The International Monetary Fund screwed up in the aftermath of the global financial crisis. But a string of stuff-ups over recent decades begs the question: will it ever learn?
The IMF’s internal auditor has released a damning assessment of the IMF’s actions after the collapse of Lehman Brothers. After initially lobbying for fiscal and monetary stimulus -- the right decision -- the IMF quickly pushed for widespread fiscal consolidation.
“The call for fiscal consolidation proved to be premature, as the recovery turned out to be modest in most advanced economies and short-lived in many European countries,” the IMF’s Independent Evaluation Office said.
According to the report, “IMF projections as of late 2009 indicated that economic growth in advanced economies would turn positive in 2010 and strengthen in the medium term.”
That proved to be the turning point in the financial crisis. Both the US and the UK introduced austerity measures and growth stalled. The US stumbled along -- supported by aggressive action by the Federal Reserve -- while the UK fell back into recession during 2012.
Unfortunately the worst was yet to come. In 2010, the IMF also recommended that “each euro area economy engage in fiscal consolidation by 2011 at the latest.” The punch-line? The actions would be taken to enhance investor confidence.
Remarkably, the IMF’s grand plan to enhance investor confidence involved reducing economic growth and increasing unemployment. Critically it failed to recognise the absurdity of its policy recommendations, which placed the future of the euro area in the -- economic unproven -- hands of what is now known as the “confidence fairy”.
The policy prescriptions during this period show a fundamental misunderstanding of rudimentary economics. They made amateur mistakes that proved that ideology is more important at the IMF than rigorous analysis.
The literature on fiscal multipliers and austerity are relatively well established. There is rarely a clear-cut consensus in economics but the policy prescriptions by the IMF were certainly at the extreme end of economic opinion.
In prescribing austerity among advanced economies the IMF underestimated the multiplier effect of fiscal consolidation. As a result, countries within the euro area not only suffered years of harsh cuts but also failed to reduce their overall debt burden. The whole experience -- all that pain -- has been for naught.
The IMF’s other major stuff-up during this crisis was its failure to recognise that in the presence of a liquidity trap, monetary policy does not work effectively. As advanced economies underperformed during 2011-13, “the IMF recommended progressively easier monetary policies to stimulate demand.”
Contrary to economic literature, they implicitly believed that monetary -- rather than fiscal -- policy was the best way to boost aggregate demand during a severe recession.
For all the trillions poured into the global financial system over the past six years, very little of it has found its way into the real economy. Research shows that the multiplier on fiscal policy exceeds that of monetary policy and would have gone some way to reducing the human misery caused by the global financial crisis (Fund fiscal policy, not greedy banks, October 17).
The actions taken by the IMF during this crisis are not without precedent. Its policy recommendations during the Asian Financial Crisis were similarly suspect and the Fund has been widely criticised for the role they played in prolonging that crisis. In that crisis -- as with this one -- they failed to tailor their advice on a country-by-country basis.
Free-market ideology appears to still run rampant at the IMF and the end result has been an economic disaster. The European economic crisis is already six years old and there is no end in sight. It appears unlikely that the European Central Bank will increase interest rates this decade.
With Europe already on a demographic time-bomb (they are the second oldest region after Japan) it is quite possible that rates won’t rise more than, say, 50 basis points in a generation.
Despite its stuff-ups, the IMF will remain a key feature of the global financial system. It will continue to offer policy recommendations for a range of countries -- advanced and developing alike -- but its performance over the past six years clearly affects that credibility.
With ‘secular stagnation’ an increasing reality for advanced economies, financial crises and recessions are set to become more commonplace over the next few decades. The IMF has a significant role to play in managing these less favourable times but successfully navigating these challenges will require the IMF to learn from past failures -- admitting that they were made is surely the first step -- and ensuring steps are taken to ensure that these basic mistakes are never made again.