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IMF Schyzophrenia

October 10, 2012 Leave a comment Go to comments

I had already noticed that the IMF at times looks like Jekyll and Hide. But not to this point. Last time I cited a simple working paper. This time we are talking about the most important document produced by the IMF. Here are some excerpts from the October  IMF World Economic Outlook, released on Monday:

Those forces pulling growth down in advanced economies are fiscal consolidation and a still-weak financial system. In most countries, fiscal consolidation is proceeding according to plan. While this consolidation is needed, there is no question that it is weighing on demand, and the evidence increasingly suggests that, in the current environment, the fiscal multipliers are large. (p. XV)


Fiscal adjustment should be gradual and sustained, where possible, supported by structural
changes, as, inevitably, it weighs on weak demand. Developments suggest that short-term fiscal multipliers may have been larger than expected at the time of fiscal planning. Research reported in previous issues of the WEO finds that fiscal multipliers have been close to 1 in a world in which many countries adjust together; the analysis here suggests that multipliers may recently have been larger than 1 (p. 21). […] The main finding, based on data for 28 economies, is that the multipliers used in generating growth forecasts have been systematically too low since the start of the Great Recession, by 0.4 to 1.2, depending on the forecast source and the specifics of the estimation approach. Informal evidence suggests that the multipliers implicitly used to generate these forecasts are about 0.5. (p. 41)

Note: the multiplier captures the impact of a change in fiscal variables on output. If it is larger than 1 this means that a reduction of deficit of one dollar yields a drop of output of more than a dollar. Therefore, the ratio between the two, the deficit-to-GDP ratio, increases. This is the essence of self-defeating austerity. Since last Monday this captured a good deal of attention (for example, Fatas and Krugman). But let’s keep going.

Fiscal consolidation plans in the euro area must be implemented. In general, attention should be paid to meeting structural fiscal targets, rather than nominal targets that will likely be affected by economic conditions. Automatic stabilizers should thus be allowed to operate fully in economies not subject to market pressure. Considering the large downside risks, economies with limited fiscal vulnerability should stand ready to implement fiscal contingency measures if such risks materialize (p. 67).

In a sentence: Fiscal consolidation in the periphery needs to be structural (no nominal deficit targets), and be accompanied by fiscal expansion in countries that can afford it.

First, successful debt reduction requires fiscal consolidation and a policy mix that supports growth. Key elements of this policy mix are measures that address structural weaknesses in the economy and supportive monetary policy. Second, fiscal consolidation must emphasize persistent, structural reforms to public finances over temporary or short-lived fiscal measures. In this respect, fiscal institutions can help lock in any gains. Third, reducing public debt takes time, especially in the context of a weak external environment (p.101).

Et encore (talking about Japan)

When structural weakness in the financial system prevents the normal transmission of monetary stimulus and when policy rates are constrained by the zero lower bound, the risk of anemic and fragile growth is high regardless of the fiscal setting. Such a macroeconomic environment clearly precluded successful fiscal consolidation: whenever such measures were taken the economy dipped into recession (p.115)

Finally (after a while it becomes boring):

The implications vary for countries dealing with high debt levels today. For some, such as the United States, where financial sector weakness has largely been addressed and monetary policy is as supportive as possible, it would seem that conditions are in place for fiscal consolidation. In others, such as the European periphery, where financial sectors remain weak and fundamental issues relating to monetary union remain to be addressed, progress may be limited until these issues are resolved. […] The implications for today are sobering—widespread fiscal consolidation efforts, deleveraging pressures from the private sector, adverse demographic trends, and the aftermath of the financial crisis are unlikely to provide the supportive external environment that played an important role in a number of previous episodes of debt reduction. Expectations about what can be achieved need to be set realistically. (p.126).

Ok, so one would expect the IMF, on the field, to carefully assess whether the macroeconomic conditions of a country allow fiscal consolidation, and to recommend a comprehensive set of measures to make sure that the pernicious effects of deficit reduction are minimised. Yeah, right. This is what we read in a recent newswire:

The protests came a day after Greece unveiled an austerity budget that predicted a sixth year of recession in 2013 but failed to convince the troika, which has been skeptical of Athens’ plans to cut health and defence spending.
“The troika is questioning the effectiveness of the measures related to structural reforms,” a government official said, citing planned savings from restructuring entities in health and other ministries. […]
Talks over the cuts were being further complicated by an internal rift between the EU and the IMF over how to solve the Greek crisis, as reported by Reuters last week.The IMF wants Greece to cut its debt further to make up for going hugely off-track from the terms of its bailout, while Europe is resisting the option of a new debt restructuring and instead prefers to give Athens more time to get back on track, officials have told Reuters.

I could find other quotes, but I made my point. So the question is: Which IMF to believe?

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