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A troubled IMF legacy

A troubled IMF legacy

Lagarde should have backed Schäuble on Athens exit 

by Desmond Lachman in Washington

Mon 20 Jul 2015

Over the past five years, the Greek economic and political tragedy has seriously damaged the credibility of the International Monetary Fund. The IMF has consistently indulged in wishful thinking and led Greece along a policy path that has brought it close to economic and political ruin.

So it is all the more lamentable that at last weekend’s European summit that produced the latest Greek debt deal, Christine Lagarde, the IMF managing director, did not insist that the new economic programme imposed on Greece had practically no chance of working.

She should have supported Wolfgang Schäuble, Germany’s finance minister, in proposing that the time had long since come for the international community to assist Greece in making an orderly exit from the euro.

Lagarde is trying to absolve the IMF from any responsibility for Greece by saying that its debt is unsustainable and by calling on the Europeans for greater debt relief. One wonders why she didn’t make these important points during the hours of deliberations in Brussels last weekend. It is hard to understand what purpose is served by top-level IMF representation at such a gathering if the Fund waits until afterwards – as it did last week – to voice fundamental scepticism about the points on which European leaders allegedly agreed.

To understand the reason why last weekend's Greek economic agreement is almost certain to fail, we should recall that the Greek economy is already in a 1930s-style depression. A major contributing factor to Greece's economic collapse has been the imposition on Greece, by the IMF and Europe, of excessive budget belt-tightening within a euro straitjacket. That straitjacket has precluded the use of either monetary or exchange rate policy to offset the negative effect on demand of tax increases and public spending cuts.

The basic flaw of last weekend's Greek agreement is that it is mandating policies for Greece that are very little different in substance from policies that have spectacularly failed in the past. Specifically, it is again requiring major tax increases and pension cuts from a country that remains constrained by the euro rules, now in the grip of an economic depression.

Greece’s creditors are demanding these austerity measures at a time when the country’s economy is facing a massive body blow from the shutting of its banks these past three weeks. Although the banks reopen today, and this should help confidence, capital controls and withdrawal limits remain in place. To compound matters, the creditors are demanding that, should the economy again falter and should the budget not perform as expected, further pro-cyclical budget tightening should be adopted.

The basic economic question is this: Why, if past Greek budget belt-tightening within the euro contributed to Greece’s depression, will the same such policies now promote economic growth? This question is all the more relevant since Alexis Tsipras, the Greek prime minister, says he does not believe in the programme, and the Germans are officially floating the idea of Greece taking a five-year holiday from the euro. This is hardly likely to instil confidence in Greek's battered economy.

Fundamental political questions must be raised, too. The agreement requires still more budget belt-tightening from Greece than the creditors’ June proposal that the Greek electorate overwhelmingly rejected in a referendum only two weeks ago. So will not the new package tear Greece's political and social fabric asunder? And how can Alexis Tsipras survive as prime minister when he successfully campaigned for a referendum No, only to reverse his position a week later and face large defections from his government?

The stakes in Greece are very high. If the Greek economy contracts still further, this heightens the chances that Greece’s political crisis will only deepen. It also increases the possibility that Greece will soon become a failed state viscerally hostile to Europe for many years and welcoming to Russian President Vladimir Putin’s advances. One would have thought that this would be a legacy that all Greece’s creditors, including the IMF, would be keen to avoid at all costs.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a Deputy Director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.

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