IMF Fiscal Surveillance during the Eurozone Crisis

Introduction

With a few notable exceptions, economists worldwide failed to predict the emergence and gravity of the financial crisis that originated in the United States in 2007. Because governments worldwide rely on the IMF to provide a warning system to anticipate critical events (see statement of the G20 Leaders), it is crucial to investigate how the IMF failed to detect early signs of the crisis. The IMF is a multilateral organization that is statutorily mandated to provide an early warning to the member countries so that national authorities can take measures to mitigate the impact of a crisis. Despite this mandate, some have claimed that the IMF did not sound any alarm in the run-up to the current crisis, or that when raising concerns it did so in a muted or hedged manner (IEO, 2010). To illustrate this, in the summer of 2007, the IMF staff indicated that in the United States “core commercial and investment banks are in a sound financial position, and systemic risks appear low” (IMF, 2007:14). In addition, as late as April 2007, the opening sentence of the Global Financial Stability Report (GFSR), the IMF flagship on financial issues, noted, “Favorable global economic prospects, particularly strong momentum in the Euro area and in emerging markets led by China and India, continue to serve as a strong foundation for global financial stability. However, some market developments warrant attention, as underlying financial risks and conditions have shifted since September 2006 GFSR”. In addition, Subramanian (2009) says that the failure of the IMF “was to preside over large capital flows to Eastern Europe despite the lessons that it should have learned from the experience of the Asian financial crisis in the late 1990s. These flows to Eastern Europe were, in some cases, so large that it did not require hindsight to see the problems that they would lead to. Warnings about the unsustainability of these flows should have been loud and insistent. And they were not.” Others have claimed that the IMF issued warnings but that they were not heeded.

Furthermore, during the global financial crisis, the IMF’s role in financial sector surveillance involved three interrelated aspects: drawing policy lessons from the crisis and recommending actions to restore financial stability; developing recommendations to strengthen supervisory, regulatory, and macroprudential frameworks, in collaboration with other agencies; and making the Financial Sector Assessment Program (FSAP) more effective and integrating it with Article IV surveillance. The IMF’ headline messages about the causes of the euro area’s financial crisis during the crisis period were generally consistent with the EU members’ authorities’ views. The IMF indicated high sovereign debts levels, weak governance and fiscal framework as the main causes of the crisis. With respect to addressing these factors, it was proposed to reinforce policy coordination in the euro area. Specifically, the EC recommended a strengthening of the SGP, a more intrusive surveillance of external imbalances in the euro area, stronger ex-ante coordination, and a permanent framework of crisis management. Unsurprisingly, the IMF provided an enthusiastic assessment of the overall European Economic and Monetary Union response to the crisis. To illustrate, the Staff Appraisal section, the IMF noted, “the immediate crisis response has been strong and far-reaching, demonstrating the euro-area’s capability to act together when pressured” (IMF, 2010).