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The IMF Needs To Find Its Voice Again

Author: Sebastian Mallaby, Paul A. Volcker Senior Fellow for International Economics
April 14, 2011
Financial Times


The International Monetary Fund has had a glorious few years. It has escaped its reputation as a thumbscrew merchant. Its resources have tripled. Its voting system has been reformed to reflect the rise of the emerging world. But the finance ministers gathering for the IMF's spring meetings should not celebrate too loudly. The IMF can only be as coherent as they are – which means that, on many of the big issues, it remains incoherent.

Consider Europe's mess. Greece and Ireland are saddled with debts that are almost certainly unpayable. These must be reduced, either by telling lenders that they won't get all their money back or by an infusion of charitable funds. But Europe's leaders lack the guts to inflict losses on investors, and fear a backlash from voters if they bail out the periphery. And so their policy, backed by the IMF, is to fudge: to lend enough “bail-out” money to ensure bond-holders get paid promptly, but at a price that won't actually reduce the debt burden – to kick the can down the road.

The IMF is wrong to abet this cowardice, because it means unnecessarily prolonged austerity in the crisis countries and because the IMF is pouring capital into doomed programmes that (despite its preferred creditor status) it may not get back. But the incoherence doesn't stop there. In a masterpiece of double-talk, Europe's leaders are reassuring bond holders they will get all their money back – except that from 2013 onward, they might not. This is an absurd stance because markets are forward-looking: threats in the future affect bond prices now. Yet the double-talkers are powerful IMF shareholders, so the institution protests meekly and to no avail.

Next, consider its efforts to tame global imbalances. Prompted by the Group of 20 leading economies, it has launched the Mutual Assessment Process. This is meant to embarrass countries whose policies promote destabilising deficits or surpluses. But when major G20 nations say they are willing to be embarrassed, they do not mean it. Dominique Strauss-Kahn, the IMF's forthright managing director, recently described the struggle for progress on mutual assessment as “painful”.

But the best example of the IMF's incoherence is its U-turn on capital controls. In the days of the “G1”, when the IMF worked hand-in-glove with the US Treasury, it had a clear view on barriers to cross-border capital flows: bad. Now, reflecting the weight of its dirigiste emerging-market shareholders, the IMF calls capital controls a legitimate part of the tool kit: not the preferred mechanism for dealing with a surge of money, but by all means acceptable. This supposedly signals a refreshing open-mindedness; good riddance to knee-jerk laissez-faire. But the old consensus against capital controls was not mere dogma. Most of the time they don't work.

Consider India where, in 2004, leaders resisted a flood of incoming capital by throwing red tape at non-resident investors, restricting foreign-exchange borrowing and so on. But as Ila Patnaik and Ajay Shah explain in a new paper , capital inflows increased anyway. The controls failed to dampen the rupee's volatility, and failed to protect India from an asset bubble. They did not even curb foreign-exchange borrowing. The more the government was seen to be artificially suppressing the value of its currency, the more Indian companies found ways of borrowing in dollars whose value seemed likely to decline.

India is not alone. Chile was a poster child for capital controls a few years ago. Now its central bank governor, José De Gregorio, says they failed to hold down the value of the peso and failed to reduce inflows. Also, several of the assumptions behind them are shaky. As Francis Warnock shows in a new paper the notion that foreign investors exacerbate volatility by piling into hot markets may not withstand scrutiny. As they move among global markets, US equity managers are actually contrarian.

Even granting that capital controls are a contested subject, the problem with the IMF's open-mindedness is that it acts as a green light for lobbies and cowards. The IMF may say that countries' first line of defence against capital inflows should be to let the exchange rate rise until it presents a two-way bet to speculators; but vested interests in the export sector will use the IMF's endorsement of capital controls to agitate against appreciation. Equally, the IMF may urge some countries to tighten fiscal policy and so make room for lower interest rates, inducing fewer inflows – but politicians who lack the spine to cut their budgets will happily seize upon capital controls as an alternative way out. The hard truth is that if the IMF wants to be a norm-setter, it must announce its norms with some conviction. Subtlety won't work.

This article appears in full on CFR.org by permission of its original publisher. It was originally available here.

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