Q. Do IMF-supported programs impose austerity on countries in financial crisis?
A. No. A country in financial crisis is likely to face a period of austerity whether it approaches the IMF or not. An IMF program reduces the extent of the belt-tightening needed and aims at bringing about a quicker rebound in incomes than would otherwise be the case. Countries seek IMF loans when, through some combination of external events and domestic vulnerabilities (such as a high level of public debt), they have already run into deep financial difficulties. The fact is that the IMF's financial support, which is normally made available at interest rates well below those that the private markets would charge, reduces the extent of the austerity and adjustment that the country would have to make otherwise.
Q. Do IMF programs impose too many conditions on countries affected by a crisis? Isn't it true that most of these conditions have little to do with the crisis in the end?
A. The IMF's conditionality guidelines explicitly call for limiting structural conditions to measures that are critical to the achievement of program objectives. This excludes other policy measures that could be very important for the country, but do not affect macroeconomic outcomes. Discussions with country authorities focus on identifying the above mentioned critical measures and on keeping their scope and number to a minimum. For instance, conditionality in recent Fund-supported programs in Ukraine, Hungary, and Iceland focuses on the sectors that are at the root of the economic crisis:
• Ukraine: an inflexible exchange rate regime and undercapitalization in banking system;
• Hungary: liquidity shortages and capital deficiencies in banks; high fiscal deficit and unsustainable public debt;
• Iceland: excessive leverage and capital deficiencies in banking system and collapse of confidence in the domestic currency.
Q. When economic times are hard, does the Fund promote lower spending on health, education, social protection, or investment?
A. In all cases, the IMF encourages governments in their programs to protect the poor from the fiscal adjustment. Lack of financing and unsustainable debt burdens may constrain a government's ability to maintain its level of spending, including social or investment spending. In this situation, IMF teams urge country authorities to curtail lower priority or non-productive spending (such as "white elephant" projects)-but to preserve priority social spending, including on health and education. The objectives are typically aimed at providing a social safety net for the poor and ensuring that investment spending boosts the economy at a critical time.
In order to limit the effects of crisis on lower-income households, Fund staff support targeted compensation measures such as cash transfers or higher social spending. For example:
• Responding to the hike in food and fuel prices during 2007-08, programs for low-income countries supported under the Poverty Reduction and Growth Facility included a range of measures to cushion the impact on the poor.
• Liberia suspended import duties on rice, adopted targeted programs to ensure access to food (such as school-feeding), and increased subsidies for public transportation.
• As part of the $16.4 billion loan package for Ukraine, for example, the government envisages an increase in targeted social spending amounting to 0.8 percent of GDP to shield vulnerable groups.
• The recent economic program of Pakistan (loan approved by the Executive Board on November 24, 2008) includes measures to protect low-income households from increases in electricity tariffs and envisages increases in social safety net spending and scaling up of existing social programs.
Q. Why does the IMF insist on low inflation in programs? Isn't it true that growth and poverty reduction can occur at moderate inflation levels?
A. Inflation is the most pernicious tax on low-income households that lack the means to protect their salaries and scant savings against inflation. In addition to the negative impact on the poor, a large body of empirical evidence has established that when (annual) inflation passes the 5 percent mark investment and economic activity also suffer.1 It is against this background that the Fund supports policies aimed at achieving or maintaining low inflation.
Q. In a crisis situation, does the Fund call for currency depreciation, tight monetary policy, and high interest rates?
A. During the type of crises that the IMF is called to address, countries typically face a loss of investor confidence that results in large sales of domestic assets including, quite often, the domestic currency. This is also called capital flight. The public fear is that the crisis will result in high inflation and/or debt defaults. It is because of these risks that interest rates and the demand for foreign currency increase. A prudent monetary policy and other confidence-building measures are needed to help contain the run on the domestic currency and on domestic assets by curtailing inflation expectations and raising interest rates, thus preventing a disruptive situation with a free falling exchange rate and rampant inflation. However, as confidence improves and capital flows back into the country this eventually allows for lower interest rates again.
