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The Blanchard Touch

Yesterday I commented on the intriguing box in which the IMF staff challenges one of the tenets of the Washington consensus, the link between labour market reform and economic performance.
But the IMF is not new to these reassessments. In fact over the past three years research coming from the fund has increasingly challenged the orthodoxy that still shapes European policy making:

  1. First, there was the widely discussed mea culpa in the October 2012 World Economic Outlook, when the IMF staff basically disavowed their own previous estimates of the size of multipliers, and in doing so they certified that austerity could not, and would not work (of course this led EU leaders to immediately rush to do more of the same).
  2. Then, the Fund tackled the issue of income inequality, and broke another taboo, i.e. the dichotomy  between  fairness and efficiency. Turns out that unequal societies tend to perform less well, and IMF staff research reached the same conclusion. And once the gates opened, it did not stop. The paper by Berg and Ostry was widely read. Then we had Ball et al on the distributional effects of fiscal consolidation (surprise, it increases inequality). Another paper investigated the channels for this link, highlighting how consolidation leads to increased inequality mostly via unemployment. And just last week I assisted to a presentation by IMF economists showing how austerity and inequality are positively related with political instability.
  3. On labour markets, before yesterday’s box 3.5, the Fund had disseminated research linking increased inequality with the decline in unionization.
  4. Then, of course, the “public Investment is a free lunch” chapter three of the World Economic Outlook, in the fall 2014.
  5. In between, they demolished another building block of the Washington Consensus: free capital movements may sometimes be destabilizing…

These results are not surprising per se. All of these issues are highly controversial, so it is obvious that research does not find unequivocal support for a particular view. All the more so if that view, like the Washington Consensus, is pretty much an ideological construction. Yet, the fact that research coming from the center of the empire acknowledges that the world is complex, and interactions among agents goes well beyond the working of efficient markets, is in my opinion quite something.

What does this mass (yes, now it can be called a mass) of work tells us? Three things, I would say. First, fiscal policy is back. it really is. The Washington Consensus does not exist anymore, at least in Washington. Be it because the multipliers are large, or because it has an impact on income distribution (and on economic efficiency); or again because public investment boosts growth, fiscal policy has a role to play both in dampening business cycle fluctuations and in facilitating stable and balanced long term growth. The fact that a large institution like the IMF has lent its support to this revival of consideration for fiscal policy, makes me hope that discussions about macroeconomic policy will be less ideological, even once the crisis will have passed.

The second thing I learn is that the IMF research department proves to be populated of true researchers, who continuously challenge and test their own views, and are not afraid of u-turns if their own research dictates them. I am sure it has always been the case. What is different from the past is that now they have a chief economist who seems more interested in understanding where the world goes than in preaching a doctrine.

The third remark is more problematic. If I write a paper saying that austerity will not be costly because multipliers are 0.5, and 2 years later retract my previous statement and argue that austerity is in fact self defeating, the impact on the world is zero. If the IMF does the same, during the two years huge suffering will be needlessly inflicted to masses of people. This poses a problem, as research by definition may be falsified. In the past an institution like the IMF would never have admitted a mistake. And we certainly do not want to go back there. Today they do admit the mistakes, but the suffering remains. The only way out to this problem is that the “new” IMF should learn to be cautious in its policy prescriptions, and always remember that any policy recommendation is bound to be sooner or later proven inappropriate by new data and research. We don’t live in a black and white world. Adopting a more prudent stance in dictating policies  would be wise (in Brussels as well, it goes without saying). And of course, the disconnect between the army and the general is also a problem.

  1. nicola acocella
    April 18, 2015 at 8:55 am

    I agree on almost all Francesco’s remarks. his analysis is well founded. However, his conclusion sounds a bit unsatisfying. does it mean that, given the possibility of new data questioning accumulated knowledge, only half-proposals or proposals to maintain the status quo are legitimate? he does not certainly mean so. then, his analysis must be complemented by other considerations, such as the role of different institutional and historical settings.
    Economic policy prescriptions should certainly be derived from a priori considerations about market and non-market failures as well as considerations of policy effectiveness and consistency, but always mediated by historical and institutional considerations, which are largely country-specific. This consideration is usually absent from mainstream prescriptions and represents the main reason of its failure and continuous change of conclusions, in addition to availability of new data and innovations in theories and methodologies. Another caution for policy prescriptions would be the need to always indicate their distributive implications, which would avoid their uncritical acceptance.
    Francesco’s analysis should also be complemented by a study of the forces that tend to oppose not only policy reversal following new theoretical and empirical findings (from this point of view, Europe should be a fertile ground to dig in), but also progress and diffusion of theoretical innovations. Here too there are numerous examples in the realm of claims policy ineffectiveness derived from rational expectations, time inconsistency and the like.

  2. Hugo André
    April 20, 2015 at 3:30 am

    As Nicola says, a good post but with a strange ending. How would the IMF help the world by “being cautious” in it’s policy prescriptions? In situations like the financial crisis and the european crisis of confidence that followed policymakers have had to make some kind of decision. The only alternative to following informed advice from the likes of the IMF would be for the policymakers to go with their gut.

    Basically, even if economics sometimes gets things wrong it is surely better to make policy based on our (imperfect) knowledge of the economy than is the alternative.

  3. April 21, 2015 at 5:35 pm

    “cautious” is an unhelpful word. It introduces a bias towards doing “less”, whatever “less” is.

    Anyway, Hugo André,
    The problem with the IMF around the year 2010 is not so much about being “right” or “wrong”. The point is that they chose to advocate that the world engage in a massive experiment, on a global scale, in the middle is a nasty depression, to try something somewhat new (austerity).

    The “cautious” alternative was to say “Keynesian stimulus has worked for as long as we can remember, and appears to have been associated with the great recovery that came out of The Great Depression. It may not be perfect, but it’s what we’ve thought for the last decades.”. It definitely worked up to a point, and would have worked in 2010.

    Yes, some people might have argued that austerity would be slightly better, but it would have been best to allow these experiments to proceed only at a small scale. If it worked, then we could have tried austerity at a large scale next time around.

    In the medical world, for example, there will be no shortage of really intelligent people who can put together a (superficially) strong case in favour of their new drug or their new treatment. But, on average, we shouldn’t drop decades of orthodoxy based on one piece of research.

    Shiny new ideas are generally much less successful than originally thought.

  1. April 17, 2015 at 4:04 pm
  2. April 19, 2015 at 5:01 pm
  3. April 20, 2015 at 2:26 pm
  4. May 10, 2015 at 10:07 am
  5. May 10, 2015 at 9:18 pm
  6. May 22, 2015 at 6:21 pm
  7. June 9, 2015 at 4:21 pm

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