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Fellow and professor examine role of IMF in financial crises in developing countries

| Tuesday, February 3, 2015

In a lecture in the Hesburgh Center auditorium Tuesday hosted by the Kellogg Institute, visiting Kellogg fellow Bumba Mukherjee and Notre Dame assistant professor Alexandra Guisinger spoke about their joint research on financial crises in developing countries and the conditions associated with the success of International Monetary Fund (IMF) programs in those countries.

Mukherjee said based on the duo’s research, they believe the success of programs suggested by the IMF, which lends money to countries facing economic and financial crisis, is largely dependent upon the financial and political power of non-bank financial institutions — more commonly referred to as “shadow banks.”

“As financial globalization has taken off in the last 20, 30 years in the developing world in particular, [shadow banks] are becoming important business actors,” he said.

Guisinger said countries turn to the IMF to avoid the possibility of deep economic recession in times of financial and economic distress — specifically when there is danger of a “sudden reversal” or the abrupt decline in the inflow of capital. However, Guisinger said the IMF can complicate the economic situation, bringing in “a new set of actors, a new set of incentives and can interact with this more general pattern of the ebbs and flows of capital.”

The standard recommendation of the IMF for a country to avoid a sudden reversal, Mukherjee said, is to impose regulations on shadow banking. He said a problem arises when the shadow banks of a given country are powerful enough to effectively oppose the IMF regulations.

“When you have these extremely concentrated, very strong, large, financially powerful shadow banks, that’s precisely when IMF programs won’t work,” Mukherjee said. “If anything, they’ll make things even worse.”

Guisinger said the result is the departure of foreign investors and a stock market crash, which can have “cascading effects on the economy and on political conditions.”

“Stock market crashes are not trivial,” Mukherjee said. “They have terrible consequences. Investments collapse, the economy collapses, unemployment rates go up, there’s political riots — people respond.”

Mukherjee said citizens associate the IMF, and thus the government responsible for asking the IMF to help, with the financial crisis. He said this puts enormous political pressure on government officials, who resort to fraud out of fear for their political careers.

“It’s this deadly combination in terms of IMF programs and financial crises that leads to these bad political outcomes,” he said.

Mukherjee said his research with Guisinger led him to conclude that the IMF should reform its approach and consider countries on a case by case basis.

“The problem here is that the IMF is not really talking to governments who come to them desperately looking for help,” Mukherjee said. “They are coming up with this blueprint without really looking at local conditions, which is not working.”

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