Q. Do these policies constrain economic activity?
A. These policies are aimed at restoring confidence by stabilizing economic conditions and improving expectations about the country's prospects. The crisis itself brings about instability and recession; the policy response is designed to soften the blow and put the economy back on track. Once confidence is restored, consumer and investment demand recover. In the event of a currency depreciation, higher exports also provide a further boost to economic activity. Another way of looking at this issue is that, in absence of these policies, the country could face runaway inflation and an even steeper decline in the value of its currency. The ensuing climate of financial chaos would no doubt be disastrous for the economy.
Q. Is the Fund recommending fiscal stimulus for advanced countries, but fiscal tightening for countries that borrow from the Fund?
A. Not necessarily; the appropriate fiscal policy depends on the country's circumstances. Like private companies, governments may run into financial problems and be unable to borrow or become insolvent. If debt levels are high, for instance, they face high interest rates and/or lack access to financing. Countries that request financial assistance from the IMF are often in this situation and need to undertake actions to regain their feet financially. Lower deficits ultimately enable them to access new financing and persuade investors that their debt is sustainable. This, in turn, lowers interest rates and stimulates the economy.
In cases where reduced government spending is needed, the Fund takes into account the economic situation on the ground and adapts its policy recommendations accordingly. For instance, the November 2008 Fund-supported program of Iceland postpones fiscal adjustment, allowing for a high fiscal deficit in 2009 to avoid exacerbating the ongoing collapse of economic activity. In other cases, if government finances are not a serious problem but the economic situation is challenging fiscal stimulus can be an appropriate policy response. This is the case of the U.S. and many Western European countries facing the 2008 financial crisis.
Q. Does the IMF follow a "one size fits all" approach to crisis resolution and economic reforms?
A. No, reforms are tailored to the problem at hand and further molded to countries' circumstances. The type of program, the amount of financial support, and the program's conditions are country-specific. For example, in a study of 133 Fund-supported programs, the IMF's Independent Evaluation Office found considerable variation in the scale of fiscal adjustment across countries, with about 1/3 of the countries targeting a programmed increase in the fiscal deficit and spending as a percent of GDP. Similarly, low inflation has allowed monetary policy to remain accommodative in the 2008 Hungary program, while high inflation in Ukraine has called for monetary tightening in 2009. IMF programs are also flexible in response to evolving circumstances. For example, fiscal targets for the PRGF-supported program with Nicaragua were revised in 2003-04 to allow for higher social and public investment. Another case is Honduras where in response to a temporary spike in fuel prices in 2005, the PRGF-supported program was modified to allow for temporary fuel subsidies and higher spending on social safety nets.
Q. Does the IMF advocate privatization and market liberalization in poor countries, ignoring local conditions and adverse social consequences of such policies?
A. As part of the Fund's policy to streamline conditions within Fund-supported programs, privatization and market liberalization policies are only considered when they are essential to restore financial stability and unlock economic growth. The IMF relies on the World Bank and other agencies for information and expertise in these areas, and every attempt is made to take account of social conditions and prevent adverse social consequences of any policies.
Q. How do the IMF and the World Bank divide their work in developing countries?
A. The IMF and the World Bank coordinate closely their work in developing countries. The Fund focuses on macroeconomic issues including monetary, exchange rate, and fiscal policies, fiscal, monetary, and financial sector institutions and related reforms, and economic governance. Projects supported by the World Bank focus on structural reforms in such areas as private sector development, social protection, water, energy, health, and education. The World Bank works with the Fund on issues concerning governance, public expenditure, and the financial sector. An action plan to strengthen collaboration is being implemented following on the recommendations of a report prepared by a panel of experts in 2007.
1 See, for instance, Andrés, Javier "Does inflation harm economic growth? Evidence for the OECD", NBER Working Paper No. 6062:1-[40], June 1997; Fountas, Stilianos "Inflation uncertainty, output growth uncertainty and macroeconomic performance" Oxford Bulletin of Economics and Statistics, No. 3:319-43, June 2006; Gillman, Max, "Inflation and growth: explaining a negative effect", Empirical Economics, No. 1:149-67, January 2004.
