Tag Archives: IMF

After The Economist, The IMF Now Emphasizing Surplus Countries’ Responsibility

Recently, The Economist had a cover story saying that surplus nations bear responsibility for global imbalances and weak economic growth. Now, the IMF is also advising surplus nations to expand domestic demand.

The IMF tweeted this, with a link to a new report (2017 External Sector Report) on global imbalances:

click to see the tweet on Twitter

As I have said before, this is the biggest concession to Keynes’ idea that surplus countries bear the responsibility.

In an articleThe General Theory In An Open Economy, published in 1996, Paul Davidson says:

Keynes was well aware that the domestic employment advantage gained by export-led growth ‘is liable to involve an equal disadvantage to some other country’ (p. 338). When countries pursue an ‘immoderate policy’ (p. 338) of export-led growth (e.g., Japan, Germany and the NICs of Asia in the 1980s), this aggravates the unemployment problem for the surplus nations’ trading partners. These trading partners are then forced to engage in a ‘senseless international competition for a favorable balance which injures all alike’ (pp. 338-9). The traditional approach for improving the trade balance is to make one’s domestic industries more competitive by either forcing down nominal wages (including fringe benefits) to reduce labour production costs and/or by a devaluation of the exchange rate. Competitive gains obtained by manipulating these nominal variables can only foster further global stagnation and recession as one’s trading partners attempt to regain a competitive edge by similar policies.

Two Hundred Years Of Ricardian Trade Theory

Ingrid Kvangraven has a nice article200 Years of Ricardian Trade Theory: How Is This Still A Thing? on the blog, Developing Economics. In that, she asks how “the observation of persistent imbalances (and recurring debt crises in the deficit countries) appears to have little impact on the popularity of Ricardo’s theory.”

It’s a nice article going into details about the assumptions of the trade theory, but let me just add another perspective. New Consensus Economics is based on the assumption about the magic of prices and market forces acting to resolve imbalances. Government “intervention” (a loaded word), supposedly spoils this magic and economists are trained to think that this is the reason for crisis. So a New Consensus economist doesn’t find this to be contradictory. “Hey government, why did you interfere with the workings of the market”, an economist is likely to say.

The role of the government in this model is mainly about law and order and is supposed to balance its books. Whenever a crisis arises, economists tend to blame “fiscal profligacy” and recommend contraction of fiscal policy and “economic reforms”.

Of course, since the financial crisis started about ten years back, economists have conceded that they have been wrong about several things. Fiscal policy is one major area where this is so. But the “learned intuition” is so deeply ingrained and ramified into every corner of their minds—borrowing words from Keynes—that it is difficult for them to escape old ideas.

It’s unfortunate that Keynes didn’t stress much about this problem, which is huge. In his GT, he did have a chapter on mercantilism and discussed how the mercantilists behaved the way they behaved because of their distrust in the role of market forces in resolving imbalances. Keynes also had a plan called the Keynes Plan, before the Bretton Woods established. Keynes proposes a fine on creditor nations as well (page 23-24):

from page 23 of IMF’s document on Keynes’ Plan

Usually one only hears of this in Post-Keynesian literature but this was not all. He also proposed other responsibilities for creditors:

from page 24 of IMF’s document on Keynes’ Plan

Of course, the idea of a Bancor sounds crazy because of its similarity to the Euro. The trouble with the Euro is that there is no central government with large fiscal powers, such as in a federation like the United States. Bancor would need a world government. Nonetheless, we can still embrace Keynes’ genius that creditors should take responsibility in the rules of the game and reject Bancor. So apart from the principle of effective demand, this is one of Keynes’ biggest contribution to the history of humankind—that creditor nations have a responsibility.

Unfortunately, the world is still stuck with Ricardo’s ideas!

IEO On The Euro Area’s Balance Of Payments Problems

The IEO, Independent Evaluation Office of the IMF has come up with a report The IMF And The Crises In Greece, Ireland, And Portugal in which it discusses how the IMF rejected the possibility of a balance of payments crisis in a monetary union without a full political union such as in the Euro Area.

Ambrose Evans-Pritchard of The Telegraph quotes an important passage from the report in an article:

“The possibility of a balance of payments crisis in a monetary union was thought to be all but non-existent,” it said. As late as mid-2007, the IMF still thought that “in view of Greece’s EMU membership, the availability of external financing is not a concern”.

At root was a failure to grasp the elemental point that currency unions with no treasury or political union to back them up are inherently vulnerable to debt crises. States facing a shock no longer have sovereign tools to defend themselves. Devaluation risk is switched into bankruptcy risk.

The quote is in page 25 (page 33 of pdf) of the article, linked on top of this page.

