Food prices and politics: the IMF agrees with Bob Marley

I usually prefer ‘man bites dog’ research that comes up with unexpected answers, but sometimes it’s helpful to have the opposite – number crunchers who back up what you always suspected, thereby increasing your certainty and confidence. Food Prices and Political Instability, a new paper from the IMF, is in the latter category. Some highlights, with an executive summary c/o Bob Marley’s classic, ‘Them Belly Full‘:

“In Low Income Countries increases in the international food prices lead to a significant deterioration of democratic

Evidence-based food riot in Mozambique

institutions and a significant increase in the incidence of anti-government demonstrations, riots, and civil conflict. In the High Income Countries variations in the international food prices have no significant effects on democratic institutions and measures of intra-state conflict.”

[BM: 'Cost of livin' gets so high,
Rich and poor they start to cry:
Now the weak must get strong;
They say, "Oh, what a tribulation!"]

“We examined in this paper empirically the effects that changes in the international food prices have on measures of democracy and intra-state stability in a panel of over 120 countries during the period 1970-2007. Our main finding was that during times of international food price increases political institutions in Low Income Countries significantly deteriorated. To explain this finding we documented that food price increases in Low Income Countries significantly increased the likelihood of civil conflict and other forms of civil strife, such as anti-government demonstrations and riots.

[BM: 'A hungry mob is an angry mob']

Increases in the international food prices had real macroeconomic effects that went beyond average per capita income: they were associated with a significant decrease in consumption and a significant increase in the gap between rich and poor.

[BM: 'Them belly full but we hungry']

All in all, our empirical results are broadly consistent with the often made claim by policy makers and the press that food price increases put at stake the socio-economic and political stability of the world’s poorest countries.”

So people riot when food prices go up. And the effect is bigger in poor countries, where food can constitute 80% of a household’s expenditure. Well duh. But still, now we know that it’s true (because the IMF says so). And that Bob Marley was right (and Chris Blattman wrong).

So if food price spikes punish poor people and lead to political instability, what should we be doing about them? That conversation is, I think, is for another day, but if you want to kick it off, feel free.

Meanwhile, here’s the man himself, summarizing the research (but losing it a bit towards the end….)

Update: The Spanish Inquisition over at Aid Thoughts reckon that the numbers in the paper don’t warrant the strength of the IMF/my conclusions, but chief Inquisitor Matt admits he commented in a rush and may have missed something. Any data monkeys out there want to check?

Want to avoid financial crises? Then reduce inequality, says the IMF

What are they putting in the water at the IMF these days? Following its recent advocacy of not one, but two new global taxes, a new IMF working paper by Michael Kumhof and Romain Ranciere links inequality with financial crises.

“The United States experienced two major economic crises over the past century—the Great Depression starting in 1929 and the Great Recession starting in 2007. Both were preceded by a sharp increase in income and wealth inequality, and by a similarly sharp increase in debt-to-income ratios among lower- and middle-income households. When those debt-to-income ratios started to be perceived as unsustainable, it became a trigger for the crisis. In this paper, we first document these facts, and then present a dynamic stochastic general equilibrium model in which a crisis driven by income inequality can arise endogenously. The crisis is the ultimate result, after a period of decades, of a shock to the relative bargaining powers over income of two groups of households, investors who account for 5% of the population, and whose bargaining power increases, and workers who account for 95% of the population.

The model is kept as simple as possible in order to allow for a clear understanding of the mechanisms at work. The key mechanism is that investors use part of their increased income to purchase additional financial assets backed by loans to workers. By doing so, they allow workers to limit their drop in consumption following their loss of income, but the large and highly persistent rise of workers’ debt-to-income ratios generates financial fragility which eventually can lead to a financial crisis. Prior to the crisis, increased saving at the top and increased borrowing at the bottom results in consumption inequality increasing significantly less than income inequality. Saving and borrowing patterns of both groups create an increased need for financial services and intermediation. As a consequence the size of the financial sector, as measured by the ratio of banks’ liabilities to GDP, increases. The crisis is characterized by large-scale household debt defaults and an abrupt output contraction as in the 2007 U.S. financial crisis. Because crises are costly, redistribution policies that prevent excessive household indebtedness and reduce crisis-risk ex-ante can be more desirable from a macroeconomic stabilization point of view than ex-post policies such as bailouts or debt restructurings. To our knowledge, our framework is the first to provide an internally consistent mechanism linking the empirically observed rise in income inequality between high income households and poor to middle income households, the increase in household debt-to-income ratios among the latter group, and the risk of a financial crisis.”

