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It’s the IMF to the rescue

by Kenneth Rogoff

CAMBRIDGE, Mass. — With the International Monetary Fund playing a central role in the euro zone’s blueprint for a bailout of Greece, the multilateral lender has come full circle. In its early days after World War II, the IMF’s central task was to help Europe emerge from the ravages of the war. Once upon a time, the IMF had scores of programs across the Continent (as Rong Qian, Carmen Reinhart and I illustrate in new research on “graduation” from sovereign debt crises.) But, until the financial crisis, most Europeans assumed they were now far too wealthy to ever face the humiliation of asking the IMF for financial assistance.

Welcome to the new era. Europe has become ground zero for the biggest expansion of IMF lending and influence in years. Several large Eastern European countries, including Hungary, Romania, and Ukraine, already have substantial IMF loan programs. Now, the euro-zone countries have agreed that the IMF can come into Greece and, presumably, Portugal, Spain, Italy and Ireland if needed.

The IMF’s resurgence over the past year is breathtaking. Castrated by populist rhetoric during the Asian debt crisis of the late 1990s, the IMF had been struggling to re-anchor its policies and rebuild its image. When France’s Dominique Strauss-Kahn took over the helm in the fall of 2007, even poor African countries were shunning the IMF like a leper, preferring to make deals with non-traditional lenders such as China. Absent new business and new revenues, the IMF was facing dire cutbacks to ensure its own survival.

What a difference a crisis makes. Now the IMF has ascended Mount Olympus. In April 2009, G20 leaders approved a quadrupling of the IMF’s lending capacity. The increase was perhaps exaggerated in the heat of the moment, but a good chunk of the money actually appears to have materialized. And for Europe, the help has come none too soon.

Does the IMF’s arrival in Europe signal the beginning of the end of the region’s staggering debt woes? Hardly. The IMF does not bestow gifts; it only offers bridge loans to give bankrupt countries time to solve their budget problems. Although countries occasionally can grow their way out of debt problems, as China did with its 1990s banking crisis, bankrupt countries usually face painful budget arithmetic. Short of default and inflation, most countries are forced to accept big tax hikes and spending cuts, often triggering or deepening a recession.

To be fair, the IMF’s reputation for imposing austerity is mostly an illusion. Countries usually call in the IMF only when they have been jilted by international capital markets, and are faced with desperate tightening measures no matter where they turn. Countries turn to the IMF for help because it is typically a far softer touch than private markets.

But gentleness is relative. It will be very tough — not only for Greece, but for all the other overextended countries of Europe — to tighten fiscal policy in the midst of recession without risking a deepening spiral. Simply put, no one wants to be the next major IMF supplicant.

Nor does the IMF’s arrival mean that bond holders are off the hook. As Qian, Reinhart and I document, there have been numerous instances in which countries enter IMF programs but end up defaulting anyway. The most famous case is Argentina in 2002, but other recent examples include Indonesia, Uruguay and the Dominican Republic.

The endgame could be the same for many European countries. Ukraine is already struggling. But, for the most part, the sovereign default process is slow-motion Kabuki theater. Why should a country choose to default as long as there are rich benefactors willing to lend money to preserve an illusion of normalcy? Bond markets are easily lulled.

The stakes for the IMF in Europe are huge. It is not going to be an easy balancing act. If the IMF attaches tough “German-style” conditions to its loans, it risks provoking immediate confrontation and default. This is the last thing that it wants to do. So far, it has been pretty soft in Eastern Europe, endorsing programs that depend on optimistic projections of both future budget cuts and economic growth.

The problem with being “Mr. Nice Guy” for too long is that, even with its vast new resources, the IMF cannot let clients hang on forever. If it does, it might not have sufficient funds for the next crisis, which will inevitably come, possibly from an unexpected quarter such as Japan or China.

Moreover, if the IMF loses all credibility for catalyzing budget reform, its magnanimous bailouts will only serve to exacerbate the larger global sovereign-debt crisis that is brewing not just in Europe, but in the United States, Japan and elsewhere. Slow growth, aging populations, and soaring deficits are a dangerous mix.

The question for the IMF in Europe is not whether it has a plan viable for getting in. It has landed in force. The question is whether it has a plausible exit strategy.

Kenneth Rogoff is a professor of economics and public policy at Harvard University, and was formerly chief economist at the IMF. © 2010 Project Syndicate