Subscribe free to our newsletters via your
. Earth Science News .

Walker's World: Why the IMF was wrong
by Martin Walker
Frankfurt, Germany (UPI) Oct 15, 2012

disclaimer: image is for illustration purposes only

In the five years since the financial crisis began, economic analysis has been dominated by the Keynesians who want more government stimulus spending to restart growth and the followers of Hayek and the Austrian school who insist on austerity by cutting public spending and paying down debt.

Now we should start paying attention to the French. For most of the crisis, the International Monetary Fund, the nearest we have to a system of global economic governance, has been in French hands. Its leaders have been two French finance ministers in succession, Dominique Strauss-Kahn (more famous now for extra-curricular activities) and Christine Lagarde, a lawyer by training.

The IMF chief economist since 2008, Olivier Blanchard, is probably more important. On leave from the Massachusetts Institute of Technology where he is a professor of economics (he previously taught at Harvard), he along with Fed Chairman Ben Bernanke and European Central Bank chief Mario Draghi is one of the three most powerful economists alive.

Blanchard has just revolutionized the academic debate about economic policy and the crisis. In the IMF's latest World Economic Outlook Blanchard and his team have come up with new research which convinces them that austerity is the wrong way to go.

Some of us saw this coming. Last December, Blanchard's blog referred to this ongoing research and its affect on the spreads on government bond yields. But he didn't spell out as clearly as he has now done the implications of the research.

To try and make a complex issue more simple, the question Blanchard's team addressed was the affect of cuts in government spending on gross domestic product growth. We know that cuts will reduce output, since there will be less money in the hands of the public to buy products and thus less incentive for manufacturers to make more. But it is hard to calculate how much the knock-on effects of the cuts bite into growth.

This is called the fiscal multiplier. Usually, we try to calculate this another way, by asking how much extra growth will a certain amount of extra government spending produce.

For the past decade and more, the IMF (and almost all government economists around the world) have assumed that the multiplier effect of spending cuts is 0.5; that is to say, cut public spending $100 billion and you cut growth $50 billion.

The new IMF research says this was wrong, and the multiplier effect is much greater -- somewhere between 0.9 and 1.7. That means that cuts of $100 billion means growth reduced $90 billion-$170 billion.

Wow! If that is right, the IMF is saying that the more you cut government spending the more your overall output will shrink -- and you will never get out of the hole. Your economic output just continues to decline, which is precisely what we have seen happening in Greece.

How could the IMF have been so wrong in the past? There are two explanations.

First, the previous calculations about the multiplier effect were made before the crisis when most of the world economy was doing fine. So when one country got into trouble and started to cut public spending, it could export its way out of trouble.

With the whole global economy faltering, that is no longer possible, and eurozone countries are no longer free to devalue their currencies which would make exports cheaper.

The second explanation is that for the past few years central banks have been artificially holding down interest rates to extraordinarily low levels, which distorts everything.

If the IMF is right, then the Keynesian school appears vindicated and the austerity school looks like a bunch of economic sado-masochists who should be locked away in the attic like so many crazy aunts. Government should start to use those low interest rates to borrow (and when governments can borrow for 30 years at 2 percent interest, that is like free money) and invest the money is job-creating infrastructure like repairs and maintenance on roads and bridges.

The best investment of all would probably be retro-fitting all buildings to Swedish standards for insulation, which would cut future energy costs dramatically and permanently.

A huge debate is under way among economists and financial analysts to double-check the IMF's research. At first sight, it is persuasive but there are weaknesses. Much of the analysis is Europe-based and gives a lot of weight to the experiences of Greece and Germany, which may not be typical, and no weight to some Baltic countries which succeeded with debt-reduction (but which were free to devalue).

The IMF is cautious about recommending changes in economic policy, saying only "if growth should fall significantly below current projections, countries with room for maneuver should smooth their planned adjustment over 2013 and beyond."

Translated, that means don't cut for the sake of cutting; remember the need for growth.

What they left out was an apology to the Greeks.


Related Links
The Economy

Comment on this article via your Facebook, Yahoo, AOL, Hotmail login.

Share this article via these popular social media networks DiggDigg RedditReddit GoogleGoogle

Memory Foam Mattress Review
Newsletters :: SpaceDaily :: SpaceWar :: TerraDaily :: Energy Daily
XML Feeds :: Space News :: Earth News :: War News :: Solar Energy News

Fiscal policy should be 'growth friendly': IMF body
Tokyo (AFP) Oct 13, 2012
The world economy needs to balance austerity with growth if it is to recover fully from the global financial crisis, a key IMF committee said in Tokyo on Saturday. "Fiscal policy should be appropriately calibrated to be as growth-friendly as possible," the International Monetary and Financial Committee said in a communique. The statement came after days of back and forth between those -- ... read more

French broadcaster apologises to Japan over Fukushima gag

Planning can cut costs of disasters: World Bank

12 Chinese workers killed, 24 hurt in dormitory blaze

Far, far beyond wrist radios

ESA deploys first orbital debris test radar in Spain

Boeing Proposes Gas Clouds to Remove Space Debris

Microsoft to price new tablet near same as iPad

UNH scientists provide window on space radiation hazards

Scientists Uncover Diversion of Gulf Stream Path in Late 2011

Documented decrease in frequency of Hawaii's northeast trade winds

Too much of a good thing can be bad for corals

Judge scraps Amazon dam hearing

NASA's Operation IceBridge Resumes Flights Over Antarctica

Antarctic Sea Ice Reaches New Maximum Extent

Polarstern returns with new findings from the Central Arctic during the 2012 ice minimum

DRI scientist co-authors study outlining vast differences in polar ocean microbial communities

Mystery of nematode pest-resistant soybeans cracked

Gene Suppression Can Reduce Cold-induced Sweetening in Potatoes

Nepal culls chickens amid bird flu outbreak

Strengthening a billion-dollar gene in soybeans

Tropical cyclones are occurring more frequently than before

Hurricane Paul loses punch as it nears Mexico

Paul becomes major hurricane off Mexico

Scientists identify trigger for explosive volcanic eruptions

Critical bishop expelled from Chad back in Italy

Four dead after day of violence in restive Nigerian city

Thousands march in Mali to urge intervention against Islamists

Nigerian farmers sue Shell in Dutch case with global reach

Nasty noises: Why do we recoil at unpleasant sounds

UN report warns of possible rise in child marriages

Chimps said attacking humans in Africa

New human neurons from adult cells right there in the brain

The content herein, unless otherwise known to be public domain, are Copyright 1995-2014 - Space Media Network. AFP, UPI and IANS news wire stories are copyright Agence France-Presse, United Press International and Indo-Asia News Service. ESA Portal Reports are copyright European Space Agency. All NASA sourced material is public domain. Additional copyrights may apply in whole or part to other bona fide parties. Advertising does not imply endorsement,agreement or approval of any opinions, statements or information provided by Space Media Network on any Web page published or hosted by Space Media Network. Privacy Statement