Economic Governance and Crisis Management Jean-Frédéric Morin Université 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? GoalsRisks 1. Use exchange reserves Stabilizing the currency Increased exposure 2. Raising interest rates 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 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? 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 ? 5. Do crises strengthen 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 ? 5. Do crises strengthen IMF? The First Generation 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 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 ? 5. Do crises strengthen IMF? The Unholy Trinity The Unholy Trinity China Canada France

Source: UNCTAD, Responding to the Challenges Posed by the Global Economic Crisis to Debt and Development Finance, New York, United Nations, 2010, p Can States avoid crises? 2. Does the IMF coerce LDC? 3. Does the US control the IMF ? 4. What impact IMF has on borrowers ? 5. Do crises strengthen IMF? Public Debt Public Debt

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 ? 5. Do crises strengthen IMF? 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 Can States avoid crises? 2. Does the IMF coerce LDC? 3. Does the US control the IMF ? 4. What impact IMF has on borrowers ? 5. Do crises strengthen IMF? The 1997 Asian Crisis

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 ? 5. Do crises strengthen IMF? 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 Can States avoid crises? 2. Does the IMF coerce LDC? 3. Does the US control the IMF ? 4. What impact IMF has on borrowers ? 5. Do crises strengthen IMF? Trust: An Intervening Variable State actorMarket actor Affective trustNo intervention in the market is necessary Consider currencies as interchangeable and risk-free Reputational trustPeriodic market intervention (such as change in interest rates) Distinguish strong and weak currencies Momentary trustEngage in ongoing market intervention to support rates Adjust currency exposure immediately based on new information DistrustImpose exchange controlsRefuse to hold weak currencies

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 ? 5. Do crises strengthen IMF? 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 Leblang, David & Shanker Satyanath, “Institutions, Expectations, and Currency Crises”, International Organization, vol. (60), 2006, p

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 ? 5. Do crises strengthen IMF? 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 flexibility Must 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 Can States avoid crises? 2. Does the IMF coerce LDC? 3. Does the US control the IMF ? 4. What impact IMF has on borrowers ? 5. Do crises strengthen IMF? Central Bank Independence Central Bank Independence

Bernhard, William, Lawrence Broz and William Roberts Clark, “The Political Economy of Monetary Institutions”, International Organization, 56(4), 2002, p Can States avoid crises? 2. Does the IMF coerce LDC? 3. Does the US control the IMF ? 4. What impact IMF has on borrowers ? 5. Do crises strengthen IMF? Fixed Exchange Rates

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 ? 5. Do crises strengthen IMF? 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

. 2. Does the IMF coerce developing countries with conditionality? 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 ? 5. Do crises strengthen IMF?

Yes! Asymmetry of power Increasing use of conditionality Capacity to monitor and to sanction 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 ? 5. Do crises strengthen IMF? Does the IMF coerce? No! No significant correlation Some borrowers have alternatives IMF is flexible Post Washington consensus Borrowers have interests in conditionality

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 ? 5. Do crises strengthen IMF? Does the IMF bargain? Yes! Conditions vary greatly Domestic politics can increase bargaining power No!  Not time for bargaining  False alternatives

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 ? 5. Do crises strengthen IMF? 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? 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 ? 5. Do crises strengthen IMF?

A homogeneous bureaucracy of liberal economists... …relatively independent from the executive Board… …With their own preferences 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 ? 5. Do crises strengthen IMF? An Autonomous Bureaucracy? 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 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 ? 5. Do crises strengthen IMF? A K-Group Hegemony ? 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 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 ? 5. Do crises strengthen IMF? 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 Broz, Lawrence “Congressional Politics of International Financial Rescues”, American Journal of Political Science, vol. 49(3), 2005, p Can States avoid crises? 2. Does the IMF coerce LDC? 3. Does the US control the IMF ? 4. What impact IMF has on borrowers ? 5. Do crises strengthen IMF? Congress is key Congress is key

4. Does conditionality politically weaken developing countries ? 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 ? 5. Do crises strengthen IMF?

“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 Can States avoid crises? 2. Does the IMF coerce LDC? 3. Does the US control the IMF ? 4. What impact IMF has on borrowers ? 5. Do crises strengthen IMF? According to the IMF… According to the IMF…

CountryCrisis yearFiscal cost of crisis (% GDP) CountryCrisis yearFiscal cost of crisis (% GDP) Argentina198055Malaysia Argentina19951Mexico Australia19892New Zealand19871 Brazil199413Norway19878 Chile198141Philippines Cote d’Ivoire198825Poland19924 Czechoslovakia198912Senegal Egypt19910,5Spain19776 France19941Sweden19914 Hungary199110Thailand19832 Indonesia19924Thailand Indonesia199750Turkey19823 Japan199112Turkey19941 Korea199727United States19883 Keefer, P. “Elections, Special Interests, and Financial Crisis”, International Organization, vol. 61, Can States avoid crises? 2. Does the IMF coerce LDC? 3. Does the US control the IMF ? 4. What impact IMF has on borrowers ? 5. Do crises strengthen IMF? 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) 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 ? 5. Do crises strengthen IMF? 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) 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 ? 5. Do crises strengthen IMF? 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 Can States avoid crises? 2. Does the IMF coerce LDC? 3. Does the US control the IMF ? 4. What impact IMF has on borrowers ? 5. Do crises strengthen IMF? Philippines: A Balanced System

5. Do Crises Strengthen multilateral economic organizations? 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 ? 5. Do crises strengthen IMF?

IMF faces harsh criticisms during crises The lack of crises is even more challenging Some multilateral institutions benefit more from crises than others 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 ? 5. Do crises strengthen IMF? Crises and Multilateralism

The European model  The Asian model 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 ? 5. Do crises strengthen IMF? Crises and Regionalism

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 ? 5. Do crises strengthen IMF? 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 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 Morin Université libre de Bruxelles