Wednesday, October 17, 2012

IMF May Re-Think Austerity

While deathbed conversions might earn you a spot in heaven in some religions, they don’t carry you very far here on Planet Earth.

Christine Lagarde has taken too small a step in the right direction far too late to do much good. At the current IMF annual meeting in Tokyo, she’s made dramatic-sounding pronouncements consistent with the rather embarrassing admission in the Fund’s latest quarterly report that austerity is working less well than voodoo (I’ve never tried it myself, but some correspondents give it high marks).

As we stressed, the IMF has admitted what observers have already reported on, at some length, by looking at economic outcomes in Latvia, Greece, Ireland, Portugal, and Spain: its tender ministrations are leaving its patient worse off. Cuts in fiscal deficits (ex in special circumstances, such as being able to trash your currency at a time when your trade partners have good levels of growth) lead to even greater falls in GDP levels, resulting in higher debt to GDP ratios, the exact opposite of what this exercise was intended to accomplish. The bureaucratese is “fiscal multipliers.” When fiscal multipliers are greater than 1 deficit cutting makes matters worse. The IMF’s ‘fessing up to a problem without releasing country by country data suggests it is showing fiscal multiplies greater than 1 in pretty much all of the countries now wearing the austerity hairshirt.

And don’t try arguing that the IMF was blindsided. Numerous observers have railed against the all too obvious failure of “destroy the village to save it” posture of the Eurocrats. Paul Krugman points out even if you start with theory rather than practice, it was similarly not reasonable to expect small fiscal multipliers in the wake of a financial crisis.

While Lagarde’s willingness to buck her fellow Troika members a tad is a welcome development, it is too little, too late. It looks more like an effort to assuage guilt and burnish her record for posterity than do the right thing and seek to break with the IMF’s sorry history of breaking countries on the rack out of fealty to bankster-friendly but otherwise fundamentally wrongheaded policies. As we indicated, the Fund is late to recognize the failure of these policies. And on top of that, despite the dramatic headlines, Lagarde is not in fact calling for a rethinking of austerity. All she is suggesting is that when it becomes evident it is not working (as in countries miss their targets) that they not be required to make deeper cuts. This is tantamount to loosening a tourniquet once gangrene has set in. From the Financial Times:

Christine Lagarde has urged countries to put a brake on austerity measures amid signs that the IMF is becoming increasingly concerned about the impact of government cutbacks on growth.

Ms Lagarde, IMF managing director, cautioned against countries front-loading spending cuts and tax increases. “It’s sometimes better to have a bit more time,” she said…

“It’s much more appropriate to apply the measures and let the [automatic] stabilisers operate,” Ms Lagarde said. Automatic stabilisers allow for the lower tax revenues and higher benefit payouts associated with a weak economy. “That applies to pretty much all the countries, particularly in the eurozone, that are applying that policy mix.”

The Telegraph gave a clearer sense of how far Lagarde has retreated from the IMF’s past position, which is some but not all that much:

She also reiterated the softening of the IMF’s position on austerity, saying that governments should no longer pursue specific debt reduction targets but focus on implementing reforms.

If borrowing rises as a direct result of growth-sapping measures, the IMF now thinks it should be tolerated rather than addressed with even more tax rises or spending cuts. “We don’t think it’s sensible to stick to nominal targets. We think it’s much more sensible to apply measures and let the stabilisers operate,” she said.

One has to wonder if part of the reason for the public shift in posture is the way Spanish Prime Minister Rajoy has refused so far to have Spain submit to the Troika’s yoke, even as the silent run on Spanish banks accelerates. As Ambrose Evans-Pritchard points out:

Olivier Blanchard, the IMF’s chief economist, said Madrid was courting fate by trying to muddle through without a bail-out – and without the tough terms it would bring – now that borrowing costs had fallen on hopes of bond purchases by the European Central Bank…

The IMF said capital flight from Spain reached €296bn (£238bn) in the 12 months to June, or 27pc of GDP. It matches the intensity of “sudden stop” crises seen in emerging markets.

Banks in Spain, Italy, and the EMU fringe cannot easily make up the shortfall by turning to the ECB because they are short of usable collateral.

The biggest risk is that Europe’s banks will have to slash balance sheets by €4.5 trillion by the end of 2013, largely concentrated in the Club Med bloc.

The fund said Europe’s failure to flesh out promises for a banking union – needed to break the “vicious circle” between banks and states – risked a violent credit crunch, slashing an extra 4pc off output in southern Europe next year. Most economists say a shock of this magnitude would push Spain into a death spiral.

And in case you missed it, Spain is playing a game of brinksmanship over the “conditionality” terms with the surplus bloc countries. The sketchily-outlined plan over the summer left everyone thinking they had a deal for rescuing Spain’s underwater banks. But even though the Spanish sensibly wanted the banks rescued directly rather than having the borrowing channeled through the government and thus added to official debt, the northern countries appear to have retraded the deal and want Spain on the hook. Again from the Telegraph:

Mr Rajoy and French president Francois Hollande seized on the warning, demanding the AAA core stands behind its pledge to let the ESM recapitalise Spain’s banks directly. “We have to show we’re serious people and that we do what we say we are going to do,” said Mr Rajoy . Germany, Austria, Finland, and Holland reneged on the accord two weeks ago.

What is desperately needed to buy more time would be a Eurozone deposit guarantee, but so far, there seems to be no willingness to implement that in advance of a banking union, which will take time to hammer out (and that assumes that considerable differences can indeed be bridged).

While the Eurocrats have, again and again, managed to implement the bare minimum needed to stave off a full bore crisis, each intervention is buying less and less relief and the differences in underlying positions appear to be hardening. While I’d be delighted to be proven wrong, Yanis Varoufakis has said the Eurozone is on a path to dissolution, and it’s hard to see how the politics can shift enough to alter the current trajectory.


No comments: