On the first day in her new job the IMF boss was interviewed by the in-house survey unit and asked to outline her agenda. She clearly thinks the IMF remains a centrepiece of the international monetary system. The evidence would suggest otherwise. The conduct of the IMF over its long history has not advanced prosperity and once the fixed-exchange rate system collapsed as unworkable the rationale for the IMF also disappeared. In trying to reinvent itself over the last 40 years, the IMF has become an exemplar of neo-liberal free market thinking and action and caused many of the larger crises that have evolved during this period. Its role in the current crisis exemplifies its culpability. It turns out that a leading mainstream economists also thinks it is time to shut the doors at 700 19th Street, N.W., Washington, D.C. 20431.
In reply to the question: “what are the biggest challenges facing the global economy?”, the new IMF boss’s first response was:
You have sovereign debt issues in most of the advanced countries. This is most acute in a monetary zone called the euro zone … but it’s not the only one. The sovereign debt issue is pretty much all over the place in the advanced economies, from Japan to the United States, and obviously epitomized in the European Union, and the euro zone in particular.
She then mentioned inflation threats and finally “unemployment rising, or not resolved, and not abating”.
She was then asked “What is the role of the IMF in helping its member countries tackle some of these challenges that you’ve mentioned?”
Her reply was that the IMF has to conduct “bilateral surveillance” of national outcomes and it “has the largest, biggest, and most powerful brain power assembled together under one roof” to conduct this surveillance.
Secondly, the IMF can provide “lending, supporting, and helping out countries that need a program because they are going through a difficult situation. It is a current account balance fix essentially”.
Third, it should make “recommendations” to specific organisations such as the Group of Twenty (G-20).
I have written several blogs about the IMF in the last few years, among them are:
- Life in the IMF fantasy world
- The IMF – incompetent, biased and culpable
- There are riots in the street but the IMF wants more unemployment
- The IMF continue to demonstrate their failings
- Are capital controls the answer?
- IMF agreements pro-cyclical in low income countries
- The IMF fall into a loanable funds black hole … again
There are two broad angles which we can criticise the IMF. First, it has outlived its role. Second, in trying to redefine its role it causes more trouble than it is worth.
In both respects, I find myself in agreement with arch mainstreamer Edmund Phelps (Columbia University). Along with Milton Friedman, Edmund Phelps was an early contributor to the “natural rate of unemployment” literature, which I have spent a career writing against.
According to this school of thought, there is no discretionary role for aggregate demand management (other than to control inflation via monetary policy) and only microeconomic changes can reduce the natural rate of unemployment.
So they claim that the only viable policy debate must be concentrated on deregulation, privatisation, and reductions in the provisions of the Welfare State with tight monetary and fiscal regimes instituted.
Of-course, the last two decades or more have been characterised by just that sort of policy – what we refer to as the neo-liberal era – and apart from high unemployment persisting and poverty at the lowest end not abating – the deregulated financial and labour markets set
In relation to the current crisis, Phelps wrote on November 2, 2009 – A fruitless clash of economic opposites – which focused on what he claims is the fallacy of the “Keynesians”:
… is their premise that all slumps, all of the time, are entirely the result of “co-ordination problems” – mis-expectations causing a deficiency of demand. Having modelled the effects of expectations decades ago, I know they have consequences. I agree that companies appeared to underestimate the cutbacks and price cuts of competitors on the way down. That excessive optimism signalled deficient demand for goods and labour. So any stimulus then may have had a Keynesian effect. By now, though, such optimism has surely been wrung out of the system. To pump up consumer or government demand would force interest rates up and asset prices down, possibly by enough to destroy more jobs than are created.
So from that you can conclude that Phelps has a thoroughly mainstream view of the relationship between government spending and interest rates such that when government spending rises the claims on a finite supply of savings (loanable funds doctrine) lead to rationing (via interest rates changes) so that other borrowers lose access to funds and their price goes up to others.
The alternative mainstream view that emerged out of Keynes thinks that money demand is motivated by transactions and the more transactions the more demand for money you would have. They also claim that the central bank controls the money supply (they believe in the money multiplier) and so if governments spend more, money demand rises, and for a given money supply there is an excess money demand. The only way this can be rationed is for interest rates to rise (and bond prices to fall).
Neither view represents an accurate description of the way a fiat monetary system operates. Government spending creates new net financial assets (bank reserves) and increases income – which increases savings. If the government borrows to match its net spending it is just offering the holders of bank reserves (that the deficits created) an interest-bearing asset. But it is just borrowing the funds it created back. The issuing of public debt does not reduce the capacity of private agents to spend.
