The Role of IMF in the Global Economy - Essay Example

The Role of IMF in the global economy Contents Introduction 3 Literature review 4 Theoretical Background 4 Role of IMF in providing financial aid 5 Method 6 Results 7 Discussion of results 8 Conclusions 10 Works Cited 11 Name of the Student Name of the Professor Course Number Date The Role of IMF in the global economy Introduction The International Monetary Fund, a rather ambitious project of the Bretton Woods conference was proposed in 1944. It took two years to set the organization up and it finally became functional in 1946. One of the most powerful multinational organizations in the contemporary world the IMF can be considered as a global umbrella to ensure that the monetary policy framed by nations can promote sustainable growth. Initially the IMF had only 48 countries under its membership but presently it includes more than 188 countries (Weiss, “International Monetary Fund: Background and Issues for Congress”). The functions of the IMF are quite broad and it ranges from enhancing monetary cooperation between nations to maintaining an acceptable level of balance of payment. Other functions include promoting stability of exchange rate, ensuring smooth flow of capital and providing funds to nations. Providing financial assistance is one of the major functions of the IMF so that problems relating to balance of payment can be reduced (Weiss, “International Monetary Fund: Background and Issues for Congress”). Monitoring the fiscal and monetary functions of nations under its membership and technical advice are also functions of the IMF. The purpose of this paper is to highlight the role of IMF in helping to protect the world economy. The paper is divided into five main sections. The chapter of literature review focuses on the key economic theories in explaining the role of the IMF. The methodology chapter briefly discusses the methods of conducting this essay and the section on results provides empirical verification of the ways in which the countries has performed with the help of the funds provided by the IMF. Literature review Theoretical Background Historically, the mechanism of working of IMF is rooted in the Keynesian macroeconomics. The IMF is essentially a monetary organization that focused on the monetary help to adjust balance of payment of a country. The works of Friedman (1950 cited in Davidson 64) regarding floating exchange rates and monetarism had influenced the functioning of the IMF. Keynes was one of the founding fathers of the IMF and he had applied his countercyclical monetary and fiscal policies to combat unemployment and recessions. However, over the years the functioning of the IMF had changed dramatically with the evolution of the new classical macroeconomic ideas. The proponents of the Keynesian and the post Keynesian theories had suggested that uncontrolled flow of capital makes countries highly vulnerable to events like banking crisis and currency crisis by fostering speculative activities. Research of Lavoie (2014) had shown that countries like Korea, Malaysia and Japan had strong domestic financial sectors that were controlled by the state. The new economic philosophy has the notion that capital flows was a good thing between the nations. Initially, the IMF had supported polices of capital control by restricting flows of capital. The research of Abdelal (2009) had shown that changing philosophies of macroeconomics and the role of the state had a major change regarding the role of the state and its intervention in economic affairs of the country. The research regarding the proper mode of functioning of the IMF is quite divergent as has been shown in the research works. Economists had failed to reach a conclusion regarding the ideal economic school of thought that should guide the policies (Moschella and Weaver 64). Previous researchers have also established that the IMF has largely relied on the role of privatisation and liberalization. It is one of the primary conditions based on which the funding of the IMF is structured for recipient countries (Marchesi and Thomas 111-125). The synthesis of the literature shows that loans, grants and debt relief programs of the IMF are actually designed on the principles of privatization and this policy has been severely criticized. This principle is also against the Keynesian principles which had focused on the role of the state (Marchesi and Thomas 111-125). The economic rationale behind privatization lies in the improvement of efficiency that lies in transferring of ownership from the public to the private enterprises. The research of Banerjee and Munger (2004) had comprehensively highlighted the benefits of privatization namely the improvement of efficiency based on market-led forces, freeing assets from the private sector, reducing the pressure from the government users and mobilization of resources. Role of IMF in providing financial aid Historically the role of the IMF has been to provide assistance to the member countries based on a clause of conditionality. There are divergent views of researchers relating to the topic. Reconciliation of the divergent views is a rather difficult task and beyond the scope of this paper. However, contrasting a few studies seems interesting. For instance, the research of Bird (2007) had explored the role of the