Abstract
The global economy continues to evolve, and the future of the IMF and other international institutions will depend on how well they adapt to the new reality. A globalised economy demands an ever-increasing number of global rules which can only be overseen and arbitrated by multilateral institutions. These institutions, however, must reform if they are to earn the legitimacy this role demands. The IMF needs to adapt its governance structure to changing times but has lost none of its importance as a result of the crisis. Rather, it has taken on an enhanced role as the leading supervisor of international financial stability.
The IMF's role in the recent crisis
The role of the IMF in the years running up to the financial crisis has recently come under scrutiny. It has been accused of failing to speak out strongly enough about the vulnerabilities that led to the crisis [10]. There are a number of points to make here. First, with economic and financial crises it is virtually impossible to say with any degree of confidence when they will hit, how long they will last or how deep they will be. All the more so as the causes that underlie crises are varied and mutually reinforcing. In the 2007 crisis, many problems stemmed from the weakness of banking supervisors in industrialised countries, where other institutions had the information. The key lesson learnt from this is the importance now being given to macroprudential policies.
Despite this, the IMF was able to diligently identify the main frailties affecting the world's economies and financial systems, many of which helped cause the recent crisis: the overvaluation of property assets in the US and other developed countries, high levels of private sector debt, the relaxation of regulations and surveillance, plentiful liquidity and the massive scale of financial innovation. It also issued repeated warnings about the risks from rising global imbalances, a background factor that exacerbated the crisis and which remains unresolved. Finally, the IMF repeatedly stressed the need for structural reform to increase the potential growth rate of economies and for fiscal consolidation to put public sector finances on a sustainable footing. 1
See the IMF's World Economic Outlook and Global Financial Stability reports issued between 2004 and 2007.
The IMF's macroeconomic surveillance was better respected by the emerging economies than by the developed world, which thought no crisis could break out in their economies, grounded as they were in low inflation and strong global capital markets. Emerging economies, in contrast, were anxious to ensure that their macroeconomic position was robust, and this served them well during the crisis.
When the US subprime mortgage market was engulfed by turbulence, and financial institutions saw their balance sheets start to deteriorate, the IMF was among the first to appreciate the extent of the crisis and its potential scale. In October 2007, nearly a year before the Lehman Brothers bankruptcy brought the financial turmoil to its peak, the IMF was already issuing clear warnings about the dangers of a collapse in the subprime market and the riskiest forms of securitisation, the lasting nature of the disruption, a credit crunch and a tightening of the terms of finance [6]. Subsequently, the IMF forecast the course of the crisis with considerable precision, both in the financial sector and in the real economy.
The IMF also took an active part in the debate on economic policy responses to the crisis, particularly on the exit strategies within the G-20, anticipating measures that, sooner or later, were implemented by nearly every country in the world. From the very first day of the crisis, the IMF came out in favour of internationally coordinated programmes of fiscal stimulus to halt the slump in activity and stressed the need to clean up the banking sector as an essential precondition for any sustainable recovery. Similarly, during the phase of fiscal consolidation, the IMF has supported cutting spending rather than raising taxes or reducing investment, so as not to imperil economic recovery.
Finally, the IMF deserves credit for adapting its financial support tools, reorienting them towards crisis prevention and the provision of global liquidity, which is a real change in philosophy compared to its original mandate of helping countries in short-term difficulties with their balance of payments. The IMF has doubled the maximum amount it can lend to a country and launched a new line of credit on easy terms for countries, such as Poland, Mexico and Colombia, with sound fundamentals and sustainable debts that are hit by a sudden flight of capital [19]. It also took part in the rescues of Iceland and many Eastern European countries, including Ukraine, Hungary, Latvia and Romania. More recently, working hand-in-hand with the EU, it played a key role in the financial bailouts of Greece and Ireland, not only as lender but also as adviser on the design, implementation and monitoring of the fiscal adjustments and structural reforms that the afflicted nations undertook.
The future of a reformed IMF in a multipolar world
It was the G-20 and not, as had traditionally been the case, the G-7 that decided the global strategic response to the collapse of the economy and international financial system in 2008. Inevitably, this led to a reform of the world's economic institutions. The IMF was set up in the 1940s and its composition and representation has long ceased to reflect global realities: emerging market countries still have a ‘minority’ participation, despite having gone from exerting only a marginal influence on world growth to generating more than 75% of it (in PPP terms). Before the middle of this century, two of the world's three biggest economies will be Asian countries currently viewed as emerging (China and India).
