[Pen-l] (Fwd) IMF not yet post-Wash.Con., says CEPR

[Patrick Bond <pbond@xxxxxxxxxxx>]

(For ease of internet distribution, I have stripped out footnotes and 
tables, which are in the original: http://www.cepr.net ... apologies to 
authors but it makes it easier to read/circulate.)

Empowering the IMF: Should Reform be a Requirement for Increasing the 
Fund’s Resources?

Mark Weisbrot, Jose Cordero and Luis Sandoval
April 2009
Center for Economic and Policy Research

About the Authors
Mark Weisbrot is co-Director, Jose Cordero is a Senior Economist and 
Luis Sandoval is a Research Assistant at the Center for Economic and 
Policy Research in Washington, DC.


Executive Summary

This paper briefly reviews the IMF’s current practices and policy-making 
in the context of a proposed quadrupling of IMF resources to $1 trillion 
dollars, and a consequent increase in the Fund’s influence over economic 
policy-making in developing countries.

In the last major set of economic crises of the 1990s, the Fund made 
serious mistakes that adversely affected the economies of Argentina, 
Indonesia, South Korea, Thailand, Russia, Brazil, and other countries. 
At the time, these mistakes drew widespread criticism, including from 
prominent economists such as Nobel Laureate Joseph Stiglitz and Columbia 
University’s Jeffrey Sachs.

In those crises the Fund failed to act as a lender of last resort, when 
it was most urgently needed in Asia, as countries such as South Korea, 
Indonesia, Thailand, the Philippines, and Malaysia fell victim to a 
severe shortage of foreign exchange. It then imposed procyclical 
policies and in some cases, such as South Korea, set unrealistic 
inflation targets that would be impossible to achieve, given the 
currency depreciation, without a severe economic contraction. The IMF’s 
own Independent Evaluation Office later conceded that “[I]n Indonesia… 
the depth of the collapse makes it difficult to argue that things would 
have been worse without the IMF…” 1

In Argentina, the Fund lent tens of billions of dollars to support an 
overvalued exchange rate that inevitably collapsed, while attempting to 
adjust the economy to this unsustainable exchange rate through 
contractionary macroeconomic policies. When the inevitable sovereign 
debt default and exchange rate collapse occurred at the end of 2001, the 
Fund again failed to act as a lender of last resort. Instead, it 
(together with the World Bank) drained a net 4 percent of GDP out of the 
country in 2002, while pressuring Argentina to pay more to its foreign 
creditors, and opposing some of the most important economic policies 
that facilitated Argentina’s recovery and ensuing six-years of rapid 
economic growth.

This paper finds that the IMF is still prescribing inappropriate 
policies that could unnecessarily exacerbate economic downturns in a 
number of countries. In El Salvador, for example, the country has signed 
an agreement that precludes the use of expansionary fiscal policy. This 
is especially problematic because the country cannot use exchange rate 
policy and is very limited in monetary policy since it has adopted the 
dollar as its currency. The IMF agreement thus cuts off practically the 
only policy tool for a country that is heavily dependent on a 
contracting U.S. economy – El Salvador gets remittances amounting to 18 
percent of GDP from the United States and exports about 9.6 percent of 
GDP there.

In Pakistan, the IMF agreement signed last December provides for 
tightening both fiscal and monetary policy, including a sharp reduction 
in the fiscal deficit from 7.4 percent of GDP last year to 4.2 percent 
of GDP for the current fiscal year. It is questionable whether such 
policies are necessary, especially given that the country’s current 
account deficit has largely disappeared, and inflation has fallen 
considerably since last October. Furthermore, the country is facing a 
number of external shocks, including declining exports and capital inflows.

The Fund has also prescribed fiscal tightening for Ukraine, where GDP is 
now projected to decline by 9 percent in 2009. The IMF Standby 
Arrangement approved in October 2008 provided for a zero fiscal balance. 
At the time, the country was undergoing a number of severe negative 
external shocks: the price of Ukraine’s steel exports, which amount to 
15 percent of GDP, had fallen by 65 percent; Russia had decided to phase 
out natural gas subsidies, implying a price increase of up to 80 percent 
in gas imports, which amounts to 6 percent of GDP; and a slowdown in 
capital inflows due to the international financial crisis. It was also 
suffering from liquidity strains and falling confidence in the banking 
system. Given these conditions, and the fact that Ukraine’s gross public 
debt is a very low 10.6 percent of GDP, the agreed upon fiscal 
tightening would appear to be inappropriate.