IMF and the funds provided by it on the global economy. His research has found out that abandoning the conditionality clause in the IMF lending is a rather useful one because without this clause it would rather be infeasible to conduct effective lending. Some researchers have also tried to establish the cause that leads to difference in results. The time of measurement of the variables is a rather crucial factor and economic variables may perform differently within stipulated time (Mobekk and Spyrou, 2002). The works of researchers like Mobekk and Spyrou (2002) is a rather interesting one as it focuses on the perception of the recipient country and the effectiveness of the IMF funds. Their research had shown that the perception that the local people had towards the structural adjustment programs was a crucial factor in determining their success. However, the research had also pointed out that excessive reliance on liberalization and privatization can be particularly harmful for small economies. The role of the IMF has been a controversial one as a provider of financial resource. Some suggest that the organization has been helpful while others criticize it vehemently. The research conducted by Dreher and Walter (2010) had shown that IMF have a major role to play in the reduction of financial crisis particularly for developing countries. In yet another research that was conducted by Presbitero and Zazzaro (2012) it was found that the lending made by the IMF had a significant positive impact on reducing the contagion effect. Their research had also shown that the IMF had particularly contributed more money into countries where the impact of the crisis was significantly higher. According to the research conducted by Fischer (1998) it has been established that IMF has a key role to play in the macroeconomic stabilization and it must be treated as the last resort. Few researchers have also attempted to focus on the financial surveillance and the currency crisis and the role that IMF plays in preventing these unfavourable situations like currency crisis. This is one of the positive contributions of the IMF and under such cases the conditionality clause of the IMF has no major impact on the outcome. In one of the recent research works that has been undertaken by Gola and Spadafora (2011) had pointed out that in order for the IMF lending to be successful, it is extremely important to ensure that the regulations imposed by the Fund must be followed meticulously to ensure their success. Further, it has also been pointed out that if the existing mechanism of financial surveillance is not improved then it is unlikely that the programs will be successful in the future. For instance, the research conducted by Barro and Lee (2005) had pointed out that IMF actually magnifies the moral hazard problem as it mainly wants to insure foreign banks from the losses made during difficult economic scenario. His research had also pointed out that bailouts provided by the IMF are largely counterproductive as the IMF is highly committed itself to insulate the domestic producers from loss. Most of the research works conducted post the financial crisis is of the opinion that the position of the IMF has been greatly undermined during the severity of the crisis. Critics of the IMF stated that the lending policy of the IMF is rather poor as it imposes a number of inappropriate conditions on the countries receiving the loans. The research conducted by Stiglitz (2002) have pointed out that the privatization and austerity programs that had been devised by the IMF in Russia, Brazil and South East Asian countries have actually resulted in the capital outflow. There is a significant amount of research showing the impact of the IMF programs on the Latin American countries. These research works suggested that the impact of IMF funds on the Latin American countries had largely weakened the short-term economic growth (Boughton,117). Most of the stabilization programs in Latin America were largely related to the failure of the policy implementation. However, few research works suggests that failure of the policies were not entirely the mistake of the IMF but certain external conditions like poorly designed policies of Latin America combined with unfavourable external conditions (Abbott, Andersen and Finn Tarp 17-26). Method This research is essentially a qualitative one that reaches conclusions based on the works of other researchers. It is a descriptive one that mainly interprets the figures and relates it to the studies of the previous researchers. A case study approach has been used by the researcher to develop the case. Researchers have shown that in a case study approach non-numeric methods are adopted by researchers to compare data between independent cases. The intrinsic case study approach has been used to reach to the conclusions as in this approach cases are studied in a descriptive manner (Lewis, Thornhill and Saunders 23). This research is also based on secondary data only, as the time and resource constrained has made it non-feasible to collect primary data. Secondary data can be described as any type of data that is collected by other researchers for their own research work (Lewis, Thornhill and Saunders 54). The data has been mainly collected from scholarly articles, newspapers, websites and government