IMF programs usually relieve austerity rather than make it worse

This is another of the surprising papers/speeches by a noted economist.

Ken Rogoff of Harvard says IMF lending programs are wrongly accused of pushing the countries into fiscal austerity drive. Infact IMF imposes much lesser stringent conditions than other lenders would impose! Rogoff says IMF does not go to countries but countries come to IMF. The countries susuaully goto IMF whwn all other options have been exhausted. Given the situation, IMF lends on more favorable conditions than other private sector lenders..

Perhaps the leading charge against the IMF over its long history is that it invariably imposes harsh austerity conditions on hapless developing countries in their time of greatest need. Over the past three decades the world press has been replete with images of mass demonstrations against IMF programs, with food riots against price hikes and shortages being a particularly compelling graphic. Although the IMF has been accused of many mistakes over the years (most famously perhaps by Joseph Stiglitz [2002]), the austerity charge is the one that cuts most deeply at the IMF’s moral authority and ultimately its power and effectiveness. Is the austerity charge fair?

The short answer is that the IMF almost always makes austerity for a bankrupt country lighter than it might otherwise have faced. The superficial view that the IMF creates needless austerity is just naïve and wrong. However, even as the IMF relieves austerity, a great deal of judgment is required in calibrating how much and for how long the IMF should help, and under what conditions. The deeper question of how the IMF should design and calibrate its rescue programs to relieve austerity is a legitimate one over which views on best practice are constantly evolving.

Traditional anti-IMF rhetoric is so effective that most people are shocked when they are told that IMF programs usually relieve austerity rather than make it worse. How can that be, they will ask, given so many press articles and so much political rhetoric reinforcing the populist view that the IMF puts budget balance and the interests of foreign banks ahead of the welfare of ordinary people? Straightening out the simplest misconceptions about the IMF and austerity is an essential starting point to any rational conversation about what the real issues are.

IMF lends just above rates at which Germany and US can borrow money:

When the IMF comes in, it typically makes a country a bridge loan at an interest rate far below what it could imagine getting on international markets, even prior to the crisis. That is, the IMF usually charges an interest rate only slightly greater than the rate that triple-A borrowing countries such as the United States and Germany pay. In principle, the IMF bridge loan allows the troubled debtor time to adjust to the shift in international lending, to sustain essential services, and to restructure finances for an eventual return to international borrowing. Again, one must underscore the point that the IMF does not impose itself on a country; it comes in only by invitation. A country opens its doors to the IMF (admittedly usually quite reluctantly) precisely because the government knows that an IMF bridge loan can help cushion austerity.

Thus, as I have argued in the past (e.g., Rogoff 2003, which restates my review of Stiglitz 2002), the fact that the IMF is often found near the scene of sharp budget cutbacks does not mean that it is the primary cause. Doctors can be found treating plague victims; this does not mean doctors cause plagues. Fire engines are found near fires; this does not mean fire engines cause fires. The simplistic populist notion that the IMF is the root cause of austerity in a crisis is utterly naïve and wrong, despite the huge success of many polemicists in propagating this view.

He points while lending IMF has many issues upfront:

  • How large the loan should be
  • How large a deficit should a country be allowed to run
  • The fiscal figures are usually dodgy, hence determining the right amount of deficit is always a q mark? (there is a nice example of how govts do this)
  • Political capacity to absorb austerity…this leads to most bad press coverage

He says the problem is not whether IMF is too stiff on debtors. But whether it is too kind to creditors leading to moral hazard:

In my mind, the big question about IMF programs is whether they are far too biased toward bailing out creditors, stoking moral hazard and sowing the seeds of future crises. That is, does the fund design its programs with a view to making sure a country is able to pay off its creditors, particularly foreign creditors? One obvious interpretation of this bias, of course, is simply that the fund places a heavy weight on the interests of creditors, perhaps because its voting structure gives such large weight to the rich countries who, at least over the past three to four decades, have by and large always been lenders rather than borrowers. Foreign lenders, both bond and bank lenders, typically come disproportionately from rich countries as well.

Now, to some extent, the view that the fund takes into account rich-country creditors is correct. But the fund would claim a deeper rationale for promoting full repayment of debts, based on the view that ensuring creditors are repaid is ultimately in both the debtor country’s interest and in the broader interest of the global financial system. Both arguments have merit but do not necessarily withstand a considered cost-benefit analysis in many cases.

This takes to the earlier post of how IMF governance is developed country biased.

The idea should be to curb this favorable conditions to creditors. He says the creditors should be pushed into becoming equity investors rather than take debt of economies. THis should solve some problem.

If there is a systematic flaw in IMF programs, it is not necessarily excessive austerity policies toward debtors, but its generosity toward creditors. It arguably overestimates the costs to a country of a negotiated default and, more importantly, underestimates the long-term moral hazard problems created by recurrent bailouts. If the international financial system of the 21st century is to be less prone to crises, a good starting point would be to work toward institutional changes to redirect financial flows toward equity and foreign direct investment, away from debt instruments.

In this regard, an International Monetary Fund, with its huge pool of lendable resources and its arguable bias toward ensuring repayment, is problematic. From this perspective, it is the fund’s generosity, not its austerity, which is ultimately the problem.

Fascintating to say the least…


2 Responses to “IMF programs usually relieve austerity rather than make it worse”

  1. How corruption eats into an economic and political system? « Mostly Economics Says:

    […] post was on IMF bailout packages do not imposing austerity. The paper was a lecture Rogoff gave at […]

  2. Fish Oil Says:

    Fish Oil…

    […]IMF programs usually relieve austerity rather than make it worse « Mostly Economics[…]…

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