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IMF Suddenly Decides It Might be OK to Loosen Austerity Tourniquets Now that Gangrene is Setting In

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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.

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13 comments

  1. vlade

    I’d havea different explanation of the multiplier from Krugman, but I’d say the main point is the multiplier is not a constant – it moved depending on context (although it’s a nice side track for the opponents of the multiplier, picking a period where it is sub one, declaring it a constant and thus saying even if it exists it’s bad).

    Even if the multiplier was sub 1 in say 2005 makes no better argument for it to be sub 1 in 2010 than saying that since growth was >3%in 2005 it should be >3% in 2010.

  2. RT

    On page 43 the WEO concludes thus:
    “More work on how fiscal multipliers depend on time and economic conditions is warranted.”

    And Ms. Lagarde says:
    “It’s sometimes better to have a bit more time.”

    Indeed. But with this she only addressed others, not the IMF’s own faults and omissions, and that’s some sort of cowardice or dishonesty or both. So indeed, too little, too late, and too evasive.

  3. Ich liebe... Ich liebe doch alle

    I have not been so excited by transformative leadership and vision since the Extraordinary 41st Council Session opened boundless new vistas for the Comecon brotherlands.

    1. charles sereno

      “Christine Lagrade (sic) has taken too small a step in the right direction far too late to do much good.”

      Aside from after-life considerations, Yves has given us a model sentence with a remarkable information/word ratio. The subject and main verb merely provide an introductory framework; “step,” “direction,” “late,” “good,” along with their modifiers efficiently carry messages that others spend paragraphs on. Oops! I’m doing that now myself.

  4. g kaiser

    She might have taken a step in the right direction, but she is a former syncronized olympian swimmer. So swim figure!
    And she is also, tothether with most of the rest wrong. You can’t continue keeping sinking ships aflot by printing money!
    Lest all of us sink.
    That much should be clear, especially to a swimmer.

  5. different clue

    Perhaps Lagarde is merely pretending to care and to admit a mistake of some kind, just like Greenspan’s insincere “mea culpa” about his financial actions. Perhaps lagarde and the IMF are secretly pleased that austerity is achieving just exactly what they mean for austerity to achieve . . . which is to collapse the targetted European economies the way the end-stage Soviet Union collapsed so that the private Overclass can bring their money back from tax-haven seclusion and use it to buy distressed people and assets for less than a penny on the benjamin all over targetted Europe. In other words, perhaps Lagarde and the IMF are secretly pleased that the Yeltsinization of Europe is proceeding exactly as intended and she has to pretend to be upset in public so as to throw people off the scent.

  6. The Dork of Cork

    Look this is not that hard to make out.
    There is a symbiotic relationship between the banks ,the financial capitals and their host countries.

    London / UK , Paris,Lyon / France Franfurt / Germany etc. etc.
    For them to live the lives they have grown accustomed to they must burn every village as they know nothing of net capital formation.
    Its a simple real goods extraction operation.

    http://www.youtube.com/watch?v=E1GRlhCrtvE

  7. The Dork of Cork

    The Irish economy blog has posted a piece on about a Irish CSO pub. – “measuring Ireland progress”

    I like the humour , its a interesting bunch of stats.

    The gross fixed capital formation figures are interesting.(Y2011)

    Ireland is at the bottom of the list of course (10.1% 0f GDP with Greece slightly above. (14%)
    But the UK looks very third worldish at 14.2%
    France is at 20.1%

  8. The Dork of Cork

    The Brits are without vision.

    Direct from ORR

    “Government subsidy towards the railway industry in 2011-12 was £3,901 million (£3.9 billion), this is £59 million lower than the previous year.

    2). Government support reached its peak in 2006-07 with £6,308 million; government support has declined every year since.”

    The lines to the south are now reaching capacity limits because of a lack of fiscal money as passenger numbers keep increasing.

    Don’t believe the spin.
    This is not the greatest investment in the rail system since the victorian era – not in real terms at least.

    Much more real British resourses go into high powered 4 wheel drives.

    To compare british private investment in rail capital during Y2011 /12 was £503 million of which £369 million was rolling stock.

    French investment excluding the state and regions exceeds the Brits
    twitter.com/transportktn/status/250530978261504000

    3.4 billion this year ? the big banks are investing in RFF , JP and the lads
    in.reuters.com/article/2012/09/28/idINWNA639220120928
    SNCF spent 2.364 billion Euros on capital stock in Y2011 (58 % on rolling stock , 42 % on stations etc)

    And remember the state and regions sometimes invest a third each or more in rail projects leaving RFF with the remains.

    http://www.youtube.com/watch?v=dOkLFaIdUwA
    38% state
    38% region
    24% RFF

    The Brits are externalising their losses on Europe using their monetary power.

  9. Ruben

    ” Cuts in fiscal deficits [...] 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.”

    From the northern countries point of view it might also be clear that the chemical therapy is not only killing the cancer but it is also killig the patient – BUT relaxing austerity now would allow the cancer to rebound. The cancer is something quite big that nobody wants to speak about because it will really hurt the feelings of Southern politicians and bring about a whole lot of ‘mala leche’ among euro partners, possibly quite swift dissolution. But the cancer is there, waiting to rebound. This cancer are the southern political classes themselves, incompetent and corrupt elites of political parties in Spain, Italy and Greece. Shall the savings of northern country workers and the solidity of northern countries economies be put at risk to save the parasitic southern countries political classes because these parasites are taken their own populations down with them? This is the conundrum faced by northern country politicians and that´s why Wolfgang Schauble has responded today to IMF’s report saying that the austerity efforts shall continue. The real solution, the solution that will empathasize northern countries pops and gov’ts, is a replacement of the current southern political leaders with competent, credible and above all, honest new ones.

    “And in case you missed it, Spain is playing a game of brinksmanship over the “conditionality” terms with the surplus bloc countries.”

    How naive. The Spanish boss is just waiting for the Galician elections. He is lending a helping hand to his comrade in crime the current presiden 0f Galicia, who wants to be re-elected. Asking for the rescue now would joepardize the chances of Galician parasites to keep control of the State machinery. The Spanish boss did the same with the first package of structural reforms, he waited until the Andalucian elections, to help his man there to be elected, a bet that failed and that had the cost of sinificantly increasing national debt by delying the cuts that he had ready for the masses to endure.

    In this pices Ives gives the general impression that the Spanish leader is playing some kind of skillful act of brikmanship in waiting for the rescue. My humble blogger, gimme a break!

    1. Aussie F

      Rajoy should simply stare down the IMF. ‘Pay up, or the banks, and their northern counter parties, can whistle.’
      Rather than holding the population hostage to the banks, why not start holding the banks hostage? After all, they have a lot more to lose.

      The IMF’s a paper tiger, and they will cave the minute a national leader discovers a backbone.

      Lagarde is virtually conveying the same message. Like a nervous hostage taker she’s loosening the bonds, smiling at the victim, and thinking carefully about her plea bargain.

      If Rajoy can overcome Stockholme syndrome Spain’s in with a chance.

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