Does the IMF Work? in Another Great Depression the Answer Be No.

Listener 28 October 2002.

Keywords: Macroeconomics & Money;

Wanting to avoid the Great Depreciation of the 1930s, the leaders of the world established the International Monetary Fund in 1945. It has a number of purposes but a major one is to provide enough international liquidity should a 1930 type crisis ever occur again. Think of the IMF as the international equivalent of a reserve bank, and don’t confuse it with the International Bank for Reconstruction and Development (a.k.a. ‘World Bank’) whose purpose is to provide international capital for development investment, not short-term liquidity.

International financial crises of the magnitude of the 1930s happen very occasionally, so the main activity of the IMF is providing international liquidity for countries in individual (or regional) financial crisis. Their immediate problem is they have a shortage of foreign exchange. There are usually requirements of what the country has to do to qualify for an IMF loan. But this is no different from going into a banker for a large overdraft. Prudence requires some confidence that it is going to be able to payed it off, and not just incur more debt. Very often a country going to the IMF for financial assistance has been doing some stupid things (like spending extravagantly) and in order to get the foreign exchange loan they have to cut back. So the IMF is often associated with austerity measures, although the measures would be a lot more austere if there were no IMF advances, because the country would be desperately short of foreign currency and, for instance, it might be unable to pay its food, medicine, and oil bills.

Critics of the IMF have been recently joined by the weighty Joe Stiglitz. He has an impressive record: chairs in a galaxy of top level universities, impressive text books, major theoretical contributions, service on the US President’s Council of Economic Advisers, and chief economist at the World Bank, before his criticisms became so serious that he was ‘moved on’. In a recent paper evaluating the IMF’s response to the Asian financial crisis, ‘gravest economic crisis in a half-century,’ he says ‘I was appalled.’

He summarises the IMF (and the US Treasury) response to it as ‘quite frankly, a student who turned in the IMF’s answer to the test question “What should be the fiscal stance of Thailand, facing an economic downturn?’ would have gotten an F (ail mark).’ He accuses the staff of being ‘third rate students from first rate universities’, and ‘the mathematical models the IMF uses are frequently flawed or out-of-date. Critics accuse the institution of taking a cookie-cutter approach to economics, and they’re right.’ He goes on ‘the calamity in Russia shared key characteristics with the calamity in East Asia – not least among them the role that the IMF and US Treasury policies played in abetting it.’

Yet his logic is not that New Zealand should withdraw from the IMF, although it would be wise to do our damnedest never to have to borrow from it. Moreover, Stiglitz would be appalled by those who argue the IMF should be abolished. He certainly sees the need for some international provider of liquidity to deal with financial crises. Ultimately his argument is that international economic issues are often supranational, and the world needs supranational institutions to deal with them.

He wants greater openness. Stiglitz is uncertain as to how decisions are made at the IMF and who is responsible for them. But there is also an implicit demand that the US Treasury should be less involved, or perhaps should pursue a different policy (which – and Stiglitz does not say this, although it seems to be an implication – should take a broader perspective than the immediate interest of US financial capital). The US authority comes from it still being the world’s biggest economy, and that the US dollar is still the currency which people want when they are short of foreign exchange. (The European Community and Euro ought to be offering a challenge, but they don’t seem to be sufficiently politically organised to do so.) One has to conclude from the closely argued paper that if we have another crisis like that of the 1930s, the current international institutions may be quite unable to cope.