Conclusion (after lots of suitably impressive equations)? “restoration of poor and middle income households’ bargaining power can be very effective, leading to the prospect of a sustained reduction in leverage that should reduce the probability of a further crisis.”

Dynamite. [h/t Matthew Lockwood]

Is the IMF getting serious about inequality? Looks like it

Is the IMF going socialist? Hardly, but on Monday Dominique Strauss-Kahn, its Managing Director, gave a pretty extraordinary (and welcome) speech, entitled “Human Development and Wealth Distribution”. Here are a few excerpts:

“Adam Smith—one of the founders of modern economics—recognized clearly that a poor distribution of wealth could undermine the free market system, noting that: “The disposition to admire, and almost to worship, the rich and the powerful and…neglect persons of poor and mean condition…is the great and most universal cause of the corruption of our moral sentiments.”

This was over 250 years ago. In today’s world, these problems are magnified under the lens of globalization….. Globalization had a dark side. Lurking behind it was a large and growing chasm between rich and poor—especially within countries. An inequitable distribution of wealth can wear down the social fabric. More unequal countries have worse social indicators, a poorer human development record, and higher degrees of economic insecurity and anxiety. In too many countries, inequality increased and real wages stagnated—failing to keep up with productivity—over the past few decades. Ominously, inequality in the United States was back at its pre-Great Depression levels on the eve of the crisis.

Inequality may have actually stoked this unsustainable model. In countries like the United States, borrowing seemed to allow ordinary people to share in the rising prosperity. Like the Great Depression before it, the Great Recession was preceded by an increase in the income share of the rich, a growing financial sector, and a major rise in debt. Inequality could also be behind the Chinese export-oriented model, since solid domestic demand needs a healthy middle class, while a low exchange rate goes hand-in-hand with a low real wage. Of course, the unbalanced pattern of growth had a variety of causes, but we would be foolish to ignore the distribution of wealth.

Inequality goes against notions of fairness and solidarity, but it also threatens economic and social stability. This is especially true in poorer countries. Inequality can dampen economic opportunity, by preventing the poor from accessing the financing needed to pursue profitable investments. It can divert people toward unproductive activities. It can make countries more prone to adverse shocks—with fewer people able to dip into savings during bad times, the decline in growth is larger.

The invisible hand must not become the invisible fist.

An immediate task is to end the scourge of unemployment. The crisis threw over 30 million people out of work, and in the coming decade, more than 400 million young people will be looking for their first job. So clearly—growth is not enough, we need growth for jobs. And jobs are not enough, we need decent jobs—so that all can benefit from the rising tide.

We need labor market policies to focus on job creation. We need opportunities for all to prosper, through better education and training, as well as help for small businesses.

Tax and expenditure policies can support fairness and economic stability. Adequate social safety nets are essential, including decent unemployment benefits. We should also make sure that workers have adequate bargaining power, especially if this lies at the root of rising wage inequality. Collective bargaining is important. But we must avoid dual labor markets that create stark divisions between protected insiders and excluded outsiders.

The last great period of globalization—in the decades leading up to the First World War—held a lot of promise, but it ultimately came crashing down with thirty years of brutal war and economic devastation. It happened once, and it can happen again. The recent crisis was a wake-up call. We avoided a second Great Depression, and we learned many lessons. But we still have a long way to go.”

This comes on top of other interesting signs of a changing culture at the Fund, e.g. its relatively progressive stance on international financial taxes. Anyone would think DSK wanted to be President of France or something…….

[h/t Steve Price-Thomas]

Me with the IMF at the Hanoi Hilton – please add photo caption

OK, the blog’s been pretty heavy going of late, so here’s some light relief, c/o the IMF, who have just sent me multiple copies of this pic from a conference back in March on the impact of the global economic crisis in low income countries (see my previous post, or the IMF page on the event with presentations). This is the IMF/Vietnamese government’s idea of a group photo – the two in the front are John Lipsky, First Managing Director of the IMF (curiously, I can’t find any evidence of a Second Managing Director – is this evidence of US-style grade inflation – all those Vice Presidents and Assistant Professors?) and Nguyen Van Giau, Governor of the State Bank of Vietnam.

