IMF gets it wrong; blames faulty multipliers

Continuing a practice it began in 2011, the IMF once again considerably reduced its official global economic growth forecasts from those it made three months earlier.

But for the first time, the Fund’s chief economist offered an explanation for IMF forecasters’ almost pathological over-estimation of economic growth predictions over the past several quarters: blame it on the multiplier.

IMF chief economist Olivier Blanchard explained on Tuesday in Tokyo that the Fund’s forecasters have figured out that the multipliers they used to calculate the macroeconomic impact of austerity (or "fiscal consolidation" or deficit reduction) policies that many countries have applied since 2010 were too small.

He made this admission during the presentation of the IMF’s World Economic Outlook (WEO) report ahead of the IFI annual meetings on 12-14 October.

Neither Blanchard nor the WEO provided anything more than speculative explanations as to why the Fund’s economists had gotten their forecasting models so wrong.

The WEO helpfully suggests: "More work on how fiscal multipliers depend on time and economic conditions is warranted."

With the new downward revisions of growth forecasts, the IMF now predicts that 10 European Union countries will experience negative GDP growth in 2012.

They are joined by 12 more in other regions, but some of these are countries in political turmoil (and no figures are presented for Syria).

The sharpest downward growth revisions have been made to GDP projections in emerging-market economies, where growth nonetheless remains stronger than average.

Among large emerging economies, the greatest downward revisions of the GDP growth forecasts originally announced in July are for India (1.3 percentage points lower in 2012) and Brazil (1.0 percentage point less).

Among large advanced economies, the largest downward adjustments were made to the GDP growth figures of Italy and the United Kingdom.

Although the IMF’s WEO recognises that the recessionary impact of austerity policies has been far stronger than it had expected and even asserts that "risks for a serious global slowdown are alarmingly high", it offers little change to the general policy platform it has put forward over the past two years: try to repair broken banking systems so as to get credit flowing and undertake fiscal consolidation over the medium term.

Many specific proposals in the WEO are for Europe, once again.

The Fund encourages the EU to make the new European Stability Mechanism "operational as soon as possible" so as to be able to buy bonds at lower interest rates from those euro-zone crisis countries that have not yet received a full-fledged bailout, notably Italy and Spain; establish an integrated euro-zone financial regulatory and supervisory structure; and continue with labour and product market reforms in euro-zone "periphery" economies.

The WEO singles out Germany and China as the two largest trade surplus economies that need to boost domestic demand.

The report states that in Germany "the underlying strength in the labor market should foster a pickup in wages, inflation and asset prices, and this should be seen as part of a natural rebalancing process" within the euro-zone.

The WEO states that Germany and the Netherlands (the other major euro-zone surplus economy) should accept inflation rates of 3-4 per cent, which would be still allow the zone as a whole to keep inflation below 2 per cent if the crisis countries (Greece, Ireland, Italy, Portugal and Spain) keep their inflation under 1 per cent.