Austerity's impact surprised IMF, official says

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WASHINGTON -- Consider it a mea culpa submerged in a deep pool of calculus and regression analysis: The International Monetary Fund's top economist on Thursday acknowledged that the fund blew its forecasts for Greece and other European economies because it did not fully understand how government austerity efforts would undermine economic growth.

The new and technical paper looks again at the issue of fiscal multipliers -- the impact that a rise or fall in government spending or tax collection has on a country's economic output.

That it comes under the byline of fund economic counselor and research director Olivier Blanchard is significant. Fund research is published with the caveat that it represents the views of the researcher, not the institution. But this paper comes from the top, and it attempts to put to rest an issue that has been at the center of a debate about how fast countries should move in their efforts to tame large debts and deficits.

If fiscal multipliers are small, countries can cut spending faster or raise more in taxes without much short-term damage. If they are large, then the process can become self-defeating, at least in the short run, with each dollar of government spending cuts costing the economy more than a dollar in lost output and, thus, increasing ratios of debt to gross domestic product.

That is what has been happening with a vengeance in Greece, where fund forecasters in 2010 predicted that the nation could cut deeply into government spending and quickly bounce back to economic growth and rising employment. Two years later, the Greek economy is still shrinking, and unemployment is at 25 percent.

Of course, no two circumstances are alike. Shut out of international bond markets, Greece had little choice but to begin bringing its public finances into line or face a catastrophic default. Financing wasn't available to sustain prior spending levels. But for an economy that has been reeling for several years, a billion or two in extra government programs or investment could have kept a few small businesses open and kept a few more families employed and spending.

"Forecasters significantly underestimated the increase in unemployment and the decline in domestic demand associated with fiscal consolidation," Mr. Blanchard and his co-author, IMF economist Daniel Leigh, wrote in the paper.

That somewhat-dry conclusion sums up what amounts to a tempest in econometric circles. The fund has been accused of intentionally underestimating the effects of austerity in Greece to make its programs palatable, at least on paper. Fund officials have argued that it was its European partners, particularly Germany, who insisted on deeper, faster cuts.

The evolving research on multipliers may have helped shift the tone of the debate in nations such as Spain and Portugal, where a slower pace of deficit control has been advocated.

But the paper includes some subtle and potentially troubling insights into how the fund works. Mr. Blanchard -- effectively the top dog when it comes to economic science at the fund -- writes in the paper that he could not determine what multipliers economists at the country level were using in their forecasts.



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