At least I made it to the inner table – third from the right. You can’t miss me – I’m the white guy in the suit. I also have a bubble coming out of my head. The hierarchy then moves on to the outer table, or worse still, total relegation to the outer darkness at the back of the room.

In case you think this is my normal routine, the next day I was down in Ho Chi Minh City talking to motor bike taxi drivers, street vendors and disabled lottery ticket sellers. Sometimes, this is one weird job. Meanwhile, back at the Hilton, what was going through my mind? I can’t remember, so over to you for some captions – winner gets an honourable mention, but no junkets.

[updated: now included - current front runner from Matt, who is clearly trying to win by sheer force of numbers (monkeys, typewriters etc)]

The IMF pronounces on the Robin Hood Tax

Yesterday, I discussed the IMF’s fascinating new proposals for two international taxes on the financial sector  – a ‘financial stability contribution’ (FSC) and a ‘financial activities tax’ (FAT). But the leaked interim report to the G20 also discussed the financial transactions tax (FTT), better known as the Robin Hood Tax. What did it say?

First the good news: ‘The FTT should not be dismissed on grounds of administrative practicality. Most G-20 countries already tax some financial transactions’. So could all those people who argue that the FTT is unworkable please shut up now?

But the IMF does not endorse the FTT for the purpose of the mandate set out by the G20, namely exploring ‘how the financial sector could make a fair and substantial contribution toward paying for any burden associated with government interventions to repair the banking system’.

Why not? The report’s author, Carlo Cottarelli, gives a succinct explanation in a blog on the IMF website:

“We don’t think this is the best way of meeting the two key objectives set out above. An FTT is not  focused on reducing systemic risk and it isn’t effective at taxing rents in the financial sector—much of the burden may well fall on ordinary consumers. [So the IMF disagrees with the recent finding in a paper by Sony Kapoor of Re-define that the Robin Hood Tax would be highly progressive].

Moreover, the financial services industry is very good at devising schemes to get around such a tax and (this is also true, to be fair, of the FSC and FAT, but we suspect to a lesser extent).

One way to think about the comparison is that just as a FAT is like a VAT, an FTT is like a turnover tax—and most countries have long found that the VAT is better at raising revenue: in the jargon, more efficient. All this doesn’t mean we rule out an FTT in other contexts—but it is not the most effective way to address the task at hand.”

That last sentence is important – the IMF is saying the FTT is workable, and could be applied in other contexts, like raising the hundreds of billions of dollars desperately needed to combat climate change and poverty. It just doesn’t think it’s the best way to tackle financial sector volatility (which is a view I share).

Oh, and the Robin Hood Tax campaign has clearly had an impact on the Fund – Carlo’s blog notes ‘the last few months have left us in no doubt as to the seriousness of the public support this enjoys.’

Stand back a bit, and I think the Robin Hood Tax campaign can allow itself several pats on the back. We now have the IMF feeling the heat and pushing international bank taxes, establishing important precedents on the financial and social responsibilities of a sector that has been allowed to get away with murder for far too long (and is now back to mega-profitability, leaving the rest of us to clear up the mess). The Fund is also acknowledging the practicability of FTTs for other purposes like financing for development (although we need to nail the issue of incidence). In the end, the acronym – FSC, FAT, FTT or whatever – matters little if it raises the cash for development and climate change. As Deng Xiaoping once remarked “It doesn’t matter whether a cat is white or black, as long as it catches mice.” I’m sure Robin Hood would echo the sentiment.

A global taxation system, as proposed by the IMF

IMF suggests
Global taxes on all banks
History is made

What have they put in the water supply at the IMF? First they see the light on capital controls, and now they’re putting out ground-breaking ideas on the international taxation of banks. I’ve been reading the supposedly confidential (but available on the BBC website – if you have problems with this URL, just search on BBC + title of report) interim report to last week’s IMF Spring Meeting with a growing sense of astonishment and delight. There are some potentially historic shifts in thinking going on. Apologies in advance for a long post, but I think it’s worth it for this issue. To keep some kind of ceiling on size, I’ll post tomorrow on what the report says about the Robin Hood Tax.