Some economists clearly saw it coming. Here’s Wynne Godley from his 1991 article Commonsense Route To A Common Europe for The Observer:

… But more disturbing still is the notion that with a common currency the ‘balance or payments problem’ is eliminated and therefore that individual countries are relieved of the need to pay for their imports with exports.

Quite the reverse: the existence or a common currency makes a country more directly dependent on its ability to sell exports and import substitutes than it was before, particularly as it will then possess no means whereby it can (in the broadest sense) protect itself against failure.

Why doesn’t it happen to a state in say the United States? This is because, there’s a federal government which is engaged in automatic fiscal transfers. Weaker states as a whole will receive more from the government than what it sends as taxes, especially during downturns. This has the effect of stabilizing the current account balance of payments of the whole region and prevents its indebtedness from exploding relative to its economic output. The Euro Area clearly does not have it.

IMF’s World Economic Outlook On Global Imbalances

The IMF has released a couple of chapters from its upcoming World Economic Outlook. There is one chapter Are Global Imbalances At A Turning Point, which talks of not just “flow imbalances” (current account deficits/surpluses) but also “stock imbalances” (international investment positions).

There is a nice table with a lot of information (although it is interested in absolute indebtedness and misses out small countries with high indebtedness in the list but still good information).

IMF Largest Creditor And Debtor Economies

The article stresses that flow imbalances are not just enough to analyse the macroeconomics but stock imbalances also need to be studied. Of course, in reality deficits/surpluses are not the true measures of imbalances as Nicholas Kaldor stressed in a footnote in his 1980 article The Foundations Of Free Trade Theory And Their Implications For The Current World Recession (published in Collected Essays Vol. 9):

Morever, the actual surpluses and deficits are not a proper measure of the potential size of such imbalances (and of the deflationary force they exert) since the countries who suffer from an excessive import propensity tend, on that account, to suffer from an insufficiency of domestic demand as well so their aggregate output or income is demand-constrained; they may, in addition be forced to follow a deflationary fiscal and monetary policy, and for both of these reasons, will import less from the surplus countries than they would do under full employment conditions.

The same reasoning is valid for stock imbalances as well. The true solution to reverse the imbalances without hurting aggregate demand is to rein in free trade and expand domestic demand by fiscal policies, especially by creditor nations but with so much orthodoxy around — especially from the IMF, there still is a long way to go. The global imbalances problem itself is the result of neoliberal policies promoted by the IMF.

Exchange Rate Arrangements

The IMF publishes a report annually on exchange rate arrangements and restrictions for all its members. This document is surprisingly not oft-quoted. You may find it very useful.

The full report Annual Report On Exchange Arrangements And Exchange Restrictions can be obtained via courier from the IMF bookstore – it is a protected pdf on a CD and has about 3000 pages. The smaller version for 2013 (released December 2013) is here on the IMF website.

Interesting things: there are a few more currency unions other than the Euro Area and the central bank in those unions have a different arrangement than floating. So there’s ECCU (currency board with the US dollar as the anchor currency) and WAEMU, CAEMC (conventional pegs with the Euro as the anchor) in addition to the EMU (whose currency floats freely versus other currencies)

Table 1 (pages 16-17 in pdf view or pages numbered as 5-6) is very useful and lists all IMF members and the arrangements. There are 10 classifications: No separate legal tender, currency board, conventional peg, stabilized arrangement, crawling peg, crawl-like arrangement, pegged-exchange rates within horizontal bands, other managed arrangements, floating and free floating.

The Globalization Paradox

I am reading Dani Rodrik’s The Globalization Paradox and borrowed the title for this post.

I am curious as to what Barry Eichengreen has to say in his talk at the Federal Reserve’s annual forum at Jackson Hole, Wyoming. He is the author of the book Exorbitant Privilege: The Rise And Fall Of The Dollar And The Future Of The International Monetary System – one of the books I want to read soon. The phrase Exhorbitant Privilege was coined in the 1960s by the then French Finance Minster Valéry Giscard d’Estaing. The term refers to the high ability of the United States (and directly and indirectly, the United States government) to borrow in US$ to finance its balance of payments deficit.

To some extent, the scale and timing of the Federal Reserve’s emergency operations during the credit crisis which started around 2007 has helped maintaining the hegemony of the US$ for a while and Barry Eichengreen knows that. This United States Government Accountability Office (GAO) report Federal Reserve System – Opportunities Exist To Strengthen Policies And Processes For Managing Emergency Assistance is a nice reference for the kind of operations done by the Fed, especially international swap lines. Many central banks made use of the swap lines and lent large quantities of US$ to the banking system because banks were facing funding issues in dollars.

