26 January 2012

Lorenzo Bini Smaghi: How to equip the IMF for the crises of our time

After each major financial crisis, the IMF experienced several reforms aimed at strengthening its ability to deal with the new challenges. The most recent crisis in advanced economies, in particular Europe, does not yet seem to have triggered a comparable movement for reform.

Recent events have shown that crises in advanced economies may develop in very different ways from those of past crises in developing or emerging economies. This suggests that the options available to the IMF may need to be rethought and updated, from several perspectives.

First, the time horizon of standard IMF programmes appears to be too short. As a rule, IMF funding is provided for three years, on the assumption that in the meantime existing imbalances will be corrected and access to capital markets fully restored. Second, and related to the above, the practice of taking countries in IMF programmes away from the markets for a few years and funding them entirely with official financing may not be appropriate for developed economies.

Third, recent experience has shown that the conditions in advanced economies’ programmes should include details of the specific structural policies that will be necessary to ensure the sustainability of the macroeconomic adjustment. Fourth, debt restructuring in advanced economies has much more damaging effects than in developing countries. Debt restructuring should thus be a last resort and avoided as far as possible, in particular by inserting in the conditions of the programme specific measures aimed at selling available assets and using the proceeds to reduce the debt.

Finally, the preferred creditor status of the IMF and other official creditors seems to have generated destabilising effects in financial markets, as the impact on private creditors of a possible debt restructuring tends to become larger the greater the size of the official financing. It may also weaken the incentives for stricter surveillance.

Deep thinking and strong leadership are urgently required. In the old days this was provided by the Group of Seven leading economies. But since this forum decided to dissolve, and the G20 is not yet an adequate successor, the world seems dangerously without guidance. Not the best position to be in the midst of a financial crisis.

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