WaPo has an interesting article that I think everyone should read in which the International Monetary Fund which called for austerity measures for European countries in debt crisis, had its lead economist to admit they were wrong, apparently because they "did not fully understand how government austerity efforts would undermine economic growth."
I'm not an economist, so I don't want to critique this too much, but I might add, that this is why we should all read Paul Krugman. He knows his shit. He was right about the housing bubble and now this.
Back to the article:
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.The relevant conclusions from the paper:
“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.What's interesting is that some of the initial motivation for the IMF decision was probably political, rather than actual economic principles and knowledge:
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. The evolving research on multipliers may have helped shift the tone of the debate in countries like Spain and Portugal, where a slower pace of deficit control has been advocated.
On the other hand, they might not know what they are doing:
But the 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.This article might be a lesson for those pushing for drastic cuts in the United States, since there will clearly be short term effects.
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.
“The results do not imply that fiscal consolidation is undesirable,” the two write. “Virtually all advanced economies face the challenge of fiscal adjustment in response to elevated government debt levels and future pressures on public finances from demographic change. The short-term effects of fiscal policy on economic activity are only one of the many factors that need to be considered in determining the appropriate pace of fiscal consolidation for any single country.”