Hungary, Georgia, Latvia, Serbia, and Belarus all have signed IMF 
agreements that provide for fiscal tightening that could unnecessarily 
exacerbate these countries’ economic downturns.

The Fund may also have contributed to the vulnerability of countries in 
the current crisis, as it did in the run-up to the Asian crisis a decade 
ago. For example, the Fund has supported the liberalization of capital 
flows, as well as inflation targeting. Central banks that have targeted 
a specific inflation rate tend to let the currency appreciate, which 
encourages the private sector to borrow in foreign currency. This 
foreign borrowing has made many countries more vulnerable to the current 
crisis, because households and firms are hit especially hard when the 
currency depreciates. This also limits the ability of countries to 
ameliorate the crisis by allowing the currency to depreciate. The IMF 
has also generally opposed capital controls, which can help governments 
stem the loss of reserves, currency crashes, and other problems 
associated with large capital outflows. This cuts off an important 
policy tool and makes governments more dependent on tightening fiscal 
and monetary policy to resolve balance of payments difficulties.

The main purpose of having international institutions to provide hard 
currency lending, especially in a time of world recession, is to allow 
countries that would otherwise be prevented by balance of payments 
problems from pursuing expansionary (counter-cyclical) policies to do 
so. China, for example, is able to implement one of the largest stimulus 
packages in the world because it has $1.95 trillion in reserves. The 
resources of the IMF should be used to allow and encourage 
counter-cyclical policies wherever possible, not procyclical policies.

The IMF’s current lending practices have implications for the immediate 
future of the affected countries, because procyclical policies can 
exacerbate the world economic downturn. But more importantly, the 
proposed quadrupling of IMF resources will have implications for many 
years to come, even after the world economy recovers. Although the new 
resources are unlikely to reverse the trend of governments avoiding, 
whenever possible, the Fund’s lending and influence, they will help to 
re-establish an unreformed IMF as a major power in economic and 
decision-making in low-and-middle income countries, with little or no 
voice for these countries in the IMF’s decision-making. This could have 
long-term implications for growth, development, and social indicators in 
many countries.

Governments that are contributing to this increase in funding should 
think carefully about these implications and the possibilities of making 
such increases contingent on serious reforms of the IMF – especially in 
the areas of governance and accountability.


Introduction

At the last meeting of the G-20 in London on April 2, 2009, an agreement 
was reached to increase the resources of the International Monetary Fund 
by up to $750 billion (USD), for a total that could reach $1 trillion.

Much of the increase in funding for the IMF still has to be approved by 
the governments of the contributing countries.

The assumption was that the increase in resources for the Fund would 
allow it to help low- and middle-income countries that face severe 
problems during the current economic crisis. Certainly there are many 
such countries that are in need of assistance as the world recession 
continues to deepen. However, this was also true during the last major 
economic crisis of 1997-1999, which began in Asia and spread to Russia, 
Brazil, Argentina, and numerous other countries.

During that time and for some years afterwards, the IMF was widely 
criticized for having prescribed inappropriate and even procyclical 
macroeconomic policies that worsened the economic situation in countries 
that borrowed from the Fund. Among the critics were prominent 
economists. Jeffrey Sachs, currently Director of the Earth Institute at 
Columbia University, called the IMF “the Typhoid Mary of emerging 
markets, spreading recessions in country after country.”2 Nobel Laureate 
economist Joseph Stiglitz, who was then Chief Economist at the World 
Bank, also criticized the Fund for its mishandling of the Asian crisis, 
and went on to write systematic critiques of a number of IMF policies: 
for an unrealistic “market fundamentalism,” for maintaining overvalued 
exchange rates for the benefit of foreign investors, for “pursuing 
policies that are in the interests of creditors,” and other errors of 
analysis and judgment.3

