The Errors of Austerity: The Blanchard Prescription
Economists were created and feted to make witchdoctors respectable. The harm that economists can produce, while still not quite in the vicinity of those of doctors, can be extensive. Errors are tolerated, fictions propagated. Dangerous doctrines become impenetrable and the mainstay of governments.
It was therefore interesting that the IMF’s chief economist Olivier Blanchard, along with his colleague Daniel Leigh, made a confession in a recent paper that, “Forecasters significantly underestimated the increase in unemployment and the decline in domestic demand associated with fiscal consolidation.” Last October, they were already busy at work seeking to pull the carpet from under the very organisation they are employed by, taking issue with the orthodox school of austerity. The calculations upon which the austerity measures were then inflicted upon such countries as Greece were deemed inaccurate.
Both Blanchard and Leigh received criticism for their stance, necessitating, in their view, a “revisiting” of their approach and results. Their views were, however, affirmed by the likes of Victoria Chick and Ann Pettifor, who had argued in PRIME, an outlet examining policy research in macroeconomics, that “Fiscal consolidation does not ‘slash’ the debt, but contributes to it.” Writing on January 6 in Prime, Pettifor noted that a body staffed by 1100 professional economists with an overall budget of $800 million “failed to make that correct call.”
The IMF paper “Growth Forecast Errors and Fiscal Multipliers” (Jan 2013) has been the Blanchard-Leigh riposte, a new year’s gift fellow economists did not want to receive. The authors are cautious not to bite the hand that feeds them, standard protocol in making sure employees ignore the egg on the face of their employers. “This working paper should not be reported as representing the views of the IMF…Working papers describe research in progress by the author(s) and are published to elicit comments and to further debate.”
Cold comfort then to know that such “research” is divorced from policy, and that the IMF’s stance on that position may not be at one with the researchers. While it is true that the current IMF is not the same organisation that breathed fire at the very mention of relaxing austerity in the 1990s, scant comfort can be found in the current outfit. Blanchard’s position, however, has been deemed “dovish” and formidable.
The thrust of the paper is that “fiscal multipliers were substantially higher than implicitly assumed by forecasters.” This was due to the fact that the fiscal consolidation that had taken place in advanced economies “has been associated with lower growth than expected, with the relation being particularly strong, both statistically and economically, early in the crisis.”
Why have these “multipliers” increased? The authors speculate on several grounds – interest rate policies and the nature of consumption, to name but two. These again point to the flawed models embraced by the voodoo forecasters. For every 1 percentage point of GDP gained in the fiscal consolidation forecast for 2010-11, a loss of 1 percentage point of real GDP occurred. “A natural interpretation of this finding is that multipliers implicit in the forecasts were, on average, too low by about 1.”
It is now assumed that Greece is in a category where, to use the standard jargon, fiscal multipliers are large, and their effects considerably greater than the financial boffins were aware of. (Such errors were similarly perpetrated upon the economies of Portugal, Italy, Spain and Ireland.) Cuts in spending can increase ratios of debt to gross domestic product in severe fashion. To put it in simple terms, pruning the tree too severely will see less growth. Extreme tax hikes and cuts in expenditure can off-set the gains made in any fiscal consolidation. The result is a stunted creature. Such outcomes seem entirely logical, though logic tends to be extra-terrestrial to much economic forecasting.
Since 2010, more than 68,000 Greek businesses have closed, a numbing state of affairs for any minister of finance to contemplate. Prime Minister Antonis Samaras, heading a precarious coalition, is set to impose a further $17.45 billion in spending cuts and tax hikes. Given that the Greek economy is in its sixth year, the tree of economic growth is set for another round of inane savaging.
Financial order is certainly desirable and there is little doubt that Europe’s financial system is debilitated. But financial madness, affected through the current austerity regime, is not. When senior IMF employees working on key economic standpoints start taking different routes of reason, re-assessments are in order. It remains to be seen whether the Blanchard prescription will take hold at all.