THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 569

CHAPTER 20

How Should
the IMF
Operate?

The International Financial System

537

The IMF would produce better outcomes if it made it clear that it will not play this
game. Just as giving in to ill-behaved children may be the easy way out in the short
run but supports a pattern of poor behaviour in the long run, some critics worry
that the IMF may not be tough enough when confronted by short-run humanitarian concerns. For example, they have been particularly critical of the IMF s lending to the Russian government, which has resisted adopting appropriate reforms
to stabilize its financial system.
The IMF has also been criticized for imposing on the East Asian countries
so-called austerity programs that focus on tight macroeconomic policies rather
than on microeconomic policies to fix the crisis-causing problems in the financial sector. Such programs are likely to increase resistance to IMF recommendations, particularly in emerging-market countries. Austerity programs allow
politicians in these countries to label institutions such as the IMF as being antigrowth, rhetoric that helps the politicians mobilize the public against the IMF
and avoid doing what they really need to do to reform the financial system in
their country. IMF programs that are focused instead on reforms of the financial
sector would increase the likelihood that the IMF will be seen as a helping hand
in the creation of a more efficient financial system.
An important historical feature of successful lender-of-last-resort operations is
that the faster the lending is done, the lower is the amount that actually has to be
lent. An excellent example involving the Federal Reserve occurred in the aftermath
of the stock market crash on October 19, 1987. At the end of that day, in order to
service their customers accounts, securities firms needed to borrow several billion
dollars to maintain orderly trading. However, given the unprecedented developments, banks were nervous about extending further loans to these firms. Upon
learning this, the U.S. Federal Reserve engaged in an immediate lender-of-lastresort operation, making it clear that it would provide liquidity to banks making
loans to the securities industry. What is striking about this episode is that the

extremely quick intervention of the Fed not only resulted in a negligible impact of
the stock market crash on the economy, but also meant that the amount of liquidity that the Fed needed to supply to the economy was not very large.
The ability of the Fed to engage in a lender-of-last-resort operation within a
day of a substantial shock to the financial system is in sharp contrast to the
amount of time it has taken the IMF to supply liquidity during the recent crises
in emerging-market countries. Because IMF lending facilities were originally
designed to provide funds after a country was experiencing a balance-ofpayments crisis and because the conditions for the loan had to be negotiated,
it took several months before the IMF made funds available. By this time, the
crises had gotten much worse and much larger sums of funds were needed to
cope with the crises, often stretching the resources of the IMF. One reason
central banks can lend so much more quickly than the IMF is that they have set
up procedures in advance to provide loans, with the terms and conditions for
this lending agreed upon beforehand. The need for quick provision of liquidity
to keep the loan amount manageable argues for similar credit facilities at the
international lender of last resort, so that funds can be provided quickly as long
as the borrower meets conditions such as properly supervising its banks or
keeping budget deficits low.
The flaws in IMF lending programs discussed above led to countries avoiding
borrowing from the IMF in recent years. Countries did not want to be subjected to
harsh austerity programs and also were unhappy with IMF delays in disbursing
funds during a crisis. As an alternative to the IMF, countries built up substantial
cushions of international reserves to deal with balance-of-payments problems on