The report, titled ‘A Fair and Substantial Contribution by the Financial Sector’, was commissioned by the G20 ministers, who at their summit in Pittsburgh last year, asked it to ‘“…prepare a report for our next meeting [June 2010] with regard to the range of options countries have adopted or are considering as to how the financial sector could make a fair and substantial contribution toward paying for any burden associated with government interventions to repair the banking system.”

The mandate is important – the IMF effectively stretched it to include the indirect costs of the crisis in the rich countries – fiscal stimuli, quantitative easing and all the rest, as well as the direct costs of bank bailouts, but unfortunately, stopped short of extending it a bit further to include the indirect costs of the crisis on poor countries, in the shape of a large fiscal hole that will need to be filled. And it was never going to extend it all the way to the wider need for innovative financing to meet aid targets and the big money needed to deal with climate change.

As widely reported in the press last week, the paper proposes two kinds of tax: a ‘financial stability contribution’ (FSC) and a ‘financial activities tax’ (FAT – the IMF has even acquired a sense of humour). The FSC seems to be based on the US ‘Financial Crisis Responsibility’ fee, and the FAT on the British and French Governments’ bonus taxes.

In an excellent blog on the IMF site, the paper’s lead author Carlo Cottarelli explains the reasoning:

On the FSC: “One reason the crisis was such a painful mess was that many governments did not have the tools to wind down failing institutions in a quick and orderly manner. All too often their only options, both hugely unpleasant, were to either (1) let a systemic institution fail and bear the chaotic fallout or (2) pump in enough public support to keep it alive, so confirming the prior suspicion that these institutions were indeed too big to fail. Governments lacked a way to ‘resolve’—a new word even for many economists—large failing institutions.

Resolution means equity holders would be wiped out, management replaced, and unsecured creditors take a loss—a ‘haircut’—on their claims. All this should be nasty enough for owners and managers to reduce any problems of ‘moral hazard’ (taking too much risk in the expectation that someone else will bear the costs if things turn out badly). But most countries still don’t have such a mechanism. Financial stability requires creating them.

So where does the idea of a contribution come in? Resolution requires upfront cash, to reduce uncertainty for creditors (and the creditors’ creditors…) by quickly giving some value to their claims. And the industry should pay for this: it is, or should be, a cost of doing business just like paying for deposit insurance, or maintaining their information systems. This is what we call a Financial Stability Contribution (FSC).”

On the FAT: “FAT is just a tax on the sum of the profits and remuneration paid by financial institutions. Profits plus all remuneration is value added. So a tax of this kind would be a kind of Value-Added Tax or VAT. And that could make sense because current VATs don’t work well for financial services, which are largely VAT-exempt.

This means that a FAT of this kind could make the tax treatment of the financial sector more like that other sectors and so help offset a tendency for the financial sector, purely for tax reasons, to be too large—or too fat.

Now suppose that the base included only remuneration above some high level, and only profits above a ‘normal’ rate of return. Then the base of the FAT may not be a bad proxy for taxes on ‘rents’—return in excess of competitive levels—earned in the sector. Some might find taxing that excess fair.

Or one might include only profits above some level well above normal. Taxing away some of these high returns in good times may help correct for any tendency to excessive risk-taking implied by financial institutions not attaching enough weight to outcomes in bad times (whether because of limited liability, or because they think themselves too big to fail).”

Might have to adjust that message

Why does this matter?

1. The most orthodox of international financial institutions has just set out the basis for an international taxation regime

2. That sets precedents for how public goods other than financial stability could be funded – like climate change and development

3. The FAT explicitly aims both to shrink the financial sector, which has grown so large that minor fluctuations imperil the much smaller real economy, and to change behaviour to reduce excessive risk-taking.

4. The FAT’s idea of a windfall tax on rents could easily be extended to other sectors – like the suddenly super-profitable oil and gas industry (see BP’s latest jump in profits)

5. All this is a wonderful counterweight to widespread pessimism on financing for development following the crisis. If the IMF thinks we can rustle up 2-4% of global GDP as a resolution fund, suddenly 0.7% for international development doesn’t look such a big deal.

