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Can the IMF Really Save the World Economy?

Wednesday, April 8, 2009

Increasing the IMF’s resources does virtually nothing to ameliorate the unprecedented slump presently afflicting the world’s major industrialized countries.

Last week’s G-20 heads of state meeting took place against the backdrop of the worst global economic crisis in the postwar period. Yet judging by that meeting’s meager results—largely limited to an increase in the size of the International Monetary Fund—one could be excused for thinking that the G-20 must believe that whatever might presently be ailing the global economy can be readily fixed with an IMF band-aid. One has to hope that global policymakers get much more serious about the present economic crisis or the world economy will find itself caught in a deflationary trap.

Since the G-20 meeting in Washington last November, the world economy has sunk much deeper into a synchronized recession on a scale not experienced in the postwar period. GDP is now contracting at more than a 6 percent annualized rate in the United States and Europe, while it is declining at annualized double-digit rates in Japan. The Organization for Economic Cooperation and Development (OECD) is now forecasting that the industrialized countries will contract by more than 4 percent in 2009, which would mark their worst economic performance in the last 60 years. Compounding matters has been a collapse in international trade that raises the real specter of a return to the destructive protectionist policies of the 1930s.

The most striking aspect of the recently concluded G-20 meeting was its failure to make any progress in dealing with the real problems afflicting the global economy.

Most economists would agree that the two primary factors driving the global economic recession have been a severe asset price bust and a “once in a lifetime” credit-market crunch in the major industrialized countries. As an indication of the severity of the decline in global equity and housing prices, the OECD now estimates that approximately US$50 trillion in global household wealth, or the equivalent of around 100 percent of world GDP, has been wiped out over the past year. As an indication of the severity of the banking crisis, the IMF estimates that the total losses to the global banking system from bad lending practices will amount to US$2.3 trillion, or more than double the losses that the banks have recognized to date.

The most striking aspect of the recently concluded G-20 meeting was its failure to make any progress in dealing with the real problems afflicting the global economy. For, despite all the spin that policymakers are putting on the meeting, no agreement was reached on the additional fiscal policy stimulus so sorely needed to offset the ravages of falling asset prices on global household expenditures. And the meeting also failed to come up with any new initiatives that might adequately recapitalize the global financial system, another necessary condition for starting a sustainable global economic recovery.

One has to hope that global policymakers get much more serious about the present economic crisis before the world economy finds itself caught in a deflationary trap.

While the G-20 meeting was unable to reach agreement on the real issues presently afflicting the global economy, it did make substantial progress in increasing the size of the IMF. Indeed, the G-20 credibly pledged to treble the size of the IMF from US$250 billion to US$750 billion and to effect a US$250 billion additional allocation of Special Drawing Rights, the IMF’s unit of account. The question remains, however, whether this agreement was more than a fig leaf to hide the lack of progress on the more substantive challenges facing the global economy, and whether by itself it can do very much to staunch the bleeding.

To be sure, the prospective enlargement of the IMF’s lending capability should be helpful in cushioning the blow of the global economic crisis on the emerging market economies in general and on those in Eastern Europe in particular. With substantially increased loanable resources, the IMF can be more effective in shoring up the external finances of these countries as they grapple with shrinking export markets and with a sudden drying up in capital inflows from abroad.

The Organization for Economic Cooperation and Development is now forecasting that the industrialized countries will contract by more than 4 percent in 2009, which would mark their worst economic performance in the last 60 years.

The key point, however, is that increasing the IMF’s resources does virtually nothing to ameliorate the unprecedented slump presently afflicting the world’s major industrialized countries. And until one gets a meaningful recovery in those countries, the emerging market economies will continue to be under severe pressure. They will remain so as they find their export markets continuing to shrink, their commodity prices continuing to decline, and their foreign bankers reluctant to roll over their loans.

If ever there was a time that global economic policy coordination was needed to prevent the world sliding deeper into recession it has to be now. However, judging by the meager results of yet another G-20 meeting one has to wonder whether a smaller forum comprised of the world’s four major economies—the United States, Japan, China, and Germany—might not be better suited to get meaningful policy coordination among the countries that really count for the global economy. One also has to wonder whether the global economy has the luxury of waiting another six months before the G-20 has another go at getting its act together.

Desmond Lachman is a resident fellow at the American Enterprise Institute. Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney.

FURTHER READING:  Lachman has also written for The American on the failures of the previous G-2- meeting, the next economic shoes to drop, and not repeating Japan’s mistakes during its financial crisis in the early 1990s.

Image by Dianna Ingram/The Bergman Group.

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