Alternative Views of the IMF Thorvaldur Gylfason Stellenbosch, South Africa 2-13 November 2009.

Alternative Alternative Views Views

of the IMFof the IMF

Thorvaldur GylfasonThorvaldur GylfasonStellenbosch, South AfricaStellenbosch, South Africa

2-13 November 20092-13 November 2009

Background: Political Background: Political economy is inherently economy is inherently

controversialcontroversial Positive vs. normative Positive vs. normative

economicseconomics Milton Friedman (1957)Milton Friedman (1957)

Economic policy is intertwined Economic policy is intertwined with politics and political with politics and political debatedebate

Dividing lines in politicsDividing lines in politics Right vs. left – not always helpfulRight vs. left – not always helpful Efficiency vs. equalityEfficiency vs. equality Free trade vs. protectionismFree trade vs. protectionism Public interest vs. special Public interest vs. special

interestsinterests

Economists can disagree on Economists can disagree on politicspolitics But they can still be objectiveBut they can still be objective

Old controversies about plan vs. Old controversies about plan vs. market are now deadmarket are now dead New controversies about New controversies about

globalization have replaced them, globalization have replaced them, including …including …

Renewed controversies about the Renewed controversies about the IMF and the World Bank and their IMF and the World Bank and their programs, projects, and policy programs, projects, and policy recommendationsrecommendations

Background: Political Background: Political economy is inherently economy is inherently

controversialcontroversial

Two waves of Two waves of controversycontroversy

First wave: 1970s and 1980sFirst wave: 1970s and 1980s Main criticism: Fund programs Main criticism: Fund programs

may help strengthen the balance may help strengthen the balance of payments, but they are of payments, but they are sometimes inimical to output in sometimes inimical to output in the short runthe short run

Second wave: 1990s and 2000sSecond wave: 1990s and 2000s Several aspects, including Russia, Several aspects, including Russia,

Asia, capital flows, globalizationAsia, capital flows, globalization Ongoing, unsettledOngoing, unsettled Serious issues involvedSerious issues involved

Not just a Not just a

convenieconvenie

nt nt scapegoascapegoa

tt

Outline of controversiesOutline of controversies

1.1. Is the Fund subservient to its Is the Fund subservient to its main shareholders?main shareholders?

2.2. Fund programs: Is one size Fund programs: Is one size meant to fit all countries?meant to fit all countries?

3.3. Do Fund programs strengthen Do Fund programs strengthen the balance of payments as the balance of payments as intended?intended?

4.4. Do Fund programs hurt output Do Fund programs hurt output and growth?and growth?

II 1970s and 1980s


5.5. Did the Fund respond too Did the Fund respond too slowly in Russia?slowly in Russia?

6.6. Did the Fund advocate Did the Fund advocate premature financial premature financial liberalization in Asia?liberalization in Asia?

7.7. Did the Fund advocate Did the Fund advocate excessive increases in interest excessive increases in interest rates in Asia?rates in Asia?

8.8. Is the Fund on the wrong side Is the Fund on the wrong side of the debate of globalization?of the debate of globalization?

IIII

Discuss these briefly, one by one, from general to specific

1990s and 2000s


5.5. Did the Fund respond too Did the Fund respond too slowly in Russia?slowly in Russia?

6.6. Did the Fund advocate Did the Fund advocate premature financial premature financial liberalization in Asia?liberalization in Asia?

7.7. Did the Fund advocate Did the Fund advocate excessive increases in interest excessive increases in interest rates in Asia?rates in Asia?

8.8. Is the Fund on the wrong side Is the Fund on the wrong side of the debate of globalization?of the debate of globalization?

IIII

Non-quantitative approach

1990s and 2000s

Subservience to owners?Subservience to owners?11 Fund is occasionally accused of Fund is occasionally accused of

partiality in favor of its main partiality in favor of its main shareholders. Is this a fair shareholders. Is this a fair charge?charge? Collection agency for big banks?Collection agency for big banks? Some think so, others do notSome think so, others do not

Analogy: Owners of newspapers Analogy: Owners of newspapers typically limit their interference typically limit their interference to their selection of editorsto their selection of editors Few editors admit to being under Few editors admit to being under

pressure from owners, but there pressure from owners, but there are exceptions, also in the IMF’s are exceptions, also in the IMF’s historyhistory

