Asgeir Jonsson’s interesting and perceptive article in today’s Wall Street Journal provides a clear lesson for students and policymakers alike about the harm that comes from bailouts and the good that comes from avoiding them. If a government recognizes the reality of a solvency problem early, and deals with it, its citizens will end up much better off than if it wishfully thinks it’s a liquidity problem and takes bailouts. Iceland recognized its problem early and took action, while Ireland thought wishfully and took bailouts, and that’s made all the difference.
It was a lesson learned by many emerging market countries about a decade ago, and it has made a big difference for them too. That’s one reason why an emerging market leader would make a good IMF leader today. More on that later.