Will the IMF Stand Up to Europe?

CAMBRIDGE – As the eurozone crisis continues to deepen, the International Monetary Fund may finally be acknowledging the need to reassess its approach. New Managing Director Christine Lagarde’s recent call for forced recapitalization of Europe’s bankrupt banking system is a good start. European officials’ incensed reaction – the banks are fine, they insist, and need only liquidity support – should serve to buttress the Fund’s determination to be sensible about Europe.

Until now, the Fund has sycophantically supported each new European initiative to rescue the over-indebted eurozone periphery, committing more than $100 billion to Greece, Portugal, and Ireland so far. Unfortunately, the IMF is risking not only its members’ money, but, ultimately, its own institutional credibility.

Only a year ago, at the IMF’s annual meeting in Washington, DC, senior staff were telling anyone who would listen that the whole European sovereign-debt panic was a tempest in a teapot. Using slick PowerPoint presentations with titles like “Default in Today’s Advanced Economies: Unnecessary, Undesirable, and Unlikely,” the Fund tried to convince investors that eurozone debt was solid as a rock.

Even for Greece, the IMF argued, debt dynamics were not a serious concern, thanks to anticipated growth and reforms. Never mind the obvious flaw in the Fund’s logic, namely that countries such as Greece and Portugal face policy and implementation risks far more akin to emerging markets than to truly advanced economies such as Germany and the United States.