TOKYO – Graduates of IMF emergency loan programs accepted the Fund’s admission that it miscalculated the cost of austerity with a mix of schadenfreude and frustration that the change came too late to spare them economic pain.
Countries such as Argentina, Indonesia and South Korea, which were required to make deep budget cuts in exchange for tens of billions of dollars in International Monetary Fund aid, said the lending institution was finally learning from mistakes made during financial crises in Asia and Latin America.
“People learn from what happened in the past,” said Indonesia’s Trade Minister Gita Wirjawan. “Certainly what we went through in 1998 was painful. I lived through that, and hopefully the … difficulties we went through served as lessons.”
Indonesia signed a US$10 billion IMF loan deal in 1997 as the Asian financial crisis raged, and started an economic program that called for spending cuts, tax increases, bank closures and tight monetary policy which the IMF predicted would limit the downturn.
Indonesia’s economy ended up contracting by 13 percent in 1998, nowhere near the IMF’s forecast for 3 percent growth.
Former IMF Managing Director Dominique Strauss-Kahn admitted in 2010 that the lending institution had made “mistakes” in Asia.
Last week, the Fund released research showing that the economic damage from aggressive austerity measures may be as much as three times larger than previously assumed.
In line with the research, the IMF has softened its earlier advice on austerity in the eurozone crisis, arguing now that forcing Greece and other debt-burdened countries at the center of the debt storm to reduce their deficits too quickly would be counterproductive.
Cushioning the Blow
The IMF’s research shows a marked difference in how austerity affected advanced countries before and after 2009, when most of the world’s major central banks had cut interest rates to near zero to fight the global financial crisis.
Normally, when fiscal policy tightens, central banks can cushion the blow by lowering interest rates. But because rates are now about as low as they can go, monetary policy can do little to offset the budget tightening.
“We are in a period in which many countries are in the liquidity trap,” said Olivier Blanchard, the IMF’s chief economist. “As we know it doesn’t mean they cannot use monetary policy, but monetary policy is much more constrained than in normal times. In this case, you just get the effect of fiscal consolidation without the offset from monetary policy.”
In Indonesia back in 1997, the IMF recommended both budget cuts and tight monetary policy, which critics have long argued exacerbated the downturn.
The IMF acknowledged in 1999 that it could have allowed for quicker policy easing when it became apparent that the economy was faring far worse than predicted. But it also blamed the government for not properly implementing the program.
The IMF’s reputation in Asia remains tarnished to this day, and countries in the region have amassed some US$6 trillion in foreign exchange reserves in part to ensure they will never again have to seek a bailout.
Strategies ‘Bound to fail’
Hern Lorenzino, Argentina’s minister of economy and public finance, said the IMF’s admission was a “first step” that should lead it to change tack in Europe, where it has lent to Greece, Ireland and Portugal.
Argentina borrowed about US$23 billion through a series of IMF loans over the past decade, which it has since repaid, and is now a vocal critic of the conditions that the institution places upon loan recipients.
Although Lorenzino cancelled his trip to the Tokyo meeting at the last minute, citing the need to resolve a labor dispute at home, he spoke out against the Fund, saying it “overestimates the impact of its recipes,” according to the local Ambito daily.
South Korea took out a US$21 billion IMF credit line in 1997 and agreed to an economic program that envisioned its gross domestic product slowing to 3 percent in 1998 from 5.7 percent the year before. The economy actually contracted by nearly 6 percent in 1998.
Chung Duck-koo, who headed the South Korean delegation that negotiated the 1997 bailout, said the Fund misdiagnosed a currency crisis as a fiscal policy problem and prescribed the wrong reforms.
“It was like a fire fighter, having arrived far too late, who turned out to be short of sufficient water and short of the precise assessment of the nature of the fire,” he told Reuters. “Therefore, the fire resulted in getting bigger.”
At least one country said it has found success in diverging from the IMF’s economic recipes.
Bolivian Finance Minister Luis Arce said his government had decided to ignore IMF policies after observing the failure of the fund’s policies in other countries.
Arce said his government had reduced extreme poverty to just over 24 percent of the population in 2011 from more than 38 percent in 2005 by pursuing policies contrary to Fund recommendations. Per capita GDP doubled between 2005 and 2011.
“In Bolivia we have achieved better wealth distribution with higher state involvement. We have never had faith in the market and we abandoned a market-based economy in 2006,” Arce said, adding that the faith many IMF economists have shown in the “perfect market” was misguided, given the economic crises caused by their policies.
“The directors of the IMF have good intentions but certain departments are absolutely deaf to the changes that should be made within the Fund,” Arce continued. “The best thing Lagarde could do is make sure her good intentions make it through to the next level.”