One size for all?One size for all?22 Background: Resistance to Background: Resistance to

reforms based on argument reforms based on argument that “general principles do not that “general principles do not apply here”apply here” Exemptions from economic lawsExemptions from economic laws But rivers always flow But rivers always flow

downstreamdownstream A basic principle of IMF A basic principle of IMF

operations has always been to operations has always been to treat countries uniformly and treat countries uniformly and yet acknowledge their different yet acknowledge their different circumstancescircumstances So, tailor programs to specific So, tailor programs to specific

needsneeds

Not really controversial; they doNot really controversial; they doEmpirical evidence shows that Empirical evidence shows that

Fund programs work chiefly as Fund programs work chiefly as intendedintendedReduce current account deficitsReduce current account deficitsBolster foreign exchange reservesBolster foreign exchange reservesReduce inflation, but not always, Reduce inflation, but not always,

partly because of currency partly because of currency depreciationdepreciation

To see how, and prepare for #4, To see how, and prepare for #4, consider a small modelconsider a small model

Do Fund programs Do Fund programs strengthen the balance of strengthen the balance of

payments?payments?33

Reserves and output in Reserves and output in the short run: A simple the short run: A simple

modelmodelExpress key accounting Express key accounting

linkages in terms of simple linkages in terms of simple algebraalgebra

Use model to describe how Use model to describe how nominal income and foreign nominal income and foreign exchange reserves depend on exchange reserves depend on domestic creditdomestic creditDemonstrate how BOP target Demonstrate how BOP target

translates into prescriptions for translates into prescriptions for fiscal and monetary policies fiscal and monetary policies

Financial programming in actionFinancial programming in action

List of variablesList of variables

M = moneyM = money

D = domestic creditD = domestic credit

R = foreign reservesR = foreign reserves

R = R-RR = R-R-1-1 = balance = balance of paymentsof payments

P = price levelP = price level

Y = real incomeY = real income

v = velocityv = velocity

X = real exportsX = real exports

PPxx = price of exports = price of exports

Z = real importsZ = real imports

PPzz = price of imports = price of imports

F = capital inflowF = capital inflow

m = propensity to m = propensity to importimport

Two behavioral

parameters: m

and v

List of relationshipsList of relationships

M = D + R M = D + R (monetary (monetary survey)survey)

M = (1/v)PYM = (1/v)PY (money demand)(money demand)

R = (1/v)PY – DR = (1/v)PY – D (M schedule)(M schedule)

R = PR = PxxX – PX – PzzZ + FZ + F (balance of (balance of

payments)payments)

PPzzZ = mPYZ = mPY (import demand)(import demand)

R = PR = PxxX – mPY + F + RX – mPY + F + R-1-1 (B schedule)(B schedule)Estimate m and v

by regression

analysis

The M scheduleThe M schedule

Reserves (R)

M schedule

1

v

R = (1/v)PY – D

D up

An increase in reserves increases quantity of money, and hence also income

PY = v(R + D)

PY is nominal income GNP (PY)

The B scheduleThe B schedule

B schedule

1

m

R = PxX – mPY + F + R-1

F up, e down

An increase in income spurs imports, so reserves decline

Reserves (R)

GNP (PY)

Domestic credit contractionDomestic credit contraction

M

B

D down

M’

A

When D falls, M also falls, so that PY goes down and PzZ also decreases. Therefore, R increases. Here, an improvement in the reserve position is accompanied by a decrease in income.

R*C

Too low reserves

Reserves (R)

GNP (PY)

Domestic credit contractionDomestic credit contraction

M

B

D down

M’

A

So, credit restraint per se strengthens the BOP: R increases. But, and this was the charge against the IMF, income goes down, and this means that real real income goes down because prices are sticky. But …

R*C

Too low reserves

Reserves (R)

GNP (PY)

Not in theory because Fund Not in theory because Fund programs contain at least two programs contain at least two main elementsmain elements

Fundamental rule of the theory Fundamental rule of the theory of economic policy: It takes two of economic policy: It takes two stones to hit two birdsstones to hit two birdsSo, use credit policy to adjust BOP So, use credit policy to adjust BOP

……… … and, use some other instrument and, use some other instrument

to address the implications for to address the implications for outputoutput

E.g., exchange rate policy or E.g., exchange rate policy or structural measures that impact structural measures that impact supply sidesupply side

Do Fund programs hurt Do Fund programs hurt output in the short run?output in the short run?4a4a

Domestic credit contraction Domestic credit contraction accompanied by devaluation*accompanied by devaluation*

GNP (PY)

M

BD down

B’

M’

A

C

When D falls, M also falls, so that PY goes down and PzZ also decreases. Therefore, R increases. Further, devaluation* strengthens the reserve position and helps reverse the decline in income.