Such errors were clear in the Fund’s handling of the crises of the 
1990s. 4 The Fund failed to act as a lender of last resort, when it was 
most urgently needed in Asia, as countries such as South Korea, 
Indonesia, Thailand, the Philippines, and Malaysia fell victim to a 
severe shortage of foreign exchange. It then imposed procyclical 
policies and in some cases, such as South Korea, set unrealistic 
inflation targets that would be impossible to achieve, given the 
currency depreciation, without a severe economic contraction. In 
Indonesia the IMF also failed to arrange a rollover of the short-term 
foreign debt owed by Indonesian non-financial firms. Indonesia was thus 
unable to stabilize its currency and economy, and firms could not obtain 
the necessary credits for essential imports and even exports. The IMF’s 
own Independent Evaluation Office later conceded that “[I]n Indonesia… 
the depth of the collapse makes it difficult to argue that things would 
have been worse without the IMF…”5

In Argentina, the Fund lent tens of billions of dollars to support an 
overvalued exchange rate that inevitably collapsed, while attempting to 
adjust the economy to this unsustainable exchange rate through 
contractionary macroeconomic policies. When the inevitable sovereign 
debt default and exchange rate collapse occurred at the end of 2001, the 
Fund again failed to act as a lender of last resort. Instead, it 
(together with the World Bank) drained a net 4 percent of GDP out of the 
country in 2002, while pressuring Argentina to pay more to its foreign 
creditors, and opposing some of the most important economic policies 
that facilitated Argentina’s recovery and ensuing six-years of rapid 
economic growth.6

Partly as a result of these experiences, many middle-income countries 
“self-insured” and piled up reserves that would enable them to avoid any 
need to borrow from the IMF. From 2003-2007, the Fund’s loan portfolio 
practically disappeared, shrinking from $105 billion to less than $10 
billion. Just two countries, Turkey and Pakistan, owed most of the $10 
billion. This collapse in lending was partly due to the relative growth 
and stability in the world economy during this period, and the lack of 
major financial crises – as the Fund has argued. But there is no doubt 
that it is also due to the fact that governments actively sought to 
avoid the IMF’s influence, in some cases even paying off large amounts 
of outstanding debt (Brazil $15 billion, Argentina $9.8 billion)7 in 
order to clear their books with the IMF entirely.

The IMF has occasionally, although very rarely, acknowledged having made 
policy mistakes.

In April 2007 the IMF's Independent Evaluation Office released a report 
that examined the experience of 29 Sub-Saharan African countries that 
underwent Poverty Reduction and Growth Facility (PRGF) programs, and 
were therefore subject to IMF conditions, from 1999-2005. The report was 
highly critical of the IMF's role, and among other findings noted that 
nearly three-quarters of the aid money reaching these countries was not 
spent. Rather, at the IMF's urging, this money was used to pay off debt 
and to add to reserves.8

But the Fund has not taken any institutional measures to hold anyone 
accountable for results that were in some cases economically disastrous 
-- e.g. Russia, Argentina, and Indonesia. As Stiglitz has noted: “It has 
never asked why the mistakes had occurred, what was wrong with the 
models, or what could be done to prevent a recurrence . . .”9

The Fund has made some changes with regard to some of the conditions 
attached to its lending. In response to the criticisms of the Meltzer 
Commission, established by the U.S. Congress to examine the lending of 
the IMF and World Bank in the wake of the late 90s failures, the IMF 
reduced the number of structural conditions attached to its lending. 
(These are conditions such as privatizations, pension or labor market 
reforms that were often unpopular because of their adverse impacts on 
lower and middle-income wage earners).

The Fund has recently committed to eliminating “structural performance 
criteria” in future loans starting on May 1. However IMF statements made 
it clear that this does not mean that the Fund will stop negotiating 
structural reforms in its agreements.

In October 2008, the IMF announced a new lending option, the Short-Term 
Liquidity Facility (SLF) that would not carry any conditions for the 
borrowing country. While there were no conditions attached to this type 
of loan, the IMF did require pre-conditions. Eligible countries had to 
have “track records of sound policies, access to capital markets and 
sustainable debt burdens”.10 On the policy side, eligible countries were 
expected to have strong fiscal positions, low and stable inflation, 
sustainable current account balances and a strong international reserves 
position. But there were no takers for these loans.

The Fund then introduced another facility in March, the Flexible Credit 
Line (FCL), similar to the SLF but with longer repayment terms and the 
ability to tap the funding as needed.

