Winner of the New Statesman SPERI Prize in Political Economy 2016

Sunday, 9 November 2014

The IMFs evaluation of 2010 austerity

The Independent Evaluation Office of the IMF has recently published its assessment of the IMF’s Response to the Financial and Economic Crisis. In many ways the IMF’s advice at the time mirrored the way the policy response to the crisis actually evolved. In 2008 and 2009 it recommended fiscal stimulus, and that is exactly what some countries, notably the UK and US, did. In 2010 it dramatically reversed its advice, and recommended austerity. At the same time the UK, US and Eurozone switched to austerity.

This independent evaluation argues the 2010 switch was a mistake. Here are some key quotes from the report (paras 32-34):

“The IMF’s call for fiscal expansion and accommodative monetary policies in 2008–09, particularly for large advanced economies and others that had the fiscal space, was appropriate and timely.”

“IMF advocacy of fiscal consolidation proved to be premature for major advanced economies, as growth projections turned out to be optimistic. Moreover, the policy mix of fiscal consolidation coupled with monetary expansion that the IMF advocated for advanced economies since 2010 appears to be at odds with longstanding assessments of the relative effectiveness of these policies in the conditions prevailing after a financial crisis characterized by private debt overhang. In particular, efforts by the private sector to deleverage rendered credit demand less sensitive to expansionary monetary policy, irrespective of its ability to maintain low interest rates or raise asset prices. Meanwhile, a large body of analysis, including from the IMF itself, indicated that fiscal multipliers would be elevated following the crisis, pointing to the enhanced power relative to the pre-crisis environment of expansionary fiscal policy to stimulate demand.”

“Many analysts and policymakers have argued that expansionary monetary and fiscal policies working together would have been a more effective way to stimulate demand and reduce unemployment—which in turn could have reduced adverse spillovers. Waiting longer to shift to fiscal consolidation might also have allowed for less aggressive monetary expansion, with less negative side effects.”

None of this will be a surprise to regular readers of this blog, but it is welcome nonetheless. Perhaps more interesting is the subsequent analysis of why the IMF got it wrong in 2010.

“In articulating its concerns [in 2010], the IMF was influenced by the fiscal crises in the euro area periphery economies (see Box 1), although their experiences were of limited relevance given their inability to conduct independent monetary policy or borrow in their own currencies.”

As the evaluation also notes, interest rates on US, UK and Japanese government debt were at historic lows. So the report essentially says that the IMF became spooked by the Eurozone crisis. That is why it is tempting to call the 2010 switch to austerity a Greek tragedy.

This is an assessment of the IMF’s view. Of course policymakers in both the UK and US had other motivations. We will never know if the switch to austerity in 2010 would have happened anyway even if the IMF had not changed its view, or whether it would have happened if politicians in Greece had not borrowed too much and attempted to deceive everyone else about this.

As the FT reports, Christine Lagarde has defended the advice the IMF gave in 2010. It was appropriate given the IMF’s forecasts of a reasonable recovery, she suggests. However that seems to miss the point. This report clearly suggests that the IMF were mainly misled by what was happening in the Eurozone and not by an overoptimistic forecast. If they had interpreted the Eurozone crisis for what it was, they would probably have concluded that the recovery was still fragile, and that therefore this was not the time for austerity outside the Eurozone periphery. Better still, they might have made their participation in the Troika conditional on a quick and full Greek default (as an earlier self evaluation by the IMF suggested), and better still on the ECB implementing OMT much sooner.

Another imponderable concerns macroeconomic theory. By 2011 Paul De Grauwe had provided a convincing explanation of why the debt crisis was confined to the Eurozone, and by the end of 2012 when the ECB’s OMT had ended that crisis it was clear he was right. If we had known in 2010 what we know now, would the IMF have taken a different view? I suspect not. Austerity is a sort of default mode for the IMF, for understandable reasons, and although there are many opinions within the IMF, it is still ultimately run by a political body. But at least we can be thankful that this IMF evaluation, untainted by political face saving or ideology, has given a clear verdict. The 2010 switch to austerity was a mistake. The conclusion is not qualified: it was a mistake in the UK, the US, and in the Eurozone as a whole. 


  1. Good to see the IMF made an honest and necessarily critical view of its position.

    My fear is though that there will be a few "I told you so" s coming out of mainstream economists, of which the new consensus (read fad) is that all is OK if a country borrows in its own currency.

