After Strauss-Kahn, IMF should go for fundamental strategy rethink: AEI

History will remember Dominique Strauss-Kahn as a man who put the International Monetary Fund (IMF) on the road to decline, and that the new leadership should bring about a fundamental rethink of the fund's economic programs for the European periphery, leading think tank American Enterprise Institute has said.

For without such a rethink, the IMF is in danger of once again reducing itself to irrelevance in the global financial system, Desmond Lachman, a resident fellow at AEI, said.

Here's the full text of the AEI's commentary on IMF in the backdrop of Strauss-Kahn's exit following his arrest in a sexual assault case:

Given that his fall from grace came at the most awkward of times for the International Monetary Fund's dealings with Greece and Portugal, many have written about Dominique Strauss-Kahn's talents and major influence during recent negotiations. History, however, is more likely to remember him as the man who put the IMF on the road to decline, by his misguided handling of the eurozone debt crisis.

Mr Strauss-Kahn's decision to treat the crisis as a matter of liquidity rather than solvency led the IMF to eschew any notion of debt restructuring, or exiting from the euro, as a solution to the periphery's public sector and external imbalance problems. Rather, he opted for draconian fiscal tightening and radical structural reform as a cure-all for Greece, Ireland and Portugal.

Experience with such policies in Argentina in 1999-2001 and in Latvia in 2008-09 should have informed the IMF that, under the euro-the most fixed of exchange rate systems-such a policy was bound to produce the deepest of economic recessions. The fund should also have anticipated that deep recessions would erode those countries' tax bases and undermine their political willingness to stay the course of adjustment.

The poor economic performance now evident in Greece and Ireland therefore risks blackening the IMF's reputation in Europe in the same way as its programmes in Asia and Latin America rendered the fund a pariah in the 1990s. At the same time, economic programmes for Europe's periphery that had little chance of restoring public debt sustainability have torn the IMF's credibility in the financial markets.

To compound matters, in supporting these programmes with unprecedented lending, the IMF is saddling its own balance sheet with enormous amounts of dubious claims on insolvent countries that the IMF will struggle to collect for many years to come.

A successful IMF programme is supposed to restore a country's balance of payments viability with a minimum cost to its growth and prospects. It is also meant to restore market confidence, which translates into lower borrowing costs. Yet one year after the European Union and IMF's $150bn loan package, the Greek adjustment programme is not working. Greece's growth is in a downward spiral, with unemployment in excess of 15 per cent. Tax revenues could be $10bn lower in 2011 than the IMF's programme had envisioned.

In addition, the programme has not restored market confidence. Indeed, the Greek government now has to pay more than 25 per cent on two-year borrowing, which has forced European policymakers to acknowledge that there is little chance Athens will be able to reaccess the financial markets in 2012 as planned. Similarly, despite the announcement of large IMF-EU support packages for Ireland and Portugal, the interest rates on their government bonds are now at the highest levels they have been since they joined the euro.

At the heart of the IMF's failures to date in Greece was the prescription of a policy approach that had little chance of success within the constraints of a fixed exchange rate system that precludes devaluation as a means to promote export growth, which is an offset to radical fiscal policy tightening. One could perhaps understand the IMF making a basic policy mistake for Greece in May 2010 in the heat of a crisis that threatened to spread well beyond its borders.

However, what is difficult to understand is why, with the poor economic performance of Greece, the IMF chose to repeat the same conceptual policy mistake in its adjustment programme for Ireland in November 2010 and in its proposed programme for Portugal right now. What is even more difficult to understand is why the IMF is now also proposing that Greece should apply more of the same policy prescriptions that have brought its economy to its current parlous state.

One must hope that a new leader at the IMF's helm might bring about a fundamental rethink of the fund's economic programmes for the European periphery. For without such a rethink, the IMF is in danger of once again reducing itself to irrelevance in the global financial system.