Review calls on IMF to deepen monetary expertise

The International Monetary Fund suffers from a lack of sufficient expertise in cutting-edge monetary economics and needs to take action, an independent review finds.

The report, published today (June 14) by the fund’s Independent Evaluation Office, finds the IMF broadly made the right calls in supporting aggressive unconventional monetary policy (UMP) in the wake of the 2008 crisis, despite warnings by many economists of possible dangerous side effects.      

Yet the IEO also finds the fund has not done enough to develop and maintain monetary expertise among its economists. The IMF’s broad-ranging macroeconomic advice requires a large pool of so-called fungible macroeconomists, but Prakash Loungani, assistant director of the IEO and lead author of the report, tells Central Banking the lack of specialists means the fund is not necessarily at the table when top economists meet and share ideas.

“You need a small team of people who are at the cutting edge, who are following the issues of the day, who are in touch with the major players thinking about monetary policy issues at the major central banks, at the Bank for International Settlements and elsewhere,” he says.

A further issue that appears to have come as something of a shock to the IMF executive board was the high level of turnover the IEO identified among IMF mission teams. This leads to further erosion of expertise, the report warns.

In their official response, directors at the IMF noted “with concern” the IEO’s observation of frequent turnover, and said these issues should be considered as part of ongoing reviews into surveillance and the fund’s human resources strategy.

Directors said they broadly welcomed the IEO report’s findings, and especially “saw merit” in building expertise in monetary policy issues.

IMF managing director Christine Lagarde said she supported the report’s main ideas, saying improving the fund’s analysis of UMP “must be a priority area, along with continued broad coverage of real and financial spillovers”.

However, Lagarde added “some important qualifications”. She said any changes to the fund’s monetary policy work would have to co-ordinate with the other ongoing reviews and would have to fit with the IMF’s budget.

The fund’s resources are already under heavy strain, as the budget has not increased in real terms for nearly a decade.

Deepening expertise

Though there may be some costs associated with developing the fund’s monetary expertise, budget resources need not be a major issue, Loungani argues. An earlier IEO report into the IMF’s financial surveillance argued – successfully – that there needed to be more spending on financial experts. But the fund should be able to build monetary expertise by reorganising its existing resources, Loungani says.

Many recruits at the fund come from central banks and therefore bring monetary knowledge – Loungani himself was previously a Federal Reserve economist. But because economists are expected to display a wide range of skills and have few opportunities to focus in particular areas, their specialisms atrophy. Simply permitting economists to specialise would be a useful first step, the IEO argues.

“It’s not a question just of resources, but of rethinking how the fund does business in this day and age,” Loungani says.

To lean or not to lean

As the IEO report notes, unconventional policy remains a hotly debated issue even a decade on from the global financial crisis. One particular controversy has been the possible links between aggressive monetary easing and risks in the financial sector.

The IEO says the fund did a good job not just of advocating UMP as a necessary response to the crisis, but also of exploring how macro-prudential policy was a more effective means of dealing with financial stability risks than monetary policy.

In this regard, the report largely sides with the prevailing thinking among central banks, who have tended to be critical of arguments made by institutions such as the BIS that monetary policy needs to do more to account for its effects on financial imbalances.

Like many central banks, the IMF does not completely rule out “leaning against the wind” (Law), the practice of using interest rates in a bid to deflate asset price bubbles. But in general Law should be a last resort, the fund says – a view recently echoed, among others, by Fed vice-chair Randal Quarles. Macro-prudential policy is seen as the first line of defence for heading off crises and building resilience.

However, the IEO review acknowledges many of these issues are still open – part of the reason why it says the fund needs to get to the forefront of ongoing debates. Answering these questions before the next major downturn could prove crucial.

Loungani says in some respects the BIS’s warnings may yet prove prescient. We don’t really know what might happen if central banks continue quantitative easing to infinity. The first round of QE by the Fed triggered in-depth discussions, he says, but that impetus faded in later rounds of easing.

“We get the sense the initial [UMP] programmes generated a fair amount of debate internally within the fund – QE1 was debated quite a bit – but I think other programmes should have received the same level of scrutiny.”

Setting the agenda

A further recommendation by the IEO is for the fund to publish a policy paper setting out its stance on UMP and the associated risks. Though missions would be free to deviate from the ‘house view’ if individual circumstances warrant, it would set a baseline for analysis.

Fund directors were more mixed in their reception of this idea. On the one hand, “many” directors supported plans to update earlier papers on monetary policy and financial stability. On the other, directors emphasised the need to avoid “over-prescriptive” approaches.

Lagarde said there should be more work on the costs and benefits of UMP, “including developing a playbook of policy responses and advice for members on conditions for leaning against the wind”. But she cautioned these were “enormous tasks” that were in competition with the “diverse and extensive” demands on the IMF’s time.

Loungani urges the IMF to press ahead with this work. “It is very important to review the evidence in a way that people know where the IMF stands on these issues,” he says. “The fund has done periodic reviews, but it needs to be a more energetic, consistent exercise.”

Overall, he seems pleased the executive board is taking the issues seriously. “I think the executive board really supported the notion that the fund should ‘raise its game’, as we put it, on monetary policy issues,” he says. “We were very happy, it was strong support.”