The World Needs the International Monetary Fund.

Opinions on Debatable Issues #26

International Monetary Fund (IMF) was established in 1944 to build a framework for international economic cooperation. Today, its membership encompasses 190 countries. Many have criticized it for being too outdated for modern international economy, exploitative of poor countries, and failure for preventing some economic crisis. Yet, it has been acting as an indispensible international institution that kept the world economy intact and helped fend off many fiancial and currency crisis. Its benefit of providing prompt and adequate loans to its member nations and acting as responsible survielliance and advicer for economically unstable regions make it much more necessary than many can perceive.

One benefit of IMF is its ability to lend up to $1 trillion to its member countries. Countries that join IMF have to pay capital subscription/quotas that are based broadly on their relative positions in the world economy. During times of financial difficulty, countries can borrow from this pool of capital to ameliorate the situation. This strategy was proven successful. In 1999, IMF provided a $2.7 billion loan to help Colombia overcome a severe recession, helping it to adopt a flexible exchange rate, which provided a buffer for economic shocks, and an inflation target to keep prices under control. According to Andres Escobar, the Former Deputy Finance Minister, IMF helped Colombia earn the “credibility of the international markets”. In 2009, Colombia met the eligibility of an IMF program that makes money available to countries with a track record of strong economic management. This reassurance gives more confidence to the international investors. The benefits were not temporary. In 2014, the flexible exchange rate helped Colombia to avoid a recession when its oil prices collapsed.

The second benefit of IMF is its function of monitoring the international monetary system and global economic developments” and undertaking regular “health checks of the economic and financial policies of its member countries” to identify risks and recommend policies for growth and financial stability. According to Maurice Obstfeld, a professor of economics at the University of California, Berkeley, research on currency crises has shown that “crises become more likely when investors lose confidence in a government’s willingness to sacrifice domestic policy goals in exchange for maintaining its exchange rate”. IMF’s conditionality, which suggests domestic measures that help countries overcome an overt or smoldering economic crisis, can thus indirectly decrease the likelihood of crises by increasing investors’ confidence that the government will adjust its macroeconomic policies.

International Monetary Fund: Benefits and Drawbacks — Investopedia

This was shown in Vietnam. In 1986, IMF initiated a program of economic reform known as Doi Moi. It helped “lift 40 million people out of poverty between 1993 and 2014”, causing the “poverty rate to drop to 14 percent from almost 60 percent.” According to IMF, advisers from the IMF have helped Vietnam improve public administration, tax policy, central banking, statistics gathering, and credit rating, which attracts foreign investment that is crucial for boosting the economy and creating jobs.

The third benefit of IMF is its ability to help advance governmental measures that aim at preventing economic instability both directly and indirectly, according to Axel Drreher, one of the 500 top economists of the world as recognized by the Research Papers in Economics. Directly, IMF provides information encouraging particular policies when there is already domestic inclination for that policy, so the information can help to reduce uncertainty and cajole domestic opponents, facilitating reform and creating an economic environment in which the emergence of a currency crisis is unlikely. Indirectly, IMF can act as a “scapegoat” to bear the fire and criticism of certain controversial economic and financial policies, according to James Raymond Vreeland, a Professor of International Relations at Georgetown University. Because currency crises can “best be avoided with authorities implementing reforms that tend to be painful in the short run”, policymakers can blame the IMF for “forcing” them to implement painful reforms to ease the political pressures on these policymakers. With less public opposition directed at the government, policies can be implemented much easier, decreasing the risk of a currency crisis in the future.

IMF Lending — International Monetary Fund

Overall, a study that evaluated IMF’s function using panel data for 68 countries over 27 years found that the existence of an IMF program significantly decreases the risk of a currency crisis and increases the likelihood that the exchange rate will be adjusted once a crisis is underway despite its potential for inducing moral hazard and susceptibility to lack of compliance from member nations. It also found that the existence of an IMF program drives this result, rather than money meaning that the credit and advice, as well as economic and financial programs, help lower the risks more than the money does. This shows the value of IMF as an important institution that has value beyond being a charitable fund.

Some criticize IMF’s intervention in the Asia Crisis of 1997 worsened the situation by raising interest rates. However, IMF did what is appropriate to the circumstances of individual countries, according to Stanley Fischer, an American economist and the former vice-chairman of the Federal Reserve. At the time of the crisis, “the reserves of Thailand and Korea were perilously low, and the Indonesian rupiah was excessively depreciated”. Thus, the first thing to do is to restore confidence in the currency, according to Fischer, by making holding domestic currency more attractive. That requires increasing interest rates temporarily, even if higher interest costs complicate the situation of weak banks and corporations. IMF utilized this strategy obtained from the tequila crisis in Latin America 1994-95, as well as from the more recent experience of Brazil, the Czech Republic, Hong Kong, and Russia. They all prevented currency crises with a timely and forceful tightening of interest rates along with other supporting policy measures.

There is no way you can stop a recession without making sacrifices. If no immediate decision was made to raise the interest rate, then, the currency will rapidly depreciate due to the eroding confidence that investors have in the domestic economy. As Fischer points out, “Asian companies with substantial foreign currency debts suffer far more from a steep slide in the value of their domestic currency than from a temporary rise in domestic interest rates”.

International Monetary Fund

Some also argue that IMF induces moral hazard, which is encouraging borrowers and lenders to behave in ways that make a crisis more likely. This argument has not been proven with empirical evidence. Also, one stated purpose of IMF is “to give confidence to members by making the general resources of the IMF temporarily available to them under adequate safeguards.” So moral hazard only occurs when IMF’s support encourages borrowers and lenders to take “excessive or imprudent risks and these extra risks outweigh the benefit of IMF financial help in easing the impact of the crisis”. In fact, history tells us IMF programs do not have a noticeable influence on investors’ perception of risks. According to the Financial Pipeline, a bond spread reflects the risks of an investment. The higher the spread, the higher the risk usually is. In 1995, IMF lent Mexico $17.8 billion, which is the largest ever approved for any member country up until that point. The spreads on bonds of several Asian emerging markets did not change when Mexico began to run into financial difficulties and when IMF support for Mexico was approved, so the risks that investors were taken show no positive correlation to the assistance that IMF lends in support of countries. No moral hazard induction can be ascertained.

In short, IFM contributes greatly to the maintainance of a stable world economy. Sometimes, it has to take austere and even radical measures to contain an crisis to prevent a global recession for the public good. As an international organization established in the 1940s, it has been evolving and striving for meeting its goals. The world witnessed their support for many nations to alleviate millions out of poverty and slow down currency depreciation. It has benefited so many, which outweighs the failures and mistakes it had created.