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.