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-The recent financial crisis has proved that the IMF has become irrelevant and should be wound up.-
This statement has gone through a lot of individual minds in the onset of the resent global financial crisis. With this statement three questions come to mind. Firstly, why was the International Monetary Fund (IMF) established? Secondly, why the IMF could not prevent the recent global financial crisis and what could have been done? Thirdly, is there a positive future for the IMF?
The IMF was formed in July 1944 when ambassadors and delegates of 45 nations gathered in the town of Betton Woods in the United States of America. These 45 countries agreed in a specific outline for future economic cooperation that would be established after the World-War II. This outline or framework was created to ensure that the disastrous economic policies, which had contributed to the Great Depression in the 1930’s, do not occur ever again. Today the IMF global membership comprises out of 186 countries. The main services of the IMF are as follows:
The IMF evaluates and tracks economic changes and performance.
Notifies member countries of arising economic problems.
Advised member countries on how to handle upcoming economic complications.
The IMF loans money to member countries that are in need of financial assistance.
The IMF has a clear part that it plays in the regulation and health of the global economy, why did this organisation not see this global financial crisis on the horizon? Prevention might have been the best cure in this financial disaster. The following section will discuss the crucial roles and services of the IMF in the global economy, causes of the current financial crisis, reasons why the IMF did not foresee this crisis, advantages and criticism of keeping the IMF in place and a recommendation for the IMF of the future.
The crucial roles and services of the IMF in the global economy
The main role of the IMF is to prevent the global economic factors, which contributed to the Great Depression. Other roles of the IMF are:
To maintain positive global financial performance by stabilizing global exchange rates.
To reduce poverty in countries so that economic growth is stimulated.
To increase the international trading and employment rates.
The IMF plays a big part in the encouragement on international financial cooperation.
The organisation also collaborates with the World Bank to make monetary resources available to member countries in the form of loans.
The IMF provides the following services/functions to member countries to maintain the IMF’s constructive role it plays in the global economy:
The IMF forms a partnership with member countries and assesses changing economic conditions within a member country. This assessment is conducted on a yearly basis where the IMF analyses the country’s current economic situation. After the assessment, the IMF would advise the member country on how the country should go about adjusting their financial and economic policies to ensure future economic stability.
“IMF offers technical assistance and training to help member countries strengthen their capacity to design and implement effective policies” (International Monetary Fund, 2010). The organisation offers support in a wide range of areas including: banking and financial service guiding and supervision, statistics, exchange rate and monetary policies and fiscal policy. It also assists member countries to combat global economic threats such as money-laundering and terrorism.
“In the event that member countries experience difficulties financing their balance of payments, the IMF is also a fund that can be tapped to facilitate recovery” (International Monetary Fund, 2010). The IMF offers poorer developing countries loans at lower interest rates to facilitate economic development within those countries. The organisation also has a partnership with the World Bank to facilitate the lending of money to struggling countries.
These services have played a crucial part in the growth and development of countries all over the world. It is clear that countries around the world would not be able to survive financially without the services that the IMF provides.
The IMF has recently improved its operations to adjust to economic changes and to ensure flexibility in critical financial time periods. The areas of adjustments include:
The enhancement of the IMF lending Facilities.
Reinforcement of the monitoring of global and international economics.
Solving global economic discrepancies.
Analysis of member country market developments.
Accountability and transparency.
The aid to poverty.
All of these areas and more are discussed in detail in Appendix 1. The adjustment of IMF’s services and operations is crucial in the effectiveness of these services. The IMF has seen that it is time to adapt to financial changes to guide the global economy out of the crisis and to better its analysing techniques to ensure that another crisis does not happen soon.
Global Economic crisis of 2008-2010 and its contributing factors
The current global financial crisis started to display its effects in the year of 2007 and by 2008 the crisis was in full swing. “Around the world stock markets have fallen, large financial institutions have collapsed or been bought out, and governments in even the wealthiest nations have had to come up with rescue packages to bail out their financial systems” (Global Issues, 2009).
It is ironic to see that the main group of countries that are being bailed-out are mainly the ones responsible for this global financial disaster. There are many contributing factors to this global crisis and the main factors will be discussed as follows:
The USA housing bubble
In the years 2003-2005 there was real-estate boom. The social policy was implemented to grant house ownership to low income households with relaxed credit standard. This caused homeowners to refinance their houses at low interest rates and/or to finance their consumer expenses by taking a second mortgage out on their property. This increased the consumer debt to the banks in the USA.
The actions of banks and other financial institutions
“Newly developed securitisation techniques then enabled banks in the United States to sell these mortgage loans to investors all over the world” (Chittenden, O. ed.- Wolfgang Franz, 2010). Banks borrowed more money from other financial institutions for lending to customers, to create more securitisation.
Bad loans were the main problem that arose with the recall of these debts by bank institutions. Banks did not regulate their capital funds with comparison to the amount of loans granted to consumers.
Inaccurate credit ratings of consumers and financial institutions also contributed to the banking problem. The standards of granting credit were lowered by American and European financial institutions, thus creating a low income consumer credit influx. Bad debts or insolvent consumers who had loans, contributed to the financial downfall of banks when they demanded payment of these granted loans.
