A Bretton Woods stocktaking

The annual meetings of the International Monetary Fund and the World Bank, taking place this week, are for the global monetary and financial system what the Davos World Economic Forum is for business—that is to say, heavy on show and light on substance. It’s unlikely that a major initiative addressing the monetary and financial consequences of the Covid-19 crisis will emerge from the week. Still, the meetings provide an indication of how international monetary leaders see the challenges facing the global economy. And they are a window onto how the Bank and the Fund are themselves evolving in response to events.

Most remarkable, perhaps, is how the two institutions have escaped the ire of Donald Trump. They have done so by taking ownership of problems that otherwise might have landed on the administration’s doorstep, the World Bank by addressing the problems of poor countries in neighboring Central America and the Caribbean, the Fund by addressing financial crises in Ukraine and Argentina. It helps that the Bank and Fund have studiously avoided doing anything that might be seen as favouring China over the US.

The World Bank has largely stuck to its knitting, focusing on problems of poverty, inclusion and economic underdevelopment, although there has been controversy about whether the country rankings in its annual “Doing Business” report have been irregular.

In contrast, signs of change at the IMF are extensive. The Fund was long thought to be dominated by stern fiscal and financial disciplinarians. Its warm and fuzzy website now features sections on gender gaps, climate change, income inequality, civil society and sustainable development. To some extent this may be marketing, but it surely reflects real change in how IMF management and staff see the world and the task before them.

For example, the IMF learned the hard way that adjustment programmes involving harsh fiscal austerity won’t work if they fail to protect essential social services and the poor. Absent this, budget cuts will provoke a political backlash and precipitate the abandonment of adjustment efforts. Even if budget cuts are needed to restore economic and financial stability, they must be implemented in ways that protect the most vulnerable. Hence the Fund’s attention to the poorest, and its recent focus on income distribution.

Similarly, the Fund’s “new institutional view” of capital controls, which dates to the early 2010s, and the “integrated policy framework” rolled out this year reflect new thinking about the management of capital flows and exchange rates. Once an apostle of unfettered capital markets and market-determined exchange rates, the Fund now acknowledges that there are circumstances justifying controls on cross-border financial flows, and that exchange rate changes can be part of the problem rather than the solution. This is a constructive move away from one-size-fits-all policy advice.

Nor was it always obvious that a multilateral financial institution focused on preventing and containing financial crises should see fighting climate change as part of its mandate. But the hurricanes, floods and crop failures spawned by changing climate have become a leading source of economic and financial calamity.

Moreover, as addressing these risks becomes even more urgent, carbon taxes will become an increasingly important component of the government budgets on which the IMF advises.  Governments are reluctant, however, to levy significant carbon taxes, fearing that domestic producers will suffer unless other countries do likewise. This creates an obvious opening for an international organisation to coordinate their efforts.

The change attracting the most attention is the IMF’s more relaxed attitude toward budget deficits. An institution notorious for insisting on budget balance under any and all circumstances is now urging countries—most of them anyway—to spend more, on infrastructure and generally.  This is less surprising than it may seem: circumstances have changed, so the IMF has changed its advice. The global economy is in the midst of an unprecedented emergency, and millions around the world depend on government spending for their very survival. Even the strictest fiscal disciplinarian will recognise these conditions for what they are.

In addition, interest rates are at historically low levels. This means that more support, if it is to be provided, will have to come via government spending, not monetary policy, which has largely run out of room. It also means that, with debt-servicing costs so low, larger deficits can be financed. The real test will come when the pandemic and economic crisis end and interest rates rise from rock-bottom levels. We will then see whether the Fund again calls prematurely for a return to austerity, as it has more than once in the past.

What is missing? It would be nice to see a major increase in the IMF’s financial resources, enabling it to provide more assistance to countries desperately in need. It would also be nice to see changes in how the debts that governments owe the private sector are managed and, specifically, restructured. The restructuring process is largely dead in the water, despite calls by the Fund and the Bank, back in the spring, for urgent renegotiation.

Progress on these fronts would make a major difference for the populations of financially-strapped countries. But any serious initiative would require the consent of the Fund’s major shareholders, which is to say the governments of the largest economies. At the moment, unfortunately, those governments have their hands full with their own pandemic-related problems.