decades, misconceptions regarding the merits and drawbacks of capital-market liberalization abound. First, it is simply wrong to conclude that countries with closed capital markets are better equipped to weather stormy financial markets. Yes, the relatively closed Chinese and Indian economies did not catch the Asian flu, or at least not a particularly bad case. But neither did Australia nor New Zealand, two countries that boast extremely open capital markets. Why? Because the latter countries' highly developed domestic financial markets were extremely well regulated. The biggest danger lurks in the middle, namely for those economies—many of which are in East Asia and Latin America—that combine weak and underdeveloped financial markets with poor regulation…