Tuesday, June 18, 2013

Don’t Misread the IMF “Mea Culpa” on Greece

Those who feel vindicated by the IMF’s “mea culpa” on Greece should really read what the IMF wrote, rather than select the “lessons” they like. The IMF has produced an interesting report on Greece—but the lessons are hardly the ones that the pundits seem to focus on.

What exactly did the IMF “admit?” Broadly speaking, it recognized two mistakes: it said Greece should have gotten a haircut earlier and that the IMF’s projections for how the Greek economy would perform were overly optimistic. But the IMF stands behind the essential elements of the program that we have come to know as “austerity.” It notes that, “it is difficult to argue that adjustment should have been attempted more slowly” (p. 20). In fact, the IMF explains:
The report does not question the overall thrust of policies adopted under the SBA supported program. Fiscal adjustment was unavoidable, as was the sharp pace of deficit reduction given that official financing was already at the limit of political feasibility and debt restructuring was initially ruled out. Structural reforms were clearly essential to restoring competitiveness. Some questions can be raised about the types of measures (overly reliant on tax increases) and structural conditionality (too detailed in the fiscal area), but the policies adopted under the program appear to have been broadly correct. (p. 32, emphasis mine).
As a result, the headline that the “IMF admits it was wrong” does not quite capture what the IMF said. We need to read more closely.

The IMF argues that Greece’s debt, even in May 2010, was likely unsustainable. Yet debt restructuring was ruled by the Europeans for three reasons: (a) reservations about moral hazard associated with debt “forgiveness;” (b) a default would have wiped out the capital of the Greek banking sector, necessitating an immediate recapitalization; (c) the effects on the European banking sector would have been hard to predict but possibly dire.

So far, there is nothing to dispute—these facts have been well known and well understood. The issue is not whether the IMF and the Europeans took different views on the merits of restructuring—they obviously did—but whether this mattered for Greece and its performance since 2010. The IMF, by the way, says very little about this. It notes that “not tackling the public debt problem decisively at the outset or early in the program created uncertainty about the euro area’s capacity to resolve the crisis and likely aggravated the contraction in output.” In a footnote, the IMF expands: “The recent paper on sovereign debt restructuring argues that delay in resolving an unsustainable debt situation serves to depress investment and growth in the debtor country and prolong financial uncertainty.” But the paper in question does no such thing—it merely states, again, that a “debt overhang” has a negative effect on economic activity.

The IMF, in other words, argues that a debt restructuring in May 2010 would have been preferable but it offers no concrete evidence why this is so. Barry Eichengreen has offered the following defense:
Had Greece quickly written down its debt burden by two-thirds, it would have been able to shed its crushing debt overhang. It could have used a portion of the interest savings to recapitalize the banks. It could have cut taxes, rather than raising them. It could have jump-started investment and gotten its economy moving again, if not in a matter of months, then, with luck, in no more than a year.
Of course, it is not clear why these positive things would have happened—why debt restructuring would have allowed Greece to “jump-start” investment and “gotten its economy moving again.” Neither is it clear why Greece would have been able to “cut tax taxes, rather than raising them.” Nor do we know where the “interest savings” would have come from since Greece had to borrow to pay interest—it could borrow to pay interest and service debt or it could default and borrow money to recapitalize banks. As the IMF acknowledges, “it is difficult to argue that adjustment should have been attempted more slowly,” meaning that the cornerstone of the program—tax hikes and spending cuts—would have been broadly similar.

