But blaming the IMF may be cursing the cure rather than the disease. Iceland is facing massive capital flight, for reasons that Felix Salmon points out:
The decision to raise rates is being painted as an attempt "to return to a market-based floating exchange rate regime". But the reason that regime fell apart was nothing to do with Iceland's monetary policy. Rather, it was a function of the fact that anybody looking to earn interest on Icelandic krona deposits would have to have that money on deposit with an Icelandic bank. Which, in turn, meant taking bank credit risk on top of FX risk. And if you wanted to take bank credit risk, you could make much more money by selling default protection.
So I suspect that this latest move by the central bank is largely symbolic. No liquid currency market can exist in a country without a functioning banking system. Unless and until Iceland gets solvent banks -- either new ones or restructured old ones -- the krona will continue to trade largely through newspaper classified ads.
This is a real problem, though the interest rates may help that recapitalization; they encourage saving and discourage consumption. They may also compensate some outside investors for the bank/currency risk, which is huge; the Krona seems to have lost about 2/3 of its value since last year, though as far as I can tell, it still isn't really trading outside of Iceland. At the very least, it will help control the inflation that will almost certainly result from the free-falling currency.
Of course, it won't be good for anyone who has to borrow money. Opponents want the IMF to stop kicking countries when they're down. But the conditions that force austerity aren't the making of the IMF; the IMF is there because of those conditions. For example, when the price of oil fell in the 1980s, oil producing nations like Nigeria blamed IMF austerity measures for their plummeting standard of living. But the IMF's job is not to insulate commodity-driven economies from falling prices; it's to prevent the resulting catastrophic financial collapse. And if the government pursues inflationary policies and continues to run a giant deficit, capital will certainly flee.
Witness Argentina recently nationalizing its private pension alternative, not because the pensioners were dissatisfied, but because the government needed the contributions to finance current spending. In past years, the Argentinian government avoided austerity measures by massively defaulting on its foreign debts--but only at the price of systematically destroying investor willingness to lend it money. Unless the world economy turns around in 2010, Argentina is going to end up with the austerity measures, and no recourse to outside help.
Ken Rogoff outlined the IMF's dilemma in a scathing response to Joseph Stiglitz's critique of the World Bank and the IMF:
Let's look at Stiglitzian prescriptions for helping a distressed emerging market debtor, the ideas you put forth as superior to existing practice. Governments typically come to the IMF for financial assistance when they are having trouble finding buyers for their debt and when the value of their money is falling. The Stiglitzian prescription is to raise the profile of fiscal deficits, that is, to issue more debt and to print more money. You seem to believe that if a distressed government issues more currency, its citizens will suddenly think it more valuable. You seem to believe that when investors are no longer willing to hold a government's debt, all that needs to be done is to increase the supply and it will sell like hot cakes. We at the IMF--no, make that we on the Planet Earth--have considerable experience suggesting otherwise. We earthlings have found that when a country in fiscal distress tries to escape by printing more money, inflation rises, often uncontrollably. Uncontrolled inflation strangles growth, hurting the entire populace but, especially the indigent. The laws of economics may be different in your part of the gamma quadrant, but around here we find that when an almost bankrupt government fails to credibly constrain the time profile of its fiscal deficits, things generally get worse instead of better.
Joe, throughout your book, you condemn the IMF because everywhere it seems to be, countries are in trouble. Isn't this a little like observing that where there are epidemics, one tends to find more doctors?
You cloak yourself in the mantle of John Maynard Keynes, saying that the aim of your policies is to maintain full employment. We at the IMF care a lot about employment. But if a government has come to us, it is often precisely because it is in an unsustainable position, and we have to look not just at the next two weeks, but at the next two years and beyond. We certainly believe in the lessons of Keynes, but in a modern, nuanced way. For example, the post-1975 macroeconomics literature--which you say we are tone deaf to--emphasizes the importance of budget constraints across time. It does no good to pile on IMF debt as a very short-run fix if it makes the not-so-distant future drastically worse. By the way, in blatant contradiction to your assertion, IMF programs frequently allow for deficits, indeed they did so in the Asia crisis. If its initial battlefield medicine was wrong, the IMF reacted, learning from its mistakes, quickly reversing course.