The main lesson that can be learned by analysing these contributing factors is that credit must be regulated with strict laws and regulations. The slack and greedy attitude that was associated with granting credit should be replaced with an attitude of thoroughness. If lenders thoroughly checked the consumers’ credit ratings, the granting of credit would have been more regulated.
The effect of the global financial crisis
The financial crisis affected every country in the world. The global financial crisis had a ripple effect that contributed to the systematic failure of the economic climate of each continent. Today (2010) the United Stated of America is recuperating and the financial crisis has moved on to Europe like a flu virus. The IMF bail-outs have already reached Europe with the IMF member country being Greece where economic conditions became too unstable for self recuperation. The next expected European countries to follow in financial dismay are Portugal, Spain and Ireland.
To show the longevity of the global financial crisis, the IMF and EU rescue of two countries, Iceland and Greece, will be discussed. The Icelandic bail-out was implemented in the early stages of the global financial crisis (2008) and the Greek bail-out was implemented in the current European situation (2010).
Icelandic bail-out (2008)
The collapse of the Icelandic banking system caused the downfall of their economy. The removal/withdrawal of local and foreign investment lead to the depreciation of the currency. This depreciation of currency caused inflation and the rising of interest rates. Iceland had a huge current account deficit and external and internal debt.
Iceland’s rescue package from the IMF amounted to a $2.1 billion loan. The bail-out loan was to restore financial stability within the Icelandic economy and to ensure the restoration of confidence in this country’s financial sector.
Greek bail-out (2010)
The failure of the Greek economy had the same contributing factors that were mentioned in the Icelandic bail-out. The EU and IMF bail-out of Greece caused much conflict in the European countries’ acceptance of such a bail-out. It was decided after long debate that Greece would be assisted with a $146 Billion rescue from the EU and IMF.
The Advantages of maintaining the IMF as a global financial regulator
The advantage of the IMF can be seen by the roles it plays in the global economy. The main advantages are:
For decades the IMF has been seen as the lender of funds to member countries who are facing and economic crisis. The IMF acts as a lender of last resort for financial aid. The organisation’s financial aid can stabilise a country’s economic despair.
The aid/service that the IMF provides to member countries can help steer a country’s economic policies and tendencies to change and ultimately be more effective. This positive change in economic policy can lead to economic growth and long-term development.
The IMF does financial risk assessments by analysing current economic situation and interpreting future probabilities. The organisation will then advise member countries who are faced with a financial crisis in the near future.
Due to recent enhancements of the IMF’s operations (Stated in Appendix 1) the services of the IMF will ensure the decrease of the severity of a future global financial crisis.
The advantages of maintaining the IMF as a global regulator highlights the importance of the IMF. The IMF stays a friend to all member countries even after the onset of the global financial crisis. The IMF will always ensure the reconstruction, growth and development of the global economy.
Criticism/Disadvantages of the IMF as a global financial regulator
The IMF has been criticised for a range of reasons by different individuals and organisations throughout the world. Some of the main criticism of the IMF:
The IMF might intensify economic problems. Some argue that the terms and conditions of an IMF loan can cause more harm to the weakened economy of a specific member country. Repayment of the loan could be a problem for poor under developed countries.
The IMF advises different member countries with the same recommendations on economic policies-One size fits all. The IMF recommendations on the devaluation of a country’s exchange rate, may help the member country but is not always and effective long-term solution.
The IMF recommendations on spending and budget cuts may cause a decline in public services within the country. The IMF is said to ignore the negative impact of its recommendations on poor communities within the member country.
Some feel that the IMF dictates national policy and take away governmental decision making.
The frequent intervention of the IMF may cause countries to develop laid back attitudes where the governments of these countries expect and rely on IMF intervention.
Even if individuals and organisations have issues with the maintaining of the IMF as global financial regulator, the IMF is still needed to ensure future economic prosperity. No other organisation is qualified enough to replace the IMF and its roles.
“the world has an important stake in giving a meaningful future to the IMF, not as a “lender of last resort” but as the “crisis and prevention manager” that it more realistically has been and should continue to be”(Litan, R, 1998). My recommendation is to keep the IMF as a global financial monitor and regulator but also implement new global credit regulations.
The amount of credit that was granted to American and European individuals and organisations, before the global financial crisis, was too large for the IMF to implement measure to prevent this crisis. The IMF is not a dictator that forces member countries to abide by the IMF’s economic recommendations, that is why there was a slow response when the IMF foresaw a global financial problem on the rise. The organisation could also not prevent the global financial crisis because of the rapid changes in the global economy.
New global credit legislation must be implemented to regulate the allowance of credit within every country in the world. A slack credit regulation is one of the main causes of the global financial crisis. The IMF can act as the credit regulator or an independent credit administrator can be established to monitor global credit activities and police illegal credit fraud. A good example of a successful credit act is South Africa’s recently implemented credit act. The key point of the South African credit Act:
The lenders of credit are required to thoroughly assess the ability of the borrowing customer to repay the credit.
The credit act bans penalty fees and penalty interest rates on all types of loans.
Prevents credit issuers from increasing the credit card limit or issuing an overdraft facility without the customer’s consent.
The National Credit Regulator regulates the amount of South Africa’s credit activity and also it enforces the strict credit laws.
If this type of credit act was implemented on a global scale in the 1990’s, the current financial crisis would never have happened and the IMF would not have to bail the whole European Union out. With the IMF and a new global credit regulating system in place, the world economy would prosper for many years to come.
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