NEW YORK – Before the crisis of 2008, the International Monetary Fund was in decline. Demand for loans was low, leaving it short of revenue. Asia remained leery of the Fund a full ten years after the currency crises of the late 1990’s. Its analytical talents remained high but downsizing placed them at risk.
The crisis changed all that. It became clear that the IMF has a crucial role to play in dealing with crisis-induced instability. Moreover, because of the Fund’s broad and deeply embedded multinational expertise, its activities are central to achieving globally cooperative solutions to economic and financial problems. Without such solutions, the system will tend to become periodically unstable, and to go off on unsustainable paths that end destructively. We have just lived through one of these episodes.
The IMF is needed for several key purposes. One involves crisis response. In a global financial upheaval like our most recent one, capital flows shift abruptly and dramatically, causing credit, financing, and balance-of-payments problems, as well as volatile exchange rates. Left unattended, these problems can cause widespread damage in a wide range of countries, many of which are innocent bystanders.
The system needs circuit-breakers in the form of loans and capital flows that dampen the volatility and maintain access to financing across the system. A well capitalized IMF, much better capitalized than pre-crisis, should be able to fill this backstop – similar to what central banks do (and did in the crisis) to prevent a credit freeze and the inevitable and excessive economic damage that would result.
The new IMF Flexible Credit Line performs this function for what amount to AAA-rated countries. A program that meets the needs of the more vulnerable countries is under construction. The challenge is to find the right mix of pre-approval, limited conditionality, and speed.
At the same time, while getting the crisis-response mechanisms right is important, it is not the whole story. The IMF is at the epicenter of large-scale global coordination challenges. Having initially been shunned, it has assumed a key role in financing – and, more importantly, implementing – fiscal-stabilization programs for the European Union’s peripheral countries. These programs are needed to limit contagion and restore stability to the eurozone, pending deeper institutional reforms that address fiscal interdependency in the context of monetary union.
The most important issue on the global economic agenda – rebalancing and restoring global demand – is a coordination challenge par excellence. The sudden reduction in excess consumption in the United States as a result of the crisis makes meeting this challenge all the more urgent. Without an effective rebalancing program, growth will be sub-par, and employment difficult to restore on a sustainable basis.
Government stimulus programs are limited in their ability to restore demand. The global economy needs the surplus countries to sustain growth and reduce excess savings – no easy task. It also needs deficit countries (and the advanced countries more generally) to develop and enact credible growth strategies that involve structural change as well as fiscal stabilization.
The G-20 is now the priority-setting and decision-making body for this kind of challenge, the crisis having made it clear that the G-7 could no longer perform this function. The major emerging economies are too large and too important to be left out of the search for globally cooperative outcomes. The crisis also convinced most of us that non-cooperative outcomes are likely to be distinctly sub-optimal in terms of growth, stability, and sustainability.
The G-20 can say the right things about cooperation. But, to perform this function, it needs a knowledgeable, credible, and effective secretariat. That is the IMF.
The Mutual Assessment Process to which the G-20 countries have agreed is a crucial component of the rebalancing program, for it is where the pieces of a cooperative strategy for growth will be identified, evaluated, and assembled.
If it works, what will emerge will be commitments from G-20 countries to undertake policies that are globally beneficial – on the condition that others are keeping their commitments. The US may reduce its deficits faster than it would in the non-cooperative case, but only if surplus countries are working to reduce their excess savings.
Rebalancing is not the only cooperative imperative. The international exchange-rate system is at least partially broken. The old hybrid – in which advanced countries operated with floating exchange rates and open capital accounts, while developing countries managed the exchange rate via capital controls and reserve accumulation as part their growth strategies – worked as long as emerging markets’ systemic effects were relatively small.
Those days are gone. The distortions and distributional issues are set to become more pressing as the size and impact of the major emerging economies increases, owing to their return to rapid growth, and as the advanced countries experience an extended period of sluggish performance.
To accommodate the needs of the emerging economies, as well as the interests of advanced countries, a new system will be needed, in which exchange rates are managed but adjusted according to criteria that balance domestic growth and global stability. The IMF will be at the center of the design and implementation of any new system, by reason of mandate and expertise.
The IMF is already playing a constructive role in Europe in cooperation with the EU, and its leadership is rebuilding relations with Asia. It is much better capitalized than before the crisis, and its governance structures are being reformed to give emerging-market members a larger voice in strategy and policy.
All of this is needed to enable the Fund to support the global coordination functions for which it is uniquely well equipped. Even with an authoritative IMF, the problems we face are daunting. But without it, the G-20 will mostly likely be reduced to a talking shop, characterized by good intentions, but with no effective way of realizing them.