The resignation letter of Peter Doyle, a senior IMF economist, has added to recent controversy surrounding the embattled Fund. While reports of ‘suppressed’ policy advice are telling, unfortunately it’s of no real surprise and will not disrupt the IMFs’ policy agenda. Notwithstanding the nature and causes of the Global Financial Crisis (GFC), the IMF continues to espouse fundamentally flawed policy advice, as the institution seeks to maintain its relevance and legitimacy despite becoming largely redundant following the collapse of the Bretton Woods (fixed exchange rate) system in 1971.
Background, crisis and rhetoric
The International Monetary Fund (IMF) was established in 1944, at Bretton Woods, to engender postwar economic growth, prevent a relapse into autarky (closed economy) and protectionism, and to facilitate the international payment system in the context of fixed exchange rates. Following the collapse of the Bretton Woods system, many economies transitioned to a flexible or floating exchange rate regime which allowed the foreign exchange market to determine a currency’s value and therefore eliminate the need for intervention by policymakers. Consequently the IMF sort to reinvent its operations, focusing more on policy advice and so called ‘surveillance’.
Neo-liberal economic policies began to gain traction among policymakers during the 1970s, and have since dominated the mainstream discourse. IMF polices echoed the paradigm shift, whereby, active fiscal (government) policies to promote growth and reduce unemployment was replaced by the neo-liberal free-market approach which included deregulation and privatisation policies, and monetary policy geared to low-inflation. In essence, the policy consensus became one of ‘sound’ fiscal management rather than ‘functional’ fiscal policy. Since this time, the effective use of monetary policy has largely dominated the IMFs’ discourse, with discussions of fiscal policy reduced to notions of discipline and sustainability.
The GFC marked the worst global downturn since the Great Depression. The IMF concedes that the crisis ‘uncovered a fragility in the advanced financial markets’. It is interesting to note, in the aftermath of the Asian Financial Crisis (1996-7), the IMF allegedly ‘drew several lessons that would alter its responses to future events.’ Of these, the Fund realised that ‘it would have to pay much more attention to weaknesses in countries’ banking sectors and to the effects of those weaknesses on macroeconomic stability’.
Nevertheless, the IMFs’ steadfast view on the conduct of fiscal policy wavered as the recession deepened and the primary policy instrument, monetary policy, became largely ineffective. By 2009 the IMF began to advocate fiscal stimulus, conceding that ‘past experience suggests that fiscal policy is particularly effective in shortening the duration of recessions caused by financial crisis’.
In 2010, the IMF admitted ‘we were wrong’ with respect to the importance of (counter-cyclical) fiscal policy. Furthermore, the Fund conceded that while ‘[t]he crisis was not triggered primarily by macroeconomic policy…it has exposed flaws in the pre-crisis policy framework…’
Since the advent of the GFC the IMF has slightly moderated it stance on (discretionary) fiscal policy, particularly regarding its effectiveness during economic downturns (i.e. for stabilising purposes). However, the use of fiscal policy is still heavily qualified by concerns of fiscal sustainability. For this reason, the IMF continues to advocate fiscal austerity or consolidation measures, albeit, in light of the poor economic outcomes with some caution regarding the timing of these programs.
The use of certain terminology has formed a particularly important feature of IMF policy documents. Language such as sound public finance, fiscal sustainability, fiscal space and fiscal credibility typically accompany IMF discussions of fiscal policy. However these terms are often left undefined which, firstly, reflects the lack of consensus among economists regarding operational definitions, secondly, the language is used to portray a depth of understanding and sense of authority, and finally, the IMF strategically use vagueness and rhetorical tautology to render its policy statements ostensibly unfalsifiable.
Notwithstanding the policy rhetoric, the principle flaw within IMF policy advice is a failure to adequately distinguish between a sovereign and non-sovereign economy which has important implications for the conduct of fiscal policy. Modern Monetary Theory makes the distinction.
Sovereign vs. non-sovereign
A sovereign economy operates with its own (fiat) non convertible currency and a flexible exchange rate (e.g. the U.S., U.K., Japan and Australia). A non-sovereign economy does not possess these characteristics (e.g. Eurozone economies, such as Greece, Spain, Ireland and Portugal). In essence, one must distinguish between a currency ‘user’ (non-sovereign economy) and a currency ‘issuer’ (sovereign economy).
Unlike sovereign economies, Eurozone (non-sovereign) economies do face financing constrains. They are users of a currency and must borrow that currency (e.g. Euros) if tax revenues are not enough to cover government expenditures. Thus, these economies become exposed to pressures from bond market investors and credit-rating agencies since the use of, what is effectively, a foreign currency implies these economies can become insolvent with respect to obligations denominated in that currency. Recently the threat of insolvency has materialised within the Eurozone as rising interest rates on long-term government debt. By contrast, sovereign economies maintain very low long-term interest rates, including Japan which, according to OECD data, has a (gross) government debt to GDP ratio now in excess of 200 percent (the highest ratio in the world).
