Academic journal article Economics & Sociology

Impact of Imf Assistance on Economic Growth Revisited 1

Academic journal article Economics & Sociology

Impact of Imf Assistance on Economic Growth Revisited 1

Article excerpt


The International Monetary Fund (IMF) was set up in 1944 with the aim to promote economic and monetary stability and foster economic growth around the world. Since then, the IMF provided financial assistance to numerous developing and developed countries, including, recently, a number of peripheral European countries such as Hungary, Greece and Portugal. The economic effects of IMF assistance have been the subject of an on-going and greatly controversial debate. The findings are rather disappointing: the research available so far suggests that the effect on growth has been insignificant and may even have been negative.

In theory, the IMF intervention should improve economic growth both directly and indirectly, for a number of reasons. First, the IMF gives policy advice at the times of crises. Following that advice should help improve the economic climate and thus foster growth in the future. Second, IMF loans frequently have strict conditions attached to them, such as changing the execution of monetary policy or implementing fiscal austerity. The disbursement of IMF loans only takes place if the recipient country adheres to the conditions. Following IMF's advice and accepting the conditionality should have similar effects: improved policy making, if credible, is seen by consumers as indicative of a lower tax burden and higher growth in the future, which leads them to increase their consumption, thus fuelling growth.2 Finally, the money that is disbursed helps relax financial constraints that the countries face and should stimulate their economies. In particular, as the recent EMU crisis illustrates rather well, in the absence of external financial assistance, crisis-stricken countries would face prohibitively high interest rates.

The literature also highlights possible indirect channels: moral hazard (Vaubel, 1983) and the Dutch Disease (Paldam, 1997; Doucouliagos and Paldam, 2009). The moral hazard argument rests on the fact that being able to apply for assistance from the IMF (and other similar institutions) is similar to insurance. This can give the countries in question incentive to engage in risky or unsound policies. The Dutch Disease hypothesis, in turn, points out that countries with large inflows of foreign currency may experience a pressure on their currency to appreciate, which in turn undermines the competitiveness of their manufacturing firms at international markets. Hence, while the direct channels stipulate a positive effect of IMF assistance, the indirect channels are associated with a negative impact.

An additional issue is that of endogeneity: the countries requesting assistance from the IMF may be already facing imminent economic difficulties at the time they submit their request. Alternatively, out of the countries that apply for financial aid from the IMF, those that receive support tend to be in worse economic situation that those that do not, or the former receive more substantial assistance. The negative or insignificant relationship between IMF assistance and economic growth therefore then can be due to such an endogeneity bias.

Besides endogeneity, another problem with much of the past analytical literature on the IMF involvement and its effect is that it typically only considers how such involvement affects contemporaneous economic performance. If the IMF fosters growth, the positive effect of its assistance may appear only with a lag (Clemens et al., 2012, make a similar point about the effectiveness of developmental aid).

In this paper, we revisit the effect of IMF loans while taking account of the aforementioned criticisms of the previous literature: endogeneity bias and the delay between IMF assistance and its economic effect. To account for endogeneity, we use instrumental variables. Finding suitable instruments, however, is difficult. In particular, the instruments need to possess sufficient explanatory power when it comes to explaining the probability (or size) of IMF assistance without being themselves correlated with growth to allow the analyst to exclude them from the main (second-stage) regression equation. …

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