The IMF and austerity
After reading the IMF country report on the UK, I could have sworn that this was an organisation that was rather in favour of fiscal austerity. That’s surely understandable, when it was larded with phrases like
The government’s strong and credible multi-year fiscal deficit reduction plan is essential to ensure debt sustainability.
That is certainly how it was reported in just about every newspaper. Then this morning I read Chapter 3 of the latest edition of the World Economic Outlook. Based on an historical analysis of fiscal consolidations, the Fund reports that:
- “Consolidations” hold back out put – typically, a 1 percentage point consolidation leads to a 0.5 point reduction in GDP and a 0.3 point increase in the employment rate.
- In a normal consolidation this is balanced to some extent by reductions in interest rates, but when these are already close to zero (i.e., now) the policy is more costly.
- When only one country is in this sort of crisis it is also cushioned by the effect on its exchange rates – output is cushioned by increased exports. But in an global recession it isn’t possible for everyone to increase their exports and “fiscal contraction is likely to be more painful when many countries adjust at the same time.”
The chapter does argue that, “over the long term, reducing debt is likely to be beneficial” – and I wouldn’t disagree; I certainly don’t believe in permanently high government debt. But the government’s policy of eliminating the deficit by 2015 is nowhere near long-term enough.
Someone is bound to point out that the WEO argues that one result of its analysis is that cuts are less contractionary than tax increases. This is largely because of the impact on interest rates and exchange rates; where interest rates are already very low and most of the world is in the same boat this is much less persuasive.
One argument sometimes put forward for the UK’s austerity programme is that UK government debt was seen as risky by international investors, and the cost of the extra premium we would have to pay because of that risk would hold back growth.
The IMF used the Institutional Investor Ratings index to split countries that had carried out fiscal contractions into high risk and low risk groups and then compared what happened to both groups’ growth after their consolidations. It’s true that consolidation was less contractionary for the group seen as riskier, but the key point is that consolidation was contractionary for both groups.
(The cuts carried out by Denmark in 1983 and Ireland in 1987 are an exception to this, but it’s worth remembering that Ireland’s cuts were carried out when the rest of the developed world was expanding, so Ireland was able to achieve export-led growth that isn’t really an option for us now.)
So this is a very different document from the UK report. Does the IMF’s right hand know what its very right hand is up to?