But the institution has not been reformed, and the question remains 
whether it can be expected, in this current crisis, to pursue 
appropriate macroeconomic policies in its lending; or whether it is 
necessary to insist upon reforms as a condition of any new infusion of 
funds. This paper will examine this question in light of the Fund’s 
recent activities and in the context of the global economic recession.


Balance of Payments Support During a Recession

It is important to recognize that the main purpose of providing balance 
of payments support to a developing country in a time of recession or 
approaching recession is to enable the government to pursue the 
expansionary fiscal and monetary policies necessary to stabilize the 
economy. The United States, for example, is countering the current 
recession with policy interest rates lowered to zero, quantitative 
easing (including the financing of some $1.7 trillion of debt through 
the creation of money), and an expansionary fiscal policy involving a 
proposed budget deficit of 13.1 percent of GDP for 200911 – more than 
double the size of any deficit in the post-World-War II era.

The main reason that many low- and middle-income countries cannot pursue 
similar policies is that they can run into balance of payments 
difficulties and foreign exchange constraints. To illustrate by 
counter-example, China has accumulated $1.9 trillion in foreign exchange 
reserves. As a result, it is in a situation that is similar to that of 
the United States, in that it can spend as much as it chooses in order 
to stimulate the economy, and also pursue an expansionary monetary 
policy, without worrying about foreign exchange constraints.

A country that is running a current account deficit and – due to the 
crisis – is no longer receiving enough foreign capital inflows in order 
to finance such a deficit, is in a very different situation.

Any increase in growth relative to the baseline will tend to worsen a 
country’s balance of trade and therefore current account balance. This 
is because imports will tend to grow faster than exports. Also, if 
investors see fiscal or monetary policies that they think will lower the 
value of the domestic currency, this may promote further capital flight, 
which worsens the balance of payments problem. Also, if the domestic 
currency drops precipitously, this can cause balance sheet problems in 
countries where the private or public sector has borrowed heavily in 
foreign currency.

Thus, the purpose of providing balance of payments support, as is done 
through an institution such as the IMF, is preferably to allow the 
country to continue growing while gradually reducing its current account 
deficit to a sustainable level. Indeed, at a time like this, when the 
world economy is actually projected to shrink by 2.75 percent, for the 
first time in 60 years, a strong argument could be made that balance of 
payments support should be provided without any procyclical policy 
changes for at least the next two years. In other words, we would not 
expect interest rate hikes, monetary tightening, spending cuts or tax 
increases during this time.

Of course, a country can reduce its current account deficit by reducing 
its growth and therefore reducing imports. A severe recession can 
improve the trade balance rather quickly, as happened in Argentina from 
1998-2002. A country can also sometimes attract more foreign capital 
through higher interest rates, which also slows the economy. But these 
measures should be avoided in a time of national and world recession. 
The main purpose of providing hard currency to countries in a time of 
falling aggregate demand should be to enable them to pursue expansionary 
rather than procyclical policies.

There may be an argument that in some cases, a country is on a path that 
is so wildly unsustainable – either in its balance of payments or its 
public borrowing – that adjustment must begin immediately, even in the 
midst of a steep downturn. But even in such a case the purpose of 
external assistance should be to ease the adjustment process.


Procyclical Macroeconomic Policies

In recent months, the IMF has repeatedly emphasized the need for 
counter-cyclical macroeconomic policies in order to prevent the world 
recession from deepening and to speed recovery. A recent IMF staff paper 
reads: “The International Monetary Fund has called for fiscal stimulus 
in as many countries as possible, including emerging market and advanced 
economies.”12 However, IMF Managing Director Dominique Strauss-Kahn has 
also stated: “Of course, not every country can undertake fiscal stimulus 
. . . Some will need to contract their budgets rather than expand them.”13

If we look at the agreements that the IMF has negotiated since September 
of last year, we find that all of them contain procyclical policies.14 
For example, they all require countries to reduce their fiscal deficit, 
mostly through spending cuts. It is questionable in most or possibly all 
of these cases whether this is the appropriate policy in the face of 
serious contractions in private spending.

