Why is the Greek austerity program wrong and the bailout conditions totally wrong? Because the IMF “Multiplier” was wrong! Remember the International Monetary Fund report from June 2013 admitting that the IMF failed to realize the damage caused by the austerity and that IMF applied wrong fiscal multipliers? “Hence the Troika and the bailout conditions for Greece are wrong and the Greek govt is perfectly within its rights to ask for new one, that is not based on errors” notes our economist friend Cheshire Cat, who sent us an article explaining the madness.
Petering out in Never Never land by Cheshire CatEven if the EuroZone and the Greek economy survives the present crisis, there is a madness in its arrangements (fiscal compact) that threatens the Eurozone’s long term existence. Crises will reappear whenever there is a period of strong growth in the Eurozone. Internal trade imbalances, surpluses and deficits will build up again and creditor countries and Euro institutions will again give the entirely wrong response. This, and the damage this cycle does to investment, makes Europe a lost Continent. It is ironic that Syriza, mistakenly called anti-Euro, has something that at least looks like a plan to save the Eurozone from itself.Remember that Fiscal Multiplier?
Here is a simple school exercise in numbers that seems to be beyond some European governments.
A country has a very large budget deficit and wants to reduce it. GDP is $100 and its budget deficit is 10% of GDP and it is told to reduce it to 5%. So it cuts government spending by $5 and overall spending, GDP, falls by $5.
Someone’s spending is someone’s income, and they too are forced to spend less which in turn affects other incomes. After a small cycle of after-effects (the multiplier) overall spending falls by, for example, by 1.5 times the initial cut. If the tax rate is 25%, then the following changes are
-$5 the initial spending reduction
-($5)(1.5) = $7.5 the overall fall in incomes and spending – as people loss jobs and spend less
Old tax revenues = $25 ;
new tax revenues = $( 100 – 7.5) x 25% = $23.125
-$1.875 = Fall in tax revenues
The deficit falls from $10 to $6.875 (not to $5 as the Troika hoped for).
But what percentage is $6.875 of $95? Hmmm its 7.4% not 5%. of GDP. Someone’s cheating, lets apply more cuts. Surprise, surprise… those nasty Greeks are missing their deficit targets again.
The IMF assumed /calculated the Fiscal Multiplier was close to one, but were found to be a lot higher in times of distress than in normal times. Europe’s austerity policies were therefore founded on faulty assumptions. They should be reviewed. This is basically what Syriza in Greece is asking for. It has to refuse to continue with a “bailout package” that is fundamentally wrong and destroying the real economy. For many Greeks the choice has become very simple: “your home or Grexit”.
So why are some Governments so persistent, even if it means throwing away their own taxpayers’ money?
Well you need to believe in euro fairies as every time you don’t believe in one, then one …. kind of exits. Now you do believe in euro fairies, don’t you …. ?
Never Never Land 2015
Maybe austerity in Greece didn't really work out that well. IMF f'casts v reality. HT @yvessmith and Bill Mitchell: pic.twitter.com/umU5diO48l
— Jamie McGeever (@ReutersJamie) February 9, 2015
One of the first ‘lessons’ I received in my career was when I got into an argument with my boss and I was sure that I was right (and I probably was). My boss said to me: “The graveyards of the world are full of people who were right”. My boss was Dutch…
Economics cannot be explained with numbers alone; they are not an exact science. The key ingredient of economics are the ‘economic agents’, i. e. the people. Or rather: the psychology of the people.
I would argue that the major reason why the memoranda failed is that they did not sufficiently take into account Greek psychology and culture. Perhaps the assumption was that the Greeks would react exactly like the Chileans had reacted once the Chicago Boys implemented their own version of austerity beginning in the mid-1970s.
The Chilean austerity was brutal beyond imagination. I doubt it could have been implemented in a democracy. Private and public companies were told, overnight, that “if you can’t make it on your own, you will go bankrupt. Your assets won’t disappear. A new investor will come along and buy those assets at a price which allows a return”. Speaking of neoliberalism… And the budget, of course, was brought into balance almost overnight. It was like changing from left-hand to right-hand traffic over a weekend. The traffic chaos on the following Monday was incredible.