R*

Reserves (R)

*Or, e.g., capital account liberalization

F up, e down


GNP (PY)

M

BD down

B’

M’

A

C

So, BOP improves through both channels: credit restraint and devaluation.*Meanwhile, income can go either up or down, or stay the same.

R*

Reserves (R)


F up, e down


GNP (PY)

M

BD down

B’

M’

A

C

So, not surprising that a number of empirical studies found no evidence of negative effects of Fund-supported programs on output.

R*

Reserves (R)


F up, e down

The importance of The importance of appropriate side measuresappropriate side measures

Real exchange rate:Real exchange rate:

Devaluation* must be Devaluation* must be accompanied by fiscal and accompanied by fiscal and monetary restraint to prevent monetary restraint to prevent prices from rising and thus prices from rising and thus eating up the benefits of eating up the benefits of devaluationdevaluation

To work, nominal devaluation To work, nominal devaluation must result in must result in realreal devaluation devaluation

*P

ePQ


First-wave studiesFirst-wave studies

Four kinds of studies in Four kinds of studies in ascending order of complexity*ascending order of complexity*Before and afterBefore and afterWith and withoutWith and withoutGeneralized evaluationsGeneralized evaluationsComparisons of simulationsComparisons of simulations

All concluded that, in most Fund All concluded that, in most Fund programs, output did not go programs, output did not go downdown

*Haque and Khan, “Do IMF-Supported Programs Work? A Survey of the Cross-Country Empirical Evidence,” IMF WP

1998.

The distinction between short The distinction between short run and long run was not so run and long run was not so clear in the first waveclear in the first waveThis was before the endogenous This was before the endogenous

growth revolution that we growth revolution that we discussed beforediscussed before

In the second wave, the In the second wave, the distinction was clear, and the old distinction was clear, and the old criticism – that Fund programs criticism – that Fund programs restrained economic activity in restrained economic activity in the long run – resurfacedthe long run – resurfacedTrue or false?True or false?

Do Fund programs hurt Do Fund programs hurt output growth in the long output growth in the long

run?run?4b4b

Technically, this is difficult to Technically, this is difficult to ascertain because the long run ascertain because the long run spans several decadesspans several decadesDo not want to wait that long for Do not want to wait that long for

evidence of growth effects of Fund evidence of growth effects of Fund programsprograms

So, approach the question from So, approach the question from a different directiona different directionConsider, as a benchmark, a small Consider, as a benchmark, a small

model of growth and inflationmodel of growth and inflation


run?run?

Inflation and growth in Inflation and growth in the long run: A simple the long run: A simple

modelmodelExpress key linkages between Express key linkages between

inflation and growth in simple inflation and growth in simple algebraalgebra

Use model to describe how Use model to describe how growth and inflation depend on growth and inflation depend on monetary and fiscal policymonetary and fiscal policyDemonstrate how the need for Demonstrate how the need for

low inflation and rapid growth low inflation and rapid growth translates into prescriptions for translates into prescriptions for fiscal and monetary policies, and fiscal and monetary policies, and moremore

List of variablesList of variables

= inflation (% per year)= inflation (% per year)

m = monetary expansion (% per year)m = monetary expansion (% per year)

g = growth rate of output (% per year)g = growth rate of output (% per year)

s = saving rate (% of GDP)s = saving rate (% of GDP)

E = efficiency (from Y = EK, so E = E = efficiency (from Y = EK, so E = Y/K)Y/K)

= depreciation rate (% per year)= depreciation rate (% per year)

Two relationshipsTwo relationships

= m – g= m – g (Q schedule)(Q schedule)

g = sE(g = sE() - ) - (G schedule)(G schedule)

Q schedule is derived from Mv = PY by Q schedule is derived from Mv = PY by assuming v is constant and converting the assuming v is constant and converting the equation to 1+equation to 1+ = (1+m)/(1+g) ≈ 1 + m – g = (1+m)/(1+g) ≈ 1 + m – g

G schedule comes from growth lectureG schedule comes from growth lecture Two negatively sloped relationships Two negatively sloped relationships

between inflation and growth: let’s draw between inflation and growth: let’s draw them!them!

Assume -1 < E’() < 0, so G is steeper

than Q.

