I’m imagining that things have gotten a little chilly for some in the IMF’s cafeteria. Why? Two important studies coming from different quarters of the Fund validate important and long-standing criticisms of the institution.
The first is a recent report by the IMF’s Independent Evaluation Office (the IEO), an internal body that conducts notably refreshing and often critical audits of various aspects of IMF performance. In an especially hard hitting (and on target) report, the IEO takes on the IMF’s work on exchange rate issues and specifically on “excess” foreign reserve accumulation in some countries during the period 2000-2011. After 2009, we should recall, IMF economists began to argue that excess reserve accumulation contributed to global financial instability. The report provides support for what many Fund watchers have long argued—namely, that the Fund has used the charge of excess reserve accumulation as a Trojan horse to advance the interest of its most powerful members in pushing countries like China to move toward more flexible exchange rates.
The same IEO report finds that the Fund’s analysis of excess reserve accumulation was analytically deficient on several grounds. First, the report’s authors argue that there is scant academic evidence for setting upper or lower limits to countries’ reserve levels (though the IMF has attempted to do so via a reserve adequacy metric since 2011). Second, the obsessive focus on reserves meant that Fund staff overlooked the precautionary motives that caused some countries (in East Asia and elsewhere) to amass massive reserves.
The misguided focus on reserves also distracted the Fund’s economists from identifying the real factors that led to global financial fragility: namely, light-touch financial regulation, excess global liquidity, and international capital flow volatility. Indeed, the IEO report concludes that the actual size of reserves in the global economy in 2010 should not have been considered excessive, particularly when one compares currency reserves at the time (valued at US $10 trillion) to the amounts held in the same year by global funds ($117 trillion), commercial banks ($105 trillion), or the sum of assets in bonds, equities and banks ($257 trillion).
Perhaps most satisfying to Fund watchers is the IEO’s discussion of a lack of even- handedness by the IMF in its pronouncements on the legitimacy of currency market interventions by its members. In this context the IEO notes that the IMF supported instances of aggressive exchange rate interventions by policymakers in wealthy countries. For example, the report notes that the IMF supported significant exchange rate interventions by Switzerland in 2009-10 and Japan in 2010 and 2011. Both of these were intended to counter deflationary pressures and currency appreciation pressures stimulated by global carry trade activity. We know that pressure of the latter sort bore quite heavily on many rapidly growing developing countries at the same time, but we would be hard pressed to find Fund support for currency market interventions in these countries.
None of the observations in the IEO report come as a surprise to the IMF’s critics. After all, critics have long questioned the competence of the Fund’s economists (especially in relation to being able to measure the things that they purport to measure), the politicized and disparate treatment of its member countries, and its lack of attention to the factors that contributed to the global financial crisis. (Indeed, the IEO itself made the latter point in an extraordinary previous report.) In addition, IMF critics have understood that many developing countries built up significant reserve holdings precisely to inoculate themselves from future dealings with the Fund. But it is nevertheless satisfying to see the IMF’s own auditing department come to conclusions that resonate with those of the institution’s critics. Moreover, it has been fascinating (and OK, I admit it, fun!) to follow the blistering indictments of the IEO’s report in separate written responses prepared by IMF staff and the Managing Director, Christine Lagarde.
One other fascinating tidbit from a different quarter is a recent IMF Working Paper on fiscal retrenchment by Olivier Blanchard (the IMF’s Chief Economist) and Daniel Leigh. This paper was presented at the world’s most important annual conferences for economists earlier this month. In a finding that would take no one in Greece (or Ireland or Spain) by surprise, Blanchard and Leigh find that the IMF underestimated the negative effects on economic growth of fiscal retrenchment in wealthy countries over the past few years. (The new report extends work that first appeared in an October 2012 issue of the IMF’s flagship report, World Economic Outlook.)
This report, too, has apparently generated a firestorm of criticism by, among others, the German government. This is unsurprising given Germany’s role in promoting austerity in the crisis-afflicted countries of the Eurozone. Of course there is much more that should be said about the devastating costs of fiscal retrenchment and the failed economic ideas on which this strategy rests. But this report, like that of the IEO, is notable in that it reveals the degree to which at least some at the Fund are now willing to break with the longstanding IMF catechism on fiscal and monetary matters.
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