The Meltzer Report

J. Bradford DeLong

May 2000

A possible column for Worldlink...

Last March the Meltzer Commission--established by the U.S. Congress as part and parcel of the legislation adding $18 billion to the U.S.'s capital contribution to the IMF--issued its Report. The press registered that the Commission had called for thorough-going reforms of the World Bank and IMF. But it quickly dropped from sight: the Report was more than 100 pages long. Much of it was written in economese, that peculiar language that only academic economists speak with fluency.

This is too bad, but not because the Report gave a clear description of the current flaws in the IMF and World Bank and laid out a straightforward roadmap for their reform--far from it, for the Report is a confused document, riddled with internal contradictions. But the Report's internal contradictions mirror the dilemmas of global financial, monetary, and development funding management. Understand the contradictions within the Meltzer Commission Report, and you have a keen grasp of the inevitable tradeoffs and unresolvable dilemmas placed on global managers by our highly idiosyncratic and vastly imperfect global economic structure.

What are these contradictions? Consider the Report:

First, the Commission approves of the overall principle of lending to solvent but illiquid governments--governments that will repay their loans in the long run but cannot borrow private-sector money in the short run, yet condemns the IMF's 1995 loans to Mexico, the most recent clear example of this practice.

Second, the Commission assigns the IMF the role of lender of last resort in international financial crises, but fails to give it the resources needed to fulfill such a role (in fact, the Commission strongly recommends againt any increases in the IMF's resources).

Third, the Commission urges that the IMF and World Bank forgive their loans to heavily indebted poor countries, but also proposes that neither ever again lend on a scale that could ever make debt relief important.

Fourth, the Commission urges that the international financial institutions should not be tools of US policy and playthings of US government, yet also urges that these institutions be decisively reformed according to their recommendations--the recommendations of a US-only Commission.

It is possible to confidently speculate on the reasons for these contradictions. Consider a Commission with a chairman--Allan Meltzer--sufficiently hostile to our international financial institutions to have called in 1998 at a Brookings Institution conference for the abolition of the IMF. But to repeat the 1998 vintage of Meltzer would not get a majority of Commission members to sign on. So make concessions to Commission members interested in key issues in order to approach consensus, even if in the process intellectual coherence is lost. And the resulting contradictions trace the fault lines in the Commission's internal debates.

The first contradiction shows the split between those who believe that international financial markets work well in the absence of public intervention, and those who believe that public authorities have the role that Walter Bagehot prescribed more than a century ago--to guard against a collapse of liquidity by lending freely to organizations that would be solvent if there were no crisis and will be solvent if the crisis is successfully resolved. For the first group, the fact that private-sector lenders were unwilling to roll over Mexico's debts in early 1995 means that no one should have loaned to Mexico in early 1995--even though the U.S. Treasury and IMF that did lend to Mexico earned very healthy profits on their loans, even though the loans did not lead the Mexican government to adopt unsustainable inflationary policies, even though after the fact the private-sector lenders cannot give coherent reasons for their panicked flight from Mexico. For the second group the Mexican crisis was handled properly--or, rather, would have been handled properly had loans to Mexico been larger, made for longer periods of time with less conditionality, and had the U.S. Treasury not felt under so much pressure from then-Senator D'Amato to prematurely demand repayment and so slow Mexico's recovery.

For the first group, the fact of the Mexican rescue package must have created "moral hazard"--induced overspeculation and overlending--and thus set the stage for the East Asian financial crisis (never mind that "moral hazard" can be generated only when someone pays out and never gets paid back, and that the IMF gets paid back). For the second group, the absence of pre-1997 forecasts of an East Asian financial crisis is convincing proof that an expectation of bailouts could not have induced the East Asian crisis--for if there is no expectation of a crisis, what would happen if there were a crisis has no effect on anyone's investment decisions.

The second contradiction shows a split between those who understand that a lender of last resort's actions must be decisive and must end all doubt about whether a lent-to organization will in turn meet all of its obligations--and hence know that when a lender of last resort intervenes it must have the potential to do so on a nearly-unlimited scale--and those who want to keep public institutions lean out of the fear that large-scale government failure will lead to mammoth wastes of resources. The Meltzer Commission's report tries to bridge this gap by calling for the IMF to be a "quasi" lender of last resort, and tries to avoid facing the possibility that such a "quasi" organization may lack sufficient resources to restore confidence in a crisis yet still waste enormous amount of money.

The third contradiction finds the Commission stuck between its realization that demanding repayment from heavily-indebted poor countries where loans have been corruptly stolen and bureaucratically wasted imposes an extraordinary degree of inhumane misery on such countries' citizens, and its fear that forgiving loans--allowing policy makers to gain access to IMF and World Bank loan money and never repay it--does induce "moral hazard" and lead to bad borrowing policies. The solution is to close down the possibility that truly-poor countries will ever be able to borrow on a large scale from the IMF and the World Bank again. But this solution in turn ignores the fact that the poorest countries are the most capital-scarce countries, and hence the ones where the social benefits from financing that is well-used to promote investment are the highest.

The fourth contradiction is one of governance. Members of the Meltzer Commission are uneasy that the technocratic economic mission of the IMF was distorted in the 1990s by the wish on the part of the Executive Branch of the U.S. government to make a few high-stakes bets on Russian reformers, and on the U.S. Executive Branch and Federal Reserve's willingness to use the IMF to undertake a Mexican peso-support program that the Congress was unwilling to explicitly approve. They wish for an IMF that is less politicized--and they want to use one final act of politicization in order to attain their goal, just as in the past Presidents have confidently undertaken the war to end all wars or colonels have lauched the coup that will be the last coup.

I don't have clear and convincing arguments to demonstrate the proof of my own views of which side of these fault lines is the right one--or rather of where the proper points are that do the best job of balancing vital concerns. (I do, however, recommend Barry Eichengreen's _Toward a New International Financial Architecture: A Practical Post-Asia Agenda_ for the most clear and convincing arguments that there are.) I do think that the final positions of the Meltzer Commission that paper over these fault lines are clearly faulty. Yet I also wish more people would read the Commission's Report and think about the issues. There is now no international financial crisis: it is sunny, and hence there seems to be no urgency about fixing the roof. But the worst possible time to try to fix a roof is in the rainstorm.

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