Who Should Provide Global Financial Insurance?

Ashby Monk

Managing Director of the IMF Dominique Strauss-Kahn gave an interesting speech over the weekend at the International Finance Forum in Beijing. He covers a variety of topics, but one of his areas of interest was the accumulation of precautionary reserves as self-insurance. In his view, this practice carries significant social costs. As such, providing global financial insurance is best left to the IMF:

“For all these reasons, I see a clear need for global financial insurance…At the global level, I believe that the IMF can serve as an effective and reliable lender of last resort…However, to serve as a truly dependable global lender of last resort, the Fund will need considerably greater resources.”

In my view, if the IMF wants to be a reliable lender of last resort, it should first focus on the way it lends before addressing how much money it has available.

We all know that IMF support comes with ‘strings attached’ — when it provides resources to a member country, the funding arrangements specify the conditions underpinning support. Known as IMF ‘conditionality’, this may include specifying policies that the member country will need to carry out before the arrangement takes place or policies that must be implemented before follow-on disbursements of IMF resources are made. While some of these policies are justifiable, as the IMF wants to ensure that the money is repaid, some go beyond what is appropriate to the situation.

For example, Mussa and Savastano, two IMF employees, see conditionality as an opportunity to effect more substantial domestic policy changes:

“[n]ational authorities may modify policies to comply with IMF conditionality when it would be difficult to find domestic political census in the absence of external pressure…the IMF and its conditionality become a scapegoat on both sides of the bargain. That such a scapegoat can be useful in securing necessary or desirable, but unpopular, policy adjustments is clear.”

I tend to agree with the Feldstein critique of this–he questioned whether an international agency such as the IMF should impose any policies of a domestic nature on sovereign countries. Also, he questioned the morality of taking advantage of short-term financial crises in such a manner.

In the end,  “hoarding” international reserves is seen as an essential precautionary practice if countries are to avoid becoming entangled with the IMF and losing state autonomy. Resolving this perception would be the best way for Strauss-Kahn to stop the accumulation of precautionary reserves at the national level and make the IMF a credible provider of global financial insurance.

4 Responses to “Who Should Provide Global Financial Insurance?”

  1. 1 rien huizer November 17, 2009 at 2:28 pm

    Feldstein wrote his article in the late 1990s. Kahn’s remarks are with the benefit of hindsight about what happened after that. Kahn is right in seeing a certain form of global economic governance as an ideal, but I doubt he believes it could become reality. However, implicitlty criticizing China (the reserve hoarder par excellence), he is quite right. China is the main cause of the imbalance that allowed Americans to overconsume for some 6 years,followed by a major correction. Without China’s currency manipulation, the US would probably not have “recovered” from the dot com crisis and the world would not have had to go through a couple of years of fool’s gold followed by misery.

  2. 2 Ashby Monk November 17, 2009 at 2:34 pm

    I think you’re probably right. That said, the rapid increase in reserve accumulation we saw after the Asian crisis is in large part about self-insurance (not mercantilism), according to Aizenman and Lee (2007). Countries saw that to maintain self-determination during times of crisis they could not rely on the IMF. This perception may be slowly changing…but reserves keep going up anyway.

  3. 3 rien huizer November 18, 2009 at 5:33 am

    But then again, China’s currency-cum-reserve policy was probably exactly what the US government of the day wanted and facilitated a Chinese domestic economic policy likely to support CPC legitimacy or at least a Chinese version of social stability. No one disputes that China’s rise as an industrial power has had a severe deflationary effect on the OECD economies (which could have been blunted if exchange rate policy had been more liberal; although that is not certain, since no one knows how competitive China could be were it more efficient.

    The old US argument about undervaluation of the CNY is of course only a tiny part of the problem and mainly for US domestic consumption. But FX policy is one of the few instruments available to the Centre to make China less competitive. Of course other policies (like a minimum wage, a substantial wedge between labor cost and take home pay, to be used to finance social, health and education services) would have a much greater effect, as well as abandoning urban residency policies and making non-urban workers eligible for more urban benefits. But that is politically very difficult.It takes a Bismarck to do that.

  1. 1 FT.com | Money Supply | FT economic news digest Trackback on November 17, 2009 at 1:58 pm

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This website is a project of Professor Gordon L. Clark and Dr. Ashby Monk of the School of Geography and the Environment at the University of Oxford. Their research on sovereign wealth funds is funded by the Leverhulme Trust and The Rotman International Centre for Pension Management.

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