Economic Governance and Crisis Management

Economic Governance and Crisis

Management

Jean-Frédéric MorinUniversité libre de Bruxelles

The Twin Financial Crises

Currency crises

Deficit in the balance of payments

Run of official foreign exchange reserves

Downward pressure on exchange rate

Banking crises

Massive deposits withdraw

Bank runs

Credit crunch

1) Wise decision-makers could avoid crisis; 2) The IMF coerces developing countries; 3) The US controls IMF decision making; 4) IMF policies weaken borrowing States; 5) Crises strengthen multilateral economic

governance.

Frequent Assumptions

1. Can States avoid crises?

2. Does the IMF coerce borrowers?

5. Do crises strengthen IMF?

4. What impact IMF has on borrowers?

3. Does the US control the IMF?

. 1. Can States avoid crises?

2. Does the IMF coerce LDC?

3. Does the US control the IMF ?

4. What impact IMF has on borrowers ?

The State or the Market?

“Recent events highlight the importance of sustainable public finances and the need for our countries to put in place credible, properly phased and growth-friendly plans to deliver fiscal sustainability […]. Those countries with serious fiscal challenges need to accelerate the pace of consolidation. […]

We agreed the financial sector should make a fair and substantial contribution towards paying for any burdens associated with government interventions, where they occur, to repair the financial system or fund resolution, and reduce risks from the financial system. We recognized that there are a range of policy approaches to this end. Some countries are pursuing a financial levy.”

- The G20 Toronto Declaration, June 2010

The First Generation

• Ex: Paul Krugman (1979)• Imbalances in macroeconomic fundamentals– Fiscal policy– Monetary policy

Source: UNCTAD, Responding to the Challenges Posed by the Global Economic Crisis to Debt and Development Finance, New York, United Nations, 2010, p. 36

Public Debt

Free capital flow

Sovereign monetary policy

Fixed exchange rate

The Unholy Trinity

CanadaFrance

The Second Generation

• Ex: Maurice Obstfeld (1986)• Speculative attacks are not justified by

underlying economic fundamentals.• Self-fulfilling prophecy from speculators • Regional contagion effect

King, Michael R. “Who Triggered the Asian Financial Crisis?”, Review of International Political Economy, vol. 8(3), 2001, p. 450

The 1997 Asian Crisis

How to Strike Back?Policy options Goals Risks

1.Spending foreign exchange reserves

Maintaining the value of the

currencyIncreased

exposure

2. Raising interest rates

Attracting foreign capital

Choking off economic growth

3. Allowing the currency to depreciate

Favoring exports Higher inflation

The Third Generation

• Neither the State nor the market, but their relation.

• Institutions are required for cooperation• Iteration is required to build trust

Aykens, Peter, “(Mis)trusting Authorities: A Social Theory of Currency Crises”, Review of International Political Economy, vol. 12(2), 2005, p. 321.

Levels of Trust

Trust: An Intervening Variable

• New democracies, unanticipated cabinet dissolutions, government turnovers, and divided governments increase probability of currency crisis

• Autocracies are more likely to experience currency crisis than democracies.

Leblang, David & William Bernhard “The Politics of Speculative Attacks in Industrial Democracies”, International Organization, vol. 54(2), 2000, p. 291-324.

Leblang, David & Shanker Satyanath, “Institutions, Expectations, and Currency Crises”, International Organization, vol. (60), 2006, p. 245-262.

Trust-Building Institutions

• Central bank independence • Pegged exchange rates• Insulate monetary policy• Significant loss of flexibility

Bernhard, William, Lawrence Broz and William Roberts Clark, “The Political Economy of Monetary Institutions”, International Organization, 56(4), 2002, p. 698

Central Bank Independence

Bernhard, William, Lawrence Broz and William Roberts Clark, “The Political Economy of Monetary Institutions”, International Organization, 56(4), 2002, p. 701

Fixed Exchange Rates

Trust and TransparencyCentral bank independence and fixed exchange rates are not policy substitute Central banks are opaque and difficult to monitor Exchange rate pegs are easily observed

The selected institution’s transparency is inversely related to the political system’s transparency Autocracies are more likely to have fixed exchange rates Democracies are more likely to have independent central banks

Broz, J. Lawrence, “Political System Transparency and Monetary Commitment Regimes”,

International Organization, vol. 56(4), 2002, p. 861-886

.2. Does the IMF

coerce developing countries

with conditionality?

