Financial governance and the crisis: New developments on the horizon

Ilene Grabel co-directs the graduate program in Global Finance, Trade and Economic Integration at the University of Denver’s Graduate School of International Studies. She has also lectured at the Cambridge University Advanced Programme on Rethinking Development Economics since its founding. Grabel has published widely in academic journals on financial policy and crises in developing countries, international capital flows, and central banks and currency boards. She is presently working on policies to reduce the likelihood of financial crises in developing countries for the G24 and is conducting research into the political economy of exchange rate regimes.

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In what follows, I flag a number of new developments that relate to developing country and international financial institutions responses to the ongoing economic crisis.

1. Central banks to investors: “Don’t worry–no capital controls here!”

As Triple Crisis readers know, a great many developing countries have deployed controls on capital outflows and especially on inflows in response to the myriad challenges they face in the current environment. For some countries, controls on outflows have been implemented to mitigate financial instability and currency depreciation following capital flight. Rapidly growing developing countries, on the other hand, are using inflow controls to reduce inflationary pressures, cool asset bubbles, staunch currency appreciation, and protect economies from the financial instability induced by significant future reversal of inflows. Indeed, capital controls have emerged as a key weapon of choice in the modern day “currency war.”

But recently leaders of some central banks have taken great pains to make clear that they will not draw this weapon. Among such countries, Mexico’s policymakers are highlighting their opposition to capital controls, even though the peso has been appreciating significantly against the US dollar since 2010.  Turkish, Chilean and Colombian policymakers have also publicly rejected capital controls despite the appreciation of their currencies. This is not to suggest that policymakers in these countries are sitting on the sidelines while their currencies appreciate and asset values balloon. With the exception of Mexico, these central banks have been buying dollars and implementing expansionary monetary policies to stem the appreciation of their currencies.

Certainly we would neither want nor expect policymakers to fall in line around capital controls (or any other measures for that matter). But it is nonetheless notable to see some policymakers taking pains to communicate their opposition to capital controls.  This divergence on capital controls likely reflects many factors, not least differing internal political economies (such that capital controls are politically viable in some countries, but not in others, owing to the power of the financial and/or export-oriented community), the continued sway of neo-liberal ideas in some countries, and perhaps also pride associated with dealing with the problem of an excessively strong currency in countries that have so long faced the opposite problem. (We might recall in this context that US policymakers also saw the US dollar’s appreciation during the first half of the 1980s as a reflection of the country’s might and prestige.)

2) Who will control capital controls?

Since January, we’ve been hearing in the most general terms that the IMF needs to take on the role of coordinating capital controls via some type of code or mandate on the subject. This issue has arisen in the context of concerns about the ad hoc nature of country-level responses to the currency war.  French President Sarkozy and his Finance Minister Lagarde have mentioned the need for IMF coordination on capital controls, suggesting that this might be among the signature issues of the country’s new leadership of the G20 and the G8. There is some discussion of this issue in a November 201O IMF report “The Fund’s role regarding cross-border capital flows” (see e.g., p. 35, paragraphs 49-50).

Whether the IMF seizes this opportunity and how it comes to interpret this possible new charge is of critical importance to advocates of national policy space for capital controls.  As Peter Chowla notes (and as the IMF itself notes on p. 35 of this report), the recent advances inpolicy space for capital controls could be lost if the Fund presses for capital flow liberalization (as it was poised to do in 1997). It will be important for Fund watchers to stay on this issue and continue to advocate coordination that does not presume a norm of liberalization. We can also hope that those developing countries that have used capital controls so successfully will resist any effort to expand the IMF’s authority around such a norm.  Certainly there is much in the IMF’s own actions and official statements by the institution’s key figures during the current crisis to call upon should we find that momentum builds around rewriting the institution’s new position on capital controls.

3.  IMF self-critique: A welcome development

The release of the latest report of the IMF’s internal watchdog, the Independent Evaluation Office (IEO), makes for interesting reading. The new report examines the IMF’s work in 2004-07 to determine whether it did enough to identify circumstances that led to the global crisis. The report’s authors conclude that the institution failed on many levels–a conclusion that is unequivocally correct.  The report identifies numerous failures—among them, ideological blinders that reified liberalized financial markets, a tendency toward “group think” in the institution, weak internal governance, a lack of coordination and follow up across its units, political constraints that came from powerful countries, unevenness in the institution’s surveillance across countries and in the quality of staff recommendations, and the use of economic models that were not up to the task at hand.

The numerous failings in the IEO report accord with those identified by long-time IMF critics since at least the late 1970s (not that this is acknowledged by the report’s writers). (Aside: it is a pity that the report of the US’ Financial Crisis Inquiry Commission isn’t half as good or readable as this one. See Matias Vernengo’s critique of that report.) However, the reform recommendations that conclude the report stand in sharp contrast to its hard-hitting documentation of IMF failures. The recommendations are unimaginative and timid.  For example, having indicted the IMF for its tendency toward dangerous group think, the report does not call for a fundamental rethink of the Fund’s own hiring practices.  One remedy for group think would involve hiring qualified economists who possess diverse theoretical commitments and training. And while we’re at it, why not hire from other disciplines as well (as has more often happened at the World Bank)? Why not call for bolder changes in voting rights so as to expand the voice of developing countries in a significant way (beyond the ever so modest changes that will come on line in 2012)? Why not address the issue of how the Managing Director gets selected? And why not adopt the proposals by CEPR’s Mark Weisbrot and Dean Baker for institutional reform that makes public which economists at the IMF are responsible for which of its predictions and recommendations, and then holds them accountable when they get it so wrong?

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