When a country is in financial distress and cannot meet its external debt payments, it may turn to the International Monetary Fund (IMF) for assistance. Known as an IMF bailout, the member country borrows Special Drawing Rights (SDRs), which represent a basket of major global currencies, to make up for its shortfall and stabilize its economy. Typically, the IMF lends the money in return for a commitment to implement reforms that will return its budget to surplus over time.
Regardless of their rationale, IMF bailouts are notorious for having a heavy-handed approach that can be detrimental to the recipient countries’ long-term economic development. Tough austerity packages imposed by the IMF force recipient countries to sacrifice their policy autonomy, cut spending, raise taxes, and retrench staff, with the goal of returning their budgets to surplus. In the long run, however, these policies can stifle growth in recipient countries by causing a decline in business investment, higher unemployment, and severe social instability.
The effectiveness of IMF bailouts has been the subject of debate, with a growing body of literature highlighting mixed results. This inconsistency is partly due to a lack of standard methodology for measuring the impact of IMF loans on economic performance. Dreher (2006) summarizes three popular approaches that have been used to investigate the impact of IMF bailouts, and finds that each yields different results based on the methodologies employed.
For example, some studies use control countries that are not experiencing IMF-supported programs as benchmarks to investigate whether IMF loan conditions affect bailed-out countries. Other studies rely on stock market data to investigate the causal effect of IMF programs. Using this methodology, researchers have found both positive and negative relationships between stock market indices and IMF bailouts.
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