The International Monetary Fund, the European Central Bank and the Federal Reserve and their Role in the Economic Crisis
Term Paper (Advanced seminar) 2015 15 Pages
Table of Contents
2 The International Monetary Fund
2.1 The Institution
2.2 The IMF's Role in the Economic Crisis
3 The European Central Bank
3.1 The Institution
3.2 The ECB's Role in the Economic Crisis
4 The Federal Reserve
4.1 The Institution
4.2 The Fed's Role in the Economic Crisis
The recent economic crisis can be, according to Cour-Thimann and Winkler, divided into three different phases: the start of the global financial crisis with the collapse of Lehman Brothers in the fall of 2008; the euro area sovereign debt crisis starting in 2010; and the re-intensification of the latter in 2011 (cf. 10). The breakdown of the financial markets in 2008 was caused by defaults of collateralized debt obligations, and especially key financial institutions were deeply impaired and were thus greatly in need of refinancing (cf. Denters and Viterbo 56). Therefore, in order to meet the problems associated with a global financial crisis, international financial institutions were required to meet those demands and cushion the effects of lower incomes as well as higher unemployment and uncertainty. Ruckert and Labonté even claim that “[t]he IFIs have been front and centre in the attempt to halt the financial crisis and return the world onto a path of sustainable economic growth […]” (359). This term paper is going to elaborate on the tasks and functions of certain international financial institutions, and subsequently on their role and course of action in the economic crisis. The institutions selected for that end are the International Monetary Fund, the European Central Bank and the Federal Reserve. Interestingly, all of these institutions have different spheres of influence, namely worldwide, Europe and the US, which also responds to the global character of the crisis itself. This suggests a global rescue effort which “transcended national boundaries” (Mihm and Roubini 177). This paper is concerned with the question what significant measures the respective institutions took and whether these actions were consistent with their original mandate and key objectives. For this purpose, each international institution will be examined individually, first according to their function and tasks (in tranquil times), and then with focus on their measures and reactions in the course of the economic crisis.
2 The International Monetary Fund
According to Denters and Viterbo, “[t]he IMF is the only global organization that administers and supervises monetary relations between states” (13). Thus, in the following chapters its impact and role in the economic crisis will be investigated in relation to the institution's tasks that are manifested in the Articles of Agreement.
2.1 The Institution
The International Monetary Fund (IMF) is described on its own website (imf.org) as follows:
The International Monetary Fund (IMF) is an organization of 188 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world.
The Fund was devised at a UN conference in 1944 as a result of the Great Depression of the 1930s, and in order to avoid its repetition. Its mandate is the promotion of international cooperation and the provision of policy advice and technical assistance with the main purpose “[…] to ensure the stability of the international monetary system” (imf.org). The headquarters of the institution are located in Washington D.C. At the top of the IMF's governance structure is the Board of Governors, which consists of one governor and an alternate governor for each of the 188 member countries. The Board of Governors is advised by the International Monetary and Financial Committee (IMFC) and by the Development Committee. The IMFC reports “[…] on the supervision and management of the international monetary and financial system […]” (imf.org), whereas the Development Committee is responsible for advice “[…] on critical development issues and on the financial resources required to promote economic development in developing countries” (imf.org). The Executive Board of the IMF holds most of the responsibilities and tasks within the IMF. The Board of Governors appoints its 24 directors, each representing either a country or a group of countries. The USA, Japan, Germany, France and the UK have their individual representatives, while the other 19 directors are responsible for certain geographical groups of countries, the largest one comprising 24 countries. The Managing Director, currently Christine Lagarde, is the head of staff and chairperson of the Executive Board and is appointed by that body for a term of five years (2011 – 2016). The IMF is financed by quotas of member countries, whose amount is determined according to a country's relative size in the world economy. The quota determines “[…] the subscription of each member […]; the number of voting rights of each member country; the maximum extent of balance of payments support that each member may receive; the share of SDR allocations that each member receives” (Denters and Viterbo 25). The largest quotas are paid by the USA (17.68 %), Germany (6.12 %) and Japan (6.56 %).
The three main tasks of the IMF are surveillance, lending and technical assistance. Surveillance encompasses overseeing the international monetary system by monitoring the economic and financial policies of the institution's member countries. The IMF conducts bilateral surveillance on the one hand, which means observing the policies of the individual member countries, and multilateral surveillance on the other hand in order to supervise the world economy. Central for the latter are the IMF's publications World Economic Outlook and Global Financial Stability Report. The task of lending refers to providing money to countries which experience actual or potential payment difficulties. The biggest borrowers up to date are Portugal, Greece, Ireland and Ukraine. The last task, technical assistance, describes the duty of “giving practical help to members” (imf.org), such as advice on designing and conducting thorough economic and financial policies and also training on these issues.
