WASHINGTON – European leaders met last week for yet another “historic” summit at which the fate of Europe is said to hang in the balance. Yet it is clear that this will not be the last one convened to deal with the financial crisis.
Given that Europe is the largest component of the global economy, the rest of the world has a stake in helping to avoid major financial accidents. It also has a stake in aiding continued growth in Europe and ensuring that the European financial system supports investment around the world — particularly as cross-border European bank lending dwarfs that of banks from any other region.
Now is also a historic juncture for the International Monetary Fund. The focus of the policy response to the crisis must shift from Brussels and Frankfurt to the IMF’s boardroom.
From the problems of Britain and Italy in the 1970s, through the Latin American debt crisis of the 1980s and the Mexican, Asian and Russian financial crises of the 1990s, the IMF has operated by twinning the provision of liquidity with strong requirements that those involved do what is necessary to restore their financial positions to sustainability. There is ample room for debate about precise policy choices the fund has made. But the IMF has consistently stood for the proposition that the laws of economics do not and will not give way to political considerations. At key points the IMF has offered prescriptions, not just for countries in need of funds but also for those whose success is systemically important for the global economy.
Christine Lagarde, the head of the IMF, highlighted the seriousness of problems in Europe to international financial leaders assembled in Jackson Hole, Wyoming, in August. She pointed to capital shortfalls in the European banking system and the need for adjustment to be carried on in ways that are consistent with continuing growth. Now, the IMF needs to act on several fronts.
First, it is essential that Italy’s adjustment be carried out within the context of an IMF program. After European authorities emphasized that Greece was solvent and able to service all debts in full, it is unlikely that they, acting alone, have the capacity to reassure markets. Moreover, there will be profound intra-continent political problems if Northern Europe does or does not impose conditions on Italy. It would be much better to outsource those traumas to the IMF.
Second, as the IMF deals with individual European countries, it needs to recognize more than it has in the past that they are embedded within a monetary system and community of nations with an increasing number of common institutions.
It is inconceivable that the IMF would lend money to a country whose central bank was not committed to an appropriate monetary policy or was ignoring contingent liabilities in the banking system. IMF support for any European country should be premised on understandings with the European Central Bank that controls that country’s monetary policy.
Third, when engaging individual members of a monetary union, the IMF cannot assess the prospects of one member in isolation. If some countries are to enjoy reduced trade deficits, others, most notably Germany, must face reduced surpluses. If there is no clear path to reduced surpluses, there is no clear path to reduced deficits and hence to solvency. More generally, the sustainability of any program must be assessed in the context of realistic projections of the economic environment. The IMF must not approve adjustment programs that are unrealistic.
Fourth, the IMF has a responsibility to speak clearly about threats to the global economy. Even if debt spreads in Europe narrow and modest growth is reattained, the global economy is threatened by the large-scale deleveraging of European banks. An improvement in the fiscal position of sovereigns will help, but this is insufficient. If banks are not recapped on a substantial scale soon, there will be a large contraction of credit in the global economy.
After the events of last week, attention will shift to the IMF. It must act boldly, but no one should forget a fundamental lesson of all past crises: The international community can provide support, but a nation or a region’s prospect for prosperity ultimately depends on its own efforts.
Lawrence H. Summers, a former economic adviser to President Barack Obama, was Treasury secretary in the Clinton administration.
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