Tuesday, June 4, 2013

IMF STABILIZATION POLICIES

The Mundell Fleming model has three basic assumptions that underline its operations. The assumptions include; only one good traded globally is produced by the domestic country and the good is an imperfect substitute for the goods produced in the world. Secondly, the demand for the domestic good determines how much is produced when the price is held constant and lastly, the economy of the world is larger than that of the domestic country. The model allows for the calculation of Balance of Payments and its relationship with the exchange rates. The model posits that disequilibrium in the BOP leads to disequilibrium in the exchange rates. The Pollak model on the other hand was developed six years after the formation of the IMF and it was mainly used to study the effects of increases in a country’s money supply on the BOP and income formation. The model is used by IMF in its monetary policies with specific focus on BOP. The model has been used to calculate the top ceiling for the net domestic assets of the banking operations in different countries (Grcic, n.d). The essay will discuss the relative significance of the Mundell Flemming model and the Polak model in the financial programming approach of the IMF in designing suitable stabilization policy for respective countries, the adverse effects of the IMF packages in select counties and why some countries were impacted on positively by the IMF stabilization packages. Finally, an analysis will be given of how IMF has conducted itself in the Greece crisis. The IMF programs have had a negative impact in the economies of different countries mostly the developing countries. The IMF was first involved in the development of Nigeria in 1980s due to the imbalances that the economy was facing. According to Lewis as cited in …(), the benefits of the implementation of the programs in the short run were a reduction in the ratio of debt service to the imports thus leading to a positive balance of payment in the face of declining prices of oil in the international market. The devaluation of the Nigerian Naira caused a significant drop in the living standards of the poorest Nigerians who live in the rural areas due to the increases in inflation rates and increases in the prices of essential commodities such as transportation costs. The liberalization of the market was thrown into disarray due to the devaluation of the country as most foreign investors had little confidence on the returns to the investment. The decline of local companies due to the liberalization led to massive retrenchment of workers and increased unemployment rates in the country as the local companies were forced to close down due to the increased competition form foreign companies which were offering cheaper goods. With time, the Nigerian government could not afford to provide public service because large percentage of the money was being used in debt repayment instead of service provision. This cuts on public spending led to street protests in the country to force the government to abandon the program. The beginning of the structural adjustment programs saw an increase in the GDP of the country to 7 percent which start to decrease in the early 80s (Kandil, 2011). Argentina debt crisis and the collapse of the currency came at a time when the IMF had reduced the lending levels since most of the borrowers were not paying back the money. The effects of the stabilization failed due to a number of reasons although in the short term they appear to solve the problems. The IMF altered its operations to conform the new operation paradigm of privatization, shrinking of the public sector, market liberalization and other deregulation measures. The short term effect was a decrease in the inflation rates from 95 percent in 1990 to 11 percent in 1991. The stabilization led to higher taxation, curfews on employment of new staff thus continuing to increase the problem of unemployment. The programs managed to contain the inflation rates and the budget deficit at the expense of the disenfranchised; working class and the poor. An increase in debt levels was also a problem that Argentina was to grapple with. The Federal wages in GDP decreased to 2.91 in 2001 just slightly over ten yeas of the programs from the 1991 rates which were 2.97. This had an effect on the workers as their purchasing power was reduced (Serin & Arıcan, n.d) Indonesia was another country that the effects of the IMF stabilization policies did not have the required effect. Due to the fall in the value of the Indonesian Rupiah the government sought the help of the IMF to help stabilize the currency. The inflation rates continuously increased from 2.6% in 1997 to over 20% in 1998. However, in 1999 the inflation rates were projected to hit almost 200% with the increase in prices affecting mostly the food sector. There was also a noted unemployment rates of about 2 million people due to the downsizing of local companies and reduced capacity of the government to hire due to the increasing loan repayments (Nayyar, 2008) Conditional financing by the IMF to countries is meant to correct the imbalances in the balance of payment. The funds use in the Caribbean nations as increased due to their reliance on single crops for export. Jamaica’s reliance on bauxite and sugar has led to financial difficulties especially external financing due to unfavorable terms of trade and increased expenditure by the government. Jamaica first sought the IMF funds in the late 1970 so that they could deal with the chronic balance of payment problem arising from oil shortages and reduction of revenue from the bauxite industry once and for all. There was only 30 million dollars in the Jamaican reserves down from 120 million dollars in 1975. All the attempts by the Jamaican government to control the outflow of currency from the reserve failed and they were forced to devalue their currency. Two years later, the currency had lost 95% of the value and the external debts were more than 125% of the gross domestic product. In 1992 embarked on privatization of the public entities followed by increases in the prices of the facilities that remained. The privatization of companies led to increased funding by external entities thus in the process the government could get enough revenue to fund their programs. There was a reduction in the inflation levels from almost 60% to in 1992 to 10% five years later. However, the program led to an increase in unemployment rates (about 10,000 people were retrenched from the public service). Also the economy continued to grow at a very slow rate. The stabilization programs also saw a fall in the ratio of external debt to the GDP (Fontaine, 2010). The Greece crisis was created by the downturn in the global financials condition. A package of € 110 billion was given to Greece by the IMF and EU in the ratio of 3:8 so that the country could not fallout. The bailout was given under IMF’s Stand-By Arrangements so that the Greece’s ability to import goods and other external expenses could be met. The money would be released in quarters after an assessment report of how Greece economy was responding to the stimuli. There was a condition that the government would embark on programs aimed at spurring growth such as transparency in financial use, administration of the taxes and also the strictness with which the restructuring conditions were followed. The effect of the funding on Greece has not been positive since the market prices of services and goods as began to increase so that they can finance the bailout programs. The targets of the bailout are not going to be met in the near future as they seem to have been too ambitious (Agrawal, 2010). In conclusion, the IMF stabilization has caused ore problems to the countries as the benefits to the countries are only short term. The devaluation and other conditions that are attached to the funding in most cases aggravate the countries situations. The balances of payment of most of the countries are always negative due to loan repayment. There are also inflationary issues and widespread unemployment (Bokhari & Duca, 2008). References Agrawal, A. (2010). Greece Crisis – What are the Options? Retrieved on 08/25/2011 from http://www.stcipd.com/UserFiles/File/Greece%20Crisis%20%20What%20are%20the%20Options.pdf Fontaine, T. (2010). Caribbean Country Experiences with IMF Stabilization Programs within the Context of Globalization. Retrieved on 08/25/2011 from http://www.thedominican.net/articles/stabilization.pdf Grcic, B (n.d). The Polaks Macroeconomic monetary model. Retrieved on 08/25/2011 from http://www.systemdynamics.org/conferences/2001/papers/Grcic_1.pdf Kandil, M. (2011) "Financial flows to developing and advanced countries: determinants and implications", International Journal of Development Issues, Vol. 10 Iss: 1, pp.60 - 91 Nayyar, D. (2008) "Macroeconomics of structural adjustment and public finances in developing countries: A heterodox perspective", International Journal of Development Issues, Vol. 7 Iss: 1, pp.4 - 28 Serin, V. & Arıcan, E. (n.d). An Assessment of the IMF Stabilization Programs for Developing Countries. Retrieved on 08/25/2011 from http://www.econturk.org/Turkisheconomy/p382.pdf