Thus, equating these different economic arrangements in terms of IMF policy advice is a fundamental flaw. A sovereign economy cannot become insolvent with respect to obligations denominated in its own currency, and can always purchase goods and services available in its own currency. Hence, mainstream notions of fiscal sustainability are irrelevant to the conduct of fiscal policy in sovereign economies.
Rather, policies to reduce government deficits and debt (i.e. fiscal austerity) within sovereign economies such as the U.K., U.S. and Australia, is entirely voluntary, unnecessary and ideologically motivated. The reasons are largely political and may reflect a long standing fear of ‘big’ government or any government intervention which ‘threatens’ private sector activity.
Furthermore, in their policy statements, the IMF tend to trivialise the conduct of fiscal policy by implying that, like prudent households, all national governments are budget constrained. Thus, a government in pursuit of ‘responsible’ or ‘sound’ fiscal policy by reducing deficits and debt appear to be prudent managers of ‘taxpayer’ funds. While these claims have no economic foundation within a sovereign economy, such statements play on the entrenched (neo-liberal) beliefs within society and therefore may prove useful as an election strategy (e.g. Australia’s ‘surplus fetish’ politics, see here).
The establishment of the Eurozone (or European Monetary Union) included an attempt by policymakers to formally constrain fiscal policy in terms of the Stability and Growth Pact (SGP) requirements (i.e. 60% gross debt to GDP and 3% general government deficit to GDP). When joining the Eurozone an economy, firstly, surrenders monetary sovereignty (e.g. setting interest rates) to the European Central Bank (ECB). Secondly, the (nominal) exchange rate can no longer freely fluctuate to buffer country specific economic shocks. Finally, fiscal policy is subjected to ‘formal’ constraints and therefore becomes inherently pro-cyclical.
In essence, a governments’ budget is an outcome which reflects the spending decisions of the non-government (private and external) sector. During an economic recession, a budget deficit may occur as unemployment increases, social security transfers rise and tax revenues fall. This is a normal process which indicates that the automatic stabilisers are working to offset the economic slowdown. However, the budget outcome may conflict with voluntarily adopted SGP requirements. Consequently, Eurozone economies have pursued fiscal austerity programs which target a reduction in government expenditure and/or tax increases. Furthermore, fiscal austerity has formed an important feature of IMF, EC and ECB (i.e. Troika) supported loans.
While the government pursues fiscal austerity in an attempt to meet SGP requirements, the return to economic growth requires a private (or external) sector led recovery. During a recession, business confidence may be low, and the private sector may be unwilling to increase its consumption or investment expenditures, perhaps choosing instead to save, delay investment projects, or pay down debt. For example, OECD data reveals that U.S. household net saving rates (as a percent of disposable household income) more than doubled between 2007 and 2008 (i.e. the start of the GFC) from 2.4 to 5.4 percent. In this context, rather than reducing government deficits and debt, fiscal austerity will increase these outcomes. Harsher fiscal austerity measures may then be pursued by policymakers, or such measures may be required as a condition of a Troika bailout (and the vicious cycle continues).
Thus IMF assertions that fiscal policy can be effective as a counter-cyclical device (i.e. stimulate during a downturn), but then recommending (austerity) measures to ensure specific fiscal targets are achieved or budget deficits are reduced, which have increased because of the downturn (i.e. pro-cyclical policy), is clearly problematic. In this vein, the IMF ostensibly promotes an extreme form of neo-liberal macroeconomic policy, the continuation of which will only exacerbate and extend the Eurozone malaise.
Governments within sovereign economies should now be engaging in well targeted expenditure programs (fiscal stimulus) to boost employment and economic growth. For Eurozone economies, two broad options are apparent: First, abandon the Euro and re-establish a sovereign currency system. Second, create a fiscal union including the establishment of a Eurozone Treasury which could spend like a sovereign government. The latter however may pose a significant challenge to the democratic process.
Despite the outcome, current unemployment rates, for example exceeding 20 percent in Spain and Greece, is unacceptable, irresponsible and avoidable as long as the government restores its currency sovereignty and uses fiscal policy effectively to stimulate employment and growth. In this vein, MMT advocates promote a Job Guarantee otherwise known as Employer of Last Resort as a full employment strategy (see here and here).
The IMFs failure to adequately distinguish between sovereign and non-sovereign economies has corrupted policy inference. However, reforming the IMF is problematic since its policies largely reflect the prevailing neo-liberal economic agenda.
Notwithstanding this, national policymakers, unlike IMF officials, have an elected obligation to advance the public purpose and maintain full employment. The pursuit of accounting fundamentals (i.e. targeting specific or reduced government deficits and debt ratios) must not override, conflict or inhibit a concerted policy effort to reduce unemployment and alleviate poverty. For this reason, national governments must be accountable for their failure to provide adequate employment opportunities and promote growth in the aftermath of the GFC.