Nevertheless, much of the Chilean population reacted favorably to the new rules of the game. Entrepreneurial spirit was promoted and set free enourmous creative energies, particularly among the young Chileans. Within 5 years, the Chilean economy had returned to substantial growth and to a path towards economic sovereignty and stability.
I ask that this, please, not turn into a discussion about Pinochet and the Chilean junta. All I am trying to point out is that economic models per see cannot guarantee success because it is the reaction of the ‘economic agents’, the people, which determine whether a given model works or not.
temptation is big and inevitable to make the link with the junta. because in democracies you cannot enforce such rules with such brutality. why do you think all these scare-mongering tactics here? a psychological war aiming to suppress any reaction of the “economic agents”, the people.
IMF cure worked also in Poland relatively well. In conditions of democracy, ok , democracy beginning after communism. Of course, people were unsatisfied, protested and changed 2 times the government democratically, but it worked. Nobody – as far as I know – was killed.
I would more suppose that – except multipliers – the reason was euro. Internal devaluation instead “normal” devaluation prolonged Greek suffering. You can lose 20 % or 30 % in a year, in one shock , but when you lose 5 or 10 % every year – and the same 5 years – you lose the hope that “normal”, centrist ways will work. This is psychology, 5 years is too long – you cannot hope that it will be better any time and in despair you go to extreme.
The Polish cure was very hard, but after 2 years the economy started to get up.
so it is: Poland had its own currency
Yes, let us compare a normal devaluation to internal devaluation:
normal devaluation by 20 % : all commodities become cheaper (in foreign currency) except imports. As imports are only a part of expenditures, normal people do not see it. People buy less imported goods, but no problem for country’s goods (except if they had extreme much external component).
After some time export grows (because commodities are cheaper) and money can revalue again
Internal devaluation : you cannot make your own commodities cheaper, so you must lower salaries and pensions. But if you lower salaries and pensions, people will buy less – not only imported goods (normal devaluation) , but all goods. Then we have the amazing vicious circle of Greece: people have less money, they buy less, so businesses have less revenue, so less taxes , less taxes – again one must lower pensions and salaries, but then people buy less, so businesses… it becomes boring.
In some moment it finishes, but it is extremely painful. And it prolongs the horror to years.
PS. Normal devaluations by, let us say, more than 30 % are also dangerous – inflation.
PS. Of course, Keeptalkinggreece, we have communist past – and maybe this made people stronger, I mean more patient. Together with the IMF cure there came freedom of press, free elections, possibility to travel to the EU and outside the communist block. Maybe it made people more patient.
But I still think that after 5 years of going down one loses all hope, and one can survive 2 years of extreme austerity. Human life is not that long and it is easy to lose hope.
I agree with Klaus on many of his points. The problem with such silly economic models and their agents was the basis of the Lucas critique or Goodhart’s law (1970s) ie “When a measure becomes a target, it ceases to be a good measure” It is the stubborn or dogmatic holding on to a belief (often hidden as a model assumption), despite all evidence to the contrary, that breaks and crashes the model. The IMF, to its credit, has admitted the error and has pointed its finger at the insistence of the other members of the Troika. The case of Chile is worrying. However, I have reason to believe that the Chicago boys (& the Adam Smith boys in the UK) are more worried about the chaos that the EU’s version of austerity is creating. Plus, the geo-politics in this region is far more complicated than it was in the US’s backyard
I must admit that I am biased. My thesis at an American college was on the post-WW2 political development of Austria. I had just read a tremendous book where a highly-regarded social scientist had proposed a certain model to understand political developments. That model fit my thesis 100% and I based my entire thesis on it. I was so convinced that I had just developed something monumental that I expected to get two straigth summa’s. I got one summa (from a German visiting professor) and one which was barely a cum. I felt destroyed and sought vindication. A third professor, a very impressive American lady, was assigned. She gave me a magna but wanted to discuss the thesis with me.
