OJ Blanchard defends the IMFs interactions with Greece

I do not think that the actions of the Troika or of the 18 non Greek members of the Eurogroup are defensible. I am quite confident that, if they can be defended, IMF head economist O.J. Blanchard is the man for the job. He is very very smart and doesn’t just assume that Keynes was wrong about everythign (in fact he and Daniel Leigh provided the strongest (PDF) evidence that Keynes was right).

I do not find his argument convincing. I will semi fisk it quoting the bits with which I disagree and commenting.

Referring to 2010

Even if existing debt had been entirely eliminated, the primary deficit, which was very large at the start of the program, would have had to be reduced. Fiscal austerity was not a choice, but a necessity. There simply wasn’t an alternative to cutting spending and raising taxes. The deficit reduction was large because the initial deficit was large. “Less fiscal austerity,” i.e., slower fiscal adjustment, would have required even more financing cum debt restructuring, and there was a political limit to what official creditors could ask their own citizens to contribute.

First, there were at least two alternatives to “cutting spending and raising taxes” one is just cutting spending, the other is just raising taxes. Since the Eurogroup negotiations broke down exactly on the issue of whether Greece should raise taxes or cut spending, the absolutely unsupported assumption that the two must always go together is critical to the current argument.

What if Greece had just raised taxes and not cut spending ? I think that this would have been a better approach. First I must argue that it would be possible to eliminate the primary deficit without cutting spending given the well known Greek tax evasion problem. It is certainly possible, because income, payroll and value added taxes are not the only taxes. A capital levey, a one off tax on financial wealth can be used to deal with debt, deficits and hyperinflation. Default, debt forgiveness and a capital levy are the way Germany handled problems similar to the Greek problem. This worked fine in 1923, when the German primary deficity was 97% of the budget.

See this post .

This is very important because of the evidence (from Blanchard and Leigh) that the government spending multiplier is 1.5 three times as large as the IMF assumed (that’s my one sentence abstract of their paper). Using a super crude back of the envelope guess I think that their work suggests a balanced budget multiplier on the order of 1. Blanchard says the primary deficit was “over 10% of GDP”. Based on Blanchard and Leigh, Simon Wren-Lewis argues that spending cuts necessary to eliminate that deficit would cause GDP to decline 30%. In contrast my envelope says that lump sum tax increases (if possible) would cause a decline of 6% while increasing taxes paid mainly by the rich would have a smaller effect.

The Troika doesn’t just demand an increase in the primary surplus — it demands that Greece follow the advice of Laffer not of Keynes. Blanchard does not address this issue at all. He pretends that “cutting spending and raising taxe” are one thing ignoring the ordinary English meaning of the word “and”.

Blanchard’s assertion that “lower fiscal adjustment, would have required even more financing cum debt restructuring, and there was a political limit to what official creditors could ask their own citizens to contribute.” is not proven or supported by evidence. Paul Krugman has argued that it isn’t true. It would obviously be true if Keynes were totally wrong as assumed by TROIKA policy makers. Blanchard has proven they are wrong and here assumes they are right.

I think that Blanchard means “lower fiscal adjustment, would have required an honest assessment of the amount of fincancing, debt restructuring and/or default which was inevitable and there was a political limit to the honesty of official creditors”. I think the modified claim is true, but does not amount to a defense of the IMF.

Later Blanchard responds to the claim that structural reform hurt Greece by saying it would have worked if it had been fully implemented.

Given the dismal productivity growth record of Greece before the program, a number of structural reforms were seen as necessary, ranging from a reform of the tax administration, to reduced barriers to entry in many professions, to reforms of pensions, to reforms of collective bargaining, to reforms of the judicial system, etc.

Many of these reforms were either not implemented, or not implemented on a sufficient scale.

The argument that the recommended policy was not “implemented on a sufficient scale” is a universal excuse which can be made whenever a policy fails.

Blanchard expresses no doubt that the recommended structural reforms would have caused higher Greek GDP. He also presents no evidence. I stress not just no evidence based on the Greek experience but also no evidence based on the long history of the IMF. His claim is simply an assertion of faith. I too am confident that some of the reforms would have helped Greece, but I am also confident that our shared faith is not based on solid empirical evidence (a bleg if commenters know of any evidence that structural reforms of the type discussed by Blanchard have caused higher GDP growth please tell me about it in comments).

