IMF study says it was wrong about Keynesianism.

[davidm]

The IMF Admits It Was Wrong About Keynesianism

In an important new study, Olivier Blanchard, the Chief Economist at the International Monetary Fund (IMF), has just admitted that having respected and accepted the advice of conservative economists has turned out to be a blunder.

This has cost the world’s advanced economies dearly, and must be reversed if the world is to avoid an economic tailspin.

To me, this seems intuitively obvious, but of course intuition does not equal science.

So, does this study really say what Business Insider claims it says? Has Olivier Blanchard really “admitted” what it claims he has admitted? Is this article just spin?

Was the study done properly? Does it really mean anything?

[Voyager]

I’m not sure anyone here is qualified to dispute a report by the Chief Economist of the IMF, but given that they are admitting a mistake I’d think they’d be pretty sure of their results. Krugman mentions this study in his column today, btw. The economy in most of Europe is not reacting to austerity in the way it was predicted to by the austerity fans, that is for sure.

[Nametag]

The paper is far more tepid than the, well, idiot who wrote the article seems to think. They don’t “admit” jack; the abstract reads in full:

This paper investigates the relation between growth forecast errors and planned fiscal consolidation during the crisis. We find that, in advanced economies, stronger planned fiscal consolidation has been associated with lower growth than expected, with the relation being particularly strong, both statistically and economically, early in the crisis. A natural interpretation is that fiscal multipliers were substantially higher than implicitly assumed by forecasters. The weaker relation in more recent years may reflect in part learning by forecasters and in part smaller multipliers than in the early years of the crisis.

The rest of the paper is equally cautious. I’m not aware of Blanchard, really, but judging from his writings, he’s never been a fan of severe austerity measures, and is not claiming to have made any error here. His policy recommendation appears to be “expand in haste, contract at leisure.” In his 2011 year-end blog, he made several points, among them that assuring liquidity is top priority, while fiscal consolidation should be done slowly and deliberately; above all, make a sensible plan and stick to it.

Voyager, got a link to Krugman? I don’t see it.

[Askance]

Here’s another article on the same paper, which says in part (emphasis added):

The IMF, on the other hand, solemnly advised the nations of Europe coming out of the financial crisis to raise taxes and wind back government spending. Its commandments had weight. Yes, it had failed to foresee the crisis in the first place, but it was the lender of last resort. They might need it.
And it had modelled what would happen if they did what it said.** For every dollar they cut their budgets, their economic growth would suffer just 50¢. Its forecasts said so.**

On Friday, in its first working paper of the year, it revealed the full horror of what did happen. Personally authored by the fund’s chief economist, Olivier Blanchard, the paper said that for every dollar those nations cut their budgets their economies crumpled something more like $1.50.
Rather than suffering far less than the savings they made on their budgets, the economies suffered far more. As mistaken advice it’s monstrous - like going to see a doctor who tells you the medicine won’t hurt much and finding it lays you low for years.

The fund forecast that if the eurozone took its advice it would grow 1.8 per cent throughout 2011. It grew 0.7 per cent. Italy would climb 1.3 per cent; it slid 0.5 per cent. Spain would surge 1.8 per cent; it grew not at all.

[IClaudius]

@Nametag

The paper is far more tepid than the, well, idiot who wrote the article seems to think.

They don’t “admit” jack; the abstract reads in full:
The rest of the paper is equally cautious. I’m not aware of Blanchard, really, but judging from his writings, he’s never been a fan of severe austerity measures, and is not claiming to have made any error here.

Wrong. The IMF has released many qualifications to the issue of consolidation, but it’s undeniable that they forecast that consolidation and micro-reforms would produce growth. These claims were not only completely wrong, they reinforced and prolonged the harmful policy of austerity.

Personally authored by the fund’s chief economist, Olivier Blanchard, the paper said that for every dollar those nations cut their budgets their economies crumpled something more like $1.50.

Rather than suffering far less than the savings they made on their budgets, the economies suffered far more. As mistaken advice it’s monstrous - like going to see a doctor who tells you the medicine won’t hurt much and finding it lays you low for years.

