Will Greece go to the IMF?

* SIMON JOHNSON | Thursday February 18, 2010 00:00

Over the past few decades, the International Monetary Fund became associated with excessive fiscal austerity, extreme political insensitivity, and - since the Asian financial crisis of 1997-1998 - with an out-and-out stigma. Countries borrowed from the IMF only under duress, when all else failed - and when there was simply no other way to pay for essential imports. (For Iceland in the fall of 2008, for example, the only alternative to IMF financing was to eat locally obtained goods, which mostly means fish.)

But the IMF has changed a great deal in recent years, largely under the auspices of Dominique Strauss-Kahn, its current managing director. Strauss-Kahn, a former French finance minister and contender for the Socialist nomination for the French presidency, has pushed through changes that allow the IMF to lend without conditions in some circumstances, and to give greater priority to protecting social safety nets (including unemployment benefits and healthcare systems). He has also moved the Fund decisively away from its obsession with fiscal austerity measures (a big early mistake - with lasting traumatic consequences - in Indonesia and Korea in late 1997).

Greece undoubtedly has serious problems today. The great opportunities offered by European integration have been largely squandered. And lower interest rates over the past decade - brought down to German levels through Greece being allowed, rather generously, into the euro zone - led to little more than further deficits and a dangerous buildup of government debt.

Germany and France - as de facto leaders of the European Union - are haggling over a belated support package, but they have made it abundantly clear that Greece must slash public-sector wages and other spending. Greek trade unions know what this means - and are in the streets.

If Greece still had its own currency, everything would be easier. Just as in the case of the United Kingdom since 2008, the Greek exchange rate would depreciate sharply. This would lower the cost of labor, restoring competitiveness (as in Asia after 1997-98) while also inflating asset prices and thereby helping borrowers who are underwater on their mortgages and other debts.

But, with Greece and other troubled euro-zone economies (known to their detractors as the PIIGS: Portugal, Ireland, Italy, Greece, and Spain) having surrendered monetary policy to the European Central Bank (ECB) in Frankfurt, their currencies cannot fall in this fashion. So Greece - and arguably the PIIGS more generally - are left with the need to curtail demand massively, lower wages, and reduce the public-sector workforce. The last time we saw this kind of precipitate fiscal austerity - when countries were tied to the gold standard - it contributed directly to the onset of the Great Depression in the 1930's.

This is a situation tailor-made for Strauss-Kahn and the 'new IMF' to ride to the rescue. Since early 2009, the Fund has had significantly greater resources to lend to countries in trouble, to cushion the blow of crisis, and to offer a form of international circuit-breaker when it looks like the lights might otherwise go out. The idea is not to prevent necessary adjustments - for example, in the form of budget-deficit reduction - but to spread them out over time, to restore confidence, and to serve as an external seal of approval on a government's credibility.

T he IMF was created in the waning days of World War II, essentially as a United States-West European partnership. Europe retains strong representation at the Fund, and has always chosen its top leader - in fact, most emerging markets (in Asia, Latin America, and Africa) complain that Europe is overrepresented and has far too much say in how the Fund operates. Yet at this moment of growing European crisis, while there is still time to act, the Fund is confined to the sidelines.

This is partly because German Chancellor Angela Merkel, currently maneuvering to ensure that a German is the next head of the ECB, does not want the Fund to become more involved in euro-zone policies. The IMF might reasonably take the position that ECB policies have been overly contractionary - resulting in a strong euro and very low inflation - and are no longer appropriate for member countries in the midst of a financial collapse. If the IMF were to support Europe's weaker economies, this would challenge the prevailing ideology among Frankfurt-dominated policy makers.

But the real reason is much simpler. When French President Nicolas Sarkozy put forward Strauss-Kahn's name to run the IMF, he meant to park a past and potentially future rival in a faraway place about which people cared little. Then the global financial crisis hit, and Strauss-Kahn was propelled to center stage. With France's next presidential election fast approaching in 2012, the last thing Sarkozy now needs is for Strauss-Kahn to play a statesman-like role in saving the euro zone. We can expect to hear all kinds of misleading excuses from EU sources for excluding the IMF: 'the Fund is too American,' 'Europe must resolve its own problems,' and 'the IMF is not appropriate to our circumstances.' Given the magnitude of the Greek crisis, they will all ring hollow.

Sometimes history is driven by deep forces beyond our control, and sometimes by sheer chance. And at other times, like now, much that hangs in the balance is affected by the deliberate, personal, and short-term tactical considerations of people running for election.

The EU's leaders will try hard to keep the IMF at bay. This is not good news for Greece - or for anyone who cares about global financial stability.

* Simon Johnson, a former chief economist at the International Monetary Fund, is a professor at MIT's Sloan School of Business, a senior fellow at the Peterson Institute, and the co-author of the forthcoming book 13 Bankers. Copyright: Project Syndicate, 2010. Will Greece Go To the IMF?