The International Monetary Fundhas thus far played a supporting role to the European Union in managing the sovereign debt crisis that threatens to break up the economic and monetary union, and trigger a second and deeper European recession. But some analysts say IMF leaders must step directly into the political arena and employ national parliaments to affect change.
“The IMF primarily deals with finance ministers. Now is the time for the fund to ramp up its engagement with national legislatures that hold the key to fiscal reforms,” says Julie Chon, a senior fellow at the Atlantic Council that’s devoted to international affairs.
European leaders have been criticized for not reacting quickly enough, and in a piecemeal fashion, to Greece’s sovereign debtand banking problems that have spread, in varying degree, to other euro-zone nations, such as Portugal, Ireland, Italy, and Spain.
Now, some 18 months since the crisis began in fall 2009, policymakers are paying the price as they also battle bailout fatigue.
“All the advanced countries have less policy room to maneuver than they did in 2008,” says Edwin Truman of the Peterson Institute for International Economics. “There are fewer tools available and they can use them with less force."
With World Bank and IMF members gathering for their annual meeting in Washington, D.C. this week, there's plenty of interest in how policymakers might step up the rescue timeframe and expand the euro rescue fund, the European Financial Stability Facility (EFSF).
Also on the watch list: any efforts to strengthen Europe’s banks that are saddled with impaired assets. EU finance ministers this past weekendstressed the need to shore up the banks or face a new credit crunch.
New IMF Managing Director Christine Lagarde, who left the post of French Finance Minister for the job, will be pressed on both issues.Europe Issues
Despite a massive Greek package, policymakers are still battling contagion, where negative spillovers from one financial institution, market, or country seep into another.
“Rescue packages supported by the IMF ran into roadblocks in key legislative bodies this summer, aggravating market volatility,” says Atlantic Council's Chon.
Austerity measures and bailouts have failed to put a meaningful halt to the slide in investor confidence, while stoking civil unrest and economic hardship.
In Greece, “they’ve lost the belief that something could even be done,” says Diane Garnick, a former investment strategist who recently spent several weeks in the country.
In both urban and rural areas, Garnick says she spotted vacant retail outlets and incomplete and abandoned building construction. “There didn’t seem to be any ray of hope,” she said.
Also, despite periodic and bold claims to the contrary, there are mounting questions about Greece falling out of the EU's economic and monetary union, even though European leaders already agreed to reduce Greece’s debt burden as part of a $157 billion rescue package. Such a scenario could contribute to an unraveling of the whole 17-nation block.
In addition, tension among euro-zone lenders and loan recipients has risen. Put more bluntly, should, for example, wealthier German taxpayers pay for the problems of Greece or Ireland? Such touchy questions strike at the core of the moral hazards associated with the IMF’s role in the debt crisis.
“They have to move forward or move back. They’re not in a stable equilibrium,” says Truman of the Peterson Institute. “The risk is real, which politicians understand. It could unravel the whole European project.”
Some economists worry that expelling Greece would send smaller European economies into a panic. Even something less than that could derail the European recovery.
“We think they’re going to slide into a double-dip recessionnext year,” says Stan Shipley, economist and managing director at International Strategy & Investment.
To grasp the IMF’s challenge in the euro zone, some clues lie in its founding and the ability to carry out its missions. The IMF was created toward the end of the World War II to promote monetary cooperation and stability.
Since then its track record has been mixed.
The IMF's handling of the Asian contagion crisis of 1997won plaudits, but its bailouts elsewhere, in Latin America in particular, have been criticized.
As recently as 2007, the IMF failed one of its key mandates—to monitor financial and economic risks.
In February of this year, the IMF's Independent Evaluation Office issued a reporton the fund’s performance in the runup to the global financial crisis. The report card on IMF’s surveillance in 2004-2007 was not good.
Weak analysis, including a group-think mentality, and a silo-like infrastructure that impedes sharing of information werecited in the report.
“The fund acted more like an echo chamber than a risk watchdog,” says Chon, a U.S. Senate Banking Committee staffer from January 2007 until May 2011, and chief adviser for international finance issues, including IMF funding and policy.
"The IMF has taken steps to improve its surveillance capacity, by building up its financial expertise,” says Chon, who adds any lasting effects remain to be seen.
More broadly, there are two major differences between the IMF's crisis management of the past and those of today. The size of the European financial problem dwarfs that of Latin America and Asia in the past two decades, and one of its popular tools, a currency devaluation, is not an option with Greece and other ailing EU members.
The second major difference is that in tackling European sovereign debt, the IMF is dealing with its prime sponsors, western democracies, even a G7 member in the name of Italy.
How can Lagarde, a European insider who replaced another European insider, Dominique Strauss-Kahn, solve the debt crisis on her home turf, yet remain dispassionate enough to engage the emerging economies?
Lagarde “has to demonstrate to non-European members that she’s her own person, that she’s thinking of the system as a whole,” says the Peterson Institute's Truman.