publications of different countries. These websites and publications are considered to be authentic and can provide to be a good source of collecting data for secondary research. Also peer reviewed journal articles has been used in this research to frame the section of the literature review. Results The above table shows that the level of SDR Holdings has consistently increased for that of the entire member over the last 14 years. It can also be seen from the above table that the level of aid had particularly increased after 2008 indicating the reliance of the country on the IMF. This shows the heavy dependence of the member nations on the funds provided by the IMF. Figure 1: SHR holdings of countries (Source: “IMF Members Financial Data by Country”) As the provision of IMF funds are largely based on conditionality so there is a great divide between the countries which receive the funds. It has been observed that countries like United Kingdom, Canada, India, Brazil and Peru are the ones which receive majority of the fund. The work of Przeworski and Vreeland (2000) had considered multiple developing countries in their sample. The results from their study had shown that participation in IMF programs had actually slowed the rate of economic growth of countries till the point they were under the program. Once they had left the program they began to grow faster. However, this rate of growth was not greater compared to the estimate if the country had not at all participated in the program. For instance, the IMF is actively contributing towards the economic recovery of the U.K. Presently the total fund holding of the U.K. is 10,738.50 SDR millions. The U.K has been able to reduce its structural deficit by 3.5% from 2010 to 2013 with the help of the fiscal consolidation program designed with the aid of the IMF (“IMF Members Financial Data by Country”). Structural reforms and fiscal austerity programs have also been devised by the country to convert the current spending into capital spending so that the fiscal consolidation can be achieved. It is expected that the Fund’s role in the U.K. can cause economic growth of 2.7% in 2015 which is much higher than other advanced countries (“IMF Members Financial Data by Country”). Another country receiving the help of the IMF is Brazil. It has been observed that the present quota for Brazil is 4,250.50 SDR millions (“IMF Members Financial Data by Country”). In case of Brazil it has been observed that the supply side constraints in the country are largely hampering the economic growth. The IMF has suggested that monetary tightening and fiscal consolidation must be sought by the country to overcome the supply side constraints. Similarly the case of China can also be discussed which have made very high contribution to the IMF over the years. At present the quota China has increased to 9,525.90 SDR millions (“IMF Members Financial Data by Country”). All these figures clearly indicate that the role of IMF as a lender of last resort has strengthened manifold times over the past few years. Researchers have reached the consensus that IMF has indeed been a saviour during difficult economic times ((“IMF Members Financial Data by Country”). Discussion of results There is no denying the fact that IMF is currently one of the most important transnational agencies that has contributed to the recovery of economies from the global financial crisis of 2008. The fiscal consolidation programs and the structural adjustment programs devised by the institutions have been widely accepted by countries like France and Greece in order to obtain the funds. Comparison of cross-countries is even more difficult because all countries do not have similar external conditions which can result in failure of the policies (Papi, Presbitero and Zazzaro, “IMF lending and banking crises”). Poor macroeconomic conditions in countries like high rate of inflation, overvaluation of exchange rates and high budget deficits does not perform well under the fund programs. Many researchers have researched on the lending capacity of the institution and have found out that theoretically the concept of lending by the IMF can induce systematic banking crisis, moral support, lack of liquidity support and bad signalling. However, the empirical verification of the results may be difficult (Papi, Presbitero and Zazzaro, “IMF lending and banking crises”). Despite the weaknesses of the Fund programs one of the fundamental realities is that weak financial conditions is one of the primary reasons which leads to advancement of firms. Again evidences exist that the impact of bad signals and moral hazards can be reduced with the help of funds (“IMF lending and banking crises”). The countries considered in the study namely China, the United Kingdom and Brazil have shown a huge dependency on the IMF for the purpose of borrowing funds. It appears that the position of the IMF is a rather complicated one as it can often create difficult situations for the recipient. If the IMF has to continue its role as a major financial contributor in the past then it must undertake few reforms to strengthen its position. Firstly, the organization must lend only to countries which have been heavily affected on account of the crisis and devise prudent macroeconomic policies in which the countries can repay their debt. Though