The fund forecast that if the eurozone took its advice it would grow 1.8 per cent throughout 2011. It grew 0.7 per cent. Italy would climb 1.3 per cent; it slid 0.5 per cent. Spain would surge 1.8 per cent; it grew not at all.

---

The shocking thing about the incorrect IMF forecasts confirmed by its chief economist is that there were few unexpected events. The global environment was broadly as forecast. The nations of Europe did what was forecast. The consequence was nothing like what was forecast. The fund misunderstood the mechanics.

As Blanchard put it, his forecasters “significantly underestimated the increase in unemployment and the decline in private consumption and investment associated with fiscal consolidation”.

His defence is that in normal times they would have got it right. In normal times a budget cut of $1 would have cut economic growth by 50¢. But the times weren’t normal. European interest rates had been cut to nearly zero, meaning there wasn’t the normal room for authorities to cut further, and households were more heavily indebted than normal, so cuts to their income flowed through more quickly than normal to cuts in their spending. And the starting point was different. The European economies had been in recession, which was far from normal.

Read more: When a guess is as good as a forecast

Apologies for reposting the same article - Askance beat me to it.

[zoid]

I’m not up to speed so bear with me…

Is it accurate to say:

[ul]
[li]If I understand Keynesian economics is the theory is that government should spend to induce growth.[/li][li]The IMF opposed Keynesian economics and instead voted for austerity[/li][li]The IMF now admits austerity was a bust and that in face Keynesian economics would have been better capable of handling the Eurozone economic crisis[/li][/ul]

Please correct me if I’ve missed the point.

[Happy_Fun_Ball]

Sounds right, except that Keynesian economics is the theory that government spending induces growth during a downturn only.

[zoid]

So is there any chance both US parties will agree that government initiatives to induce economic growth is a good idea?

[BrainGlutton]

@Voyager

The economy in most of Europe is not reacting to austerity in the way it was predicted to by the austerity fans, that is for sure.

“The beatings will continue until morale improves.”

[BrainGlutton]

@zoid

So is there any chance both US parties will agree that government initiatives to induce economic growth is a good idea?

There was a time, back in the '50s and '60s, when both parties did, apart from some weirdo hard-right GOP outliers like Senator Robert Taft and Barry Goldwater . . . but then “movement conservatism” came along and took over the GOP. Since the Tea Party appears to be its latest iteration, it’s not going away just yet, more’s the pity.

[zoid]

Slight hijack…

I saw a link on the dope to a great presentation about the Greek fiscal crisis. It was a guy doing stuff on a drawing board and he compared the way the EU treated Greece to the way the US treated Boston (?) when the city had a financial crisis. He detailed the way that the EU response simply drove Greece into further chaos while the US response (economic incentive) rescued Boston from disaster to financial viability.

Anyone know what I’m talking about? I’d love to find that.

[IClaudius]

@zoid

I’m not up to speed so bear with me…

Is it accurate to say:

If I understand Keynesian economics is the theory is that government should spend to induce growth.

Not exactly. Keynesian economics is concerned with fiscal policy in a recession. Because the economy is falling or stuck in disequilibrium, with idling capacity and high unemployment, the government should step in to take up the slack of the private sector. However, that position say nothing about policy during a boom. The Keynesian position during a boom is that you should accumulate budget surpluses and avoid crowding out the private sector.

Almost all mainstream economists believe that normal macroeconomic stabilisation involves some counter-cyclical fiscal operations through automatic stabilisers and monetary policy set by an independent central bank. The issue is more about the inadequacy of modern monetary policy (central banking based on an inflation target and Taylor rule type function) at the zero lower bound - and thus the necessity and effectiveness of discretionary fiscal stimulus.

Despite the heated nature of the public controversy over stimulus, conservative economists have historically been very comfortable favouring tax cuts as stimulative in this regard, despite their low multiplier, whilst denying other forms of expenditure-based stimulus. This is intellectually inconsistent - though they have other reasons for favouring tax cuts.