    Such people are historically illiterate and do not know too much about how economies really work outside the United States, especially, but not only, developing countries. Some countries find it easier to borrow in their own currencies than others. That is why many countries wanted, and still want to enter the Eurozone in the first place. That is why emerging countries in East Asia peg to the US dollar and are carefully accumulate foreign exchange reserves. International trade is denominated in US dollars - and that is important if you are dependent on international trade, that is if you have to export to pay for crucial imports. You have to earn those US dollars. The reasons for the US dollar's position are to do with history, power and crucial events that happened between about about 1918 and 1945, not at all explained by New Keynesian or other such theory.

    It was also good to see an honest appraisal by the IMF of its behaviour during the Asian Financial Crisis. What it proved regarding capital controls was that Mahathir (then an eccentric economically illiterate maverick - but who understood his own country and economy very well) was right, and the New Keynesian establishment, starting with Stanley Fischer, was wrong.

    The IMF's now advocates:

    "Flexibility in targets and approaches (including direct budget support and judicious use of capital and exchange controls)."

    The bigger lessons are for macro-economic theorists. Disengagement with accumulated knowledge outside the discipline and faith in questionable models and other such gimmick and their universal application, irrespective of the country, has been positively tragically harmful.

  2. Why leave the poison called Fhinehart-Rogoff out of this mea culpa? It was as culpable as the Greek debt crisis in providing the excuse for austerity to right wing politicians that were looking for an excuse to shrink the size of government. This should remain a dark stain on their professional careers given the immense amount of human misery inflicted on the populace.

    1. Agreed: the damage done by Rogoff and Reinhart exceeds the damage done by the two atom bombs dropped on Japan at the end of WWII.

    2. But not as much as the actual Nazis themselves, their contemporary equivalents being the British National Party of which you appear to be a member.

    3. Ejh,

      Nazism consisted, amongst other things of invading other countries for no good reason, and killing large numbers of their inhabitants. Labour and the Tories invaded Iraq for no good reason or at least highly questionable reasons, and took part in the slaughter of a million Muslims, while the BNP opposed the invasion from day one.

      Care to withdraw your snotty little BNP=Nazism jibe?

  3. Robert Shiller at Project Syndicate Sept 20th 2012 'The Narrative Structure of Global Weakening' gives an account of the-Greece-crisis-is-spreading story from 2008 not just from February 2010 when the LibDems in particular started saying very queer things about the UK economy.

    At least the IMF seems to be far ahead of the BIS!

  4. If the IMF is accepting some level of responsibility for the crisis and I don't think I'm exaggerating to say the crisis has caused incredible suffering to millions (and death if you're willing to include suicides and people who didn't manage to afford heating, food Etc.) then how is Lagarde not resigning?

    1. Well, it would be good if somebody asked her. It would also be good if somebody asked Blanchard the same question. It would also have been good if people started asking hard questions of Mario Draghi, instead of the "Super Mario" refrain that we hear every time he has a patball press conference. The one this last week, when he deliberately evaded questions about his role in the Trichet/Ireland fiasco, was particularly offensive.

      It might also be worth asking when the IMF proposes to start appointing Managing Directors who do not find themselves the subject of serious criminal investigations, since my by count they are now on three in a row in that respect.

    2. Draghi, Fisher, Lagarde, the bankers - all these people are still calling the shots.

    3. Let's just remind ourselves about what the Patron Saint of New Keynesianism, Stanley FIsher, advises when countries are hit with a financial crisis - in this case in reference to the Asian Financial Crisis

      "Indeed, the reluctance to tighten interest rates in a determined way at the beginning has been one of the factors perpetuating the crisis. Higher interest rates should also encourage the corporate sector to restructure its financing away"

      Looking at the last sentence, I wonder whether such "New Keynesians" disagree with the fundamental message of the General Theory or just haven't read it?

      It isn't just Lucas and Sargent who have a lot to answer for.

  5. the trouble with this analysis is that it is not country specific

    for example, the claim:
    ''the policy mix of fiscal consolidation coupled with monetary expansion that the IMF advocated for advanced economies since 2010 appears to be at odds with longstanding assessments of the relative effectiveness of these policies in the conditions prevailing after a financial crisis characterized by private debt overhang. ''

    this only applies to the countries with a housing bubble, Italy didn't have a housing bubble, private debt is low in Italy, there is no deleveraging going on. Italy had low growth before and after 2008, it has nothing to do with the financial crisis.
    For each country you can tell a different story.

