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It was said of the Bourbons that they learnt nothing and forgot nothing. One wonders whether the same might not be said of the IMF in its gross mishandling of the European debt crisis. For not only does the IMF seem to have learnt very little from its unsuccessful Asian and Latin American economic adjustment programs of the late 1990s. It is now also not materially adapting its thinking about its European financial adjustment programs despite the mounting evidence that these programs are driving the European periphery into a self-defeating deflationary spiral with untoward social and political consequences.
“To widespread charges that the IMF had essentially outlived its usefulness, the IMF justified its continued existence by emphasizing its surveillance role.” -Desmond LachmanIn the aftermath of the IMF’s failed Asian and Latin American economic adjustment programs in the late 1990s, the IMF was virtually declared persona non-grata in both of those two regions. To widespread charges that the IMF had essentially outlived its usefulness, the IMF justified its continued existence by emphasizing its surveillance role. In that role, the IMF was supposedly providing early warnings about the buildup of domestic and external imbalances in the global economy that might have systemic consequences. It was also supposedly providing sound policy advice as to how those imbalances might be addressed.
Sadly, over the past few years the IMF failed miserably to remotely anticipate the two largest and systemically most important economic and financial crises of the post-war period. First, it failed to anticipate US housing market and sub-prime mortgage debacle of 2008-2009, not to mention the highly damaging spillover effects of that crisis onto the rest of the global economy. And then it failed to forewarn about the more recent European sovereign debt crisis despite the enormity of the economic and financial imbalances preceding that crisis and despite the risks that this crisis posed for the global economy.
It is particularly disturbing that the IMF failed to flag the acute risks inherent in the buildup of massive external current account deficits in countries like Greece, Portugal, and Spain, considering that balance of payments problems are supposed to be the IMF’s main area of expertise. Despite these countries’ current account deficits having reached double digit figures as a percent of GDP, the IMF happily went along with the mistaken view espoused by Jean Claude Trichet, the former ECB president, that external imbalances do not matter in a monetary union where countries shared the same currency.
If the IMF’s surveillance role has left much to be desired, its handling of the European crisis has hardly covered it with glory. More than two years into the crisis, there is every sign that the IMF’s prescription of severe austerity measures within a Euro straitjacket is simply not working. There is also every sign that the failure of these policies is in the process of destabilizing the European political landscape.
“If the IMF’s surveillance role has left much to be desired, its handling of the European crisis has hardly covered it with glory.” -Desmond LachmanThe Greek economy is now literally in a state of collapse with GDP having declined by over 20 percent from its pre-crisis peak and with a further 4½ percentage point decline officially expected in 2013. Meanwhile, the Italian, Portuguese, and Spanish economies are all now mired in very much deeper economic recessions than were officially projected. Those economic recessions are putting those countries’ budget deficit reduction targets well out of reach and are resulting in rising rather than declining debt to GDP ratios. They are also giving rise to disturbing political backlashes.
An important factor in the IMF’s failure in the European crisis has been a fundamental misdiagnosis of the crisis. Right from the start, the IMF treated Greece’s problems as ones of liquidity rather than as ones of solvency. As a result, it was only belatedly in early 2012 that the IMF supported a 74 percent write-down in the present value of the Greek government’s privately owned sovereign debt. And it is only now after the collapse of the Greek economy that the IMF is pushing for official sector involvement.
An even more fundamental misdiagnosis on the part of the IMF was not to anticipate that severe fiscal tightening, within a Euro straitjacket that precluded the use of the exchange rate to promote exports and at time that Europe was experiencing an acute credit crunch, would result in severe recessions throughout the European periphery. It is only now more than two years into the crisis that the IMF is finally acknowledging that the fiscal multipliers prevalent in the European periphery are between two and three times larger than the IMF had initially thought. However, this recognition is not preventing the IMF from continuing to advocate more fiscal austerity in a Euro straitjacket that has produced such dismal results to date.
A former boss of mine once wisely, albeit cynically, remarked that in Washington nothing succeeds like failure. Judging by the ever increasing role that the IMF has been assigned in the European crisis despite its poor handling of that crisis I am coming to be more convinced by my boss’ observation.
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