Also Pension reforms have “structural” benefits only if the problem is insufficient labor supply. This is not a problem in Greece. I think they are correctly called cuts in transfers. If Greece had a problem with high inflation, keeping people in the labor force by refusing to pay them a pension would have supply side benefits. This has nothing to do with Greece’s current problems.

Greece has achieved a massive internal devaluation with a 17% decline in relative unit labor costs. This obviously hasn’t solved their problems largely because that means they have also achieved massive debt deflation.

Tipping his hat to himself and Leigh (as I do) Blanchard does concede

The decrease in output was indeed much larger than had been forecast. Multipliers were larger than initially assumed. But fiscal consolidation explains only a fraction of the output decline. Output above potential to start, political crises, inconsistent policies, insufficient reforms, Grexit fears, low business confidence, weak banks, all contributed to the outcome.

Here I think that the key fundamental main problem with Blanchard’s post is that he doesn’t consider the implications of Blanchard and Leigh’s observation that “Multipliers were larger than initially assumed.” and, in particular, that government spending multipliers were 3 times larger than the IMF research department assumed. This implies a different optimal mix of tax increases and spending cuts. According to Krugman, it implies that further debt relief (and or default) could not be avoided by imposing Government spending cuts. The difference between a 1.5 multiplier and a 0.5 multiplier changes everything.

I fear that I think the assertion “fiscal consolidation explains only a fraction of the output decline” is simply false. Greece is a double outlier with both huge fiscal consolidation and a huge output decline. But Greek data are near the non-Greek still rich country regression line. The data don’t even demonstrate nonlinearity let alone Blanchard’s claim.

Here I steal Krugman’s standard scatter. I think that it is easy to guess which points are Greek. There doesn’t seem to be much anywhere in that graph inconsistent with the extreme crazy model in which fiscal policy explains everything.


There is a sign error “insufficient reforms” can’t cause a decline. The (unsupported claim) that Blanchard knows of something that would be done which would have caused higher GDP does not have anythi to do wingth the question of whether the effects of fiscal consolidation are greater than or less than 100% of the decline in Greek GDP. Also Grexit fears are causing high demand. The assertion that such fears must cause lower GDP is based on confidence fairy BS and a refusal to distinguish the demand side from the supply side. A fear that financial assets will be forceably converted to Drachmas and devalued should cause high demand for durable goods — Grexit risk amounts to a negative expected real return on Euro denominated assets subject to Greek law. Negative real interest rates would help Greece.

We believed that a small primary surplus, increasing over time, was absolutely necessary to maintain debt sustainability. Having examined the budget closely, we did not see how this could be achieved without VAT reform to broaden the tax base, and pension reform to put the pension system on a sustainable footing. On these, our views coincided fully with those of our European partners.

This is nonsense. It may be that VAT reform (which means raising prices tourists pay in order to deal with the trade deficit ???) and pension cuts are the best policies. However, the assertion that a growing primary surplus couldn’t be achieved by other tax increases or spending cuts can’t be true. I haven’t examined the Greek budget at all, but I am willing to bet Blanchard that, given time, I could propose reforms which (assessed with dynamic scoring using IMF models) would yield a growing primary surplus without any changes in VAT or pensions. I am willing to give him 10 to 1 odds (and not just because I know he can’t accept the bet). In any case, Blanchard doesn’t discuss the Greek proposal which was rejected by the rest of the Eurogroup. The argument against it was pure supply side economics which would be of very questionable relevance to a country suffering from vastly insufficient demand, even if there were any solid evidence from anywhere ever in support of the argument (I don’t claim their isn’t, but I can’t think of any). The Greeks claimed they could manage without further budget cuts. The fact that the IMF and its European partners reject that claim doesn’t mean that it is inconsistent with the budget or even that the IMF has asserted that the Greek claim is inconsistent with the Greek budget.

In sum, I think that Blanchard has not responded to the claim made by Krugman and Wren-Lewis that actual real world government spending multipliers (as estimated by Blanchard and Leigh) imply that Greek government spending cuts caused enormous costs, and provided no benefits even for creditors who only care about getting their money back. I don’t see anywhere in his post where Blanchard acknowledges that lower GDP causes lower tax receipts, or concedes that changes in tax receipts other than those which result from changing the tax code have anything to do with government deficits.

In particular, he refuses to note the policy implications of the important research of Blanchard and Leigh. I conclude by quoting what I think are the three key words one must read to understand the existence and content of the post

“a political limit”