    1. Before 2008 Italy had low growth. After 2008 it had a 10% GDP collapse. Italy was forced to hugely increase taxes and to cut welfare because "public debt was too high". The outcome: production and employment collapse, lower tax receipt, and HIGHER public debt / GDP ratio.

    2. Japan followed your prescription: fiscal stimulus, the outcome: higher public debt /GDP ratio.

    3. But a much better employment and GDP picture than both Italy AND the Eurozone as a whole.
      And who cares about more yen-denominated debt when the central bank can buy as much as needed ? and interest rates are close to zero and there is no inflation ?

  6. Private sector deleveraging was the code word for Japan too: let public debt rise until the private sector has finished paying down debt.
    Only to find out they have replaced the problem of too much private debt with too much public debt. Now what?
    I hear you say: Japan is different. Yes, but than all countries are different.

  7. "Only to find out they have replaced the problem of too much private debt with too much public debt. "

    Oddly, Krugman said that in the early 2000s. I wonder if he would still say that now?

    Japan's problem, if it has one, is not too much government debt. Japan is a net creditor. Indebted countries owe Japan.

    Large government debt is simply a means of absorbing a of large pool of domestic savings in excess of profitable private sector investment opportunities.

    1. interesting view. If Japan doesn't have a problem, why the QE?

    2. It is all relative. 4,7 per cent unemployment, a large balance of payments surplus, low inflation, why do they need high growth with a falling population? A lot of people would like their problems.

      QE is explained in the comment above. Large savings surpluses are going into government investment. That is their business to choose capital to be invested in that way. Just because they are not using a target interest rate for MP as Model says they should, does not mean they have a problem.

      "Unconventional" in some eyes, but In fact in many ways they are returning to they type of MP they always knew.

    3. if debt/GDP ratio apparently doesn't matter, just keep ''investing'' domestic savings in government debt. Why the QE?

    4. It allows for a dispersal of central bank credit when banks are cautious on lending and there are bottle necks in the flow of funds.

      Would like to hear your view?

    5. ''It allows for a dispersal of central bank credit when banks are cautious on lending and there are bottle necks in the flow of funds.''

      hm, not sure what that means.

      I do not really have a view on Japan, and I am not an economist. But I am interested in knowing the outcome, as maybe we can learn something from it in the eurozone. Surely what they are doing can't go on forever, can it?

    6. Your question is a good one. "Why inject more liquidity when there is a liquidity glut?" The view is that with the central bank injected liquidity will somehow restore a mismatch that has emerged between savings and investment. This might be surprising given that Japanese banks have largely restored their balance sheets. The hope is that, however, BOJ purchases of long term government bonds and targeted private securities will lead the way.

      Will it work? I'm not convinced. Mind you I am not convinced there really is a huge problem anyway at the macro-level and Japan has entered its post high growth phase and investment opportunities are declining. Can it go on indefinitely? The QE, in Japan's case, yes.

  8. Just because neoclassical New Keynesians are right about austerity being bad in a slump (which Keynes said 80 years ago) doesn't justify their ideology.

    Their 2% inflation targeting, which is a mutation of Friedmanite monetarism, caused the collapse of the Western economy in the first place.

    By the time "Great Moderation" inflation-targeting was put in place -- by the second half of the 1990s -- we were back to pre-Keynesian boom-to-bust economic cycles. First the dot com bubble. Then the housing/derivatives meltdown.

    One cause of excessive risk taking by the financial sector could be they were used to the high real interest rates (risk-free money) inflation-fighting brought about.

    Saying inflation targeting is a success because it predicts austerity will cause a downturn in a slump, is like saying a building collapse is Ok because the spire remained intact.

    It's time to bring back the democratic Keynesian economics that created the wealth of the developed nations in the post-war era (1945-1979.) Then we had rising living standards for all segments of society, low inequality, economic stability, high GDP growth and paid down high government debt.

    1. Paul Krugman in his latest post links up to Chris Sims, who says that recent economic models failed in 2008 because it was an "exceptional event".

      As you point out, and any historian would point out, such "exceptional events" usually after problems have been building up for a long time. Models are useless if they cannot detect them.

      Keynes again:

      "The forces of disillusion may suddenly impose a new conventional basis of valuation. All these pretty, polite techniques, made for a well-panelled Board Room and a nicely regulated market, are liable to collapse. At all times the vague panic fears and equally vague and unreasoned hopes are not really lulled, and lie but a little way below the surface." (Keynes, 1937)

      Economists need more humility and think more like historians and other social scientists and stop their scientific pretensions. And this point badly needs to be made to Messrs Krugman and Sims.

