At the recent Spring Meetings of the International Monetary Fund (IMF) and the World Bank, the IMF outlined what it called “Steps to Energize Global Recovery.” These were generally met with skepticism, as many observers pointed to a global “stalemate” that is preventing the implementation of the international policy framework needed to address the remaining challenges from the global financial crisis. To get a better understanding of the situation and of the related discussions at the IMF meetings, we talk to Domenico Lombardi, director of CIGI’s Global Economy Program and a former member of the IMF executive board.

CIGI: In an interview with The Washington Post, you referred to the IMF’s statements on the employment aspect of a European Union recovery as “a ‘diversion’ from the fact that there is a fundamental disagreement among and within nations about how to proceed.” Can you elaborate on this and what you think the IMF’s role should be in helping to overcome this impasse?

Domenico Lombardi: The IMF has just pointed out that the euro area is going through another year of contraction (-0.3%) driven by the sustained decline in the GDP of the periphery, including Italy (-1.5%) and Spain (-1.6%). France too will see its GDP falling, albeit by a modest amount (-0.1%), evidence that the crisis has now spread to (some parts of) the core.

As the financial crisis affects the real economy, this may well fuel an increasing political risk, whereby parties may see scope for electoral gain in campaigning on a euro-skeptic or full-fledged anti-European agenda. What happened in the February 2013 Italian general elections — where the populist Five Star Movement became the largest political party — might thus become a broader political trend.

Against this backdrop, euro zone governments should provide a more comprehensive response. Southern Europe needs to embrace the reform agenda with more determination, while northern Europe needs to generate more demand to avoid a deflationary adjustment in the south. While southern Europe is in depression, northern Europe runs a current account surplus — broadly speaking, a measure of excess saving — of a few hundred billion dollars.

In this setting, the IMF has an invaluable role to play, leveraging on its third-party nature, high-level economic analysis and unrivalled access to senior officials. On that basis, the IMF could, for instance, monitor a “contract” or “program” between northern and southern Europe, whereby the availability of northern Europe to join a coordinated macro framework is conditional on clear and sustained progress on reform implementation in the south.

CIGI: Was there anything over the course of the meetings that gave you optimism that we might see positive movement in this area or are we stuck in a “first-mover” conundrum — where no country wants to be the first to implement the necessary policies without guarantees that others will follow suit?

Lombardi: In the closed-door, off-the-record meetings, foreign policy makers conveyed their substantial concerns on the euro zone developments backed by IMF analysis. First Deputy Managing Director David Lipton noted in a follow-up speech that the IMF still sees a “risk that Europe could fall into stagnation.” Thus, it is not surprising that there seems to be some early, tentative signs of a breakup in the rigorist front, with the European Commission apparently emphasizing a more balanced approach between consolidation and growth. The next step is to monitor developments in the next European Central Bank Governing Council’s decisions.

This is not say that fiscal adjustment should be de-emphasized from the European agenda —quite the contrary. Yet, what we have learnt on the basis of the latest evidence and the IMF’s analysis, is that for it to be effective, GDP must grow, otherwise debt sustainability will worsen rather than improve. Italy is a case in point. Its debt-to-GDP ratio will increase to more than 130 percent this year despite the likely achievement of a balanced budget in structural terms. In 2010, that ratio stood at 119 and the budget exhibited a structural deficit of 3.6 percent. Bringing those 3.6 percentage points down over a relatively shorter time horizon has resulted in an increase of more than 10 percentage points in the debt-to-GDP ratio on account of a dismaying growth performance. As Italy has a high fiscal multiplier, the short-term depressive impact of fiscal consolidation can be quite high and, indeed, is. The same is true for other southern economies that are adjusting. That said, the need for a more effective calibration time wise does not imply less fiscal adjustment, just a more credible and effective one.

CIGI: At both the IMF and G20 finance ministers and central bank governors meetings, debate continued as to the appropriate balance between austerity and stimulus, especially within the euro zone. How would you describe the general consensus at the IMF meetings and what do you see as the Fund’s role in this area going forward?

Lombardi: There are two noteworthy aspects emerging from the communiqués of both the IMFC (the IMF ministerial committee) and the G20. The first is a reference to symmetric adjustment (i.e., on both debtor’s and creditor’s side) so that, for instance, “[t]o support rebalancing, deficit countries must continue to raise national saving and surplus economies must boost domestic sources of growth. In addition, fiscal and structural reforms…are needed to ensure that the correction continues.” Along similar lines, the G20 finance ministers and central bank governors stated that “[l]arge surplus economies should consider taking further steps to boost domestic sources of growth” followed by “[w]e will continue to implement ambitious structural reforms to increase our growth potential and create jobs.”

The second feature coming out of these meetings is the relatively “flexible” language in the G20 communiqué with reference to fiscal targets: “maintaining fiscal sustainability in advanced economies remains essential. Advanced economies will develop medium-term fiscal strategies by the time of the St. Petersburg Summit…We will present and review our strategies at our next meeting.”

From now onward, the Russian presidency will be working on a difficult compromise that has to take into account the quite divergent views among the G20 membership: those who consider it helpful to set some common fiscal targets, while supporting the need for demand rebalancing, like Canada; those who privilege the demand rebalancing item, like the United States; and those, at the opposite end of the spectrum, who support the relevance of common fiscal targets but disagree on the issue of demand rebalancing, like Germany. Given the variety of positions, it will be challenging to reach some common, meaningful compromise at the St. Petersburg summit.

CIGI: Coming out of the meetings, how would you describe the status of IMF reform?

Lombardi: IMF reform appears to be losing momentum. The governance package (“Seoul package”) endorsed by G20 leaders at the Seoul summit in November 2010 and then approved by the IMF governance bodies has to yet come into effect, despite the deadline for ratification — October 2012 — having come and gone.

The US Congress may appraise the reform plan toward the end of this year, and its approval will be key for the package to come into effect. The latter will enable, beyond a shift in voting power toward dynamic and underrepresented economies, a recomposition of the Executive Board by allowing all 24 chairs to form multi-country constituencies. The move is expected to facilitate the consolidation of European representation, paving the way to a stronger voice and representation from other, non-Western European members.

While the 2010 Seoul package has yet to come into effect, consensus on a new quota formula was not reached by the agreed deadline of January 2013. Accordingly, a new governance reform may not be agreed by January 2014, as originally provided. If so, the credibility of the G20 and of some IMF membership would come into question and the fear that IMF reform is losing momentum would become exceedingly clear.

"From now onward, the Russian presidency will be working on a difficult compromise that has to take into account the quite divergent views among the G20 membership." Domenico Lombardi
Program
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