One big question that the IMF paper ducks (but will hopefully answer in its final version in June) is what level of rate (and thus revenue) a FAT could raise. For the FSC, 2-4% of GDP corresponds to $1.2-2.4 trillion, so to fill up the resolution fund over a five year period, it would have to raise about $400bn. Coincidentally, that’s how much the Robin Hood Tax campaign reckons is needed for climate change and development. So when the resolution fund hits its target, there’s a ready-made use for further revenue…..

The danger is that in the negotiations that follow, the FAT will be sacrificed to get the FSC. That would be a shame, as it’s the more interesting of the two proposals. The final version of the IMF’s paper will go to the G20 summit in Canada in June. In the UK, income tax was introduced in response to a crisis - William Pitt the Younger put it in his budget of December 1798 to pay for weapons and equipment in preparation for the Napoleonic wars. Could international taxation be the biggest legacy of the 2008-10 global crisis?

The IMF debates the crisis and industrial policy

The Hanoi Hilton,
IMF, Robert Wade and
jet lag. One strange day.

[any feedback on these wonku summaries, introduced in response to the reader survey?]

My week in Vietnam kicks off with a weird jet-lagged day at the Hanoi Hilton c/o the IMF and the Vietnam State Bank, who organized a conference on ‘Post Crisis Growth and Poverty Reduction in Developing Asia’. The conference was very formal - all suits and ties and long panel discussions punctuated by lunch at the neighbouring Hanoi Opera (wonderful old building left over from the French colony – Ho Chi Minh addressed the crowds from its balcony) and a dinner with some haunting music and a rather unsettling attempt at Vietnamese flamenco – the frilly skirts were right, but the serene smiles and stately, graceful movement gave it an unreal, underwater quality. After lunch, all the long distance travellers (including me) struggled to stay awake, evoking a scary future in which all the big global decisions are taken by jetlagged zombies. I presented our findings on the global economic crisis, but I think the blog has probably had enough about that. What were other people saying?

The IMF, led by big cheeses John Lipsky and Anoop Singh, talked like the World Bank, (as it tends to these days), stressing poverty reduction, inequality, social protection and climate change, as well as the need for growth, growth, growth and macroeconomic stability. It seems particularly keen to stake a claim to climate change funding via a $100bn Green Fund. Heck, the conference was even carbon neutral (I asked how much all that offsetting cost, and the IMF guy said, ‘it better not come to over $10,000……).

The big surprise of the day was the keynote by Robert Wade of the LSE. Robert is a long time proponent of industrial policy, which is hardly the IMF’s favourite theme, so I was intrigued at his invitation. And he pulled no punches. Starting off with this New Yorker cartoon on the role of the state, Robert argued that the rise of Asia pretty much demolishes the Washington Consensus view that the state should confine itself to a regulatory role. With Alice Amsden and Ha-Joon Chang, he’s been making that argument for the best part of 20 years, and I think they’ve made a lot of headway.

But what caught my attention was the distinction he drew between two kinds of industrial policy – ‘leading the market’ and ‘following the market’. Leading the market is South Korean style picking winners – we want a steel or chip industry, so we’re going to spend big time and just make it happen. That worked in the Korean case, but has failed in many others. Following the market, on the other hand, is a much less risky form of industrial policy, based on systematically ‘nudging’ firms to upgrade their technologies through incentives, performance requirements, or the state playing a brokering role putting firms in touch with foreign investors. Robert saw this as a third way (sorry) between the command and control of South Korea, and the passive laissez faire of the traditional World Bank view that governments should stick to sorting out the ‘enabling environment’ of property rights and keeping the bureaucracy in check. Robert held up Taiwan as a model of successful following-the-market type industrial policy.

James Adams for the World Bank politely demurred, stressing that elements of the Washington Consensus (eg cautious macroeconomic management) have withstood the test of the time. Think I may have to dig out John Williamson’s original list of Washington Consensus policies and give them marks out of ten in light of the global crisis – or has someone already done that?

As for how the discussion in Vietnam varies from that in the UK – growth and infrastructure were the big themes. Hard to imagine getting any interest in all that limits to growth stuff – it was all how to shift from 6 to 8% per annum, with no acknowledgement at all that at some point, that might just be relevant to carbon emissions.

Oh, and I just checked, and yes, the Hanoi Hilton meant something else entirely during the Vietnam war.