The new challenges of the international economy can only be met by institutions that can claim legitimacy. A multipolar world needs new economic governance, with international institutions that encourage cooperation between countries and in which emerging market states feel they have a stake [5,20]. The IMF is leading the way in this essential modernisation but it is tough going, since it means taking power away from some countries and giving it to others. The package of reforms to bolster the IMF's legitimacy as a global economic forum, agreed to already in 2006 and 2007 and finally approved in 2010, may seem insufficient but is still a major milestone for the organisation. This agreement is the most radical reform of the IMF's governance structure in its 65-year history. Once implemented, the reforms will increase representation for the world's emerging market states on the Executive Board and transfer more than 6% of voting rights away from the over-represented advanced nations to emerging market and developing countries.
It is inevitable that EU countries, which together control nearly 32% of the IMF's voting rights versus 17% for the US, will gradually cede terrain and make way for emerging and developing economies. But this need not entail a loss of European influence, provided the bloc can improve its political coordination and reach united positions on trade, financial and economic issues, where their interests should increasingly converge.
Only by taking steps to rebalance global power can the developed world ask emerging market countries to share responsibility for reducing current macroeconomic imbalances and creating a more efficient and stable economic and financial system. There is also the paradox that these imbalances have built up thanks to the transfer of savings from poor countries like China to rich ones like the US. The severe consequences of the recent financial crisis suggest we are entering an era when growth will be slower and the struggle against poverty will get harder, amid tighter credit and problems reconciling the interests of countries with high and persistent current account deficits with those of nations that run up large surpluses [1,13]. Trade imbalances will not correct on their own, through the action of market forces. These are in any case being blocked by countries’ individual growth strategies. We need to find cooperative solutions. To do this, we need to reform and redesign not only the strategies of each individual country but also the global rules of the game which have helped foster more than 60 years of rising prosperity but which have little by little become obsolete.
The IMF has emerged rejuvenated from the ‘Great Recession’, with stronger financial resources, enhanced legitimacy and a coordination and arbitration role in the world's efforts to resolve global imbalances while avoiding trade wars and instability on currency markets. The current agenda of international financial reform is the broadest-ranging in decades: new reserve currencies, management of capital accounts, creation of high quality global assets, global liquidity and so on.
The IMF can and must be a key player in the system, spotting and remedying risks, arbitrating in debates over exchange rates, supporting the restructuring of sovereign debt, increasingly taking the lead in liquidity crises and acting as global lender of last resort by offering hard currency credit lines to countries in difficulties [15]. Its informational advantages (no other institution has such extensive global databases) and its experience in studying the linkage between the financial system and the macroeconomy should secure the IMF an active role in the design of future regulations and the surveillance of financial markets and the international monetary system [18].
The IMF can lead the economic debate
It is now two years since the world started to recover from the Great Recession that threw into question the international economic and financial order and traditional ways of managing economic policy. We now face a new economic and financial situation that demands new forms of management. Nobody has the answers yet, but the IMF is making a significant contribution to the debate. The conference Macro and Growth Policies in the Wake of the Crisis, held in Washington on 7–8 March 2011, brought together different perspectives on the direction of macroeconomic reforms and included important contributions that are opening up new lines of research.
No unanimity was achieved in any of the conference's key areas of discussion but at least some consensus emerged on the need to reformulate the basis of monetary policy. As both Olivier Blanchard [3] and Guillermo Ortiz [12] showed in their presentations, the aims of monetary policy have multiplied to such an extent that it is now in need of new tools. The traditional model based on a single policy instrument (short-term rates) and a single target (inflation or a rule combining inflation and the output gap) proved too simple. Financial stability needs to be added to the list of aims and new tools must be found to safeguard it: macroprudential surveillance and regulation, focusing on the system as a whole rather than individual firms. Macroeconomic policy will in the future have to make a greater contribution to the stability of the financial system and vice versa.
Also, although this was not an issue directly addressed at the conference, it would be good to develop a clearer early warning system that would help anticipate financial risks. Indicators that were monitored only in emerging economies would have flagged the scale of imbalances building in some developed countries had they been monitored in these countries also. For instance, in the EU periphery states, persistent current account deficits, the expansion of credit, the recipients of the loans and the overall size of the financial sector should have rung alarm bells for economic policymakers long ago, even in an environment of overly complacent financial markets.
