Economic Crises and the IMF

Why governments seek help from the IMF

Periodically, governments and the economies they regulate face economic and financial crises. Non-industrial, or Third World economies are particularly vulnerable to crisis. The origins of these crises are multiple, coincident causes. They include a set of national causes: poor management of the economy, and an imbalance between government spending and revenue collection. In addition there are a set of international causes to these crises: changes in the global economy, such as reduced demand and lower prices for the goods the country exports, changes in the price of oil, and rapid flows of hot money (finance seeking quick or speculative returns).

As a result of these contributing factors to economic crises governments face something akin to bankruptcy. That is, they cannot fund activities such as public services and employment, debt repayment and infrastructure development. A recent example of an economic and financial crisis occurred in Argentina in the period 2000-03.

To weather these crises, governments are often forced to seek loans from the International Monetary Fund (IMF). The map sequence here shows growing use of IMF credit over the last 30 years. The effectiveness of these credit programs in hotly debated among policy makers. The IMF's intention with there programs is to provide "shock therapy" for an ailing economy. While the transition can create numerous hardships, the overall outcome is a healthy economy. some argue that these short-term hardships last too long and cause further social and economic upheaval. For a description see Use of IMF Credit.

Symptoms of crisis

There are three common symptoms of economic crises: a balance of payments crisis, government spending exceeding government revenues, and rapid inflation. A balance of payments situation arises, most simply, when the earnings from exports are insufficient to meet the costs of imports. In the short term, this imbalance of trade may be prolonged, without provoking an economic crisis, if other funding sources an be found. Thus, money borrowed by the government, foreign investment, or foreign aid payments, might bridge the gap between export earnings and import costs, but these cources become insustainable over long periods of time.

If, in addition to an imbalance of payments, there is rapid inflation and the government is spending more than its revenue, it may be difficult for the government to borrow money from foreign lenders, and foreign investment may dwindle. the culmination of these symptoms leads to the IMF becoming a lender of last resort for countries in crisis.

Why governments seek help from the IMF

What can governments do when they face a multidimensional economic crisis of this sort? They could seek short-term loans from private capital markets. But private lenders, such as big banks, may be unwilling to provide loans unless there is evidence that the various crises of government spending, trade and economic management are being adequately addressed. And global corporations may be unwilling to provide investment capital while economic activity is uncertain. In the knowledge that private loans may be unavailable, governments may seek finance from International Monetary Fund, the multinational financial institution established to provide loans for just this purpose.

When governments seek loans from the International Monetary Fund, those loans can be made under several different arrangements (see Current IMF Arrangements). But, when the IMF gives a loan, it establishes a set of policy conditions called structural adjustment conditions (see IMF History and Adjustment Conditions). By default, at the beginning of the 21^st Century, these conditions have established the ground rules for global economic policy. As can be seen in maps above, almost all governments in the developing world have accepted one or more structural adjustment loan and the conditions that accompany those loans.

In order to borrow from the IMF, a government has to agree to a set of conditions. The package of conditions has varied over time, and varies to a certain extent with the particular government concerned. Usually the conditions includes:

• Devaluation of the currency – to make imports more expensive (to buyers within the country) and exports cheaper (to foreign buyers).
• Raising interest rates – to make loans within the country more expensive
  
• Reducing government spending to bring it in line with revenues. This usually means that health and education spending and employment in government must be cut. Most governments protect the other major part of spending on the military and the police.
  
• There may also be privatization of government enterprises, including water and power utilities, and state purchasing agencies.

Reference list

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