    2. Agreed. How is it, it took New Keynesians a global economic meltdown to come up with "evidence" their theory works?

      BTW, here's a couple of graphs I put together that show how the 2% inflation targeting tight money put the kibosh on the economy:

      Tight money very long-run 'unneutral'

      Both New Keynesians and New Classicals both believe in long-run monetary neutrality. Who knows what they mean by long run? 50 years? 5000 years? But my guess is that the tightening they did to bring about the 2% inflation targeting (from 1989-1999) will be felt long into the future. (Not exactly what they meant by 'neutrality.')

      Krugman is playing tag team with Nick Rowe against the Neo-Fisherites. But Rowe is the as far from Keynesian as Friedman was. (Neoclassical ideologues keep looking to put the economy on autopilot: first monetarism, then inflation targeting, now it's NGDP targeting.)

      I think real centrist Keynesians will put distance between themselves and ultra-right-wing free-market ideologues. That's what's required if we are to achieve any meaningful change (and prevent plutocrats from bringing civilization crashing down around their ears...)

  9. A Comment via Twitter from Peter Doyle


    First, given that IMF management and board have rejected the key conclusions of this report, I do not understand why in your closing para you refer to it as an "IMF report", It very clearly does not enjoy the imprimatur of the institution. That fact--
    rather than an attempt to give authority to the views it advances by describing them as "IMF"--is the first point that any review of the report should make. The highly regrettable fact of the IMF's rejection of the report's case against austerity, even in
    hindsight, should be the headline.

    Second, rejection by Management and Board of such ex post analysis is becoming typical. The key points in the ex-post review of Greece were similarly dismissed. And this serial dismissal also draws attention to the de facto rejection by the
    Management and Board of the IMF of the earlier auditor report's cautions regarding "Groupthink" in the institution. That problem is, evidently, not cured if Management and Board only acknowledge critiques they agree with.

    Third, the report itself has two major shortcomings. First, it draws no distinction between 2010 and 2011. In particular, in 2010, there were genuine and reasonable concerns that the Euro Area could, in reasonably short order, break up. Whether that possibility warranted an immediate switch to austerity in 2010 within and without the Euro area is a matter for debate. But the report does not even acknowledge that the possibility of total collapse, rather than a mindsetinfestation which extrapolated sovereign financing difficulties within the Euro Area to the same for countries with independent currencies, may have underpinned the intellectual case for the switch.

    The story for 2011 is different. By that time, rightly or wrongly (more the latter given the 2012 Euro breakup panic), the risk of total collapse of the Euro was judged by the IMF to have completely receded. Indeed, not only receded, but the view was that so robust were prospects in the Euro Area and outside of it that simple cyclical analysis required the initiation of policy tightening. (See 2011 Euro Area Staff report here.) As a further example of this, the November 2010 UK Staff Report by Ajai Chopra was unambiguous; given the rebound in activity, austerity "benefits outweigh expected costs". Both reports were, of course, strongly endorsed by IMF Management and Board.

    In short, the intellectual argument advanced by the IMF for austerity in 2010 was totally different from the argument for it in 2011. The auditor report simply ignores this key distinction. This is a major gap because the intellectual foundations of the
    IMF prescriptions were radically different in each of those key years, and both (and the lessons to be learned from each of them) should be studied separately. Second, and relatedly, the report's account of the reasons for the IMF prescriptive
    failures misses their much deeper roots. It does so because, as is typical of such reports, it looks at a single episode. But such failures are not single; they are serial--including missing the long antecedents to the global and Euro Area crises, total
    misdiagnosis of Greece in 2010, and these austerity errors in 2010 and 2011. And the errors have kept coming since then too. Until there is a full assessment "in the round", these one off ex post regrets will keep coming and they will continue to be dismissed. Here is my assessment in the round.

    Peter Doyle.

    Links from text:

    1. It looks like quite a lot of internal debate is going on within the IMF between pro and anti- austerity camps. At least though there is a debate. In some ways things have moved in a positive direction since the Washington Consensus days.

  10. hello,
    What do you mean, when you say: "The 2010 switch to austerity was a mistake," What would have been the right decision? Investments in times of financial crisis? Or do you think of something else?

  11. I find one crucial topic missing: would markets have accepted higher deficits?
    It seemed to me that when some countries speculated about losening the grips, markets tended to react pretty nervously.

    1. Did markets accept higher us Uk japanese deficits ? Sure: they were entirely guaranteed by central banks. The ecb has to do the same for the eurosystem to avoid collapsing.


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