She said that she gave me a magna because it was obvious that I made very substantial research, more than normally required, and that it was obvious that I felt passionately about my work. But then she explained her reservations. She said that, as a matter of principal, one should be very suspicious when economic and/or political models are expected to explain the economy or the politics of a society because rational thought should convince one that there cannot be such an all-encompassing model. Well, that made a lasting impression on me and more than once in my life did I see that rule proven.
The so cold Chilean economic ‘miracle’ was a neoliberal fraud. The economic growth of Chili at that time was lower than the surrounding countries. And what is economic growth worth as the majority of Chileans not benefited from it. Yes after 30.000 deaths ‘reacted much of the Chileans population favorable to the new rules of the game’ because they came out of the barrel of a gun!
All true – but there are two problems :
1. IMF published it some time ago (maybe two years ago) that they made a mistake in multipliers. Probably since then they tried to correct themselves. And throwing out Troika and speaking instead with governments (including Germans, Finns) is risky – Germans are more pro-austerity than Troika.
2. Syriza is absolutely right in wanting to decrease primary surplus – these 2 or 2,5 % of difference in GDP will flow then to economy , diminishing austerity and helping development. No matter how it will be spent, in lowering income tax or paying more for hospital or… Both ideas are ok. It can mean beginning of development.
3. The problem is too many promises and too much confrontation – after the elections. At the beginning I was also scared that Syriza is communist, but they are just left – no more communist ideas like nationalizations anymore etc.
But asking for reparations from Germans now – I fear that both sides, instead of speaking about multipliers and primary surplus, will take nationalistic attitude and then… I hope not. But I imagine with big difficulty Germans blinking now and saying : yes, we will help you with primary surplus and pay the huge reparations. Both would cost…
OK, sorry for trolling again. The problem is – both sides are partially right, but very inclined to fight. But we will know what will happen soon :). On Wednesday.
As far as I know, the IMF knew from the beginning that the fiscal multiplier could be over one (as the fund later on admitted). But because of the European Commission “needed” the number to be below one they “chose” 0.5 there.
Without it, you cannot justify austerity. Fiscal multiplier was on my top topics a couple of years back.
Do you have any data that they (IMF) knew it before ? Any link ? It would change totally the story : from an error to a crime.
I can believe that they committed a grave error, but if they had known it before… It would have no sense to “save” Greece , knowing that it will drown.
I still believe it was an error, but …
Its an error (or rather an classical assumption form the 1990s onwards ie http://en.wikipedia.org/wiki/Ricardian_equivalence that tied down the ability of models to forecast).
The IMF are, in a way, more sympathetic to Greece. The problem lies with the other members of the Troika, and the Troika on the ground who are just following instructions. It is the political narrative that is difficult to change.
If anything is criminal, then it is the “there is no alternative” narrative. Forecasting and policy models are always subject to errors.
For links – see the KTG link above or more directly
New paper reports
these are much too many links
whoops… in twitter mode 🙂
yes 🙂 always in twit mod
As I said, the main problem in “Troika” was the European Commission. It had an agenda “to punish the sinners”, even though for every recklessly borrowed euro, there must be a reckless bank borrowing it.
I blame also The ECB on that front, when (via Basel Committee) The ECB declared every euro nation as “completely riskless”.
Yes, it brought down the interest rates for Greece and thus it is not a bad thing. The bad thing was that this gave room for much heavier debt, which – according to one grrrrhhhhhh politician – “We all ate it together”…
There have been reports that “IMF was sceptical” in first (i.e. at the beginning) of European Commission’s “decision that the fiscal multiplier is 0.5”. I think they can still be found on IMF’s own site as “working papers” released later.
I agree this is much like “a crime”. For example IMF calculated (again later) that on some countries, notably Spain, the fiscal multiplier could be even above 3! (So if you cut 1€ of expenses your GDP drops by at least 3€).
