See I Told You So

Never bark at the big dog. I’ve been warning for two years now about the bad consequences of austerity. During that time much more prominent figures have been trying to reassure us all that everything is hunky-dory and austerity is the Holy Grail of growth and prosperity. One of those prominent figures was the chief economist at the IMF.

Until now, that is. Behold his mea culpa:

Consider it a mea culpa submerged in a deep pool of calculus and regression analysis: The International Monetary Fund’s top economist today acknowledged that the fund blew its forecasts for Greece and other European economies because it did not fully understand how government austerity efforts would undermine economic growth.

This “did not fully understand” part has cost Greece five years of shrinking economy, mass unemployment, an entire generation’s future destroyed by economic devastation – and a rise of totalitarianism to now win the support of 40 percent of the electorate.

I’ve been warning about the dire consequences of austerity for more than two years now:

I have done this based on traditional Keynesian macroeconomic analysis. In the meantime, everyone from reputable scholars at major think tanks in Washington, DC to the big wigs at the IMF, the European Central Bank and the EU have promoted austerity almost like the Second Coming.

That is, of course, until the IMF now caves in and admits that Keynes might actually have been right after all. The Washington Post again:

The new and highly technical paper looks again at the issue of fiscal multipliers – the impact that a rise or fall in government spending or tax collection has on a country’s economic output. That it comes under the byline of fund economic counselor and research director Olivier Blanchard is significant. Fund research is always published with the caveat that it represents the views of the researcher, not the institution itself. But this paper comes from the top, and attempts to put to rest an issue that has been at the center of debate about how fast countries should move in their efforts to tame large debts and deficits.

The IMF seems to be downplaying this to be a matter of macroeconomic technicalities:

If fiscal multipliers are small, countries can cut spending faster or raise more in taxes without much short-term damage. If they are large, then the process can become self-defeating, at least in the short run, with each dollar of government spending cuts, for example, costing the economy more than a dollar in lost output and thus actually increasing debt-to-GDP ratios. That is what has been happening with a vengeance in Greece, where fund forecasters, as part of the country’s first bailout program in 2010, predicted that the nation could cut deeply into government spending and pretty quickly bounce back to economic growth and rising employment.

What on God’s Green Earth made them believe that?? It’s not that complicated to understand why austerity spending cuts don’t work.

“Forecasters significantly underestimated the increase in unemployment and the decline in domestic demand associated with fiscal consolidation,” Blanchard and co-author Daniel Leigh, a fund economist, wrote in the paper. That somewhat dry conclusion sums up what amounts to a tempest in econometric circles. The fund has been accused of intentionally underestimating the effects of austerity in Greece to make its programs palatable, at least on paper; fund officials have argued that it was its European partners, particularly Germany, who insisted on deeper, faster cuts.

In fairness toward the IMF, I did report in November that one of its former officials had admitted that the Fund’s austerity programs for countries like Greece were doing nothing god and a lot of harm.

Still, that was a former official speaking. If current officials had spoken up earlier they might have avoided such destructive austerity packages as the latest government budget in Portugal, which is now going to wreak havoc on their economy.

Back to the Washington Post:

[The research paper] includes some subtle and potentially troubling insights into how the fund works. Blanchard – effectively the top dog when it comes to economic science at the fund – writes in the paper that he could not actually determine what multipliers economists at the country level were using in their forecasts. The number was implicit in their forecasting models – a background assumption rather than a variable that needed to be fine-tuned based on national circumstances or peculiarities. Heading into a crisis that nearly tore the euro zone apart, in other words, neither Blanchard or any one of the fund’s vast army of technicians thought to reexamine whether important assumptions about the region would still hold true in times of crisis.

Imagine a doctor who prescribes pencillin for your boken leg because last time you came in you had a cold. That is, in a nutshell, how dumb the IMF economists apparently are when it comes to multipliers. These are people with Ph.D.’s from prestigious schools like Harvard, UCLA, Carnegie Mellon and MIT. These are people who are supposed to be the cream of the crust of the economics profession. And I, who earned my Ph.D. at a small liberal arts school in Denmark, knew far better than them what the consequences were going to be if they continued to force austerity down the throats of troubled European nations.

Reminds me of the anecdote about Jan Tinbergen, the father of econometrics, who told John Maynard Keynes that “your estimate of the multiplier was correct”. Keynes, who knew very little econometrics, had made a simple estimate based on regular macroeconomic data, while Tinbergen had spent a lot of time working through complex regression analysis. Keynes smiled mildly and replied: “I’m glad you got the right number”…

The problem with econometricians is that they are vastly over-confident in their models. To them, smooth results are often more important than results with high real-world reliability. When I was teaching macroeconomics I butted heads with the department’s econometricians all the time over how they taught their students to put distance between reality and their regression analysis in order to get “smooth” results. I kept telling them – and the students – that for every step you take away from reality, you are coming closer to pure sophistry.

Usually the consequences are just bad forecasts of some isolated variable in the economy. In this case, though, the fallout has been downright draconian.

In fact, what the IMF has done here is nothing short of macroeconomic malpractice. If a pharmaceutical company released a drug that made millions of people sick, it would be sued out of existence. If a car company manufactured a car where critical functions failed, it would be sued into oblivion.

Even a meteorologist who makes a very bad weather forecast has to take a lot of flak and can lose his job.

When a bunch of economists make fatally erroneous predictions that austerity is good for a country, they can reduce it to technicalities in regression analysis.

I have not used any regression analysis to explain why austerity is bad. I’ve used standard Keynesian macroeconomic theory. I beat them all, and I am proud of that. But more importantly, I am outraged that people who dare call themselves economists can allow this to happen.

This is a reason for economists to reconsider their obsession with econometrics and other mathematically based analytical methods.

It is also a reason for a renewed debate about how to get rid of big government without causing undue harm to the poor and needy among us.