Monday, November 10, 2008

Anchoring to the IMF, II

On Friday, there was a well-written article in the International Herald Tribune on Turkey's IMF dilemma, i.e. to anchor or not to anchor. Daniel Altman catches the gist of the article in his IHT blog by calling an IMF help a Faustian bargain. It is true that the Fund is mostly fiscal, so irrespective of whether the government genuinely plans to resort to fiscal stimulus against a slowing economy or is worried about the upcoming municipal elections (it has recently been reported in the media that one of the major disagreements between the IMF and the government is transfers to municipalities, so even a hopeless optimist cannot disregard the latter), it wouldn't be too happy with the IMF on its gullet, to quote the PM himself.

Leaving the issue of local elections aside, a case can still be made that Turkey should not go for IMF help. The same signalling argument I had made for IMF earlier could also be used for the counter-argument: An IMF agreement could put Turkey in line with countries like Pakistan, Ukraine, Iceland and the like. Similarly, it could be argued that in a time when East and West are going for fiscal stimulus (the Economist has an excellent recent article that makes the case for fiscal stimulus), going against the wind will hurt the country more than it helps.

I am not saying I buy these arguments. On the contrary, I believe that both theory and empirics support that an IMF anchor and tight fiscal policy would be beneficial for the Turkish economy. Here's why:

Leaving signalling issues aside, to quote a great economist, emerging markets, with balance sheet constraints, debt and current account sustainability issues and currency & maturity mismatches, are simply different animals and fiscal policy that works for developed countries may not work for developing countries (sorry for the awkward attempt at putting much of the EM-related international macro literature of the last two decades into one sentence)- for a simple example how the well-known IS-LM model changes in the context of EM, see this paper and its accompanying comment.

Leaving the ivory tower of theory in favor of practical economics, in a world where your sovereign risk premium is measured by your international reserves relative to your external financing requirement, having IMF cash ready would definitely help (forget the Krugman argument that your reserves would be depleted instantaneously during a currency attack, it is the perception of markets that matter here). And while there is some evidence that lax fiscal policy could promote growth in EM and be perceived positively by markets, even then revenue-based adjustment usually works better than spending-based adjustment and tax-financed spending is better than debt-financed spending. Moreover, in countries with weak institutions, fiscal restraint is likely to be more growth-enhancing than expansionary fiscal policy. When I add all of these together, IMF and fiscal restraint simply weigh more on my scale.

Therefore, I should seem happy by the recent convergence of the academia, media, economists and businessmen (basically anyone except the government and those against the IMF on political grounds) towards a new with-money IMF program (whatever its exact name be). In fact, I am not, even though I have formed my own opinion in favor of fiscal restraint and the IMF. The reason of my discontent is basically the lack of a debate on this important and controversial issue. I have read a couple of articles arguing against the IMF and fiscal restraint (and discussed one of them in a recent post), but the debate is extremely one-sided at the moment. Moreover, despite all the uproar, I have not heard that many convincing arguments from the IMF-fiscal restraint camp either. IMF is good because it will please markets is not a valid argument, unless you add a because to it. And frankly, leaving aside a few notable exceptions, that is unfortunately more or less the depth of the arguments.

Given the importance of the issue and the uncertainty in its nature (as are most policy discussions in Economics) I would have expected a more balanced and lively debate on the merits of an IMF program and fiscal restraint. Maybe, we Turks are just hoping that as in Faust, angels will descend and save us when the moment of truth comes.

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