In one agreement - El Salvador’s January 2009 Standby Arrangement - 
there is hardly any fiscal tightening. The target for the fiscal deficit 
is 2.8 percent for 2009, as compared with a 2.9 percent projected 
deficit for 2008. However, this is much worse than it seems. In 2001, El 
Salvador adopted the U.S. dollar as its national currency. It therefore 
cannot use exchange rate policy –i.e. depreciation – to stimulate its 
economy. On the contrary, the rush to the relative safety of the U.S. 
government-guaranteed financial system and the U.S. dollar over the last 
12 months has caused the dollar to appreciate substantially against 
other currencies. The use of the U.S. dollar also eliminates most 
options with regard to counter-cyclical monetary policy.

El Salvador receives remittances of about 18 percent of GDP from the 
United States. The rate of growth of these remittances began to fall in 
2006. Since October, the monthly year-over-year growth in remittances 
has been continuously negative (See Table 1). It is worth noting that 
the 6.7 percent drop in remittances in the month of March amounts to a 
sizeable drop in income for the country, relative to a year ago, about 
1.2 per cent of GDP.

El Salvador also exports about 9.6 percent of GDP to the United States. 
The IMF also forecasts a sharp drop in foreign capital inflows, from 3.3 
percent of GDP for 2008 to just 0.3 percent for this year. The most 
recent available figures from El Salvador’s Central Bank show that 
economic activity decelerated in the last quarter of 2008 (see Table 2). 
Given El Salvador’s large dependency on U.S. remittances and trade, 
further substantial shocks are likely as the U.S. recession continues 
throughout this year and possibly into the next year.

By restricting El Salvador from further government spending, the IMF 
Standby Arrangement is preventing the government from using practically 
its only remaining policy tool to counteract severe external shocks to 
its economy. This could worsen the country’s downturn significantly 
beyond what it would be if expansionary fiscal policy were allowed.

The other countries that have signed IMF agreements during the last 
seven months have mostly agreed to much more fiscal tightening. For 
example, Pakistan’s Standby Arrangement of October 2008 provides for a 
reduction of the fiscal deficit from 7.4 percent of GDP last year to 4.2 
percent of GDP for the current fiscal year. (The fiscal year begins in 
July). While this might be a desirable goal, it is questionable whether 
this reduction should all be done this year, when the economy is 
suffering from a number of external shocks that are reducing private demand.

Should Reform be a Requirement for Increasing the Fund’s Resources? • 13

Pakistan’s exports for the first quarter of this year (January-March) 
are down 16.8% per cent from the previous year, due to falling demand 
among Pakistan’s main trading partners.

Foreign portfolio investment has collapsed over the last two years, from 
$3.3 billion in FY 2007 to negative $53 million and negative $957 
million for the July-March period of the last two fiscal years, 
respectively. (IMF p. 33; State Bank of Pakistan).

Pakistan also depends significantly on remittances from workers abroad, 
for example in the Gulf Cooperation Council (GCC) states. In 2007/2008 
these remittances were 4 percent of GDP. These remittances have held up 
so far (through February), but they can be expected to decline, as 
remittances worldwide are falling.

At the time this agreement was signed, there was every reason to believe 
that these negative demand shocks would get worse. To commit to a 
deficit reduction of this magnitude in the face of such conditions seems 
inappropriate.

The Standby Arrangement also states as one of its key elements that 
“Monetary policy will be tightened… The State Bank of Pakistan (SBP) 
recently increased its discount rate by 200 basis points to 15 percent 
and stands ready to further tighten monetary conditions, as needed . . 
.” (p. 6) This will also tend to slow growth.

Are these measures necessary? One argument on the IMF side would be that 
the contractionary fiscal policy is necessary to bring down the current 
account deficit, which shot up to 8.4 percent of GDP in FY 2008. 
However, in the current fiscal year (since July 2008), this deficit has 
already disappeared (see Table 3). A large part of the prior increase in 
the current account deficit, probably about a third, was due to oil 
prices, which peaked in July of 2008; the collapse of oil prices since 
then eliminated a big part of the current account deficit. A large 
reduction in other imports – which so far have declined much faster than 
exports – got rid of most of the rest of the deficit.