Second, it became clear that the real problem is not the absence of economic policy instruments to achieve the declared aims but a lack of knowledge about how they work. In many cases, we do not know how to apply them. For instance, in response to the crisis governments in most leading economies turned to massive fiscal stimulus packages to revive the economy, acting proactively. However, we are unable to reliably estimate the impact of fiscal policies: there is great uncertainty as to the multiplier effects of changes in public spending—particularly in developed economies—or tax policies. In general, the impact of fiscal policy depends on multiple factors, including the state of the economy, the health of the financial system and the accompanying action on monetary policy, to name but a few [2,17]. We also need to consider the impact on public debt, which diminishes solvency and, in the long term, inhibits growth.
In the financial world the gaps in our knowledge are even wider. The concept of liquidity and the best ratios for tracking it are absolutely unknown [16]. Nor do we yet have any clear understanding of how capital controls work, although there is a gathering consensus that they work ‘reasonably’ well, in the short term, to tackle skewed exchange rates caused by speculative capital flows. And, for instance, on the regulatory front, the financial sector's well-proven capacity for innovation could render ineffective any policy measures that are unchanging over time. Professor Paul Romer [14] therefore advocates dynamic rules to avoid recurring crises. In many of these areas it is increasingly clear that close cooperation will be needed between the IMF and central banks.
The IMF has a major role to play in the oversight of the international financial system
The original competences of the IMF did not include either oversight of the financial system or surveillance and regulatory issues. Nevertheless, the institution has gradually built up its capabilities to analyse the financial system and become the internationally recognised authority on global finance and a key player in the drive to reform the international financial architecture alongside many other bodies.
The process started around 2000, in response to the Asian, Russian and Long-Term Capital Management crises, when the IMF initiated two programmes that ultimately became its most effective tools for analysis of the financial system: the Financial Sector Assessment Program (FSAP) and the Global Financial Stability Report (GFSR). The first FSAP assessments were conducted in 1999 as part of the Fund's bilateral surveillance. They are one-off studies of a national financial system to assess its stability (solidity of institutions, surveillance practice, identification of weakness etc.) and its level of development (efficiency, competitiveness, infrastructure, legal system etc.) [8]. GFSRs are biannual multilateral surveys of the world financial system designed to identify any systemic threats brewing within it.
In addition, the IMF has been building closer relationships with national regulatory and supervisory authorities through the International Monetary and Financial Committee (IMFC) and the Financial Stability Board (FSB, replacing the Financial Stability Forum). The IMFC was set up in 1999 to replace the Interim Committee and advises on monetary and financial issues as well as analysing significant events that affect the world's economic and financial stability. The FSB, also founded in 1999, is tasked with strengthening and coordinating financial surveillance and information exchange [9]. The IMF also bolstered its links with the private sector through the Capital Markets Consultative Group—created in 2000—under whose auspices the Managing Director holds periodic meetings with representatives of the most important institutions in international capital markets.
The IMF's drive to consolidate its role in global finance and its financial analysis capabilities were decisively stepped up in the years that preceded the crisis. Article IV staff reports, the key tool in bilateral macrosurveillance, began to include more detailed analysis of the financial sector, and FSAPs were revised and extended [11]. In December 2006 the IMF restructured its organisation to bring its work on capital markets and financial institutions, hitherto conducted separately, within the remit of a new and powerful Monetary and Capital Markets Department. It also beefed up the role of its multilateral fora (the IMFC and the Exogenous Shocks Facility) and, between July 2006 and March 2007, launched consultations with the US, the Euro area, Japan, China and Saudi Arabia on global imbalances. All of this reinforced the IMF's leadership in global financial affairs, to the point that in 2006 it took over the role of internationally recognised authority previously held by the G-7 Financial Stability Forum.
The recent crisis has shown how right the IMF was to reinforce its monitoring of the financial sector, but has also highlighted a number of shortcomings: the IMF failed to pay enough attention to the close links between financial stability and the macroeconomy or to the high risk that turbulence would lead to contagion—multiplied by increasing financial integration across different economies—and it took an excessively benevolent view of developed countries. However, since 2009 the IMF has been working to correct these faults. FSAP assessments are now compulsory for national financial systems of systemic importance and have been made more flexible to better reflect the individual features of each country. The fund has improved its analysis of contagion risks and the crossover between banking and the real economy and between sovereign risk and banking. It has also integrated assessment of the financial system more closely into its bilateral surveillance work [7].
It seems clear that the international economy is in a period of transition, a time when short-term trends are intertwining and overlapping with structural changes—effects of the economic crisis and the rise of emerging economies—and when the economic paradigms that dominated recent decades have been called into question. This is a time when the IMF can show its worth, if it continues the process of adapting to the new reality which it has been pursuing for the last 10 years. As Barry Eichengreen, professor of economic history at the University of California, Berkeley, wrote: ‘Global crises used to remind us why we have the IMF’ [4].