Inflation and growthInflation and growth

Economic growth

Infl

ati

on

G

A

45°

Q

= m – g= m – g

g = sE(g = sE() - ) - m

m

G schedule slopes down G schedule slopes down

because inflation because inflation

reduces efficiency: E’(reduces efficiency: E’() )

< 0 < 0

Slope = -Slope = -

11

Economic growth

Infl

ati

on

Q’

G

A

B

Q

Increased monetary expansion Increased monetary expansion increases inflation and reduces increases inflation and reduces

growthgrowth

As m goes up, Q shifts right, so also goes up and g goes down because the rise in reduces E.

m1 m2

45° 45°

Economic growth

Infl

ati

on

QG

A

G’

B

Increased saving* increases Increased saving* increases growth and reduces inflationgrowth and reduces inflation

*Including public saving

As s goes up, G shifts right (and tilts), so g also goes up and goes down because m does not move.

m45°

How would we expect long-run How would we expect long-run growth to respond to Fund growth to respond to Fund programs in this model?programs in this model?

The model implies that fiscal The model implies that fiscal and monetary restraint reduces and monetary restraint reduces inflation and stimulates long-inflation and stimulates long-run growthrun growthBut output may or may not fall in But output may or may not fall in

the short run, a different questionthe short run, a different questionAlso, recall adverse effect of high Also, recall adverse effect of high

inflation and overvaluation on inflation and overvaluation on long-run growthlong-run growth


run?run?

Back to base

Jeffrey Sachs* says soJeffrey Sachs* says soHe claims that the US wanted He claims that the US wanted

Russia to remain weakRussia to remain weakHe urged a Marshall plan for He urged a Marshall plan for

RussiaRussiaEven so, the IMF put strong Even so, the IMF put strong

emphasis on Russia and other emphasis on Russia and other transition countries in early transition countries in early 1990s and onwards1990s and onwardsEstablished European Established European

Department II Department II

Did the Fund respond too Did the Fund respond too slowly in Russia?slowly in Russia?55

*Jeffrey Sachs, The End of Poverty, Penguin Press, 2005.

Joseph Stiglitz* says soJoseph Stiglitz* says soHow would we describe a How would we describe a

collapse of confidence as collapse of confidence as occurred in Thailand in 1997 in occurred in Thailand in 1997 in our models?our models?By a plunge in F in the short-run By a plunge in F in the short-run

model, so both R and Y go downmodel, so both R and Y go downBy an outward shift of the Q By an outward shift of the Q

schedule in the long-run model, schedule in the long-run model, so so goes up and g goes down goes up and g goes down

Did the Fund call for Did the Fund call for premature financial premature financial

liberalization in Asia?liberalization in Asia?66

*Joseph Stiglitz, Globalization and its Discontents, W. W. Norton, 2002, and Making Globalization Work , W. W.

Norton, 2006.

Collapse of confidence: Collapse of confidence: The short runThe short run

GNP (PY)

M

B

F down

B’

A

C

When F falls, B shifts left, so that both R and PY go down from A to C. (The resulting fall in e may help reverse the leftward shift of B.) Dilemma: How should monetary policy react? Should D expand or contract?

Reserves (R)

?

?

Collapse of confidence: Collapse of confidence: The short runThe short run

GNP (PY)

M

B

F down

B’

A

C

If D expands, interest rates fallfall, so F falls further and B shifts farther to the left. If D contracts, interest rates riserise, so the fall in F is reversed and B shifts back to the right.Malaysia restricted movements of F.

Reserves (R)The M and B schedules are interdependentThe M and B schedules are interdependent

Stiglitz* says so, as does SachsStiglitz* says so, as does SachsThey have a point, as IMF They have a point, as IMF

concedesconcedesWithout knowing well how to Without knowing well how to

sequence policy reactions, an sequence policy reactions, an attempt was made to do as much attempt was made to do as much as possible at onceas possible at once

In retrospect, Malaysia was In retrospect, Malaysia was probably right to restrict capital probably right to restrict capital movementsmovements

Liberalization of trade should Liberalization of trade should precede liberalization of capital precede liberalization of capital movements to reduce volatilitymovements to reduce volatility

Did the Fund advocate too Did the Fund advocate too much monetary restraint in much monetary restraint in

Asia?Asia?77

*Joseph Stiglitz, Globalization and its Discontents, W. W. Norton, 2002, and Making Globalization Work , W. W.