More IMF revisionism, this time on capital controls

Another day, another IMF U turn, this time in a ‘Staff Position Note’ on capital controls by Ostry, Ghosh, Habermeier, Chamon, Qureshi, and Reinhardt (they seem to prefer writing by committee at the Fund – personally, I’m with Sartre: ‘hell is other people’). This comes hard on the heels of its recent rethink on inflation, part of a laudable institutional journey of reflection, prompted by the financial meltdown. Don’t think this one needs subtitles, so here are the highlights, plus some comments from me.

First the intro, which drives a wedge between the case for liberalizing trade and that for opening up capital markets, and summarizes the concerns of emerging market economies (EMEs) on the latter.

‘The benefits from a free flow of capital across borders are similar to the benefits from free trade, and imposing restrictions on capital mobility means foregoing, at least in part, these benefits. Notwithstanding these benefits, many EMEs are concerned that the recent surge in capital inflows could cause problems for their economies. A concern has been that massive inflows can lead to exchange rate overshooting (or merely strong appreciations that significantly complicate economic management) or inflate asset price bubbles, which can amplify financial fragility and crisis risk. More broadly, following the crisis, policymakers are again reconsidering the view that unfettered capital flows are a fundamentally benign phenomenon and that all financial flows are the result of rational investing/borrowing/lending decisions. Concerns that foreign investors may be subject to herd behavior, and suffer from excessive optimism, have grown stronger.

The question is thus how best to handle surges in inflows. The tools are well known and include fiscal policy, monetary policy, exchange rate policy, foreign exchange market intervention, domestic prudential regulation, and capital controls.’

And the findings?

‘If the economy is operating near potential, if the level of reserves is adequate, if the exchange rate is not undervalued, and if the flows are likely to be transitory, then use of capital controls is justified as part of the policy toolkit to manage inflows. Such controls, moreover, can retain potency even if investors devise strategies to bypass them, provided such strategies are more costly than the expected return from the transaction: the cost of circumvention strategies acts as “sand in the wheels.”

A key issue of course is whether capital controls have worked in practice. Our sense is that the jury is still out on this. Controls seem to be quite effective in countries that maintain extensive systems of restrictions on most categories of flows, [got that? – the IMF is saying that capital controls work best when they’re comprehensive!] but the present context relates mainly to the reimposition of controls by countries that already have largely open capital accounts. The evidence appears to be stronger for capital controls to have an effect on the composition of inflows than on the aggregate volume. For example, in the case of Chile and Colombia, controls do appear to have had some success in tilting the composition of inflows toward less vulnerable liability structures.

Looking at the current crisis, our own empirical results suggest that controls aimed at achieving a less risky external liability structure paid dividends as far as reducing financial fragility. An interesting twist is that some foreign direct investment (FDI) flows may be less safe than usually thought. In particular, some items recorded as financial sector FDI may be disguising a buildup in intragroup debt in the financial sector and will thus be more akin to debt in terms of riskiness.’

A few caveats, which largely seem to be about not encouraging China to see capital controls as an alternative to devaluing its currency (a political hot topic in Washington and elsewhere):

‘Global recovery is dependent on macroeconomic policy adjustment in EMEs, which could be undercut by capital controls, notably in cases where currencies are  undervalued. In addition, controls imposed by some countries may lead other countries to adopt them also: widespread adoption of controls could have a chilling longer-term impact on financial integration and globalization.’

The caveats are weaker, and the U turn more pronounced than in the paper on inflation I reviewed last week. That’s partly because this is a journey that began over a decade ago. On the eve of the Asian financial crisis of 1997/8, the Fund was on the verge of amending its Articles of Association to enshrine capital account liberalization as one of its explicit aims. The Asia crisis started a rethink, which has continued with the latest trauma. But I’ll only believe that the Fund has really changed when we see its staff out there advising developing countries on the best ways to introduce capital controls.

And anyway, a rethink at the Fund may not be enough. The push for capital account deregulation has been locked in in several regional and bilateral trade agreements. In its bilateral trade agreements with Chile and Singapore, the US government insisted on the elimination of precisely some of those ‘speed bump’ controls now recognized by the Fund as useful tools to help economies navigate the turbulent seas of international capital.

So a long way to go to make capital markets work for development, but this is at least a welcome step. More coverage in the Economist and the New York Times.

