Friday, 1 February 2013

Mea Culpa but let's repeat it: IMF and the Bail-outs

Olivier Blanchard, IMF's Chief Economist
It appears that the IMF's spokesperson, Mr Jerry Rice, has said the following over an interview yesterday, concerning Washington Post's article on what appears to be Olivier Blanchard's (the IMF chief economist) mea culpa:

"(...) going way back to 2010, if we can cast our minds back, I think it's fair to say everyone was a bit too optimistic on forecasting Greece's recovery. (...) These included, the depth and the protracted nature of the European crisis itself, and the political crisis in Greece, which severely affected economic confidence, and delayed the implementation of reforms. (...)
When it became apparent that the underlying conditions were different to what had been assumed, we certainly moved as fast as we could to update our multiplier assumption. (...) there's been a lot of discussion of this fiscal multiplier, which is probably something very few people had heard of until some months ago. (...) I think it's a very healthy thing that the IMF and Olivier Blanchard have been completely transparent in how this was done, what the whole context was. I think that's the basis we want to move forward on."

From what it appears, nobody at the IMF had any idea what a fiscal multiplier was about a year ago. To say that there have been academic papers published the subject for the last 20 years would be an understatement. A simple search of "Olivier Blanchard Fiscal Multipliers" in Google Scholar yields results which date from 1987! Even if that is not enough then results from 2002 (including Blanchard's own paper) and 2009 could have assisted them. The point is that their estimations were wrong. That is why I have been calling the whole situation "the Greek experiment" (see here, here, here or here just to give out some of them). It appears just like if some people have been trying their theory to see if it works in the real world as well. Well it doesn't.

We can all agree that it is a healthy thing that they have been completely transparent about this. Yet, it would be an even greater thing if they were not trying to do it again in Cyprus, Spain and Portugal. Greece is not so different than any other ailing nation. It's as simple as that: government spending going down means that GDP is going down; just faster. Obviously I am not against fiscal consolidation. Yet as I have stated before, it needs to be made gradually. We cannot just slash €3-4 billion from government spending and expect the economy not to react. Of course it will. That is why change needs to be more subtle. 

Think of it this way: if there is only a buyer and a seller, then if we cut the buyer's wage by 30% don't we expect that he will buy less? Obvious isn't it? Now you may imagine the whole link: the seller will order less goods, then less goods would mean less raw material and so on. But I guess economists cannot think that simply can they?

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