• Asymmetry of power• Increasing use of conditionality• Capacity to monitor and to

sanction

Does the IMF coerce?No!

• No significant correlation• Post Washington consensus• IMF is flexible• Borrowers have interests in

conditionality

Does the IMF bargain?Yes!

• Conditions vary greatly• Borrowers have alternatives• Domestic politics can increase

bargaining power

No! Not time for bargaining False alternatives

Does the IMF socialize?Yes!

Several socialization opportunities

The “ownership” paradigm Developing countries are

receptive to IMF arguments

No! Surveillance and peer-

review are not designed for socialization

3. Does the US control the IMF

decision making?

A homogeneous bureaucracy of liberal economists...…relatively independent from the executive Board…

…With their own preferences

An Autonomous Bureaucracy?

We should not forget the Europeans A G5 coalition can have major impact But a split in the G7 favors IMF autonomy

A K-Group Hegemony ?

Anecdotal evidences• Turkey 1998 (Önis, 2006)

• Egypt 1987 and 1991 (Momami 2004)

Statistical evidences (Stone 2008; Thacker 1999; Dreher & Jensen 2007; Oatley & Yackee 2004; Broz & Hawes 2006; Barro & Lee 2002)

• US allies more likely to have loans• US allies receive fewer conditions • US allies are punished less severely for non compliance • Strategic countries receive larger loans

The “G1” as the Principal

• Congress has constitutional power and uses it

• Constituencies and interest groups influence Congress votes

Broz, Lawrence and Michael Brewster Hawes, “Congressional Politics of Financing the International Monetary Fund”, International Organization, vol. 60 (2006), p. 367-399

Broz, Lawrence “Congressional Politics of International Financial Rescues”, American Journal of Political Science, vol. 49(3), 2005, p. 479-496

Congress is key

4. Does conditionality

politically weaken developing countries ?

“The results show that the presence of an IMF-supported program does not reduce public spending on either health or education—measured as a share of total public spending, GDP, or in per capita real terms. In fact, we estimate that during program periods, and with all other factors being the same, public spending in each of the health and education sectors increased by about 0.3 to 0.4 percentage points of GDP compared to a situation without a program”

- IMF Independent Evaluation Office, 2003, p. 8

According to the IMF…

Country Crisis year Fiscal cost of crisis (% GDP)

Argentina 1980 55 Malaysia 1997 16Argentina 1995 1 Mexico 1995 20Australia 1989 2 New Zealand 1987 1

Brazil 1994 13 Norway 1987 8Chile 1981 41 Philippines 1983 13

Cote d’Ivoire 1988 25 Poland 1992 4Czechoslovakia 1989 12 Senegal 1988 10Egypt 1991 0,5 Spain 1977 6

France 1994 1 Sweden 1991 4Hungary 1991 10 Thailand 1983 2Indonesia 1992 4 Thailand 1997 33

Indonesia 1997 50 Turkey 1982 3Japan 1991 12 Turkey 1994 1Korea 1997 27 United States 1988 3

Keefer, P. “Elections, Special Interests, and Financial Crisis”, International Organization, vol. 61, 2007

The cost of Crises

• The effect on social spending is particularly pronounced in democracies (Nooruddin & Simmons 2006)

• Autocracies react to crisis with higher decisiveness (Haggard and MacIntyre 1998)

Regime Type Matters

• Credibility is as important as decisiveness (Keefer, 2007)

• A wide dispersal of veto authority increases rigidity but a centralization of veto authority increases volatility.

• A balanced distribution of authority is optimal (MacIntyre 2001)

So Autocracies Are Better Off?

Source: MacInyre, Andrew, “Institutions and Investors: The Politics of Economic Crisis in Southeast Asia”International Organization vol. 55(1), 2001, p. 83

Philippines: A Balanced System

5. Do Crises Strengthen multilateral economic

organizations?

• IMF faces harsh criticisms during crises • The lack of crises is even more challenging • Some multilateral institutions benefit

Economic Governance and Crisis Management

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