Thus, although the current account deficit was sizeable at the time of 
this agreement, it appears to have been rapidly reducible. Also, in May 
of 2008, because of balance of payments problems, the government of 
Pakistan adopted a number of foreign exchange and import measures, which 
probably contributed to the elimination of the current account deficit, 
including the reduction on the import side.15

It is worth noting that this agreement provides for Pakistan to get rid 
of one of the recently proposed exchange controls: the limit of 25% 
percent for advance payments on imports. This raises another question 
about IMF policy choices in this agreement, as well as a more general 
problem with the Fund’s policy choices. The IMF has had a long-standing 
opposition to capital controls. In the case of Pakistan’s current 
account deficit, it might make sense to rely more on foreign exchange 
controls to reduce the current account deficit, rather than reducing 
imports by bringing down aggregate demand and therefore output and 
employment. But the Fund appears to favor the latter option. The 
tightening of monetary policy is also relevant here: according to the 
Fund, this is necessary partly to restore investor confidence and reduce 
capital flight. But capital controls could also contribute to a solution 
to this problem. Thus, the Fund’s preferences may cause it to reject 
viable options that would allow for higher growth, more employment, and 
lower poverty rates.

The other rationale for tightening fiscal and monetary policy in 
Pakistan, despite an economic slowdown, is to reduce inflation. Consumer 
price inflation averaged 7.8 percent for the 2007 fiscal year but shot 
up to an annual rate of 25 percent in October 2008, with core inflation 
at 18 percent. The idea is that this inflation posed a serious enough 
threat to justify the contractionary policies even in the face of 
falling aggregate demand. But here, too, the IMF’s fears may have been 
exaggerated. Table 4 shows annual, monthly, and year-over-year consumer 
price inflation in Pakistan. As can be seen from the year-over-year 
figures, inflation has fallen from 25.3 percent in August to 19.1 
percent in March. It is possible that measures taken in accordance with 
the IMF agreement since October contributed to the fall in inflation, 
but it is more likely that the collapse of commodity prices, as well as 
deflationary pressures both domestically and worldwide contributed to 
the decline. This indicates that the Fund was too willing to sacrifice 
output and employment in order to bring down inflation.

In a measure which has not been common in IMF Standby Arrangements, the 
agreement provides for an increase in spending on the social safety net, 
in recognition that the contractionary macroeconomic policies in the 
agreement could have adverse impacts on the poor. However, the amount of 
spending committed is very small – just 0.3 percent of GDP. It is not 
clear that this would keep poverty from rising, given the pressures on 
employment and output that follow from the agreed-upon macroeconomic 
policies, as well as the cuts in energy subsidies that are included in 
the agreement.

The Fund has also prescribed fiscal tightening for Ukraine, where GDP is 
now projected to decline by 9 percent in 2009. The IMF Standby 
Arrangement approved in October 2008 provided for a zero fiscal balance. 
At the time, the country was undergoing a number of severe negative 
external shocks: the price of the Ukraine’s steel exports, which amount 
to 15 percent of GDP, had fallen by 65 percent; Russia had decided to 
phase out natural gas subsidies, implying a price increase of up to 80 
percent in gas imports, which amounts to 6 percent of GDP; and a 
slowdown in capital inflows due to the international financial crisis. 
It was also suffering from liquidity strains and falling confidence in 
the banking system. Given these conditions, and the fact that Ukraine’s 
gross public debt is a very low 10.6 percent of GDP, the agreed upon 
fiscal tightening would appear to be inappropriate.

The IMF’s fiscal target of a balanced budget proved to be politically 
unrealistic in Ukraine. In early 2009, the IMF suspended the second 
disbursement of the loan after failing to reach an agreement with the 
Ukrainian authorities over a budget deficit. Most recently, on April 17, 
an agreement was reached on a deficit of 4 percent of GDP. But it is 
important to emphasize that this revision was made only after a struggle 
with the Fund and the refusal of Ukraine's parliament to accept Fund 
conditions (they were approved unilaterally by the executive).16 The IMF 
Standby Arrangement for Ukraine also prescribes monetary tightening, and 
that foreign exchange controls be eliminated as soon as possible. These 
latter policies are also questionable in Ukraine’s situation. There has 
been considerable pressure on the domestic currency, which had 
depreciated by about 25 percent in the months before the agreement. This 
causes special problems for Ukraine because of a high level of private 
borrowing in foreign currency. At the same time, Ukraine was running a 
current account deficit of 6.2 percent of GDP and depleting reserves 
trying to defend the currency. In this situation, foreign exchange 
controls may be a more sensible means of ameliorating the current 
account and balance of payments problems, rather than relying solely on 
fiscal and monetary tightening, which exacerbate the recession.