The market monetarists have a far better critique of fiscal stimulus.

The IMF opposed Keynesian economics and instead voted for austerity

They were more qualified than that. But essentially they did predict that consolidation and reforms would produce growth.

The IMF now admits austerity was a bust and that in face Keynesian economics would have been better capable of handling the Eurozone economic crisis

Not only was it a predictive bust, but it was totally counter-productive to the fiscal position they were ostensibly worried about.

[Tom_Tildrum]

@zoid

I’m not up to speed so bear with me…

Is it accurate to say:

[ul]
[li]The IMF now admits austerity was a bust and that in face Keynesian economics would have been better capable of handling the Eurozone economic crisis[/li][/ul]

I don’t think that what they’re saying includes the bolded language (and if they did, it would only be speculation). It’s not either-or, that if one doesn’t work, the other would have. Bear in mind, for instance, that Administration economists similarly overestimated the growth effects of the 2009 fiscal stimulus.

[zoid]

@Tom_Tildrum

I don’t think that what they’re saying includes the bolded language (and if they did, it would only be speculation). It’s not either-or, that if one doesn’t work, the other would have. Bear in mind, for instance, that Administration economists similarly overestimated the growth effects of the 2009 fiscal stimulus.

Ah - OK.

So all they’re saying is “what we tried didn’t work”’

Which does not mean “we admit that what the other guys wanted would have worked”

So - “We were wrong, that doesn’t make the other side right”

Yes?

[WillFarnaby]

For the most part, European governments haven’t been practicing austerity. Not in any meaningful way. Some countries have continued to increase spending.

With this knowledge, how can someone say that empirically austerity is not working in Europe?

[puddleglum]

@IClaudius

Despite the heated nature of the public controversy over stimulus, conservative economists have historically been very comfortable favouring tax cuts as stimulative in this regard, despite their low multiplier, whilst denying other forms of expenditure-based stimulus. This is intellectually inconsistent - though they have other reasons for favouring tax cuts.
.

Conservative economists have disputed the idea that tax cuts have lower multipliers. Here is a review of some of the literature
As has already been pointed out most of what is called austerity are actually tax increases coupled with a leveling off in government spending, not actual cuts in spending.
What Keynesianism would recommend is borrowing money to pay for increased government spending. During the Euro zone crisis countries that are most effected have seen borrowing costs go up significantly, so it is not clear that the Keynesian response was possible.

[Richard_Parker]

@WillFarnaby

For the most part, European governments haven’t been practicing austerity. Not in any meaningful way. Some countries have continued to increase spending.

With this knowledge, how can someone say that empirically austerity is not working in Europe?

Some relevant graphs.

The latest in the attempt to make excuses for the abject failure of austerity is the claim that European countries didn’t really practice austerity after all. This is mainly coming from the usual suspects – the people who, for example, used Census hiring to claim that Obama was presiding over a vast expansion of government employment. (What will it take for pundits to realize that if Veronique de Rugy, for example, cites a number you can pretty much assume that it’s wrong?) But I have to say that the responses I’ve seen have been surprisingly weak – some people who should know better are conceding the point that maybe there haven’t been big spending cuts. Yes, there have.

And her reply, as long as we’re just quoting the exchange.

[Latro]

@Voyager

I’m not sure anyone here is qualified to dispute a report by the Chief Economist of the IMF

Wellll, it does mean I was right all along…

[Fotheringay-Phipps]

Can someone explain Krugman’s position here?

Why is it that welfare/unemployment payments or bank bailouts don’t count, either as Keynesian stimulus or in measuring austerity?

I mean, I can understand that they don’t count if someone was measuring the social-political orientation of a country. But why would they not count in terms of these economic policies?

[IClaudius]

All policies which consolidate the fiscal position, including reducing spending growth, if not the level, as well as taxes, are technically part of what we are calling austerity. Essentially the problem is these policies are pro-cyclical reinforcing disequilibrium.