IMF has been quite active recently hosting seminars, updating forecasts, new publications etc. I came across this IMF note titled Initial Lessons of the Crisis (there is another one titled “Lessons of the Financial Crisis for Future Regulation of Financial Institutions and Markets and for Liquidity Management” ).
This note is a good honest appraisal of IMF of its work and views.
This paper summarizes the initial lessons of the financial crisis along three dimensions—regulation, macroeconomic policy, and the global architecture for stability. The focus here is not on the near-term resolution of the crisis or the long-term consequences (which must be left to other papers), but rather on prevention, bearing in mind that crises will inevitably recur. The underlying analysis is elaborated in three related staff papers to be issued separately.
I will just pick up a few key things I noted. For monetary policy:
The pre-crisis period was characterized by the increasing popularity of inflation targeting in the macroeconomics profession. Some central banks geared monetary policy nearly exclusively to stabilize inflation. Others gave weight to aggregate activity as well. Few, if any, took sufficient account of risks from asset price increases or leverage for three reasons. First, they underestimated the associated build up of systemic risk. Second, they relied on prudential regulation to control any such build up. And third, they assumed that, if and when asset price booms reversed, the effects on activity could be largely counteracted through lower interest rates at that time. In the event, there was indeed a major build up of risk across many sectors.
To the extent that the build up of systemic risk can portend a sharp economic downturn, and to the extent that regulation cannot fully prevent such a buildup, it is now clear that policy makers must take more account of asset price movements, credit booms, leverage, and the build up of systemic risk. The issue remains of how to identify and then to react to such buildups.
Fairly interesting and straight-forward. After IMF’s controversial analysiswhich said central banks shoudl look at housing prices, here is further development. The next line of action is of course to suggest how do we monitor asset prices within monetary policy framework.
However, what was a bigger surprise was IMF’s stance on capital flows. It says the crisis has become global because of global imbalances. The solution is:
Surely, the lesson is not that capital flows should be sharply curtailed. But this crisis, as well as many episodes before it, shows the potential dangers of large capital inflows. Such inflows can lead to excessive risk taking and to exposure of domestic financial institutions, households, firms, to exchange rate risk. They can lead to sharp appreciations, often followed by abrupt reversals and strong effects on balance sheets. They can put pressure on demand, and on output. Monetary policy may work poorly in this context, as the attempt to slow down activity through higher interest rates may make domestic assets even more attractive.
Thus, the crisis raises two issues. The first is the need to revisit when and how to react to large imbalances, through macroeconomic and structural policies that affect saving and investment. As elsewhere, an attitude of benign neglect has proven to be a mistake. The second is the potential role for prudential measures to reduce systemic risk associated with large capital inflows—e.g., through constraints on the foreign exchange exposure of domestic institutions and other borrowers.
(Emphasis is mine). IMF calls it prudential measures but they are capital controls. The same thing which IMF has criticised each time in its research, policy papers, advices etc. How much will this crisis change IMF’s views - ”Monetary Policy should look at asset prices”, “Fiscal policy is beneficial in times of crisis” and now “capital controls are ok” as well. (Infact I had read somewhere IMF had asked Iceland to impose capital controls as well as part of its relief package)
Then IMF takes a critical appraisal of itself in the crisis:
A key issue concerns the strength and focus of warnings prior to the crisis. Although there was some prescient analysis, in general the warnings were too scattered and unspecific to attract even domestic—let alone collective—policy reaction. For example, many institutions cautioned against “risk concentrations”, but this was not actionable without a concrete name (SIVs) and a concrete policy response (charges on off-balance sheet exposures). Nor was there any suggestion of dire macroeconomic consequences. Although the Fund was hardly alone in this, its surveillance significantly underestimated the combined risk across sectors, and the importance of financial sector feedback and spillovers.
Even when warnings were raised and problems realized, the machinery and commitment for coordinated actions were inadequate. For example, the disorderly unwinding of global imbalances was acknowledged as a major systemic risk for many years—even if the precise nature of the potential collapse was unclear (e.g. a flight from all dollar assets or just from private dollar assets). Yet, as noted earlier, collective action proved elusive, with the IMF’s effort under its new Multilateral Consultation in 2006-07 yielding only modest policy commitments from the participants. Even after the onset of the crisis, the initial policy response was far from collaborative, let alone coordinated.
This is exactly what is needed from other leading institutions as well. I had pointed earlier that most (including IMF earlier) instead preferred to pass on the blame to others.
A good introspection from IMF.