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Bumba Mukherjee Assistant Professor

Why IMF Stabilization Programs Fail to Prevent Currency Crises in Some Financially Distressed Countries, But Not Others?. Bumba Mukherjee Assistant Professor Dept. of Political Science and Dept of. Economics & Econometrics University of Notre Dame Visiting Associate Research Scholar

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Bumba Mukherjee Assistant Professor

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  1. Why IMF Stabilization Programs Fail to Prevent Currency Crises in Some Financially Distressed Countries, But Not Others? Bumba Mukherjee Assistant Professor Dept. of Political Science and Dept of. Economics & Econometrics University of Notre Dame Visiting Associate Research Scholar Princeton University smukherj@Princeton.edu

  2. Daily Brazilian Real/$, 2002-2003 100% Volatility Clustering IMF SBA loan 80% 60% 40% %Change 20% 0% -20% -40% 2003 2002 Do IMF stabilization programs increase (decrease) the likelihood of a currency crisis? • Article I IMF: Promote Stability of Exchange Rates and Currency Markets • IMF Failures in the 1990s: Russia, Indonesia; “Abolish” IMF: for e.g. Stiglitz • IMF’s record in preventing currency crisis (not crisis resolution) is “mixed”

  3. Smoothed Transition Probability of Currency Crisis (S=1) in Thailand 1997-98 from Markov-Switching Model 531 Stabilization Programs 82 countries, 1974-2002: 60% Prevented Crisis, 40% Failed

  4. What explains variation in Effect of IMF Programs on Currency Crises? • Scholars examine how IMF programs affect macroeconomic outcomes, e.g. growth (Barro, Dreher, Vaubel, Stone, Vreeland), but not currency markets. • Political Scientists..…study how domestic institutions affect currency/financial markets (Leblang; Bernhard; Freeman; Hays; Satyanath)…. how international institutions such as WTO affect trade (Mansfield, Reinhardt; Goldstein,Tomz & Rivers; Gowa & Kim). • Answer: Impact of IMF programs on likelihood of currency crisis conditional on extent of institutionalized state intervention in borrowing country’s financial sector. • Greater (lesser) the state’s role in the financial sector of the borrowing country’s financial sector, the higher (lower) the likelihood that IMF loans under its stabilization programs will lead to a currency crisis.

  5. Model of Speculative Trading • 3 Players: Currency traders, IMF, Debtor Country (financial problems but not fully blown currency crisis) that borrow IMF loans • Macroeconomic fundamentals of debtor country; s = signals about • Currency Trader’s Payoff: • Traders’ start a speculative attack if • IMF: Prevent speculative attack; provides m conditional on financial reforms • Debtor government that gets m implements reforms l, reform implementation (l) affected by extent of formal state intervention in financial sector, i.e. v

  6. Causal Story and Hypotheses • Nash equilibrium: • comparative statics • Causal Story…. • Higher state intervcntion in financial sector of debtor country… • Greater political resistance to financial reforms suggested by IMF • Ex ante commitment to implement reforms lack credibility & • IMF loan/program engenders moral hazard under weak commitment • Declining fundamentals = speculative attack =currency crisis • H1: IMF stabilization programs engender “moral hazard” in borrowing countries with high state intervention in financial sector • H2: IMF stabilization programs increases likelihood of currency crises in borrowing countries with high state intervention in financial sector

  7. Sample and Statistical Model • 82 countries, 1974-2002 • 2 Methodological Issues: • Non-random participation in IMF programs (selection) • spatial dependence in likelihood of currency crisis & participation in IMF program • Spatial Autoregressive Error (SAE) Bivariate Probit model

  8. Key Variables • DV in outcome equation: Currency Crisis =1 if change in index of exchange rate pressure exceeds mean plus 2 times the country specific std deviation. • Index: weighted average of real exchange rate changes and % reserve losses • IV in outcome equation interaction term: IMF Program x StateCredit/GDP • IMF Program dummy for IMF loans provided for short-run financial stabilization via SBAs, BSFF, CSF, SRF, CFF and EFF; Not PGRF and SAF • State Credit/GDP: Share of State Owned Credit GDP; Proxy for state intervention in financial sector • Several Controls in Selection and Outcome equation: M2/Reserves, Divided Government, Terms of trade growth, external debt….

  9. Outcome Equation of SAE Bivariate Probit Model: Select Variables ** (*) Indicates significance at 1% (5%)level;Substantive Effect of Interaction term: 18%

  10. Conclusions & Future Research • Effects of IMF programs on currency markets –especially the likelihood of currency crisis – not direct • Conditional on state’s role in financial sector • Study more closely the details of the IMF programs, how financial markets and domestic politics in debtor countries respond to these programs • Gather additional data as well

  11. Selection Equation: Select Variables only

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