Hungary, Georgia, Latvia, Serbia, and Belarus all have signed IMF 
agreements that provide for fiscal tightening that could unnecessarily 
exacerbate these countries’ economic downturns.17


Macroeconomic Policy Traps

One of the criticisms of the IMF during the Asian crisis was that it not 
only mishandled the crisis but that it also - together with its main 
overseer, the U.S. Treasury - played a major role in causing the crisis 
by supporting a number of deregulatory measures that removed 
restrictions on capital flows and encouraged foreign borrowing.19 
Similar policies, as well as others supported by the Fund, may have 
contributed to the vulnerabilities of emerging market and developing 
countries in the current crisis.

For example, among the countries with recent IMF agreements Iceland, 
Latvia, and Hungary face one common difficulty: their private sector’s 
foreign debt is huge. This means that they are especially vulnerable to 
currency depreciation, because it causes both households and firms to 
face a serious deterioration of their balance sheets. This limits or 
precludes the use of currency depreciation as an adjustment to external 
shocks and fall-off in demand.

Iceland and Hungary have had inflation targeting regimes since 2001. 
Ukraine did not adopt inflation targeting, but has committed, in a 
letter of intent to the IMF, to gradually move their monetary regime to 
one based on inflation targeting and flexible exchange rates. Latvia 
operates under a quasi-currency board system that has emphasized the 
maintenance of the currency peg; the system has been in operation for 
the last 15 years, and is seen as an important instrument to eventually 
enter the Euro zone.

But inflation-targeting regimes (and also currency boards) are designed 
to turn the fight against inflation into the overwhelming priority of 
the monetary authorities. Under inflation-targeting regimes, central 
banks raise interest rates to target a specific rate of inflation; but 
in so doing, they also attract capital inflows which tend to cause an 
appreciation of the currency. The latter encourages the accumulation of 
foreign debt in the private sector. Under a currency board, on the other 
hand, capital inflows do not appreciate the currency (relative to the 
one it has been pegged to), but can promote the acquisition of foreign 
debt by convincing the private sector that the exchange rate will not 
depreciate.

Inflation targeting has been in use in a number of high-income countries 
for some years, and the IMF has recommended it in some developing 
countries including most recently, Ukraine, Armenia, and Serbia.20 Also, 
due to their success in containing inflation pressures, the IMF has 
sometimes been supportive of pegged rates (as in the convertability 
system that operated for nearly a decade in Argentina –until it 
collapsed-, and as in the one that is in operation in Latvia), and 
similar or related dollarization systems (like the ones in Ecuador and 
more recently in El Salvador).21 But as seen above, these systems can 
promote a systemic vulnerability which can become critical when 
economies face terms of trade shocks, international credit crunches, or 
declines in demand for their exports.

These regimes can therefore help create the vulnerabilities that make 
economies fragile, and also constrain the set of instruments that could 
be utilized in the event of a crisis or a sudden reversal of capital flows.


The Question of Governance

The IMF’s governance structure is much more reflective of the world of 
1944, when it was established, than of the world today. The United 
States has 16.5 percent of voting shares, which gives it a veto over 
some issues; but more importantly, the U.S., Europe, and Japan together 
have a solid majority of 55.6 percent of the votes. Europe and Japan 
have almost never voted against the United States in 65 years of the 
IMF’s existence. Thus, the rich countries effectively run the 
organization, with the U.S. Treasury as the mostly unchallenged leader 
(despite the fact that the managing director of the IMF is by tradition 
a European). Low and middle-income countries have almost no significant 
voice.

A number of governments have raised objections to giving more money to 
the IMF without a change in its governance structure to assure some 
significant representation to countries other than the handful of 
governments currently in control. At the G-20 meeting in London on April 
2, the G-20 communiqué included a statement that was interpreted as 
saying that the head of the IMF will no longer have to be a European. 
However, without a change in the voting structure, it is not clear that 
this symbolic change will give developing countries any more voice or 
lead to any significant reforms or accountability at the Fund.


