Director of the IMF’s European Department Marek Belka stressed that the EU must ensure that the extraordinary support provided to banks and other financial institutions does not turn into an addiction. Meanwhile, the need for fundamental reforms in the financial sector should not be forgotten.
As Europe embarks on its projected recovery, wide differences in economic performance and financial stresses will persist, IMF officials say.
During the crisis, countries inside the eurozone benefited from the relative stability of the euro. emerging market countries ranging from Latvia to Hungary and Romania and sought emergency assistance from the European Union and the IMF. Today, with the worst of the crisis behind us, markets are taking a new, critical look at countries within the eurozone, with Greece, Spain, and Portugal currently in the headlines. Where this reappraisal will lead remains to be seen. New challenges are arising for many emerging economies. While the exact nature of those challenges differs substantially from country to country, there are common themes.
In a recent series of blog posts, Director of the IMF’s European Department Marek Belka, himself a former finance and prime minister, offers his take on the lessons policymakers should learn from the crisis. Below is a short summary of his postings.
Much is riding on getting the timing of the exit right from the extraordinary policies used to combat the global economic and financial crisis. Exiting too early may jeopardize the recovery. But exiting too late may sow the seeds for the next crisis. And exiting in an uncoordinated fashion will lead to a renewed build up of financial instability.
With the recovery still fragile, fiscal and monetary policy should continue to support the recovery. Yet we do need to worry about the surge in government indebtedness and the potential for an adverse shift in sentiment about fiscal sustainability. To avert this, countries need to announce already now credible plans for fiscal consolidation.
In the financial system, we must ensure that the extraordinary support provided to banks and other financial institutions does not turn into an addiction. Thus, the time has come to begin to gradually unwind these policies. Meanwhile, we should not forget about the need for fundamental reforms in the financial sector.
In emerging Europe, the transition from planned economies to capitalism has resulted in a rapid and near-complete openness to trade and foreign capital. In the years before the crisis, foreign money flowed generously to the region and to banks in particular. This precipitated a credit boom, which turned to bust when the crisis hit. And although the withdrawal of foreign capital was less aggressive than initially feared, it is clear that the large pre-crisis capital flows to the region were unsustainable and destabilizing.
In our highly globalized economy, large and rapid flows of money across borders are here to stay. The challenge for emerging economies is to find ways to manage these flows so that they don’t exacerbate boom-bust cycles, while still leaving the door open to productive (and hopefully stable) investment. This means using all available tools, particularly greater use of prudential regulations, and keeping an open mind when it comes to capital controls.
In his final blog posts, Belka draws on his own experience as a former policymaker and offers lessons he believes reformers in Eastern Europe should take away from the crisis. In bullet form, they are:
• Good policies and strong institutions matter. Countries with unsustainable fiscal policies and weak institutions were the first to face difficulties.
• Sound public finances are created in good times. If policymakers think growth and prosperity is time for relaxing and enjoying, rather than to save for a rainy day, they can forget about fiscal stimulus when it’s needed or even allowing automatic stabilizers to do their job during a recession.
• Capital inflows are beneficial for growth, but some are better than others. Those that increase output potential deserve support, but those that just stimulate demand have to be watched carefully and kept in check if necessary.
• Selling domestic banks to foreigners (highly controversial initially in some emerging markets) turned out to be a rather good idea. What really matters is whether banks have a sustainable business model - one that depends on stable funding (as provided by strong parents) rather than the global wholesale market.
• Self-regulation of the private sector has its limits. The ultimate responsibility for ensuring stability and fair competition rests with the state.
• Pragmatism, pragmatism, pragmatism. Policy advice to emerging economies must be refined. As these economies advance, so does the sophistication of their policymakers.
© International Monetary Fund
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