The root problem of cutting expenses are that some absolutely useless jobs are “reward jobs” for political parties’ root supporters. They are not cut, but instead nurses, teachers… This is why fiscal multiplier reaches so high.
Here are a couple of links I studied when I first came across in Fiscal Multiplier, I hope they help:
guys, you drive me crazy with the links
I am sorry, but I was asked and this time these are very related to the main topic. 🙂
Excellent conversations on this blog post, so good work.
Thanks again for Kepting Greece Talked about. 🙂
Humanity (and officials) commit errors all the time, we live in a reality that cannot be fully foreseen , especially in economics. So I still think it was an error, but I would be extremely interested if it were wrong :).
I want my currency back!
To verify my hypothesis that euro works not well, I decided to troll a little more. Of course, we can compare only past – maybe it will be totally another way in the future. I took from Wiki GDP (purchasing power parity) 1999 and 2013. And what do we get ? Germany and Austria develop with about the same velocity as rich countries without euro, but France already develops more slowly, and Italy and Greece develop very badly.
First conclusion: Euro is probably not so good even for the north of Europe – it does not cause that Germany develops more quickly than UK, US, Australia. And it is a disaster for the south.
Second conclusion : bankruptcy is not so bad. Notoriously bankrupt Argentina and Ecuador with its original tactics develop much more quickly than Greece.
Third conclusion : Chinese case is amazing. Better to privatize Piraeus Port, if the buyers are Chinese :).
By the way, Chile seems to be richer than neighboring countries – so Chicago boys’ cure under guns was probably pretty effective.
Austria 27600 44000
Australia 28300 45000
China 2600 12000
Germany 27000 43000
Switzerland 35000 53000
Italy 26000 34000
US 34600 53000
Greece 18000 25000
Argentina 12000 22000
Chile 11000 23000
Canada 28000 43000
France 27000 39000
Finland 25000 40000
UK 23000 36000
Ecuador 5700 11000
Chili was already richer before Pinochet’s coup. It got worse by the neoliberal experiment. “Chile had the second worse rate of growth in Latin America between 1975 and 1980. The average growth in GDP was 1.5% per year between 1974 and 1982, which was lower than the average Latin American growth rate of 4.3% and lower than the 4.5% of Chile in the 1960’s.” [Rayack, Not so free to Choose, Op. Cit., p. 64]
Possible, I did not investigate Chile’s case fully. We should in any case look in the longer run than 5 years. The other conclusions hold probably better. And they are already strange enough.
I tried to look at it – but true, the data seem to confirm that you may be right. But they are too erratic. I withdraw what I wrote about Chile in any case.
PS. Netherlands (31000 46000) seems also to develop more slowly than Australia or Canada or the US. So where to find any country who is a winner with euro ?
Not Belgium – 27600 41000, not Spain – 22400 32000 (UK fared better), for sure not Portugal – 19000 25600 (it looks even slightly worse than Greece !)
We have no real winner and plenty of losers in this game.
I hoped I made no mistake with copying.
And thank you very much for the links, I have now much reading for the evenings :).
And I forgot about Japan in “secular depression”, with terrible demographic problems and debt over 200 % GDP : 24400 36600. It is not an amazing result, worse than Finland, but still much better than Italy. I think it looks like own currency is better, although we do not know the future.
Brr, Turkey 1999 9500, 2013 around 19000 usd. Greece 18000 – 25000.
The difference is becoming much smaller.
Yes, but euro is amazing , isn’t it ? Soon Turkey will be richer than Greece if the trend continues. 5 or 7 years ?
This is all a little bit crazy.
The domain name is a disrespect to a nation. I wonder who had the bright and insulting idea to create a website under this name, and furthermore I wonder if a domain like “keeptruyinggermany.com”, which is free by the way, exposing corruption between companies, politicians and the IMF would be online for more than two days.
Given that I provide my name, I would like to see this posted.
I assume you have no idea, what the “Keep Talking, Greece” is about.
BTW: in your email is unclear what you want to have removed: a) article or b) your comment here.
WTF is this guy talking about ?