‘Too slow for too long’. This is the title of the just-released IMF World Economic Outlook. Global growth has been stuck in a rut, running between 3% and 3.5% for the past four years, and the forecast numbers are not much stronger. Policy-makers have become inured to this persistently feeble performance, with policy unresponsive to the pleas from the Fund (and a growing chorus of others) for policy action.
With its Plan A message (growth-enhancing policies) falling on deaf ears, the Fund has been exploring the adequacy of the existing Plan B — the global financial safety net, aimed at preventing a domestic crisis from becoming global. The Fund points to the greater complexity and interconnectedness of global finance now, compared with 2008. The Fund sees an important role for itself in this Plan B, but the starting point in thinking about this issue is to ask: ‘what role did the IMF play during the 2008 crisis — not just the worst recession since 1930, but also the most globally interconnected?’
Foreseeing impending problems is the best way to avert them, however we shouldn't judge the Fund too harshly for its failure to see the 2008 crisis coming. Hardly anyone else did either, although the Bank for International Settlements staff did better, muffled and censored though they were by the Bank's major shareholders, particularly the US. The Fund’s monitoring, through the resource-intensive annual Article IV reports on every member country and the Financial Sector Action Plans, gave no operational forewarning of the problems to come.
Once the 2008 crisis began to unfold, the core issues reflected domestic failings, with ineffectual national prudential supervision at the epicentre. The main failings were in countries which had the capacity to handle their own problems (the US, the European Union, Switzerland and the UK), with national central banks and treasuries shoring up failing financial institutions.
Certainly, there was global contagion that affected ‘innocent bystanders’, such as South Korea and Indonesia. But the IMF was more or less irrelevant in the first phase (2008-2010), with tiny Iceland, among the affected countries, the only one to call on Fund assistance.
The key cross-border action was the US Fed’s provision of swap arrangements (i.e loans between central banks) to a range of countries in need of dollar-denominated liquidity. The 2009 G20 meeting in London provided the only example of international policy coordination, when it orchestrated what most countries were going to do anyway; provide fiscal stimulus.
The second stage of the GFC began in 2010, affecting the European periphery, where Greece, Spain, Portugal and Ireland all ran into trouble. Among these, the only one involving an IMF program was Greece, and a strong case can be made that the IMF should have left this to the Europeans to sort out. The IMF was involved because the then-managing director Dominique Strauss-Kahn saw political advantage for himself and the institution, and the Germans were glad to have someone else to share the rescue costs and the unenviable task of trying to put some discipline into Greek finances.
The Fund approved 27 assistance programs in the crisis period, but only Greece and Iceland had any close connection with the global crisis. There were large programs with Ukraine, Hungary and Romania, but economic contagion was not the main issue (although political contagion might have been a central motivation).
So much for the past. Will there be a greater role for the IMF next time?
It’s true that the current Plan B is not in great shape, although the Fund itself is much better prepared. Countries’ first line of defence is their own foreign exchange reserves, which are a costly and inefficient form of insurance: as was demonstrated in 2008, a modest fall in reserve levels is taken by financial markets as a signal to panic. The various regional arrangements (such as the Chiang Mai Initiative Multilateral) have yet to be used and there is no formal coordination mechanism between them and the Fund. Many of the regional swap deals would not be much use in time of trouble.
The big change, however, is that the relevant part of Plan A (preventative measures in the financial sector) is in much better shape. For a start, the memories of 2008 are fresh, and awareness is a powerful antidote. The G20’s Financial Stability Board (successor to the BIS’ Financial Stability Forum) has had principal carriage of reinforcing the prudential framework. The national prudential supervisors are far better prepared than in 2008 and the domestic Plan Bs are much more fully developed.
This is important when thinking about the nature of any future financial crisis, and the need for a global ‘Plan B’ to contain the fallout. Europe might yet experience something that looks a bit like the 2010 crisis in the peripheral countries, if Italian banks fail. But this should be for the EU and the European Central Bank to sort out. Let’s hope the IMF has learned the lesson of Greece, and stays on the sidelines.
Elsewhere, the problems are much more likely to be the standard problem the Fund has dealt with since its creation: an individual country which gets into trouble through poor policies or bad luck (usually the former), whose problems are idiosyncratic and not very contagious. Brazil comes to mind, but there are others as well. The Fund’s resources have been substantially augmented since 2008 to handle these situations.
What about the Big One: if China has a financial crisis? This would certainly have repercussions for the rest of the world (including Australia) but it is hard to see much of an expanded role for the Fund. It seems extremely unlikely that China would ask for a Fund program to handle something which it has the resources and ‘fiscal space’ to look after itself. There might be ‘innocent bystanders’ dependent on China trade (Africa is probably more vulnerable than our region), but these are small-scale problems which the Fund’s existing programs seem well placed to handle, with not much likelihood of the sort of global contagion demonstrated in 2008.
It’s good that the Fund is ‘thinking the unthinkable’ and exploring all the things that might go wrong in its sphere. But having done that, there doesn’t seem much of a case for any empire-building in Washington.
Photo courtesy of Flickr user Graeme Maclean