Norton, 2006.

Collapse of confidence: Collapse of confidence: The long runThe long run

Economic growth

Q’

G

A

B

Q

When confidence collapses, money demand goes down (v goes up), so Q shifts right, inflation goes up and growth slows down.

m1 m2

Infl

ati

on

Collapse of confidence: Collapse of confidence: The long runThe long run

Economic growth

Q’

G

A

B

Q

Need to increase s through fiscal measures to shift G shift G rightwardrightward and reduce m through monetary policy to shift Q leftwardshift Q leftward to move back southeast from B.

m1 m2

Infl

ati

on

No! – not in my viewNo! – not in my viewBut Stiglitz and others raise good But Stiglitz and others raise good

points about, inter alia, points about, inter alia, increased inequality, pointing increased inequality, pointing out that …out that …Asia grew rapidly with reasonable Asia grew rapidly with reasonable

equality in the distribution of equality in the distribution of incomeincome

Inequality has increased recently Inequality has increased recently due, in part, to globalization and to due, in part, to globalization and to rapid technological progressrapid technological progress

Increased inequality precedes Increased inequality precedes crisescrises

Recall: Equality may be good for Recall: Equality may be good for growthgrowth

Is the Fund on the wrong Is the Fund on the wrong side of the debate of side of the debate of

globalization?globalization?88

William Easterly* says soWilliam Easterly* says soUnconditional foreign aid as Unconditional foreign aid as

manna from heavenmanna from heavenAid, like natural resources, needs Aid, like natural resources, needs

good management as well as good good management as well as good institutionsinstitutions

Aid accompanied by good policies is Aid accompanied by good policies is more effective than aid with bad more effective than aid with bad policiespolicies

Rationale for conditionalityRationale for conditionality

Development Development assistance: assistance:

A mixed blessing?A mixed blessing?

Before concluding

*William Easterly, The Elusive Quest for Growth, MIT Press, 2001, and The White Man’s Burden, Penguin

Press, 2006.

Increased transparencyIncreased transparencyPublication of policy Publication of policy

recommendations and recommendations and discussions on the webdiscussions on the web

Transparency helps local Transparency helps local reformers as they are able to reformers as they are able to point to Fund advicepoint to Fund advice

Increased opennessIncreased opennessFund no longer circumnavigates Fund no longer circumnavigates

sensitive matters like corruption sensitive matters like corruption if it is a matter of macroeconomic if it is a matter of macroeconomic concern concern

Examples: Kenya, RussiaExamples: Kenya, RussiaFlexibility, as now in IcelandFlexibility, as now in Iceland

In fairness to the FundIn fairness to the FundOne more thing

Entire banking system collapsed Entire banking system collapsed 20082008 Inflicting financial losses of ca. seven Inflicting financial losses of ca. seven

times GDP on foreign and domestic times GDP on foreign and domestic clientsclients

IMF was asked for helpIMF was asked for helpStand-by arrangement: $5 billion, of Stand-by arrangement: $5 billion, of

which $2 billion from IMF and rest which $2 billion from IMF and rest from Nordic countries and othersfrom Nordic countries and others

Shared conditionalityShared conditionalityNovel program featuresNovel program features

Temporary capital controlsTemporary capital controlsFiscal space for one yearFiscal space for one year

Iceland storyIceland story

Conclusion: Conclusion: Changing role of the FundChanging role of the Fund

The EndThe End

World has changed, IMF adjustedWorld has changed, IMF adjustedThe long run matters, tooThe long run matters, tooSo, Fund and Bank overlap more than beforeSo, Fund and Bank overlap more than before

Fund programs now are more varied than beforeFund programs now are more varied than before Public health issues are now a macroeconomic concernPublic health issues are now a macroeconomic concern

Institutional issues now receive more attentionInstitutional issues now receive more attention Financial markets; same is true of national central banksFinancial markets; same is true of national central banks

Personally, I think Fund has done goodPersonally, I think Fund has done goodPolicy advice, technical assistance, trainingPolicy advice, technical assistance, training

Example: Emphasis on inflation control has helped Example: Emphasis on inflation control has helped bring inflation down around the world, and – bring inflation down around the world, and – remember! – that’s good for growthremember! – that’s good for growth

Fund offers expertise in handling financial Fund offers expertise in handling financial crisescrises

Alternative Views of the IMF Thorvaldur Gylfason Stellenbosch, South Africa 2-13 November 2009.

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