Missing the Downturn

That’s what people around the world should have been asking when the IMF presented its latest assessment of the fiscal and economic prospects for nations around the world last week. Much of the world remains mired in the worst downturn since the Great Depression; a downturn that the IMF totally missed, as noted by the IMF’s own Independent Evaluation Office.

This was not a minor mistake; this was a horrendous failing. It’s comparable to the surgeon amputating the wrong leg or leaving his operating tools inside the patient. This is the sort of incredible mess-up that most people lose their jobs over and likely never find work again in the same field.

Yet, as far as the world knows, not one person at the IMF lost their job. In fact, it’s not even clear that anyone missed a scheduled promotion. As far as anyone can tell, an economic downturn that ruined the lives of tens of millions of people around the world has had no impact whatsoever on the people who actually have the responsibility for preventing such calamities, at the IMF and in other major governmental and international financial institutions.

This makes the IMF’s stance behind the continued drive for austerity in much of world especially infuriating. How can Greek workers feel about being told that they will have to work longer for smaller pensions by IMF economists who can retire with six-figure pensions in their early 50s? The vast majority of Greek workers do their jobs. The IMF economists failed at their job.

Beyond the issue of fairness is the question of competence. The IMF economists obviously did not understand the implications of asset bubbles that were building up in the United States, the United Kingdom, Spain and other wealthy countries. The financial and economic crisis caused by the collapse of these bubbles caught them by surprise.

This is really remarkable. While the IMF economists performed no worse than the vast majority of mainstream economists, this fact cannot provide much consolation for the people who are expected to rely now on their expertise.

Is there any reason to believe that the same people who were so completely clueless in their understanding of the economy just four years ago are now qualified to be giving advice to governments around the world? Did these people go back to school and re-learn economics? Did they at least take night classes where they could learn the basics of economics so that they would not make the same sort of mistakes again?

Judging from their latest policy prescriptions, there is little evidence that they learned much from recent history. Instead of encouraging Greece and other troubled euro-linked economies to go through additional rounds of austerity, which will only lead to further declines in GDP and higher unemployment, the IMF should be telling the European Central Bank (ECB) to increase its inflation target to a 3-4 percent range.

If the euro zone maintained a moderate rate of inflation it would allow the Greek economy to become competitive without experiencing a wrenching process of wage deflation. It would also erode the real value of debt alleviating the burden on both heavily indebted countries and homeowners throughout the euro zone

The IMF does not have to look far for respectable economists arguing for higher inflation as an alternative to continued austerity. Its own chief economist, Olivier Blanchard, made exactly this argument in an IMF paper last year. It would be reasonable to expect that the IMF economists giving advice to countries around the world would at least be familiar with the writings of the organization’s chief economist. If there is an effective response to Blanchard’s argument, it has not appeared on the IMF’s website.

In fact, another benefit of going the route advocated by Mr. Blanchard is that the ECB, as part of its efforts to moderately increase inflation, could simply hold much of the debt that it buys for this purpose. In other words, if attaining a 3-4 percent inflation rate requires the ECB to buy an additional 3 trillion euros of the debt of member countries in order to pump reserves into the banking system, the ECB could simply hold this debt indefinitely.

This has the advantage that the interest paid on debt held by the ECB is refunded to member countries. This reduces the interest burden that these countries will face in future years as a result of the deficits needed to boost the economy in a crisis. At least for the debt held by the ECB, the interest burden would simply be an accounting entry. Interest would be paid to the ECB and then refunded to the member states.

To prevent the additional reserves from creating a problem of inflation once the economy has recovered the ECB could simply raise its reserve requirement. This would have the same impact on the larger money supply as withdrawing reserves from the system by selling off its debt holdings, but the higher reserve requirement route has the advantage of reducing the interest burden of the debt for member states.

Unfortunately, we don’t hear the IMF pushing for a more expansionary policy from the ECB. Nor do we hear it discussing ways that the ECB (and other central banks) could reduce the debt burden for its member states. It seems that the IMF’s economists’ understanding of the economy is no better today than it was before the economic collapse.

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of Plunder and Blunder: The Rise and Fall of the Bubble Economy and False Profits: Recoverying From the Bubble Economy.

This column was originally published by The Guardian.



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Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University.

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