Joseph P. Joyce (is a Professor of Economics at Wellesley College and the Faculty Director of the Madeleine Korbel Albright Institute for Global Affairs
Guest post: Speaking Truth to Power
When the full history of the European debt crisis is related, one important part of the story will be the uneasy relationship of the International Monetary Fund with its European partners in the “Troika,” the European Commission and the European Central Bank. The Fund and the Europeans came to hold different views on the nature of the crisis and how it should be handled soon after its outbreak in 2010. Their disagreements reflect the split in the Fund’s membership between creditors and debtors, and the inherent ambiguity of the position of an intergovernmental organization that serves principals with different interests.
Greece obtained $145 billion from the Troika in May 2010. Of that amount, $40 billion was provided by the IMF in the form of a three-year Stand-by Arrangement. This represented 3,200% of the Greek quota at the IMF, far above the usual access limits. Susan Schadler has drawn attention to the modification of IMF policy that was made in order to allow the agreement to go forward.
The IMF has criteria to be met in deciding whether to allow a member “exceptional access” to its resources. One of these of these is a high probability that the borrowing member’s public debt will be sustainable in the medium-term. At the time of the arrangement, the IMF’s economists realized that there was little probability that Greek sovereign debt would be sustainable within any reasonable timeframe. The IMF, therefore, amended the criteria so that exceptional access could also be provided if there were a “high risk of international systemic spillover effects.” There was little doubt that such effects would occur in the event of a default, but whether this justified lending such large amounts was questionable.
It soon became clear that the two of the other four criteria would not be met. Greece would not regain access to private capital markets while it participated in the Fund program (criterion #3). Moreover, there was little prospect of a successful implementation of the policies contained in the original agreement (criterion #4). By 2011, it was evident that the program with Greece was not viable. Talks began on a new program and a restructuring of the debt, which eventually occurred in 2012. Moreover, Ireland received assistance from the Troika in December 2010, as did Portugal in February 2011.
This was the background when newly-appointed Fund Managing Director Christine Lagarde, a former French finance minister, appeared at the annual gathering of central bankers and financiers at Jackson Hole, Wyoming, in August 2011. Ms. Lagarde voiced her concerns that her fellow Europeans were responding too slowly to the dangers posed by the sovereign debt crisis. (Lagarde also called upon U.S. policymakers to undertake steps to resolve the housing crisis.) But her recommendations for more vigorous actions went unheeded. Her call for a more accommodative monetary policy was ignored by outgoing ECB President Jean-Claude Trichet. And European bankers were displeased by her assessment of their capital base as inadequate and her proposal of public injections of capital if private sources were inadequate.
In retrospect, Lagarde’s judgments look prescient. Trichet’s successor at the ECB, Mario Draghi, came to a very different view of what that institution needed to do to maintain financial stability. The ECB lowered its key interest rate in November 2011, and the following month instituted a longer-term refinancing operation for European banks. European banks, however, are still seen as relatively frail.
The IMF subsequently reassessed the response to sovereign debt crises and reviewed the framework for debt restructuring. Its review found that “debt restructurings have often been too little and too late, thus failing to re-establish debt sustainability and market access in a durable way.” The report’s authors claimed that: “Allowing an unsustainable debt situation to fester is costly to the debtor, creditors and the international monetary system.” The policy review raised the possibility of more involvement of the official sector in debt restructuring.
But the development at the IMF of a proposal to write down unsustainable debt at an earlier stage of a crisis has aroused resistance from German and other policy officials. They see the suggestion of a standstill on debt repayments as an assault on the rights of bondholders. Any mention of delay or reduction of payments is viewed as the first step towards the evasion of borrowers’ responsibilities.
Such a position in the wake of the restructuring of the Greek debt is alarming. Other borrowers will suffer financing problems, and relying on exhortations to repay in full will not improve their circumstances. Moreover, ignoring the costs to the debtor of a (attempted) repayment is self-defeating. The Greek economy may have touched bottom, but even under the most optimistic scenario its debt/GDP ratio will not decline for years.
The IMF is the agent of 188 principals. To be credible, it must serve the interests of all its members, not just its partners in a lending arrangement. Moreover, the IMF has established more credibility in this crisis than those who have consistently refused to acknowledge its extent. In seeking to improve the process of dealing with debt restructuring, the IMF is fulfilling its mission to provide “…the machinery for consultation and collaboration on international monetary problems.” (IMF Article of Agreement I(i).) Its members should allow it to meet that mandate