Recently, the IMF have been working hard to establish a bigger fighting fund to help out insolvent Eurozone economies. (Although they say, it is not just for the Eurozone, but for the whole world economy.) Extra contributions from IMF members have raised an extra £300bn – taking the total of IMF funds to £1,000bn.
- The aim is to have a bigger ‘firewall’. If economies experience liquidity crisis – e.g. can’t meet borrowing requirements, then they can apply for a loan from the IMF.
- The fact that there is a lender of last resort like the IMF – means markets are, in theory, less worried about countries becoming illiquid and experiencing shortages. This confidence factor can help avoid capital flight in the first place.
- Given the greater uncertainty in the world economy, the IMF has been keen to build up an even bigger fund than usual.
How Do Countries Contribute to IMF?
- The UK recently gave £10bn to the IMF. This doesn’t come out of public spending. It is invested from UK foreign exchange reserves. The UK can also gain interest on this ‘investment’ into the IMF fund.
Limitations of the IMF Fund
- One Trillion pounds is a big fund, but given the amount of potential losses in the Eurozone, it would be insufficient to cope if countries like Spain or Italy defaulted.
- A fighting fund can help with liquidity issues, but insolvency is something much more difficult. Markets won’t be impressed by a bailout if it can’t deal with the underlying bank / government losses.
- The Euro crisis is much more than a shortage of funds. Struggling countries in the Eurozone like Greece, Spain and Portugal have a lack of competitiveness and no clear plan for economic growth. Usually, the IMF would recommend structural reforms, such as devaluation to restore competitiveness, but countries in the Eurozone can’t do this. Therefore, IMF bailouts may prove ineffective because they can’t address the underlying problems.
- The IMF have produced several reports about the likelihood that austerity policies will prove counter-productive. Therefore, there has been conflicting advice. On the one hand struggling economies are being told to cut deficits, but at the same time, evidence suggests cutting deficits is not solving the excessive level of debt to GDP
- Emerging economies bailing out richer economies. It does seem a paradox that a bailout of Europe requires funds from much poorer countries in emerging economies. It is a paradox that living standards can be relatively high, yet several countries at risk of default. Emerging economies will be wanting more say in how the IMF is run in return for funds.
- Will the Money Achieve Anything? A bailout fund of $300bn is no mean feat, but is it throwing good money after bad? There is still no clear path or plan for indebted countries to return to normal economic growth. Therefore, it is only a small part of the solution.