A big rethink at the IMF, with subtitles for non-economists

The IMF is doing some very interesting (and praiseworthy) rethinking in response to the global crisis, if a new paper co-authored by its chief economist Olivier Blanchard is anything to go by. It’s written by and for economists, so it’s not exactly bedtime reading (unless you’re an insomniac), but here’s the highlights, and my attempts at translation.

Overview: ‘The great moderation lulled macroeconomists and policymakers alike in the belief

All change at the IMF?

that we knew how to conduct macroeconomic policy. The crisis clearly forces us to question that assessment.’

Translation: we thought we knew it all. We don’t. Back to the drawing board.

‘To caricature: we thought of monetary policy as having one target, inflation, and one instrument, the policy rate. So long as inflation was stable, the output gap was likely to be small and stable and monetary policy did its job. We thought of fiscal policy as playing a secondary role, with political constraints sharply limiting its de facto usefulness. And we thought of financial regulation as mostly outside the macroeconomic policy framework.’

Translation: We thought all you had to do was keep inflation down, and all you needed to do that was vary interest rates to control prices. Government finances were secondary, and anyway, we didn’t like pesky politicians interfering. We thought regulating financial institutions was irrelevant to overall stability. Whoops.

‘It is clear that the zero nominal interest rate bound has proven costly. Higher average inflation, and thus higher nominal interest rates to start with, would have made it possible to cut interest rates more, thereby probably reducing the drop in output and the deterioration of fiscal positions.’

Translation: because we kept inflation rates so low, interest rates were also low, so when the crisis hit and we needed to boost the economy, we only had a bit of leeway to lower interest rates (you can’t take them below zero). Instead we had to spend shedloads of cash, and that has left us with a massive fiscal hangover.

‘The crisis has returned fiscal policy to center stage. It has also shown the importance of having “fiscal space”. The aggressive fiscal response has been warranted given the exceptional circumstances, but it has further exposed some drawbacks of discretionary fiscal policy for more “normal” fluctuations—in particular lags in formulating, enacting, and implementing appropriate fiscal measures (often due to an awkward political process).’

Translation: Fiscal policy really matters, and many governments have tried to spend their way out of recession, but getting spending plans through the legislature takes much longer than dropping interest rates, and gets bogged down in pork. In normal times, it’s better to have other options (like more leeway on interest rates).

‘Identifying the flaws of existing policy is (relatively) easy. Defining a new macroeconomic policy framework is much harder. The bad news is that the crisis has made clear that macroeconomic policy must have many targets; the good news is that it has also reminded us that we have in fact many instruments, from “exotic” monetary policy to fiscal instruments, to regulatory instruments. It will take some time, and substantial research, to decide which instruments to allocate to which targets, between monetary, fiscal, and financial policies.’

Translation: Damn, life is more complicated than we thought. Still, lots of work for us researchers….

‘The crisis has shown that large adverse shocks can and do happen. In this crisis, they came from the financial sector, but they could come from elsewhere in the future—the effects of a pandemic on tourism and trade or the effects of a major terrorist attack on a large economic center. Should policymakers therefore aim for a higher target inflation rate in normal times, in order to increase the room for monetary policy to react to such shocks? To be concrete, are the net costs of inflation much higher at, say, 4 percent than at 2 percent, the current target range? Answering these questions implies carefully revisiting the list of benefits and costs of inflation.’

Translation: We think we need to double inflation targets to give governments more room for manoeuvre on interest rates. But hold on a minute, we work for the IMF, so we’d better play safe and pretend we’re merely posing this as a question.

‘If one accepts the notion that, together, monetary policy and regulation provide a large set of cyclical tools, this raises the issue of how coordination is achieved between the monetary and the regulatory authorities, or whether the central bank should be in charge of both. The increasing trend toward separation of the two may well have to be reversed. Central banks are an obvious candidate as macroprudential regulators.’

Translation: The economy is just too important to be left to elected politicians. Why not put the Central Bank in charge of everything? 

This paper is mainly about policy in the rich countries, but if the change in tone ‘trickles down’ into the Fund’s work in poor countries, it should at least lead to a reduction in its traditional insistence on low inflation at any social cost. Encouraging signs? Further coverage in the FT and on the Vreelander blog.

