Mike Callaghan is Director of the Lowy Institute's G20 Studies Centre.
IMF Chief economist Olivier Blanchard recently confirmed that he was 'right about being wrong' in underestimating the effect of fiscal tightening on European economic growth. When he first suggested, in the IMF's October 2012 World Economic Outlook, that forecasters like him had miscalculated the negative impact of tax increases and public spending cuts on economic growth, there was pushback by the advocates of fiscal austerity, particularly in Europe. Others saw the admission as a reason to abandon fiscal austerity.
Blanchard takes on his critics in a report he has recently co-written. He confirms his findings about the effects of austerity, but he has a number of caveats, including that forecasters do not typically state their assumptions regarding the impact of fiscal tightening on growth and that his results are averages, meaning that the impact for individual countries may vary. He also points out that his results do not imply that fiscal consolidation should be avoided, and that the short-term effects of fiscal policy on economic activity are only one of many factors that need to be considered.
Reaction to Blanchard's work continues to primarily be viewed in terms of the sterile 'growth versus austerity' debate. In reality, short-term fiscal consolidation should always be considered in the context of the broader policy advice provided by the IMF. And here the IMF has been largely consistent since the onset of the crisis. [fold]
Its broad policy prescription has been: accommodative monetary policy; fiscal adjustment that includes concrete and credible plans to reduce debt over the medium-term but does not undercut growth in the short-term; clean-up of the banking sector; and pursuit of reforms to boost productivity and lift growth.
For example, in its policy advice to the G20 in February 2009, at the height of the crisis and when the focus was on aggressive fiscal policy action to stop the decline in activity and restore growth, the Fund emphasised that fiscal packages should be set within medium-term frameworks so as to maintain confidence in fiscal sustainability.
In October 2010, the IMF again emphasised the importance of repairing financial sectors, the need for credible medium-term fiscal consolidation plans and to postpone planned consolidation if growth slows, and that fiscal adjustment will be easier if accompanied by structural reforms.
The message was similar in 2012, with a recognition of the need to calibrate the pace of fiscal adjustment with both the state of the economy and funding pressures, the need to maintain confidence with credible consolidation plans, that monetary policy should continue to aid the recovery and that more reforms are needed to boost growth potential.
The IMF Deputy Managing Director's advice for countries at the start of 2013 was: provide accommodative monetary policy; strike a balance on fiscal adjustment, tightening where possible but taking care to support short-term growth; complete the clean-up of the banking sector and implement reforms to boost productivity and growth potential.
So, the IMF can be criticised for many things, but its broad policy advice has at least been consistent.
It is a pity that all elements of this advice have not been followed. Instead, there's been a narrow focus on one aspect of the required policy response, namely short-term fiscal consolidation. Where would Europe be today if it had paid more attention to all elements of the IMF's advice and decisively cleaned up its banking sector, if the German and the British fiscal consolidation plans had payed more attention to the importance of short-term growth and if all countries had accelerated labour and product market reforms so as to lift growth potential?
Similarly, what would be the impact on US business confidence today if there had been an early agreement on a credible plan which dealt with the growing US debt burden but supported growth in the short term?
On all counts, these economies would each be a lot better off than they find themselves today.
Photo by Flickr user blehk.