A famous photograph taken in 1998 tells us a lot about the clout of the International Monetary Fund (IMF). Indonesia was then in an economic mess, and its government had agreed to accept IMF conditions in return for a bailout. In the photo, IMF’s erstwhile chief Michel Camdessus towers grimly over a humbled Suharto, as the Indonesian strongman signs on the dotted line. Raghuram Rajan later wrote in Fault Lines, his acclaimed book on the financial crisis, that the photo “suggested an image of the conqueror accepting the unconditional surrender of the defeated”.
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IMF isn’t the horned devil of popular mythology. It has provided liquidity to embattled economies and pushed for essential economic change that the domestic political equilibrium of some countries would otherwise not have allowed. However, the Fund has sometimes been blinded by hubris. Such arrogance has been harmful not just because IMF dictates terms to troubled economies, but also because it has been the fount of global policy consensus. The flow of people and opinions between the Fund and economic ministries across the world helps transmit the same set of ideas through member countries, even those not staring into the abyss of default.
The financial crisis showed in stark terms how terribly wrong an organization can go, even one like IMF that is stocked with world-class talent. The IMF Independent Evaluation Office has highlighted some of these limitations in a frank report released in February. It shows that pre-crisis analytical reports written by IMF economists gave little clue about the approaching storm. Even after the subprime mess became public knowledge and the first financial shocks were just four months away, an IMF report in April 2007 said that “world growth will continue to be strong” and that global economic risks had declined since September 2006. And in July 2008, two months before the spectacular collapse of Lehman Brothers, the Fund said: “Risks of a financial tail event have eased.”
The root of the problem is the thinking within IMF. The brutally honest evaluation report said: “The IMF’s ability to correctly identify the mounting risks was hindered by a high degree of groupthink, intellectual capture, a general mindset that a major financial crisis in large advanced economies was unlikely, and inadequate analytical approaches.” Incentives within IMF are such that few of its economists try to give independent opinions. Views tend to converge around a deadening consensus. Advice becomes procyclical.
This week, IMF holds a seminar on macroeconomic and growth policies in the wake of the crisis, or how to evolve a new intellectual framework for policies to smoothen economic cycles and boost long-term economic growth. In a blog post last week, IMF chief economist Olivier Blanchard said that the crisis had forced the Fund to do a wholesale examination of the mainstream macroeconomic policy framework.
Blanchard raised several important issues before the seminar: that stable inflation does not necessarily guarantee stable output; whether low inflation targets should be revisited; whether credit and quantitative easing have a role in modern times, or if we should revert to a situation where interest rates are the only tool used by central banks; the role of discretionary fiscal policy once interest rates reach the lower bound; whether old rules of thumb such as a sustainable public debt to GDP ratio of 60% are still reliable; and whether countries struggling with strong capital inflows should build up reserves and use capital controls.
Many of these issues may appear either technical or innocuous. But they open up old policy debates by recognizing the flaws in inflation targeting as the only goal of a central bank, the need for discretionary fiscal policy to manage demand beyond what is done through automatic stabilizers, the opportunities for looking at currency market intervention and capital controls as valid tools in overheated economies, and the need to raise the levels of acceptable inflation.
Indian policymakers have already recognized many of these themes over the past two decades, never blindly staying with the global policy consensus. As far as growth-oriented reforms go, India has moved faster in opening up tradables sectors rather than non-tradables ones such as retail and banking. And as far as macroeconomic management goes, India has never fully embraced inflation targeting, opened up the capital account only very cautiously, and hasn’t shied away from intervening in the foreign exchange market whenever strong capital inflows have seemed a threat to stability.
The relative success of the Indian policy path could lead to hubris as well. The case for financial sector reforms and eventual capital account convertibility remains strong in India, but these should be pursued in accordance with domestic compulsions and trends rather than the ruling intellectual fashions in the West. What the experience of the past three years shows is that the flow of ideas between Washington and cities such as New Delhi, Mumbai and Beijing must be two-way.
Niranjan Rajadhyaksha is managing editor of Mint. Your comments are welcome at email@example.com