Back to the Jackson Hole Symposium. Everyone is waiting for the ECB Chairman Jean-Claude Trichet’s talk. Meanwhile Christine Lagarde, IMF’s chief touched on some issues about imbalances in her speech. She rightly points out that

… risks have been aggravated further by a deterioration in confidence and a growing sense that policymakers do not have the conviction, or simply are not willing, to take the decisions that are needed.

which is quite right, IMO because this crisis needs coordination at a scale never seen before. She also points out that

As we all know, a major cause of the crisis was too much debt and leverage in key advanced economies. Financial institutions engaged in practices that magnified, disguised and fragmented risk, while households borrowed too much. Experience tells us that these excesses (combining both housing and financial crises) take a long time to work off—and require decisive action. We have made some progress, but not enough to unshackle growth.

I am by no means downplaying what has been done. In 2008, governments took bold action to prevent a calamitous collapse in demand. They offset private contraction with fiscal expansion and used public resources to recapitalize financial institutions. They strengthened financial regulation, and reinforced the capacity and resources of international institutions. And monetary authorities did their part as well.

But today, it is public sector balance sheets themselves that are in the firing line. Today, the headline problems are sovereigns in most advanced economies, banks in Europe, and households in the United States.  Adding to this—global growth is also being held back by policies that slow demand in some key emerging market economies while balance sheet risks are increasing in others.

The fundamental problem is that in these advanced economies, weak growth and weak balance sheets—of governments, financial institutions, and households—are feeding negatively on each other. If growth continues to lose momentum, balance sheet problems will worsen, fiscal sustainability will be threatened, and policy instruments will lose their ability to sustain the recovery.

which is quite right. Fiscal expansion has helped nations recover from the private sector imbalance but fiscal policy alone cannot achieve everything. However, somewhere her message won’t work well because she mentions earlier in her speech that

Two years ago, it became clear that resolving the crisis would require two key rebalancing acts—a domestic demand switch from the public to the private sector, and a global demand switch from external deficit to external surplus counties. On the first, the idea was that strengthened private sector finances would allow the engine of growth to switch back from the public to the private sector. On the second, the idea was that higher demand in surplus countries would make up for a lower spending path in deficit countries. But the actual progress on rebalancing has been timid at best, while the downside risks to the global economy are increasing.

implying thereby that coordinated fiscal policy (expansion) has no role in the long run, at least giving the impression to the reader/listener. However, she is right in stressing that surplus nations need to take up the task of rebalancing.

While talking of “urgent recapitalization” banks in Europe require, Lagarde also talks of a common vision for Europe:

Third, Europe needs a common vision for its future. The current economic turmoil has exposed some serious flaws in the architecture of the eurozone, flaws that threaten the sustainability of the entire project. In such an atmosphere, there is no room for ambivalence about its future direction. An unclear or confused message will add to market uncertainty and magnify the eurozone’s economic tensions. So Europe must recommit credibly to a common vision, and it needs to be built on solid foundations—including, for example, fiscal rules that actually work.

but no mention of a fiscal union! Most people – economists at least – would take the above to mean a plan to work toward achieving targets for deficits and public debt – an impossible dream.

Lagarde’s conclusions are right

There is a clear implication: we must act now, act boldly, and act together.

but this comes only by at least and not limited to coordinating fiscal policies not by “fiscal consolidation” – a phrase which literally suggests a fiscal contraction.

Conclusion

The IMF is a part of the problem but Christine Lagarde’s heart is in the right place – she needs to carefully think about how fiscal policy really matters and convey to others some of the ideas she has thought of, since they are slightly different from the IMF’s traditional beliefs. How far she goes will be interesting to see.

The sectoral balances identity

NAFA = PSBR + BP

(where NAFA is the private sector net accumulation of financial assets, PSBR is the public sector borrowing requirement to finance its deficit and BP is the current balance of payments) and the approach which is built around this, implies that if the public sector wants more saving, the government has no choice but to accommodate this demand unless it is prepared to run the economy at less than full employment. However, it doesn’t mean that the government has the ability to fully relax its fiscal stance up to constraints from the supply side, because if domestic demand starts expanding faster than domestic output, the nation’s balance of payments situation will suffer and this can be resolved only by correctly negotiated international policies which is good for all. The IMF should look at it that way instead of recommending fiscal expansion as a temporary measure.

Update

For a different take on Lagarde’s speech check Zero Hedge

Update 2:

Financial Times has a post Lagarde calls for urgent action on banks on this. The writer points out that

On fiscal policy, she continued the IMF’s change of emphasis away from immediate fiscal tightening, and towards fiscal programmes that reduce deficits over the long-term but which allow spending to continue while economies stay weak.