Allen on IMF’s cooperative assistance
The IMF has always seen preventing crises—and managing those that it couldn’t prevent—as a critical part of its responsibilities. The Latin American debt crisis of the 1980s and its aftermath were a typical instance of this. But the crises of the 1990s have been something different. They have been remarkable for their suddenness and virulence, and for the sharp upsurge in public and academic examination of the IMF they have triggered. This scrutiny is entirely appropriate. As the central monetary institution of the global economy, the IMF should be subject to scrutiny. One criticism is that we apply the wrong remedies in individual countries; the other, broader criticism is that IMF activities actually cause crises by making the international financial system more fragile.
The broad criticism—the moral hazard criticism—argues that the IMF, by providing insurance to feckless countries, encourages private markets to lend more than is prudent, because the markets know the IMF will make them whole in the event of a crisis. This, in turn, say critics—such as those on the Meltzer Commission—leads to more crises and a more unstable international monetary system.
In truth, all insurance is prone to moral hazard. So the question for a public provider of insurance, such as the IMF, is how the costs of moral hazard compare with the benefits of intervention. How large, in reality, are the moral hazard effects of the IMF’s activities? The Meltzer Commission report states that it is impossible to overestimate the costs of moral hazard, but hard evidence is scanty and in fact indicates the costs are pretty small. The IMF’s advances to its member countries are a small fraction of the private market claims on those countries. If markets think the IMF is going to bail them out, there must be a collective delusion concerning how many claims a single dollar can satisfy.
Indeed, while the availability of IMF money may have some effect on, say, Argentine spreads, the high spreads in that country reflect lender recognition of a high risk of default. Those who gambled on the “moral hazard play” in Russia lost a lot of money when the ruble collapsed. In addition, econometric analysis shows the possible size of the moral hazard effect must be small. So, while the moral hazard hypothesis is an interesting one, there is no evidence to support it. One might just as well recommend barring automobile insurance on the grounds that a lack of insurance will spur people to drive more safely and thus reduce the accident rate.
Also, consider the benefits of the IMF’s support for countries’ adjustment efforts. We do not live in a world where countries can be treated like minor banks or enterprises and allowed to collapse. Our prosperity is too interconnected. The true motivation for creating the IMF was not to establish a system of fixed exchange rates but to ease the adjustment effort in countries, recognizing that distress in one economy causes distress in others. The lessons of the Great Depression and World War II remind us that economic distress can give rise to international frictions and, ultimately, war.
Cooperative assistance among nations to help countries emerge from their difficulties makes sense on three counts. First, prosperous partners bring prosperity. There are few gains to be had from trade if trading partners are flat on their backs. Second, economic distress generates international political tensions and floods of migrants. And, third, there is the moral imperative to help fellow humans in distress. I do not put this forward as an idealistic or sentimental gesture. This is the real world in which the IMF operates.
IMF and capital markets
The IMF now functions in, and must adapt itself to, a new world of global capital markets. With the cost of crises so large, the return on crisis prevention becomes very high as well. One element in the IMF’s crisis prevention work is the new Contingent Credit Lines Facility. This facility is designed to provide substantial insurance to a country to ward off the spread of crises—or contagion—should the markets become nervous. To qualify, countries must have sound policies, no balance of payments need absent a crisis, healthy financial systems, high standards in such areas as the provision of data and financial institution regulation and supervision, and good relations with their creditors. Once a country has qualified, it can then draw substantial amounts of money immediately if a crisis breaks out.
While we have our eyes on several countries, so far we have had no applicants, and it is worth looking at the reasons why this may be so. The first concern is the market’s potential reaction. Professor Allan Meltzer has suggested that the market would reduce spreads for countries with a contingent credit line. The reality is that countries fear markets will interpret their application as a sign of concern about vulnerability.
A second concern for possible users of the facility is who the other members of the club will be. Each country aspires to have its reputation enhanced when it joins a select club. The authorities of one country, now borrowing at 100 basis points, have expressed concern about being in a club with other countries that the market is charging 350 basis points. Then there is the fear of being thrown out of the club. If a country’s policies cease to meet with approval, for whatever reason, and the country is declared no longer eligible, it may face a negative credit shock at the worst moment. The IMF believes that all these problems can and will be overcome, but they reflect some of the complexities inherent in the reform suggested by the Meltzer Commission.
IMF country information
Among the other recommendations of the Meltzer Commission is that the IMF provide reliable information on its member countries, because this information is a public good. The IMF does indeed provide the market with information, but why can the private market not provide it? Would countries not have an interest in providing accurate information and getting it certified by private sector accountants, who are concerned with their reputation? If the IMF is to do this as part of the international public sector, should there not be a domestic analogue? Why does the U.S. government not publish and certify information about banks and private firms? If the provision of information is left to the private market inside the United States, why should this not be the case for international data?
In this instance, the public good is not so much the provision of data but the setting and enforcing of standards. And it is this that is the job of the public sector. Governments have traditionally managed the infrastructure of markets, setting and enforcing standards. At the international level, the IMF is increasingly playing this role. We have become active in promoting the use of international standards in a range of areas. In this way the IMF is acting as its founders intended—as part of the structure of international cooperation needed for markets to work properly.