Oops, the IMF was wrong about austerity

Its effects on European economies have been underestimated, according to two economists of the institution

That austerity policies are bad for growth and jobs is now accepted by most economists. But that they are even more than we thought, this is what discovered two of them, not least: Olivier Blanchard, a French chief economist at the IMF, and Daniel Leigh, an economist in the same institution. According to them, the use of a bad calculation coefficient has led to an underestimation of the negative effects of austerity in Europe.

The two economists detail their thesis in an article published on January 3 on the IMF website, but in a section where the texts do not represent the official position of the organization. “We show that in developed economies, stronger fiscal consolidation has gone hand in hand with lower growth than expected,” they write. A natural explanation is that the tax multipliers were significantly higher than the forecasts implicitly estimated. ”

The multiplier that divides

The “multiplier” in question is the coefficient linking the evolution of public expenditures (or taxes) to the growth rate of the economy. When this coefficient is 0.5, for example, this means that one point of public expenditure less, or tax, in addition, leads to a 0.5 point decrease in activity. “There are two ways to calculate it,” says Xavier Timbeau, OFCE economist. Either by doing historical analysis, looking at the links between budget policies and activity; either by building an economic model and by studying the relationships between its different components. In both cases, they are not neutral models: their construction always contains a part of a priori, which correspond to ideologies. ”

However, according to Blanchard and Leigh, the “crisis” multiplier could be up to three times higher than the “normal” period, used until now. The two economists had already written in the very official annual report of the IMF, published in October 2012 (page 41): “Many documents, including some from the IMF, suggest that the tax multipliers used in forecasts are around 0.5. Our results indicate that these multipliers have actually been between 0.9 and 1.7 ” since the beginning of the crisis. Clearly, the impact of austerity would be, depending on the case, two to three times larger than expected.

“Until now, we have applied the multiplier of normal periods to crisis time,” says Timbeau. But in a crisis, everyone panics. People do not behave the same way and no one can anticipate the future. Moreover, if austerity is much more recessive than we thought, it also means that a stimulus policy would be much more effective than we imagine! ”

“There are two IMFs”

Blanchard and Leigh’s article has made economist Paul Krugman, 2008 Nobel economist, react. “The IMF was less enthusiastic about austerity than other big players, ” he says. his blog. If he himself says he was wrong, it means that all the others […] are even more mistaken. And he has the merit of wanting to rethink his position in light of the facts. The real bad news is that very few other actors are doing the same thing. European leaders, who have created suffering worthy of the 1929 crisis in the indebted countries without restoring financial confidence, persist in saying that the solution will come from even more suffering. ”

Do not deduce, however, that the IMF calls into question austerity in principle. How could this institution, which participated, in particular, in the development of the very severe Greek program? It is rather the intensity of the austerity policies challenged by the Fund since their effects are greater than expected. This is in line with the official position of the IMF: its Managing Director, Christine Lagarde, regularly reiterates her calls for “softer” trajectories to reduce debt.

“There are two IMF, the head, and the body, however, considers Xavier Timbeau. In Greece, he is the strongest on austerity, even more so than the Commission and the ECB. Whatever Blanchard or Lagarde say, in the field, the Fund applies the plan decided between the country and its creditors. It will take time for change to take place in the institution and in Europe. There is also the risk that he remains confined to the higher echelons of the IMF, without percolating into the field. ”

Europe seems to be moving in this direction. At the end of 2012, Greece obtained additional time from its creditors. And if the French government stubbornly clings to its target of 3% budget deficit for 2013, which it is the only one to believe, this is despite the advice of the IMF and Brussels, who now advocate a “softer adjustment” “for the Old Continent. After spinning.