Summary by Prakash Loungani
The IMF’s First Annual Research Conference held on November 910, 2000 featured papers on a number of important and topical themes. The conference also commemorated an exciting period in the history of the IMF’s Research Department when two of its staff members, Robert Mundell and Marcus Fleming, developed their famous and eponymous model. In an after-dinner talk at the conference, Mundell shared some background surrounding the development of the model during the 1960s, some influences that were important, “and, yes, some of the defects of the model.” In a presentation, “International Macroeconomics: Beyond the Mundell-Fleming Model,” Maurice Obstfeld—delivering the first Mundell-Fleming lecture—discussed how present research efforts have remedied some of those defects.
Currency Crises and Monetary Policy in an Economy with Credit Constraints
Philippe Aghion (Harvard University), Philippe Bacchetta (Studienzentrum Gerzensee), and Abhijit Banerjee (MIT)
Discussant: Guillermo Calvo (University of Maryland)
Monetary Policy in a Financial Crisis
Lawrence Christiano (Northwestern University), Chris Gust (Board of Governors, Federal Reserve Bank), and Jorge Roldós (IMF)
Discussant: Martin Uribe (University of Pennsylvania)
The Interest Rate-Exchange Rate Nexus in Currency Crises
Gabriela Basurto (IADB) and Atish Ghosh (IMF)
Discussant: Philip Lane (Trinity College, Dublin)
The Effects of IMF and World Bank Programs on Poverty
Bill Easterly (World Bank)
Discussant: Michael Kremer (Harvard University)
Moral Hazard in International Crisis Lending: A Test
Giovanni Dell’Ariccia (IMF), Isabel Goedde (Mannheim University), and Jeromin Zettelmeyer (IMF)
Discussant: Carmen Reinhart (University of Maryland)
Inequality, Transfers, and Growth: New Evidence from the Economic Transition in Poland
Michael Keane (New York University and Yale University) and Eswar Prasad (IMF)
Discussant: Jennifer Hunt (Yale University)
Mundell-Fleming Lecture: International Macroeconomics: Beyond the Mundell-Fleming Model
Maurice Obstfeld (University of California, Berkeley)
Crisis Resolution and Private Sector Adaptation
Gabrielle Lipworth and Jens Nystedt (IMF)
Discussant: Andrew Haldane (Bank of England)
Bail Ins and Borrowing Costs
Barry Eichengreen (University of California, Berkeley) and Ashoka Mody (World Bank)
Discussant: Charles Adams (IMF and Asian Development Bank)
Do Monetary Handcuffs Restrain Leviathan? Fiscal Policy in Extreme Exchange Rate Regimes
Antonio Fatás (INSEAD) and Andrew K. Rose (University of California, Berkeley)
Discussant: Tamim Bayoumi (IMF)
Exchange Rate Regimes and Economic Performance
Eduardo Levy-Yeyati and Federico Sturzenegger (Universidad Torcuato Di Tella)
Discussant: Miguel Savastano (IMF)
What Happened to Asian Exports During the Crisis
Rupa Duttagupta and Antonio Spilimbergo (IMF)
Discussant: Susan Collins (Georgetown University)
Panel Discussion on Private Sector Involvement
Chair: Alexander Swoboda (IMF) Panelists: Amer Bisat (Morgan Stanley Dean Witter), Lee C. Buchheit (Cleary, Gottlieb, Steen, & Hamilton), Nouriel Roubini (New York University)
Interest Rate Response to Crises
During the 199798 Asian crisis, Joseph Stiglitz and others urged a reversal of the standard IMF prescription for a country facing a currency crisis, that of raising interest rates temporarily to stem currency devaluation and to restore financial stability. This group of economists argued that raising interest rates would worsen the condition of corporate balance sheets, thus, prompting further capital flight and weakening the currency. Far from defending the currency, interest rate increases could instead have the “perverse” impact of depreciating the exchange rate.
Should this warning of a perverse impact be taken seriously? Several papers at the conference addressed this question. For the Asian crisis countries, Atish Ghosh and Gabriela Basurto found little econometric evidence that increases in interest rates depreciate the exchange rate, leading them to conclude that “the perverse effect . . . remains a theoretical curiosum.”
The answer from theoretical models was less definitive. In the model by Philippe Aghion, Philippe Bacchetta, and Abhijit Banerjee, the main burden imposed by the financial crisis is that the devaluation raises the foreign currency debt obligations of the corporate sector. Consequently, limiting the depreciation through increases in interest rates is, in most cases, good policy.
Lawrence Christiano, Chris Gust, and Jorge Roldos were more agnostic about whether or not interest rate increases are the right policy in the face of a currency crisis. In their model, the burden on the foreign currency debts may be overwhelmed by a rise in asset prices (the asset side of the country’s balance sheet). The response of asset prices hinges, in turn, on the degree of substitutability and diminishing returns in production. If the substitution between labor and imported inputs is easy to make, interest rate cuts to maintain output may be a good option. If the economy is unable to adjust factors that are complementary to imported inputs—something that may be quite plausible in the short run—then an interest rate cut could have a recessionary impact.
Impacts of IMF Lending
Critics of IMF lending to emerging markets during crises argue that rescue packages foster “investor moral hazard.” That is, investors are willing to make more loans, and at better terms, to these countries than they would otherwise make because they believe that the IMF will bail out the countries (and, indirectly, the investors) in the event of a crisis.