Further, the central bank does not control the money supply and monetary growth is endogenous and reflective of the demand for loans by consumers and firms. The central bank sets the interest rate and supply reserves to the banking system as required. Loans are never deposit-constrained – in fact, loans create deposits.
So Phelps’s representation of what is likely to happen when governments spend more is sadly astray and despite his 2006 Nobel Prize he should disqualify himself from the macroeconomic debate.
It is now July 2011 – 18 months on from when he wrote that article – and we cannot detect asset prices falling (bonds) nor interest rates rising. The reason is because the monetary system doesn’t operate in the way Phelps conceives it.
Please read my blog – Those bad Keynesians are to blame – for more discussion on Phelps.
But the question and answer section of the presentation was very interesting and bears on what I have just written.
Congressman Sean Duffy: We had talked about the QE2 with Dr. Paul. When — when you buy assets, where does that money come from?
Ben Bernanke: We create reserves in the banking system which are just held with the Fed. It does not go out into the public.
Congressman Sean Duffy: Does it come from tax dollars, though, to buy those assets?
Ben Bernanke: It does not.
Congressman Sean Duffy: Are you basically printing money to buy those assets?
Ben Bernanke: We’re not printing money. We’re creating reserves in the banking system.
We could quibble about some terminology here such as whether transactions that add to bank reserves “go out into the public”. Government spending adds to bank reserves and definitely goes out into the public. The reserve impact is after the demand boost has been registered by the economy. What he probably meant was that banks do not lend reserves and further that quantitative easing merely swaps financial assets within the federal reserve system.
There are other issues that we could raise but I refer you to Warren Mosler’s blog on this topic.
Anyway, back to Phelps. His recent article in Newsweek (July 10, 2011) – More Harm Than Good – is interesting and I find myself agreeing with the basic proposition – “How the IMF’s business model sabotages properly functioning capitalism”.
While I disagree with his motives for writing the article – which is to further deregulate the world economic system – the points he makes in relation to the IMF are in accord with my own thoughts.
The article notes that:
The International Monetary Fund’s new managing director, Christine Lagarde, has inherited an IMF that has outlived its purpose. It takes just a bit of history to explain why. The IMF was created under the 1944 Bretton Woods agreement, a plan to promote open markets through exchange rates tied to the U.S. dollar. If a country couldn’t cover its trade deficits, the IMF was to step in and lend it the needed dollars—on certain conditions. To ensure that the emergency loan would be repaid, and to clear the way for other financial institutions to make or renew longer-term loans in safety, the recipient nation had to adopt a program of strict austerity.
You may want to read the excellent book by Joseph Stiglitz (2002) Globalization and its Discontents (New York: W.W. Norton) on the history of the IMF’s austerity programs. You can find some information about the book HERE.
I could write a lot about the early history of the IMF but I have much time this afternoon.
The IMF was formed as an outcome of the Bretton Woods conference in 1944 as World War II was ending.
While that conference pitted the British (led by Keynes) and the US negotiators against each other – one side (British) being more liberal than the other in terms of organisation of the international monetary system – all sides accepted that there was a need to prevent a return to the closed financial markets and competitive exchange rate policies of the 1930s.
They agreed on a rules-based monetary system which essentially put in place the fixed exchange rate, US dollar convertibility system. The gold stocks were too unbalanced to allow a strict return to the Gold Standard so it was agreed to fix the parities against the US dollar which was then tied to gold.
The IMF was conceived differently by the British and the US. The former thought of it as a cooperative fund that could be used by the member states to maintain demand (and hence employment) when a crisis hit. So it would function like a “New Deal” organisation for all governments.
The US position was that the IMF should be a bank and thus should exercise due diligence to ensure debts were repaid. The transcripts of the conference show that the US were not really concerned about avoiding recessions and unemployment. They emphasised developmental loans based on strict conditions.
The IMF basically played that role during the Bretton Woods era (so the US won the debate) and provided “structural adjustment loans” to countries in need of funds to resolve balance of payments difficulties. The SAPs as they became known were usually relatively harsh programs and emphasised export-led growth, privatisation and deregulation.
In other words, the self-regulating private market emphasis. Stiglitz’s book is harshly critical of this ideological bias in relation to poverty reduction.
In recent years, as an aside, the IMF re-badged the SAPs under their “Poverty Reduction Strategy Initiative” – without any real change in substance.
