THE IMF ASSESSED : A GOOD WAR / THE ECONOMIST

The IMF assessed

A good war

Sep 17th 2009 WASHINGTON, DC

From The Economist print edition

The IMF has done well under Dominique Strauss-Kahn, but its future is unclear


DOMINIQUE STRAUSS-KAHN, the ebullient managing director of the International Monetary Fund, likens its role to that of a doctor. As the crisis has spread, the IMF has been called in to cure ailing economies from Ukraine to Pakistan. It is still too early to judge the success of the fund’s prescriptions for troubled countries. But the IMF itself is certainly in far ruder health than it was at the start of the financial crisis.

Just a year ago the fund’s finances were in tatters and its relevance was in doubt. During the early stages of an economic crisis that should have been its natural terrain, Barry Eichengreen, an economic historian at the University of California, Berkeley, wrote: “Global crises used to remind us why we have the IMF. If the fund doesn’t come up with some new ideas for how to handle this one, the crisis may only remind us why we can forget it.”

Part of the IMF’s problem was that its reputation had been severely dented by the experience of rescue operations during the 1997-99 emerging-market crises, when it prescribed notoriously bitter fiscal and monetary pills. As a result its advice lacked legitimacy, particularly in emerging Asia, which saw the fund’s views as geared to its rich-country backers in Europe and America.


Many emerging economies subsequently concentrated on building up enormous foreign-exchange reserves to ensure that they would not have to turn to the fund again (these reserves are held by many to have been an underlying cause of today’s crisis). That in turn meant that the fund had so little income from loans that it could not cover its costs.


Mr Strauss-Kahn himself had a difficult start when he took over as managing director in November 2007. His first big task was a contentious cull of around 15% of the staff. And just as the first group of crisis-hit emerging economies was turning to the IMF, an investigation into an affair between him and a member of staff proved an embarrassing (albeit brief) distraction. Few would have predicted at that point just how adroitly Mr Strauss-Kahn would move the fund back to centre stage.


The biggest sign of his success is a trebling of the IMF’s kitty to $750 billion. Some of the new money has come from familiar sources such as America and Europe. But in a boost to the fund’s legitimacy, the BRIC economies—Brazil, Russia, India and China—have all agreed to contribute to its coffers by subscribing to its first-ever bond issue, to the tune of $80 billion.

Equally important, the fund has been on the cutting edge of the global policy response. As Mr Strauss-Kahn puts it, the fund’s experience of 122 earlier banking crises gives it “unparalleled expertise at the intersection of Main Street and Wall Street”. He was an early, vocal and consistent advocate of co-ordinated global fiscal stimulus, advice that in hindsight seems remarkably prescient. And the IMF’s analytical work—whether in identifying the scale of the losses from the financial meltdown or in predicting the effect of the crisis on public finances—has helped reinforce its intellectual credentials.

The extra cash has allowed the IMF to go into crisis-hit countries with packages that can make a difference. It has also allowed the fund to offer “crisis insurance” in the form of a new pre-emptive lending tool, the Flexible Credit Line (FCL). Mexico, Colombia and Poland have so far used this facility. And it still has more money available to lend than it did before the crisis.


The fund’s standard crisis-mitigation loan packages have become more responsive to conditions in client countries. Mr Strauss-Kahn says that its use of conditions attached to loans has become more focused on “fixing the crisis, not fixing the world”. He points to the removal of conditions related to land reform from the IMF package in Ukraine because, though useful, they were not essential for macroeconomic stabilisation. Insiders also credit Mr Strauss-Kahn with emphasising the need to protect spending on the very poor. His background in politics has made him keenly aware of the need to ensure that economic adjustment can work politically.


Despite having had a good run so far, the IMF’s relevance once the crisis is over is far from assured. For his part, Mr Strauss-Kahn is nothing if not ambitious. He argues that the success of the FCL paves the way for the fund to become a true global lender of last resort, much as John Maynard Keynes originally proposed. For this to work, he believes that the IMF needs more money—perhaps as much as $2 trillion in all—and the trust of its poorer members, so that they rely on the fund’s resources, rather than their own reserves, to insure against crises.


Gaining this trust will require reforms to the fund’s “quotas” to give emerging economies more voting power. One round of changes has already been agreed, though not yet implemented. The G20 countries have asked the IMF to complete its next set of quota reviews by January 2011.


But to satisfy developing countries, rich ones would have to give up more power than they may be prepared to. The finance ministers of the BRIC countries want a shift in voting power toward emerging countries that is considerably bigger than anything proposed so far.


To be useful, the IMF must also be ready to take unpopular positions. Mr Strauss-Kahn quotes Keynes when he promises that the fund’s “ruthless truth-telling” will convince countries of the soundness of its advice. But more representative governance may make such candour more difficult. Some argue that the IMF has retreated from criticism of China’s exchange-rate regime as China has become a bigger backer.

Keynes also envisaged the existence of sanctions for both surplus and deficit countries. But Mr Strauss-Kahn is wary of seeing the IMF as a sort of “policy police with legal instruments to make countries change their policies”. Yet without some power to enforce its writ, the IMF is likely to be ignored, much as its advice on global imbalances was before the crisis. Like any good medic, the fund must find a way to strike a balance between being firm and being friendly.



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