Breakfast (and climate change megabucks) with George Soros

Last week George Soros was passing through London and invited a bunch of NGO types for breakfast at his very nice house in South Kensington. (In case you’re interested we all got sticky pastries, but George made do with grapefruit and muesli). He was en route to Copenhagen to launch his big new idea – using the IMF to pump prime global funding for climate change. How does it work? Here’s the excellent summary put out by his team:

‘Rich countries could double available funding to combat climate change by donating recently issued Special Drawing Rights to a new green fund. This fund would jumpstart investment in low carbon energy sources, reforestation efforts, rain forest protection, land use reform, and adaptation programs.

Unlike other proposed solutions, this plan could be implemented within already existing financial structures. SDRs, issued by the International Monetary Fund, amount to additional foreign exchange. In response to the global financial crisis in September 2009, the IMF issued $283 billion in SDRs, with more than $150 billion going to the 15 largest developed economies. This sits largely untouched in their reserve accounts, leaving a surplus that could be donated to the fund.

The IMF currently has 100 million ounces of gold, at current prices worth more than $100 billion at book value. The IMF has decided that the surplus value of its gold be used to benefit the least developed countries. Under this plan, the IMF would use its gold reserves to cover the interest incurred by the developed countries that donated their SDRs.

Paying the interest in this way would mean that developed countries would not be saddled with interest payments. In addition, the gold can also be used to guarantee the repayment of loans for the climate projects if the carbon market fails to develop as envisioned.

“This approach gives developed countries an additional incentive to create effective carbon markets,” said Soros. “If they fail, they will have to use the IMF gold reserves to cover the loan principal. This forces countries to put their money where their mouth is.”

A rapid independent analysis by the European Climate Foundation  (not up on the web yet, sorry) concluded:

‘Our analysis shows that $100 billion of SDRs allocated to a climate fund or funds could provide about $7 billion1 per year in grants, loan and equity financing to developing countries on an annual basis for the next 30-40 years. The SDR source would meet the tests of predictable funding flows, strong performance incentives, and limited short-term budgetary impact on developed country finances. This use of SDRs, particularly for adaptation, could potentially be justified under the mandate of the IMF given the adverse impacts of climate change will negatively impact the balance of payments and currency reserves of vulnerable countries.’

Time to open the vault?

The interesting precedent here is using the huge amount of gold lying around in the IMF to turn SDRs into free, potentially indefinite loans for poor countries. He’s gone for the existing SDR issue because that could be rapidly turned into cash for climate change adaptation, but the IMF’s idle gold mountain could cover the interest payments on a new and much larger SDR issue, potentially generating trillions of dollars for climate change and development. Soros describes it as, if not a free, then a ‘cheap lunch’. It looks to me like a kind of global, climate-focussed form of quantitative easing.

If it’s so easy, why hasn’t it happened already? Soros sees the main obstacles as political, not technical. Mainly, they consist of opposition in the US Congress and to a lesser extent, Germany, based on fears of inflation and the impact on the dollar/euro’s positions as international reserve currencies (China’s Central Bank governor recently argued that SDRs could provide the basis of a viable global currency). Congress would need to approve a change in the IMF’s articles of agreement before they could issue new SDRs and that is highly unlikely, unless massive public pressure builds to make it happen (as it did previously with debt relief). That’s why he’s stuck to the already issued SDRs in this proposal.

Soros sees the SDR proposal as a complement to other ways to raise additional funds for climate change and development, such as the Financial Transactions Tax.  Put them in the pot along with bunker fuel taxes, airline taxes etc, and you have the makings of a grand bargain that could fund the kinds of vast technological and economic shifts required to avoid climate catastrophe and achieve lasting development. Soros contrasts this with what he calls ‘the usual $10 billion’ likely to be agreed at Copenhagen, as at other summits, much of it merely recycling existing spending commitments.

So has Mr Soros found $100bn down the back of the sofa? This kind of funny money discussion makes my head spin, but when it comes to financial alchemy, Soros knows what he’s talking about  He famously turned a $1bn profit by ‘breaking the pound’ in 1992. He’s given away $6bn in his philanthropic work, but is still the 29th richest person in the world, worth about $11bn (enough on its own to end world poverty for at least a couple of weeks). His over-riding message at breakfast was that the money is there, if politicians are willing to harness it. They must not be allowed to hide behind technicalities. And he will back the idea with philanthropic cash if it gets enough momentum, as he has done previously with the Publish What You Pay campaign. What do people think?