The IMF was central to the fixed exchange rate system. It managed the system of parities and maintained pressure on member states to provide full convertibility of their currencies and to trade freely at the current parities.
Nations would buy and sell US dollars when they had trade deficits/surpluses to ensure the financial effects of those trade “imbalances” were neutralised and the parities retained.
The IMF would then loan nations funds when their foreign reserves were exhausted. In extreme cases, the IMF could approve a change in the par value of the currency (that is, its exchange rate) – but only if the IMF considered the balance of payments in that nation to be in “fundamental disequilibrium”. Then they would also insist on structural changes which usually damaged the local economy.
The whole monetary system was biased again nations that ran current account deficits. They were always facing domestic deflation as the central banks had to withdraw local currency (by selling foreign currency – usually US dollars) to maintain the agreed parity.
The system clearly broke down because it was politically unsustainable – current account deficit nations effectively rejected persistent unemployment and sluggish growth as the only option being presented to them.
Please read my blog – Gold standard and fixed exchange rates – myths that still prevail – for more discussion on this point.
The system collapsed in 1971 once the US was faced with massive external deficits and currencies then floated (more or less).
The Phelps article says that with the collapse of the Bretton Woods system in 1971:
… economists imagined at first that a new era of freely floating exchange rates would keep imports and exports roughly in balance, thus eliminating large trade deficits and the need to borrow abroad to cover them … When the pretense that a country was creditworthy became impossible to sustain, the IMF was wheeled in to do the dirty work and make the country safe to lend to again—until the next crisis.
We could dispute some of this history but the point is clear. The neo-liberal period has worked against the poorest nations.
And the IMF has contributed to the persistence of that poverty.
The Phelps article then concludes:
The Greek debacle and the North African drama raise existential questions about the IMF. Responsible governments have no business borrowing vast sums from abroad, rather than from domestic sources. That’s what tinpot regimes do. And lending even more to borrowers who can’t pay what they already owe? That’s what loan sharks and mafiosi do.
The IMF’s business model sabotages properly functioning capitalism, victimizing ordinary people while benefiting the elites. Do we need international agencies to enable irresponsible—verging on immoral—borrowing and lending? Instead of dreaming up too-clever-by-half schemes to stumble through crises after they happen, why not just stop imprudent banks from accommodating foreign borrowing by feckless governments? After all, it’s French and German taxpayers who are on the hook—not just the Greeks and the Irish.
The IMF approach undermines the capacity of nations to maximise their domestic potential and properly regulate capitalist firms. That is not the same thing that Phelps and his co-author are saying but it amounts to the same conclusion – the IMF is a damaging organisation.
In closing, I republish this graph which I produced for this blog – IMF agreements pro-cyclical in low income countries in October 2009. It uses data from the World Development Indicators, provided by the World Bank. It shows Gross National Income per capita, which, in material terms is an indicator of increasing welfare.
The overwhelming evidence is that the IMF SAPs increase poverty and hardship rather than the other way around. Latin America and Sub-Saharan Africa (which dominates the low income countries) were the regions that bore the brunt of the IMF structural adjustment programs (SAPs) since the 1980s.
While the high income countries enjoyed strong per capita income growth over the period shown (since 1980), Latin America (and the Caribbean) has experienced modest growth and the low income countries actually became poorer between 1980 and 2006.
The two trends are not unrelated. The SAPs are responsible for transferring income from resource wealth from low income to high income countries.
This sort of data confirms to me that the IMF has outlived its usefulness if it ever had any.
A new paradigm for economic and social development in less developing countries is needed. An international organisation that helps nations who are struggling with currency sovereignty is needed.
These nations may have ceded their sovereignty by entering currency zones; by dollarising their currencies; by running currency boards; and similar arrangements clearly are not sovereign and face the same constraints that a country suffered during the gold standard era.
My advice to them would be to implement a plan to remove themselves from these arrangements as quickly as possible. The responsible conduct of the IMF and other agencies would be to help them achieve currency sovereignty as soon as possible.
Further, where imported food dependence exist – then the role of the international agencies should be to buy the local currency to ensure the exchange rate does not price the poor out of food. This is a simple solution which is preferable to to forcing these nations to run austerity campaigns just to keep their exchange rate higher.
But that sort of role is far removed from that currently played or envisaged by the IMF.
The Saturday Quiz will be back sometime tomorrow – even harder than last week!
That is enough for today!