No, instead of Keynes, I would cloak your theories in the mantle of Arthur Laffer and other extreme expositors of 1980s Reagan-style supply-side economics. Laffer believed that if the government would only cut tax rates, people would work harder, and total government revenues would rise. The Stiglitz-Laffer theory of crisis management holds that countries need not worry about expanding deficits, as in so doing, they will increase their debt service capacity more than proportionately. George Bush, Sr. once labeled these ideas "voodoo economics." He was right.
Keynesian stimulus may work in a large domestic economy that borrows in its own currency. But in small countries like Iceland, which imports nearly everything it eats and has a small domestic capital base, the government must quickly restore the credibility of its financial system, or watch its people starve. Expect to see austerity pressed on Hungary and Ukraine as well--and a resulting backlash against capitalism in those countries.
Will someone please give Rogoff a Nobel Prize--for something, anything--so that I do not have to listen to mentally defective anti-capitalists parrot incessantly the line that "Nobel Laureate economist Joe Stiglitz say '[bombastic stuff, easily misinterpreted here].'" I mean, this guy's smart. Surely we could hook a brother up with one of those nifty Nobel thingies...."
So when will the IMF tell Paulson, Bernanke, the US Congress, et all, that their position is unsustainable?
Um, want to engage that last sentence a bit more? I remember from reading Stiglitz that one of his key issues with the IMF was that it instituted policies that are politically tone-deaf and lead to a backlash. Want to engage that risk when we are talking about former Soviet-bloc nations?
Vermando, I seem to recall that hyperinflation in economically troubled Central European countries sometimes has nasty geopolitical results too.
what about capital controls?
From what I heard Iceland's problem was never overspending by the government. I think the IMF economists overrate the reputation gains that comes from not defaulting.
Keynesian stimulus may work in a large domestic economy that borrows in its own currency. But in small countries like Iceland, which imports nearly everything it eats and has a small domestic capital base, the government must quickly restore the credibility of its financial system, or watch its people starve.
This seems like a much more relevant concern for Iceland than the Stiglitz vs. Rogoff argument you quote above. As for the risk of inflation if a country fails to adopt austerity measures, in an atmosphere of rapidly falling commodities prices, that may not be the most important concern -- a concern, but maybe not the most important one.
Finally, Rogoff is talking about countries that are facing collapse because of unwise fiscal policies. That is not the situation with emerging markets risk right now. All the emerging markets, including responsible ones like Poland and ones with massive forex reserves like Russia, are getting walloped right now due to non-rational investor herd-mentality panic. Government fiscal discipline is not going to help very much in such an environment. People are going to stampede to the dollar and the yen regardless of how disciplined Indonesia's fiscal policies are. Seems to me what we need are international capital controls, some kind of Bretton Woods II agreement, to counteract the inescapable irrationality of international financial markets during times of crisis.
Meanwhile, entering the Eurozone is looking like a proposition with some advantages that small economies didn't take account of during their national debates in the '90s. The euro is not about to lose 2/3 of its value, and you're going to continue to be able to buy groceries in euro.
Right, but the countries that are applying to the IMF are countries that had massive borrowing, either in the public or private sector. All three countries with IMF deals ran budget deficits this year; while Iceland and Ukraine's may not have been giant by developed-country standards, the relevant fact is that they have to borrow abroad, which in a currency crisis vastly magnifies government debt.
The government deficits are probably not the most important part of this particular crisis, but if the governments start accumulating more debt, they'll be in bad shape if their currency declines.
Well, it's not irrational to want to get one's money out of Iceland just now.