IMF: Review of recent literature on the financial crisis

Dominique Strauss-Kahn, Managing Director, International Monetary Fund, Source: Wikipedia

Dominique Strauss-Kahn, Managing Director, International Monetary Fund, Source: Wikipedia

 

The IMF, in an effort to play a useful role in resolving the current financial crisis, has produced research and commentary on the crisis that is available on its website, www.imf.org.  This important analysis of IMF staff can help policy practitioners and observers cut through the fog of media coverage and the associated tendency toward populism.

On March 6, the IMF produced a quantitative of the impact of fiscal expansion on government debt levels, forecasting a whopping 25% rise in debt/GDP in advanced countries by 2014!  The IMF outlined four general principles of longer-term fiscal solvency — making the stimulus temporary, undertaking medium-term commitments to reducing fiscal deficits, implementing structural reforms to raise GDP growth, and reforming health and pension programs.

In spite of skyrocketing debt levels expected, the IMF argued forcefully in two papers that sizable fiscal stimulus is needed to get the planet out of this mess. In “The Case for Global Fiscal Stimulus,” also released March 6, and “The Size of the Fiscal Expansion: An Analysis for the Largest Countries,” released February 1, the IMF discusses the likely effect of fiscal stimulus on global growth (a positive jolt of up to 2.25% in 2009) and the impact on the largest countries’ debt levels.  China, the US, Canada and the UK have room to undertake substantial stimulus, while there is less such room in Continental Europe, India and Japan, due to already high debt levels.  With the US contemplating the largest fiscal stimulus, appropriate given the deterioration in growth expected and the fact that weakened banks mean lower multipliers, it is likely to have a debt/GDP ratio in excess of other large economies, with the exceptions of Japan and Italy. 

In “Lessons of the Global Crisis for Macroeconomic Policy,” released February 19, the IMF finally argues that monetary policy should not just be geared towards fighting inflation, but also toward preventing asset price speculation.  Asset price booms in the stock market and especially in the real estate market were the proximate cause of the current crisis.  This is somewhat maddening to me because, after following emerging market crises for years, ones that often involved asset price booms, from Mexico to Asia, I came to the conclusion that monetary policy should take into account asset price run-ups and external imbalances (trade deficits).  Yet the prevailing wisdom at central banks throughout the nineties and much of this decade, epitomized in the knighting by Queen Elizabeth of Sir Alan Greenspan, was that monetary policy couldn’t prevent asset price bubbles and must solely confront goods price inflation.  This IMF paper argues that only asset price bubbles financed by debt should be attacked with monetary policy.

In a paper on the lessons of the crisis for financial regulation, released February 4, the IMF calls for expanding regulation to include hedge funds and other institutions, increasing capital requirements in good times, coordinating regulation, and tracking “interconnectedness” to limit systemic risk.

 

In “Initial Lessons of the Crisis for the Global Architecture and the IMF,” released February 18, the IMF bemoans the lack of policy coordination among nations in addressing the crisis, which I would take issue with.  Could coordination be better? Sure.  But, compared to the 1930s Beggar-thy-neighbor policies, the coordination of liquidity injections, fiscal stimulus, and bank rescues this time around seems pretty good so far.  What we must be vigilant about, and the U.S. looks worrying in this respect, is a protectionist reaction.  The IMF also calls for augmenting its resources and those of other IFIs, a sensible objective.  With only $250 billion available (that is, before the latest disbursements), and another $100 billion on offer by Japan, this appears modest relative to the task.

Finally, I point to a paper I have applauded before, “Systemic Banking Crises: A New Database,” from November 2008.  It details banking crises over the last thirty years across the globe and concludes that a targeted recapitalization of banks (i.e., a bank bailout) can limit losses in output.   

 

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