economic governance and crisis management jean-frédéric morin université libre de bruxelles

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

How to Strike Back?

Goals Risks1. Use exchange

reservesStabilizing

the currencyIncreased

exposure

2. Raising interestrates

Attracting foreign capital

Choking off economic growth

3. Allowing the currency to depreciate

Favoring exports

Higher inflation

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 First Generation

“Sudden crises in the balance of payments may not be so hard to model after all [..] [A speculative attack] is justified by a change in relative yields, for when the government is no longer able to defend the exchange rate the currency begins depreciating”

-Paul Krugman “A Model of Balance-of-Payments Crises”,

Journal of Money, Credit, and Banking, vol. 11(3), 1979, p. 312

Free capital flow

Sovereign monetary policy

Fixed exchange rate






The Unholy Trinity

China

CanadaFrance

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






The Second Generation

“Speculative attacks appear to be self-fulfilling, since they may occur even when the level of reserves seems sufficient to handle normal balance-of-payments deficits […] Such crises are apparently unnecessary and collapse an exchange rate that would otherwise have been viable”

- Maurice Obstfeld, “Rational and Self-Fulfilling Balance-of-Payments Crises”, The

American Economic Review, vol. 76(1), 1986, p. 72

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






The 1997 Asian Crisis






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

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






Trust: An Intervening Variable

State actor Market actorAffective trust No intervention in the market is

necessaryConsider currencies as

interchangeable and risk-free

Reputational trust Periodic market intervention (such as change in interest rates)

Distinguish strong and weak currencies

Momentary trust Engage in ongoing market intervention to support rates

Adjust currency exposure immediately based on new

informationDistrust Impose exchange controls Refuse to hold weak currencies






Political Regime and Trust

• Probability of currency crisis increases with new democracies, unanticipated cabinet dissolutions, government turnovers, and divided governments

• Probability of currency crisis is higher in autocracies 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 from short-term politics

Can’t lower interest rates

to favor investment

Can’t devaluate the currency

to favor exports

Loss of flexibilityMust accept decisions of a bank too liberal or

too conservative

Must defend the peg against speculative

attacks

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 Transparency

Central 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?






Yes!

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

sanction






Does the IMF coerce?

No!

• No significant correlation• Some borrowers have

alternatives• IMF is flexible• Post Washington consensus• Borrowers have interests in

conditionality






Does the IMF bargain?

Yes!

• Conditions vary greatly• 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)

Country Crisis year Fiscal cost of crisis (% GDP)

Argentina 1980 55 Malaysia 1997 16

Argentina 1995 1 Mexico 1995 20

Australia 1989 2 New Zealand 1987 1

Brazil 1994 13 Norway 1987 8

Chile 1981 41 Philippines 1983 13

Cote d’Ivoire 1988 25 Poland 1992 4

Czechoslovakia 1989 12 Senegal 1988 10

Egypt 1991 0,5 Spain 1977 6

France 1994 1 Sweden 1991 4

Hungary 1991 10 Thailand 1983 2

Indonesia 1992 4 Thailand 1997 33

Indonesia 1997 50 Turkey 1982 3

Japan 1991 12 Turkey 1994 1

Korea 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

more from crises than others






Crises and Multilateralism

• The European model

The Asian model






Crises and Regionalism






Crises and Unilateralism

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

• Regime type has a strong influence on the conditions, the management, and the impact of financial crises.

• Institutions that increase transparency and clarify expectations benefit both to the state and the market.

• Loans negotiation is a two-level game, both for the borrower and the lender

Conclusion

Economic Governance and Crisis

Management

Jean-Frédéric MorinUniversité libre de Bruxelles

economic governance and crisis management jean-frédéric morin université libre de bruxelles

Documents

impact imf

imf policies

payments crises

us controls imf decision

generation sudden crises

bruxelles slide

balance of payments

borrowing states