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Not so, Mr Tough Guy

23 April 2012 By Hugo Dixon

We’re going to be really tough on the euro zone. If they want more bailouts from the International Monetary Fund, they are going to have to submit to strict conditionality. That was the message delivered by the rest of the world when it agreed at the weekend to participate in a fundraising exercise that will boost the IMF’s resources by at least $430 billion.

But the meaning of the message isn’t quite what it seems. The IMF is actually in some ways calling for less rather than more short-term austerity in the euro zone. So if the Europeans submit to IMF discipline, it will ironically mean less of a hair shirt.

It is easy to see why the rest of the world is unhappy with the special treatment the euro zone receives from the IMF. The managing director, currently Christine Lagarde, has always been a European. Vast resources, way beyond what are normally available in IMF programmes, have been channelled to Greece, Ireland and Portugal.

What’s more, the rest for the world – from developed countries such as America, Britain and Canada to emerging nations such as Brazil – feel that, despite being pretty rich, the euro zone has not done enough to sort out its own problems. Hence, the agreement to beef up the IMF resources only after a long wrangle – and only after scaling back the original request from $600 billion as well as insisting on strict conditionality before the money is ever disbursed.

At the same time, the IMF has three recommendations, as outlined in last week’s World Economic Outlook, which are somewhat at variance with current euro zone policy. First, it wants the region not to overdo short-term fiscal austerity while placing more emphasis on longer-term structural measures to improve budgets. Second, it wants the European Central Bank to continue very accommodative monetary policies. Finally, it wants the euro zone authorities to be prepared to inject capital directly into troubled banks and to accompany that with stronger European-wide supervision of lenders. All these ideas would help reduce the pressure of the current euro zone recession and so ease the crisis.

Will the IMF, though, get its way? Well, certainly not immediately. The euro zone doesn’t have to listen to it unless another country – say Spain or Italy – needs a bailout. Even then, only the country requiring cash would technically have to pay heed to the IMF. The rest of the euro zone, led by Germany, could argue that the IMF has no business interfering with the monetary policy or banking supervision of the entire 17-member euro zone when only a few peripheral nations are receiving help.

What’s more, the bulk of the money from any future bailouts would continue to come from other euro zone countries rather than the IMF. These other countries would argue that they should have a big say, even on fiscal policy, because they will be bankrolling most of any deficit shortfall.

But even if the IMF can’t get its way immediately, the debate is shifting slowly in its favour. The euro zone may not like interference in monetary policy. But the ECB has shown itself willing to spray 1 trillion euros in long-term loans at the region’s banks in the heat of the crisis in recent months. Some of the central bank’s members, with the notable exception of Germany’s Bundesbank, are saying it is too early to plan for an end to such policies.

Or take fiscal policy. Euro zone leaders may have agreed the so-called fiscal compact which will require them to balance their budgets and cut their debts. But no sooner had the deal been signed than Spain varied its fiscal targets. Italy has followed up by saying it won’t react to a deeper than expected recession by pushing through more cuts – a policy that would just lead to further recession.

Now the Dutch government, previously the high priest of austerity, has found it cannot push through its own budget cuts. Meanwhile, Francois Hollande has promised to push for a more growth-orientated policy if he wins the French election. The austerity consensus is fraying.

Finally, consider banking policy. The intertwining of lenders and their states is unhealthy. Banks which get into trouble need to be bailed out. That makes their governments less creditworthy which, in turn, further infects banks which loaded up on their bonds. That occurred in Ireland and could be repeated in Spain.

The IMF’s proposal is to sever this incestuous relationship by getting the euro zone to put money directly into troubled banks rather than by lending to governments which, in turn, would inject capital into the banks. Such a policy would be matched by euro zone-wide supervision of banks.

The idea is rational. That, of course, doesn’t mean that it will be adopted. But with an expanded warchest, the IMF has greater ability to be heard on this and other issues – especially if it keeps reminding the euro zone that the rest of the world has insisted that strings are attached before any more countries are given bailouts.


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