Implicit in this Eichengreen worldview, however, is that debt and economic activity are intimately linked. So to explore this debt question more deeply, we have to examine the IMF’s second mistake: the larger-than-expected recession. To begin with, the IMF acknowledges that:
In any event, a deep recession was unavoidable. Greece lost market access in the first half of 2010 with a fiscal deficit so large and amortization obligations so onerous that it is difficult to see how a severe economic contraction could have been avoided. Indeed, if Greece had defaulted, the absence of deficit financing would have required primary fiscal balance from the second half of 2010. This would have required an abrupt fiscal consolidation, and led to an evaporation of confidence and huge deposit outflow that would have most likely made the contraction in output even larger. (p. 22)
Clearly, the IMF does not quite concur with Eichengreen that debt restructuring would have “jump-started investment and gotten [the] economy moving again.” The IMF believes a deep recession was unavoidable given the fiscal consolidation that had to happen anyway. So where does the IMF attribute its GDP miscalculation? Frankly, nowhere in particular. The IMF notes that:
The program initially assumed a [fiscal] multiplier of only 0.5 despite staff’s recognition that Greece’s relatively closed economy and lack of an exchange rate tool would concentrate the fiscal shock. Recent iterations of the Greek program have assumed a multiplier of twice the size. This reflects research showing that multipliers tend to be higher when households are liquidity constrained and monetary policy cannot provide an offset (see October 2012 WEO), influences that appear not to have been fully appreciated when the SBA-supported program was designed. (p. 21)
It then adds, however, that “Aslund (2013) has also argued that there is a habitual tendency of Fund programs to be over-optimistic on growth until the economy reaches a bottom (and thereafter to underestimate the recovery).” So this could be a broader bias in forecasting. Then, the IMF adds another few culprits:
However, the deeper-than-expected contraction was not purely due to the fiscal shock. Part of the contraction in activity was not directly related to the fiscal adjustment, but rather reflected the absence of a pick-up in private sector growth due to the boost to productivity and improvements in the investment climate that the program hoped would result from structural reforms. Confidence was also badly affected by domestic social and political turmoil and talk of a Greek exit from the euro by European policy-makers. On the other hand, the offset to the fiscal contraction from higher private sector growth that was assumed during the program period appears to have been optimistic … while some of the adverse political developments were endogenous and followed from limited ownership of the program ... A larger contraction should probably therefore have been expected, although it should be noted that market forecasters were no more accurate.
This seems like a much fairer and accurate read of the crisis—not one that blames “fiscal multipliers” but one that acknowledges the linkage between political change and economic activity. The lack of “program ownership” is a persistent theme in the IMF’s report—meaning that the IMF recognizes that Greek politicians were not committed to change.

To its credit, the IMF does not say that debt restructuring would have produced the magical economic benefits that several analysts assume. Perhaps because it has been bogged down in this story for three years, it has a more cynical (realistic) view of Greek political economy and the myriad problems that stand in the way of economic growth.

The real counterfactual to consider is not debt restructuring upfront but political commitment to change upfront—a rapid, immediate and across the board willingness to tackle persistent ailments in Greek politics and economics. Sadly, the only motive for undertaking reforms has been the debt overhang. Even if it has stymied economic activity—which, as I said, is not clear—it has clearly been a political catalyst. It has prompted discussion and introspection, but sadly, not quite as much reform yet. In some ways, this is what the IMF concluded as well, recognizing that this entire experience “provides further evidence that the success of a program hinges centrally on the depth of its ownership.”

If you have take away one word from the IMF’s report, it is not “mistake” but “ownership.”


  1. Obviously, the elephant in the room is the fact that Greece is doomed since neither the political class nor the population seems to be willing to undertake deep reforms. The ERT case is the perfect prove and the IMF is now planning its complete exit from this quagmire.

    I would summarise the IMF mea culpa much more aggressively: "We failed with our programme for Greece because we massively overestimated the Greek will to undertake reforms and massively underestimated the level of obstruction by the political class and the civil servants".

    1. NICOS,

      I stumbled over your book and found it very good. I have since read your blog and found it equally good, you are working your way through the events and coming nearer to the root causes every time you publish a new blog. You have realized that this is not a simple economic problem and therefore it can't be solved be changing the economic systems. You have realized that there is a political aspect also and therefore the political systems will have to bee changed as well.
      I venture that you will arrive at the same conclusion I did 10 years ago, that it is a moral problem. If my assumption is correct then we are not talking about changing systems, we are talking about changing morals of a nation (also called nation building, very time consuming and expensive). Too me the root causes are:
      -11 MIO people have been brought up to think that you can have a civilized society, and still have unlimited personal freedoms, you can't, that is the trade-off you make when you move from the wilderness into civilization, you have to obey and uphold the laws.
      -11 MIO people have been brought up to think that you can have a democratic society with peoples elected representatives making laws, whereupon the same people ignore or defy them, you can't.
      This is a hard sell in Greece as it questions the validity of Greece as the cradle of civilization and democracy (I can't resist the jibe that it may be the cradle as we have enough cry-babies).
      This should be taken as a positive input, I have great respect for your solid and systematic work with the problem(s).

      Lennard Schorlemmer

  2. The Troika, not just the IMF, most definitely did get it wrong in 2010. But the big mistake, as Nicos points, out, was that they wildly over-estimated the sense of "ownership".

    Source: The Economic Adjustment program for greece (may 2010, there's a greek-language version).


    From the section: "Risks and program monitoring".

    "Importantly, the authorities are fully aware of the challenges, and they strongly own and support the programme policies and objectives."

    "the authorities" would have been Prime Minister G. Papandreou, and Finance Minister G. Papaconstantinou.

    I'd say the latter did feel "ownership", yes. He's about the only (ex-) politician in Greece I still have respect for. The former? Forget it, G.Pap just said whatever was necessary to get the money flowing.

    And completely failed to support Papaconstantinou in the inner-Pasok arguments for structural reform.


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