Accountability and Reform

Aside from the concentration of power in the hands of a few governments, 
with the decades-long tradition of the U.S. predominating among these, 
there is the problem of lack of accountability. As noted above, it is 
difficult to find evidence that Fund officials have been held 
accountable for the major mistakes that were made in the IMF’s handling 
of previous crises, especially in the late 1990s. Part of the reason is 
undoubtedly that the governments who control the Fund do not have any 
compelling incentive to hold the Fund accountable for mistakes that 
negatively impact other, less well-off countries. In fact, the 
incentives are in the opposite direction: to do so could call attention 
to mismanagement of the Fund, with the risk that culpability could 
eventually be laid at the doorstep of the G-7 governments that are the 
decision-makers.

The Fund’s procedures also make accountability very difficult. Policy is 
formulated in a way in which it is not clear who is responsible when 
things go wrong. One way to change this would be to require the IMF, in 
its loan agreements, to provide baseline projections for what the path 
of the economy would be in the absence of the agreed-upon policy 
changes. The Fund would also have to provide projections for the same 
variables – e.g. GDP growth, unemployment, inflation – if the 
recommended policies were adopted. These are procedures that are 
followed by the bipartisan Congressional Budget Office in the United 
States. With these projections, there would be something that the 
results of the IMF program could be measured against for evaluation. Of 
course, results will differ from the projections because of unforeseen 
events; but we would not expect the actual results to be consistently 
worse than the projections. If they are, then something might be wrong 
with the policies.22

The use of baseline and program-contingent projections would also allow 
the borrowing government and the public to see what sacrifices they 
might be asked to make and for what expected gains. If the program 
promises a short-term loss of 0.3 percent of GDP for a 2 percentage 
point gain next year and the following year, that might be considered 
worth the sacrifice. But an initial loss of 3 percent of GDP, with 
consequent increases in unemployment and poverty, might be considered 
too much for the same promised gains. The procedures currently in place 
do not allow for this kind of discussion or evaluation.

The use of baseline and program-contingent projections by the IMF would 
also allow governments to evaluate the track record of specific 
economists or teams of economists.

For the present, in the context of a world recession and the IMF’s 
agreements that include procyclical policies, a more immediate reform 
may be in order. The Fund should be prohibited from attaching

postponed or adopted more gradually without irreparable harm to the 
borrowing country’s economy.

It will be difficult to guarantee that even these reforms would prevent 
the Fund from imposing inappropriate macroeconomic policies, in the 
absence of more thorough governance reforms. However, they would at 
least provide a basis for future evaluation and efforts to promote 
accountability and reform.

Finally, and perhaps most importantly in the present situation, the 
agreements signed since last year should be re-opened for revision. They 
were negotiated when the IMF had very little in the way of resources. If 
the Fund’s resources are to be greatly expanded, at the very least it 
can afford to supply more foreign exchange to ease the adjustment 
process, and allow it to take place more gradually and with a minimum of 
lost output during the current world recession.


Conclusion

This brief review of current practices and decision-making embodied in 
recent IMF agreements finds that the Fund’s current policy decisions and 
orientation remain similar to those of the 1990s, when the Fund’s 
mistakes had a serious negative impact on a number of developing 
economies. Neither the IMF nor its principal overseer, the U.S. Treasury 
Department, have acknowledged past mistakes or agreed to reforms that 
would prevent a recurrence.

This has implications for the immediate future of the affected 
countries, because procyclical policies can exacerbate the world 
economic downturn. But more importantly, the proposed quadrupling of IMF 
resources will have implications for many years to come, even after the 
world economy recovers. Although the new resources are unlikely to 
reverse the trend of governments avoiding, whenever possible, the Fund’s 
lending and influence, they will help to re-establish an unreformed IMF 
as a major power in economic and decision-making in low-and-middle 
income countries, with little or no voice for these countries in the 
IMF’s decisions. This could have long-term implications for growth, 
development, and social indicators in many countries. Governments that 
are contributing to this increase in funding should think carefully 
about these implications and the possibilities of making such increases 
contingent on serious reforms of the IMF – especially in the areas of 
governance and accountability.

_______________________________________________
pen-l mailing list
pen-l@xxxxxxxxxxxxxxxxxx
https://lists.csuchico.edu/mailman/listinfo/pen-l