The Strange Case of Dr IMF and Mr Troika
With Greece desperately trying to obtain more time to carry on its fiscal consolidation plan, it is interesting to read a recent IMF working paper on “Successful Austerity in the United States, Europe and Japan”. The study tries to assess how fiscal consolidation and the growth rate affect each other, in expansions and in contractions. I copied and pasted (from their page 7; I just suppressed a couple of technical points) the main results of the paper:
- Fiscal expenditure multipliers are significantly larger in downturns than in upturns;
- While it is plausible to conjecture that confidence effects have been at play in our sample, during downturns they do not seem to have ever been strong enough to make the consolidations expansionary at least in the short run;
- Expenditure multipliers (where expenditure is defined as public consumption and investment only) are significantly larger than tax multipliers (where tax is defined as tax minus transfers) in downturns;
- Monetary policy does not seem to have a strong cushioning effect on economic activity against fiscal withdrawals implemented during downturns—possibly reflecting the fact that during the actual downturns experienced by the countries of our sample, interest rates may not have been cut sufficiently (or cut sufficiently fast) to counteract the drop in output that accompanied the episodes of fiscal consolidation. The weak cushioning effect of monetary policy may also be due to the fact that some of the downturns in our sample might actually be induced by the monetary authorities in an effort to lower inflation;
- The probability that a fiscal consolidation initiated in a downturn deepens or extends the downturn is almost twice as large as the probability that a consolidation started in an upturn triggers a downturn;
- “Strong” consolidations are 20 percent more likely to trigger or extend downturns than “mild” consolidations. In other words, the same fiscal adjustment is less recessionary if made via an extended adjustment as opposed to a more abrupt one;
- Frontloaded consolidations tend to be more contractionary and, hence, delay the reduction in the debt-to-GDP ratio relative to smoother consolidations.
To summarize, it is better to carry on consolidations in good times; if this is not possible, it is better to do it through tax increases than expenditure reduction; gradual consolidation is more effective for debt reduction than abrupt consolidation; monetary policy is incapable of cushioning the effect of consolidation; restoring confidence is not enough to avoid the recessionary effects of consolidation.
The study confirms most of the Keynesian textbook conclusions I have been writing about (since 2009): The best way out of a debt crisis is boosting growth. And if a country (Greece, Portugal, Spain) is unable to do it, then the most effective strategy for partner countries is to run expansionary policies so that the troubled country can sustain growth through exports.
It is not the first time that the research department of the IMF warns against the effects of excessive fiscal restraint. I had already cited a speech by Olivier Blanchard, IMF Chief Economist, who argued that debt consolidation is a marathon, not a sprint. So the question arises: Do IMF leaders read what their own research department produces? Why does the Troika push for further budget cuts in a country that is spiraling down?
The IMF seems to be living a Jekyll & Hyde moment…