the provision of conditionality has been heavily debated in the existing literature there is no denying the fact that if regulations are not imposed chances of default are higher. Secondly, as one of its major long-term objectives the IMF should particularly focus on the supervision aspect so that it can supervise the financial regulation of the member countries in an effective manner. This function of financial surveillance must be taken up more seriously to ensure that the member nations does not involve in very high speculating behaviour. Thirdly, the IMF must frame prudent macroeconomic policies in the weakest countries so that they become much more self-reliant and this will reduce their need of obtaining funds. Finally, researchers have also suggested that the IMF must reduce its role as a bailout machine during financial stress. It can be suggested that the IMF should concentrate on creating robust financial framework in the countries which eliminates the need to create bailout situations. Conclusions The current position of the IMF is quite weak as the economic condition of its major contributor, the U.S.A. have been severely crippled. This research had revealed that the working conditions of the IMF have been altered severely in the past fifty years as the economic philosophies guiding has changed widely. Initially the Keynesian school of thought had guided the working of the organization but the new classical macroeconomic philosophies have been adopted since the 90’s. However, ever since the crisis of 2008 the role of the IMF has changed and its lending requirement has increased manifold times. In this paper the examples of countries like the U.K., Brazil and China has shown that the dependence of these countries on the IMF has increased since 2008 and the lending of the IMF to all its member countries have increased more than eight times. This shows that the role of financial assistance of the Fund has become higher. However, there are numerous evidences on the negative side of these lending and it has been pointed out such lending can even reduce the rate of economic growth. In order to improve the situation it is now being recommended that the IMF should create macroeconomic policies that should strengthen conditions in member countries instead of providing bailout programs. Additionally, the surveillance capacity of the organization should also be improved so that it can monitor the activities of the organization in a better manner. Works Cited Abbott, Philip, Thomas Barnebeck Andersen and Finn Tarp. “IMF and economic reform in developing countries.” The Quarterly Review of Economics and Finance 50.1 (2010): 17-26. Print. Abdelal, Rawi. Constructivism as an approach to international political economy. Abingdon: Routledge, 2009. Print. Banerjee, Sudeshna Ghosh. and Michael C. Munger. “Move to markets? An empirical analysis of privatization in developing countries.” Journal of International Development 16.2 (2004): 213-240. Print. Barro, Robert J. and Jong-Wha Lee. “IMF programs: Who is chosen and what are the effects?” Journal of Monetary Economics 52.7 (2005): 1245-1269. Print. Bird, Graham. “The IMF: A birds eye view of its role and operations.” Journal of Economic Surveys 21.4 (2007): 683-745. Print. Boughton, James M. The IMF and the force of history: ten events and ten ideas that have shaped the institution. Washington: International Monetary Fund, 2004. Print. Davidson, Paul. Post Keynesian macroeconomic theory. New York: Edward Elgar Publishing, 2011. Print. Dreher, Axel and Stefanie Walter. “Does the IMF Help or Hurt? The Effect of IMF programs on the likelihood and outcome of currency crises.” World Development 38.1 (2010): 1-18. Print. Fischer, Stanley. “The Asian crisis: A view from the IMF.” Journal of International Financial Management & Accounting 9.2 (1998): 167-176. Print. Gola, Carlo, and Francesco Spadafora. Financial Sector Surveillance and the IMF. London: Emerald Group Publishing Limited, 2011. Print. IMF Members Financial Data by Country.” International Monetary Fund.” IMF . 2014. Web. 21 December. 2014. Lavoie, Marc. Post-Keynesian Economics: New York: Edward Elgar Publishing, 2014. Print. Lewis, Philip, Adrian Thornhill and M. Saunders. Research methods for business students. New Delhi: Pearson Education. 2007. Print. Marchesi, Silvia, and Jonathan P. Thomas. “IMF conditionality as a screening device.” The Economic Journal 109.454 (1999): 111-125. Print. Mobekk, Eirin and Spyros I. Spyrou. “Re-evaluating IMF involvement in low-income countries: the case of Haiti.” International Journal of Social Economics 29.7 (2002): 527-537. Print. Moschella, Manuela and Catherine Weaver. Handbook of Global Economic Governance. London: Routledge, 2013. Print. Papi, Luca, Andrea F. Presbitero and Alberto Zazzaro. “IMF lending and banking crises.” 2013, PDF File. Presbitero, Andrea F. and Alberto Zazzaro. “IMF lending in times of crisis: Political influences and crisis prevention.” World Development 40.10 (2012): 1944-1969. Print. Przeworski, Adam, and James Raymond Vreeland. “The effect of IMF programs on economic growth.” Journal of development Economics 62.2 (2000): 385-421. Print. Weiss, Martin A. “International Monetary Fund: Background and Issues for Congress.” Congressional Research Service, Library of Congress, 2012. PDF File. Read More