Painful mistakes

As “austericide” bites, deep, the IMF is beginning to accept that it has been blinkered in its thinking

The history of the International Monetary Fund is largely one of suffering caused by its doctrinaire prescriptions, applied indiscriminately to the people of many countries. Unlike the past, when these recommendations were applied mainly in the Third World, they are now often addressed to European countries, and, in a few cases, to the US. Interestingly, if the IMF is wrong it is now practicing self-criticism, something it never did in the past.

This is what happened recently when two of its top economists, Olivier Blanchard (its chief economist) and Daniel Leigh, presented a report titled Growth Forecast Errors and Fiscal Multipliers. This report studies the effect of government spending and tax hikes on a country's economic results, and reaches the conclusion that the austerity policies recommended by the IMF (and other institutions, such as the European Commission) to countries such as Spain, Portugal and Greece, underestimated their impact on the unemployment rate, consumption and investment. They thus generated a greater degree of hardship for the population. The IMF's forecasts erred in applying a mistaken fiscal multiplier: believing that each public euro spent less, or taxed more, would destroy 0.5 euros' worth of activity: when the reality has been that for each euro withdrawn, 1.5 euros' worth of activity has been destroyed. The fiscal multiplier was greater than one.

This report by Blanchard and Leigh complements their approximations made in October of 2012. At that time the IMF presented its World Economic Outlook, including a table titled Are we underestimating the short-term fiscal multipliers? -- which notes that the smaller the multipliers are, the less costly the resulting adjustment will be. The conclusion was that, based on data from 28 countries, the multipliers in use "have been systematically too small since the beginning of the Great Recession." The real multipliers "may be higher, somewhere between 0.9 and 1.7." So, who now accepts responsibility for this error, which has led to an aggravated European recession, with the results that surround us in terms of unemployment, massive household impoverishment, and a high rate of company failures?

The multiplier concept is a Keynesian one, developed by Keynes' collaborator Richard Kahn, executor of his will and, in the 1930s, one of the few economists who formed part of the so-called Cambridge Circle, together with Piero Sraffa, Joan Robinson, Austin Robinson, James Meade and Keynes himself. Kahn worked on the multiplier for employment and investment (which Keynes incorporated in his general theory): a coefficient that linked the increment in public investment to the number of jobs created.

The present document by Blanchard and Leigh has a precedent in the Fund: in February 2011 a report was published called IMF Action in the Phase Previous to the Economic and Financial Crisis, which criticized the disregard or burial of critical voices that existed within the IMF, and a "complacent reading" of the economic problems that have led to the greatest crisis in recent decades. Amounting to a sort of internal audit, the 54-page report, hard-hitting and based on consultation with many experts, said things such as "the incentives are oriented to generate consensus among predominant opinions;" "expressing strong contrary points of view might wreck my career;" and "there were disincentives to saying the truth to powerful people, especially from other countries." The economists consulted said there was "a high degree of group thought, intellectual co-opting, and a prevalent view that a great financial crisis in the advanced economies was impossible."

Blanchard and Leigh's opinions ought to be at the center of discussion on the European "austericide," and its difference from the economic policy being applied by Obama in the United States. A difference highly pronounced in focus, and in results.