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'The IMF did not sufficiently tailor its advice to countries during the crisis'

An IMF internal review finds that some European authorities thought it was “inappropriate” for the IMF to be seated at the negotiating table.

 Finance Minister Michael Noonan and then IMF Managing Director Christine Lagarde in 2013.
Finance Minister Michael Noonan and then IMF Managing Director Christine Lagarde in 2013.
Image: Niall Carson

THE IMF GAVE leading economies faulty advice following the 2008 financial crisis, by directing them to cut spending and rely on central bank stimulus for growth, an internal policy review published today has found.

The review, published by the Independent Evaluation Office (IEO) of the International Monetary Fund, stated that that during 2010-2011 the IMF was premature in advocating austerity policies to countries in Europe, the United States and Japan.

The organisation incorrectly assumed an economic rebound was already underway, the review concluded.

Pump money to stimulate growth 

The IEO said in the lengthy report that simultaneous support for central banks to pump out money to stimulate growth led to troublesome volatile capital flows in emerging economies.

“The IMF was effective in calling for global fiscal stimulus immediately following the Lehman collapse” in 2008, the IEO said.

“But it prematurely endorsed fiscal consolidation in large advanced economies, and, in parallel, encouraged reliance on expansionary monetary policy to stimulate demand.”

“This policy mix was less than fully effective in promoting recovery and contributed to capital flow volatility in emerging markets.”

The report assessed crisis-era policies that remain controversial, especially in Europe, and fuel ongoing political debates as the leading global economies struggle to boost economic growth.

Irish dole payments Ajai Chopra, Deputy Director of the IMF's European Department gives a press conference in the Conrad hotel Dublin. Source: Julien Behal

Downturn 

The IEO noted that as the crisis began to spread globally in late 2008, the IMF became a “leading spokesman” for countries to boost their spending to fight the worldwide downturn.

“Fiscal stimulus was advocated not only for the countries at the center of the financial crisis but also for a much larger segment of the global economy, including euro area economies,” it said.

“The fiscal expansion that followed is widely acknowledged as having contributed to shortening and dampening the recession.”

The report adds that the IMF’s overall record in post-crisis surveillance was “mixed”.

Its calls for global fiscal stimulus in 2008–09 were timely and influential, but by 2010 it had endorsed a  shift to consolidation in some of the largest advanced economies, coupled with monetary  expansion to stimulate demand if needed to maintain the recovery.

The call for fiscal consolidation proved to be premature, as the recovery turned out to be modest in most  advanced economies and short-lived in many European countries.The recommended policy mix was not appropriate, as monetary expansion is relatively ineffective in boosting private  demand following a financial crisis.

Spending cuts 

In 2010 the Fund changed its advice, arguing for fiscal consolidation. The Fund said spending cuts would allow large economies to reduce debt burdens that had mounted during the first years of the crisis.

At the time, the IMF was worried that large fiscal deficits and rising public debt would threaten fiscal solvency and prolong if not exacerbate the crisis, the IEO said.

But the Fund took that stance in the mistaken belief that economic growth in advanced economies would turn positive in 2010.

That turned out to be very wrong, as the eurozone’s plunge back into recession showed.

Irish economy A protest sign on the window of the European Union House in Dublin. Source: PA Archive/Press Association Images

The IEO said the IMF’s policy focus at the time was also not well-founded.

“The policy mix of fiscal consolidation coupled with monetary expansion that the IMF advocated for advanced economies since 2010 appears to be at odds with longstanding assessments of the relative effectiveness of these policies” in the conditions that prevailed at the time, the report said.

One size fits all 

The IMF did not sufficiently tailor its advice to countries based on their individual circumstances and access to financing  when recommending either expansion or consolidation.

Switching financial gears

The report acknowledged that the Fund, under criticism especially in Europe for advocating austerity, subsequently switched gears as the eurozone economy and the US continued to struggle.

“The evaluation recognises that the IMF showed flexibility in reconsidering its fiscal policy advice when the growth outlook worsened.”

Reporting on how the IMF worked with the European Commission and European Central Bank over these years, the report states as the euro area crisis erupted, the IMF were called upon to provide both policy and  technical support and eventually to assist in providing financing to advanced economies in Europe.

The institutional arrangement that emerged involved a Troika, all to familiar in Ireland, which included the EC, ECB, and IMF.

This was a “novel coordination arrangement” states the report,  in that the monetary authority of the member country in crisis was formally seated on the same side of the table as the IMF.

Moreover, there was an understanding that disagreements would not be raised publicly.

This  arrangement raises questions as to whether it afforded greater traction of the IMF’s policy  advice, or whether it increased the pressure on the IMF to compromise its positions.

Ultimately, such questions can only be answered by examining the context of individual country program negotiations—a task that goes beyond the scope of this evaluation.

The report states that European authorities believed the IMF was “well placed” to put crisis response programmes in place, as the EC and ECB lacked experience.

However, the report finds that other authorities thought it was inappropriate for the IMF  to be seated at the negotiating table alongside the monetary authoity of a member country and was “bad governance”.

- © AFP, 2014

Additional reporting Christina Finn 

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