19 Jan 2013

The IMF's chief economist admits that they got it all wrong - Austerity is a very bad idea

Happy New Year!

Yes, I've been slow getting off the mark. My first economics blog item for 2013 on January 18th! Well, I was giving you all time to read through the 380+ pages of my complete works for 2010-2012 which I published at the end of last year..... (only kidding).

Actually, I have been very busy, and haven't had time to do much. But I was spurred into action by a piece on the front page of this weeks "Canard Enchainé" about how the head Economist at the IMF - French economist and potential Nobel Prize winner Olivier Blanchard - has admitted that economists got the whole thing wrong. For years, they have been impliciting assuming a "fiscal multiplier" of around 0.5, meaning that for every billion taken out of the economy by government austerity measures, the effect on economy is only half. It turns out that the real number, based on the most up to date numbers is much higher - they estimate something between 0.9 and 1.7. That means that government austerity measures are a complete disaster. I think that many people in Greece, Spain, Portugal, Ireland and the UK would probably agree.

Note that if the fiscal multiplier is over 1.0, it means not only that cutting back on public expenditure will do more harm than good, but also that increasing public expenditure would pay off handsomely. This a point that many people have been making, but has been studiously avoided by those in the Troika (EU, ECB and IMF) who have been forcing massive austerity on the Eurozone governments.

I thought I'd chase up the story which started back in October when the International Monetary Fund's "World Economic Outlook" came out. You can download the document here.
The really interesting bit is Box 1.1. on page 41 called "Are We Underestimating Short-Term Fiscal Multipliers?", which was written by Olivier Blanchard and his colleague David Leigh. Here's what they say:
"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. So actual multipliers may be higher, in the range of 0.9 to 1.7."
Here are the actual charts they produce. First, a graph showing the difference between the predicted GDP growth rates for the 28 countries made in april 2010 and the actual numbers.

If the economists had got it right, this plot should be flat, but it clearly isn't. And in particularly, it is way off for Greece.

Next, there is a graph showing where the forecast errors lay.

You can see that 1% of "fiscal consolidation" (read austerity) is associated with far larger drops in investment, GDP and Private Consumption than the economists had predicted. They did however get the drop in Net Exports (NX) about right. Well done! Not too difficult that one, given that the amount of exports that a country can manage will not change much when the government slashes public spending.  On the other hand, the increase in unemployment is a lot higher than the economists had predicted.

The third graph provides information about which particular group of economic modellers got it wrong the most.

And the winner is - the IMF! Yes, the IMF has demonstrated that it was nearly 1.2% off. The EU economists were slightly less terrible at 0.8%, followed by the EIU and the OECD. But basically, this is a straight admission that none of them knew what they were talking about.

I find it particularly amazing to learn that the economist doing the modelling often don't make explicit what particular value for the fiscal multiplier they are using. I quote:
"These results suggest that actual fiscal multipliers were larger than forecasters assumed. But what did forecasters assume about fiscal multipliers? Answering this question is complicated by the fact that not all forecasters make these assumptions explicit. Nevertheless, a number of policy documents, including IMF staff reports, suggest that fiscal multipliers used in the forecasting process are about 0.5."
That's truly incredible. The IMF, the ECB and the EU have been forcing governments
to impose massive austerity and increase taxation based on a number for the fiscal multiplier that the economic modellers don't even make explicit!

Not surprisingly, Blanchard and Leigh got a lot of criticism from their colleagues for making this admission. So, a few days ago, they came back with a detailed article called "Growth Forecast Errors and Fiscal Multipliers" - that was published as an IMF working paper that you can download here.
In it, they effectively back up all their  claims with a detailed analysis. 

Effectively, they demonstrate beautifully that the idea that "fiscal consolidation" is an intelligent response to government debt is based on a complete myth. At least now the economists have had the courage to admit that they really didn't know what they were talking about.

Amusingly, the working paper has a note saying "This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy." Mind you, given that Olivier Blanchard is the chief economist at the IMF, one wonders who would be better placed to give the IMF's position.

1 comment:

  1. I'm sure there are six thousand million other "potential prize winners" in the world who came to the same conclusion years ago. Listening to these "illuminati" just adds insult to injury.