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IMF chief economist admits to austerity mistake

Sunday, January 13, 2013    

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International Monetary Fund (IMF) and European economists "significantly underestimated" the cost of austerity measures on economies across the eurozone, wrote the fund's chief economist Olivier Blanchard in a working paper published two weeks ago, EconomyWatch has reported.

According to the online service that publishes news about the state of the world economy, Blanchard also admitted that the fund did not fully understand how government austerity efforts would undermine economic growth for countries such as Greece.

In a highly technical paper, which contains the boilerplate statement that it "should not be reported as representing the views of the IMF", Blanchard and co-author Daniel Leigh focused on a number used for forecasting known as the fiscal multiplier — the impact that a rise or fall in government spending or tax collection has on a country's economic output — and claimed that the "multipliers implicit in the forecasts were, on average, too low", the EconomyWatch report said.

"Accordingly in 2010, IMF forecasters were using a uniform multiplier of 0.5, when in fact the circumstances of the European economy made the multiplier as much as 1.5, meaning that a $1 government spending cut would cost $1.50 in lost output, EconomyWatch said.

"Forecasters significantly underestimated the increase in unemployment and the decline in private consumption and investment associated with fiscal consolidation," wrote Blachard and Leigh, adding that they had corrected the forecasting error in the October 2012 World Economic Outlook.

EconomyWatch said that in 2010 fund forecasters, using inaccurate multipliers, had effectively predicted that Greece could cut deeply into government spending and still quickly bounce back to economic growth and rising employment. But two years later, the Greek economy is still shrinking, and unemployment is at 25 per cent.

Blanchard and Leigh however denied that the study was denouncing austerity, claiming that "deciding on the appropriate stance of fiscal policy requires much more than an assessment regarding the size of short-term fiscal multipliers", the EconomyWatch story said.

"Our results should not be construed as arguing for any specific fiscal policy stance in any specific country. In particular, the results do not imply that fiscal consolidation is undesirable," EconomyWatch reported Blanchard and Leigh as saying.

"Virtually all advanced economies face the challenge of fiscal adjustment in response to elevated government debt levels and future pressures on public finances from demographic change," they added. "The short-term effects of fiscal policy on economic activity are only one of the many factors that need to be considered in determining the appropriate pace of fiscal consolidation for any single country."

Speaking the BBC, Professor Ngaire Woods, a former independent advisor to the IMF European Regional Advisory Group, said that the IMF has been urging "any country that can, should slow down austerity". However, these countries "shouldn't do it as one big bang upfront, because the results on the economy will produce a vicious cycle".

"Fiscal consolidation should be spread out," EconomyWatch reported Woods as saying.

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