The Economy: Mike Evans

Dec. 21, 2004
IMF policies flawed

It's time for the International Monetary Fund to change course. After the gold standard collapsed in the 1930s, the leading economic minds of that era came up with the concept of a world central bank, which would loan money to countries that were unable to meet their international obligations. Sort of like Federal Deposit Insurance -- except the amounts had a few more zeros. When the limit on FDIC insurance was $10,000 and the banking system was regulated, the whole scheme worked well. Savers knew their deposits were insured, so they didn't rush to take their money out of the banks when negative rumors swirled. Bankers, on their part, generally restricted themselves to prudent loans. As we know, the whole system came crashing down after 1982, when the upper limit on FDIC insurance was boosted to $100,000, and bankers were freed from the previous restrictions on loans. Some of them went hog wild, and eventually the government had to cough up about $400 billion to help the banking system over the rough times. Nonetheless, the heartbreak of FIRREA (Federal Institutions Reform, Recovery, Enforcement Act) had a happy ending. Alan Greenspan quietly encouraged banks to raise the spread between the prime rate and the funds rate from one percentage point to three points. The Federal Reserve Board did its part by reducing the funds rate to 3%, or 0% in real terms. The U.S. economy eventually recovered and is now the envy of the rest of the world. Notice carefully what happened. A credit crunch occurred, and the Fed eased. No one knows for sure what would have happened if the Fed had tightened, but it wouldn't have been pleasant. The U.S. economy would have plunged into a major recession and maybe even another depression. So when the financial sector threatens to come unglued, here's what to do. One, provide money to bridge the gap. Two, make the necessary reforms. Three, reduce interest rates to get the economy started again. Pretty straightforward, wouldn't you say? Not if you work at the IMF. Here come the gladiators to the rescue. One, they promise to lend money to bridge the gap, providing of course that the countries institute the necessary reforms, which in most cases means reducing the bloated government deficit. But then the IMF makes the situation much worse by insisting that these countries raise their interest rates. That is precisely the wrong course to take. The IMF has taken what was a bad situation in Thailand, South Korea, Malaysia, Indonesia, and now Brazil and made it much worse. The IMF is correct to push for fiscal reform -- but dead wrong in insisting that countries raise their interest rates. Instead, rates should be lowered in order to resuscitate domestic demand -- and raise enough in tax revenues so budget deficits can be reduced. Some economists will object that lower interest rates will reduce the value of the currency, leading to higher inflation and a lower standard of living for the impoverished masses. Under ordinary circumstances, that's right. However, these are hardly ordinary circumstances: The countries are bleeding to death, and their currencies have already fallen 50% to 80%. In this case, a sharp drop in interest rates would actually boost the value of the currencies. It would reattract foreign investment, because with stronger growth, the investment opportunities would be more likely to generate a profit. The IMF is run by well-known macroeconomists with impeccable credentials. But these high-powered economists can't save Southeast Asia and Latin America with their current flawed prescriptions any more than the "best and the brightest" were able to chart the correct course in Vietnam. To get the economies of these countries back on track requires a massive easing in monetary policy -- and the immediate termination of the well-meaning but badly flawed IMF policies. Michael K. Evans is president of the Evans Group and professor of economics at the Kellogg School of Business, Northwestern University, Evanston, Ill. His e-mail address is [email protected].

Sponsored Recommendations

Voice your opinion!

To join the conversation, and become an exclusive member of IndustryWeek, create an account today!