Detecting moral hazard is an empirical challenge. Giovanni Dell’Ariccia, Isabel Goedde, and Jeromin Zettelmeyer suggest that the Russian crisis of August 1998 provided an opportunity to observe this effect. The widespread expectation by market participants that Russia would receive a rescue package because it was “too nuclear to fail” turned out to be wrong. The sign that the international community appeared less willing to rescue emerging markets should have led investors to exercise greater caution in lending to these markets, thereby raising emerging market spreads and strengthening the link between spreads and economic fundamentals. The authors found modest evidence that spreads did increase in the aftermath of the Russian crisis; moreover, investors appear to have started paying greater attention to countries’ risks, as countries with sounder economic policies experienced a smaller increase in spreads.
Proponents of IMF lending argue that it has a “catalytic effect” in overcoming asymmetric information or sovereign risk distortions that create too little lending to some emerging markets. Barry Eichengreen and Ashoka Mody reported some evidence of such an effect. Using data on interest rate spreads for emerging market bonds issued over the 1990s, they found that IMF lending under the Extended Fund Facility programs improves the terms of borrowing and market access to private lending. In their empirical work, however, this effect appears to hold only for countries with intermediate credit ratings.
Engaging the Private Sector in Crisis Resolution
Exactly how to involve the private sector in crisis resolution is one of the most difficult issues being tackled in international financial architecture reforms. Noriel Roubini noted that there had been important shifts in the language and tone of the discussions from the coercive-sounding “bailing-in” of the private sector, to “burden-sharing,” and, more recently, to “constructive engagement.” The private sector involvement (PSI) policies followed by the official sector have, to date, struck a balance between the need to establish some rules—to reduce uncertainty and unpredictability of policy—and the need for discretion to deal with the particular circumstances of each country. Roubini noted that while, over time, the buildup of these case histories might yield some clear rules to be followed with regards to PSI, there will likely always be a need for constructive ambiguity in the overall PSI framework.
Gabrielle Lipworth and Jens Nystedt cautioned that, in the absence of clearly established rules of the game concerning PSI, the private sector will have a stronger incentive to seek new instruments that are better insulated from restructurings. They noted that the large-scale restructurings of syndicated bank loans in the aftermath of the 1980s debt crisis had provided an impetus to the use of the international bond market for emerging market borrowers. It would be natural to expect that as bond restructurings become more common, private sector creditors will try to use instruments, such as securitized or guaranteed debt, which are harder to restructure.
Poverty, Inequality, and IFI Policies
There are few ailments of modern economies that have not been blamed, at one time or another, on policies recommended by the international financial institutions (IFIs). One steady refrain has been that structural adjustment programs hurt the poor. Bill Easterly, however, found mixed evidence on the issue. While the programs appear to shield the poor from some of the pain of economic contractions, they also moderate the income gains of the poor during economic expansions. This result may come about because adjustment lending has greater impact on the formal sector than on the informal sector, to which many of the poor tend to be attached. Hence, “the poor may be ill-placed to take advantage of new opportunities created by structural adjustment reforms,” but they may also suffer less “from the loss of old opportunities in sectors that were artificially protected prior to reforms.” The inclusion of provisions to strengthen social safety nets in lending programs also cushions the impact of recessions on workers’ incomes.
IFI lending and policy prescriptions are also often blamed for increasing income inequality, particularly in transition economies that have undergone tremendous economic change over the last decade. Michael Keane and Eswar Prasad, however, challenged this conventional wisdom for one of the more successful transition countries—Poland. Using very comprehensive data on the incomes and consumption of Polish households, they found that the increase in income inequality during the transition was quite modest, leaving Poland with income inequality “closer to those of Scandinavian countries than that of the United States.” Though changes in income inequality were modest, labor earnings inequality did increase substantially during transition; however, government transfer programs mitigated the rise in overall income inequality.
Effects of Exchange Rate Regimes
With countries increasingly experimenting with their choice of exchange rate regimes, the issue of how regimes affect economic performance has become even more critical. One immediate challenge for researchers is how to classify a country’s exchange rate regime, particularly because there is often great divergence between a country’s stated regime and the one it follows in practice. The IMF provides a detailed classification based on countries’ stated regimes in its Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER). Eduardo Levy-Yeyati and Federico Sturzenegger, however, attempt an alternate classification based on observed volatility in exchange rates—both in the level of the exchange rate and in its rate of change—and the volatility of reserves. To take an example, a country with low volatility of exchange rates and high volatility of reserves is classified as a fixed exchange rate regime, regardless of its declared regime.
With this new classification, the authors find that intermediate exchange rate regimes tend to have higher inflation rates (controlling for other influences) than either fixed or floating exchange rate regimes. This result is somewhat at odds with the findings of a comprehensive 1996 IMF study by Ghosh, Gulde, Ostry, and Wolf.1 Using a classification of regimes based on the AREAER and input from IMF country experts, they found fixed regimes to deliver lower inflation than other regimes. Other results of the Levy-Yeyati and Sturzenegger study were that output growth is lower, and output volatility higher, in countries with fixed exchange rate regimes than in others with intermediate or floating regimes.
Rupa Duttagupta and Antonio Spilimbergo tackled the puzzle of why exports of Asian crisis countries responded with a substantial lag to the large real depreciations of their currencies. They presented evidence that the near-simultaneous depreciationof these currencies neutralized the competitive advantage that any one country might have gained had its currency been the only one devalued.
Atish Ghosh, Ann-Marie Gulde, Jonathan D. Ostry, and Holger Wolf, Does the Exchange Rate Matter for Inflation and Growth?, IMF Economic Issues No. 2, 1996.
The IMF’s First Annual Research Conference will be the subject of a special issue of IMF Staff Papers in 2001. Proceedings of IMF conferences and seminars, including agenda and papers, are available at http://www.imf.org/external/np/exr/seminars/index.htm.