2.2 The IMF's Role in the Economic Crisis
The IMF's response to the crisis can be described according to three categories: expanding some of their original tasks, primarily lending and surveillance; providing emergency support, especially to extremely vulnerable countries; and reforming its own governance structure. One way the institution enhanced its original tasks is by improving financial sector surveillance within countries in order to improve “[…] understanding of interlinkages between macroeconomic and financial developments […]” (imf.org) as this is considered an important instrument to fill data gaps. Furthermore, the purpose of a revised surveillance practice is to react faster as well as more efficiently to a critical situation in a globalized world. This also entails responding to member's concerns and detecting spillover-effects. Moreover, in the run-up to the crisis, the head of the IMF's Strategy, Policy and Review Department, Reza Moghadam, stated in an interview from February 2009 the following: “In the short run, we have more than enough resources to assist our members, regardless of their income level. That said, the Fund wants to be prepared for any eventuality, and we are looking to double the IMF’s resources” (imf.org). Hence, the IMF was seeking to increase its resources in order to meet crisis demands by stepping up non-concessional and concessional lending. On that account, Japan granted the IMF an additional $100 billion and the EU an additional $75 billion. Furthermore, non-concessional lending increased from close to zero in 2007 to approximately $400 billion between September 2008 and the end of 2013 (cf. Lamdany et al. 26). In addition, these actions also included an extra $500 billion from the G20 and an increase in quota subscriptions of member countries (cf. imf.org). When Iceland's three main banks collapsed in October 2008 as a result of the financial sector's high leverage and the dependence on foreign financing, the implementation of the aforementioned measures can be observed. Iceland asked the IMF for a loan of $2.1 billion and for advice on their situation and adequate future action. The loan was permitted under a so-called Extended Fund Facility, which contains a longer repayment period than would be usual. Due to the enhanced surveillance, the institution was also ensuring that the loan was used appropriately by conducting quarterly reviews. The IMF's mission chief for Iceland, Mark Flanagan, stated in an interview from February 2009: “More generally, we are providing macroeconomic advice to the government, and our financing is helping the government manage the macroeconomic burden of the restructuring in a way that minimizes dislocations” (imf.org).
The second category for the IMF's actions during the economic crisis is providing emergency support with a special focus on vulnerable and low-income countries. For once, the Flexible Credit Line was implemented with the purpose of enabling rapid non-conditional lending to countries that “[…] the IMF deems to be in good economic health but that are facing temporary financing difficulties” (Moschella 151). Moreover, Ruckert and Labonté state on the matter of supporting particularly vulnerable countries that already at the beginning of the crisis “[…] it became clear that emergency funding was urgently needed to address the massive shortfalls in the current accounts of many low-income countries, in most cases related to a steep drop off in external demand for exports” (358). In order to help these countries during the crisis, the IMF has introduced several tools, as for example the Rapid Financing Instrument, the Rapid Credit Facility, the Emergency Financing Mechanism and the Exogenous Shock Facility. The main purpose of these instruments was to provide short-term financial relief to low-income countries, at best within an approval period by the Executive Board of 42 – 72 hours (cf. imf.org; Weiss 4). The Rapid Financing Instrument and the Rapid Credit Facility were implemented to provide quick loans, whereas the Exogenous Shock Facility was introduced to provide swift and flexible “[…] support and financial assistance to low-income countries facing exogenous shocks, events that are completely out of the national government’s control” (Weiss 4), which also encompasses spill-over effects. In order to guarantee its ability to provide liquid assets, high-income countries and the G20 were lending the IMF up to $1 trillion in emergency financing (cf. Ruckert and Labonté 259).
The third effort undertaken by the IMF was to introduce reforms. The first one to be taken into consideration is the adaption of the IMF's lending toolkit to meet the needs of its crisis-shaken member countries, as for instance the aforementioned Flexible Credit Line which grants a longer repayment period. Furthermore, the IMF attempted at modernizing its conditionalities to ensure that these are fit to meet member countries' varying strengths and difficulties (cf. imf.org). Another reform that was passed was enhancing the Fund's lending flexibility by simplifying the cost and maturity structures. In addition, the access limits were increased with the “[…] aim to give confidence to countries that adequate resources would be accessible to them to meet their financing needs” (imf.org). Moreover, the institution sought to significantly increase quota subscriptions by undertaking a “[…] rebalancing of the quota shares that increases the quota ratios of emerging markets and developing countries relative to the advanced economies” (imf.org). There has been a six percent shift in quota shares towards dynamic emerging markets and developing countries and this measure aimed at increasing their voting power and thus their representation in the IMF. Furthermore, the IMF's mandate has been updated in 2012 to encompass all macroeconomic and financial sector issues that may influence global stability.
Concluding it can be said that according to the International Monetary Fund itself, “[i]n the absence of IMF financing, the adjustment process for the country would be more abrupt and difficult” (imf.org). Weiss claims on that account the following:
[…] the global financial crisis has created an opportunity for the IMF to reinvigorate itself and possibly play a constructive role in resolving, or at the least mitigating, the effects of the global downturn, on two fronts: (1) through immediate crisis management, primarily balance of payments support to emerging-market and less-developed countries, and (2) contributing to long-term systemic reform of the international financial system. (3)
This implies that the Fund managed to decrease the impact of the crisis by making financial adjustments for countries' governments and citizens less severe. Furthermore, as a result of the IMF's actions during the economic crisis, it can be said that “[…] the international policies designed to govern the risks associated with growing financial integration seem to have shifted again towards a form of centralization with a revival of the role of the Fund in crisis prevention and management” (Moschella 1). This suggests that a strengthened role of the IMF is in demand plus a sharper international regulation of financial markets. The reason for this is the need for the IMF's extensive financial resources as well the acknowledgment of its capacity to identify the distinct causes of the crisis and draw lessons from it due to the institution's in-house research facility (cf. Moschella 168). Moreover, the on-going globalizing processes call for an increased cooperation between the Fund and the individual global financial regulatory bodies (cf. Weiss 6; Moschella 139). However, Ruckert and Labonté claim that most of the IMF's resources went to middle-income countries in Eastern Europe while large parts of the developing world did not receive the necessary aid (cf. 361). This is due to the fact that the IMF's major shareholders are countries like the US and strong European countries as, for instance, Germany and France who have a lot of voting power and are thus in control of the Executive Board. Recent studies have shown that countries like China, India and Brazil have less voting power than, for example, Italy, Belgium or Netherlands, even though the former have a GDP that is four times the size of the latter (cf. Mihm and Roubini 262). Hence, it is made sure that those powerful shareholders as well as their allies and export partners benefit from IMF resources. Especially EU member countries have a strong strategic interest in keeping other members' economies going and thus maintain a financially intact union.