Thursday, 6 June 2013

Being wrong pays for the IMF - on Greece and elsewhere

Strange mea culpa from the IMF on Greece.

On the one hand, it admits that it was over-optimistic in its assessments of the impact that fiscal tightening would have on growth/public debt sustainability etc. On the other hand, Wall Street Journal reports, the lessons learned would lead them to take a tougher stance in future bailouts.

Sounds like a contradiction? Yes, it is. It's also indicative of the way that IMF has designed and implemented conditionality wherever it goes: always too optimistic. Pawel Morski, on Twitter, unearthed a couple of similar quotes for Asia and Argentina. I found the same for IMF programs in Eastern Europe during 2009-2010 (Romania, Hungary, Latvia). We can go back even further: the IMF's own Independent Evaluation Office 2003 report on Fiscal Adjustment in IMF supported programs:

Overoptimism about fiscal adjustment is partly caused by overoptimism about growth projections. 
Absolute levels of revenue respond to growth with shortfalls in growth leading to corresponding shortfalls in revenue. However, absolute levels of expenditures, projected on the basis of optimistic growth forecasts, do not fall when growth falls below expectations, leading to an increase in expenditure ratios.  (p.13)

Let's put aside the fact that austerity has a very poor record, as Mark Blyth so thorougly documented in his last book and turn to the more mundane question of too-optimist forecasts.

Forecasting errors are to be expected in a crisis when uncertainty prevails and conditionality is applied. Hardly fair to fault the IMF for that. Yet the question remains, how come the IMF is always too optimistic? Because it doesnt want to scare markets, is the typical answer. But that, in my opinion, ignores an important angle of the politics of the IMF's crisis interventions. The IMF does not negotiate with markets over austerity, but with governments.

Growth forecasts are central to fiscal conditionality. The IMF sets fiscal targets as budget deficits to GDP ratios. For example, the Greek deficit target for 2012 was 6.6% of GDP.  The choice that the IMF makes about being optimistic or pessimistic about its forecasts is a political choice. Consider again the quote from above: absolute levels of revenue fall with the lower growth, whereas absolute levels of expenditure dont. The numerator  (budget deficit) gets bigger. If the IMF chooses to be optimistic about future Greek growth, then the actual denominator will be smaller. The budget deficit to GDP ratio becomes much bigger than its target. To meet the target, the Greek government has to choices: cut more or re-negotiate targets with the IMF. 

So, it's not that the IMF somehow magically recruits optimistic people. It's rather that optimistic growth forecasts strengthen the IMF’s leverage in negotiations. Think about Greece: governments have to go back, hat in hand, to the negotiating table in order to persuade the IMF that its political survival depends on slightly less draconic targets. Being wrong pays for the IMF, as long as its being optimistically wrong.