Young Economics.

The IMF Multiplier

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Last week, the G20 came together in London and unanimously agreed to increase the resources the IMF has to lend to countries struggling to balance their budgets. This was slightly unexpected; it’s rare that we get total global agreement on a topic of substance. So why did it happen? What makes an IMF resource increase a good idea?

On the surface, it’s sensible because there are going to be many countries in need of cash in the near future due to the crisis. Shockingly, even the UK has hinted that they may line up for assistance (check out this piece by Simon Johnson).  But if you think this is the gist of the argument, think again.

Here is a must-read on some of the implications of this move (link) – it’s what the rest of this post is based on.

After the announcement of the IMF resource expansion, private lending to emerging markets shot up. The risks involved with sovereign debt instruments had been significantly reduced by the move, and investors were more willing to front the cash. Think about it: you are an investor thinking of lending to a country in risk of that country’s finances drying up. Along comes the G20 who says we will put $1 trillion on the table through the IMF which any troubled country can access. This pool acts like a buffer for you: if the country goes belly up, they can still take out money from the IMF and continue to meet their obligations.  So the real kicker is that an IMF resource expansion has a multiplier attached to it.  Not only does it bring its dollars to the lending table, but it also brings more private investment.

If you read through the article linked above, you’ll hear an argument for why this might not be such a good idea. While the move has spurred capital markets into action, it has used an incentive which makes creditors devalue real analysis and the fundamentals, pushing people to take risks they wouldn’t have taken in normal circumstances. This is an issue of Moral Hazard.

I see the reasoning behind the moral hazard argument, but still think the move was more good than bad. Let me know what you think about it, and then I’ll give you my argument for why I’m with the G20 on this one.

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Written by jk

April 6, 2009 at 8:57 pm

Posted in Economic Stuff, Just News

Tagged with , ,

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