Why Should We Trust the IMF?

Is advice from the IMF better than advice from a drunk in the street? That is the question that people around the world should be asking as the International Monetary Fund dishes out its prescription for austerity. The IMF programme calls for cutbacks in government support for healthcare, pensions, and a wide range of other public services. It also calls for weakening labour market regulations that provide workers with job security.

These recommendations are being given in a context where the world economy is suffering from a massive shortfall of demand. In other words, tens of millions of people are unemployed right now because there is not enough spending to keep them employed. The IMF's programme is almost certain to reduce spending further leading to even larger shortfalls in demand and more unemployment.

But, the IMF says that we should trust them. The question we should all be asking is: "why?"

Where was the IMF when the housing bubble in the US and elsewhere was inflating to ever more dangerous levels? Was it frantically yelling at governments to rein in the bubbles before they burst with disastrous consequences? After all, what could possibly have been more important than warning of the dangers of these bubbles?

It was easy to both recognise the housing bubbles and that their collapse would have devastating consequences for the economy. Economies don't adjust easily to a loss of wealth that in some cases exceeded 50% of GDP.

Real economists know this, but apparently the folks at the IMF did not, or if they did, they didn't think it was worth saying anything. One will look in vain through IMF publications during the build-up of the housing bubble for serious warnings of the potential dangers. While the IMF can scream about the need for austerity today, it couldn't be bothered to say much about the bubbles that got us here.

The IMF's track record gives us reason not only to question the institution's competence but also its motivations. This question comes up most clearly in the case of Argentina. At the end of 2001 Argentina defaulted on its debt, enraging the IMF. Prior to the default, Argentina had been an IMF poster child eagerly embracing the IMF's programme.

The IMF's growth forecasts clearly reflected its change of attitude toward Argentina (pdf). Prior to the default the IMF was consistently overly optimistic about Argentina's growth prospects, projecting much higher growth than Argentina actually experienced. After the default, the IMF was hugely over-pessimistic, projecting much lower growth rates than it subsequently experienced. It is difficult to explain this pattern of errors except by a political motivation.

It is possible to see a similar pattern in the IMF's latest set of policy recommendations to deal with the economic crisis. The impact of most of its proposals will be to reduce the benefits received by ordinary workers. The proposed changes in labour market regulations will likely also weaken workers' bargaining power, leading to cuts in wages. Furthermore, the reduction in demand caused by the turn to austerity will leave millions more out of work, both depriving these workers of income and further weakening the bargaining power of those who still have jobs.

There are alternatives. Central banks like the European Central Bank, the Bank of England, and the Federal Reserve Board could just buy and hold large amounts of government debt. These central banks can both ensure that there are no questions of solvency by providing a ready market for government debt and that there is no build-up of interest burdens. The interest paid on the debt held by the banks is refunded to governments.

Large-scale central bank purchases of government debt will not create inflation in a context of massive unemployment and excess capacity. This is not a point we have to debate. Japan's central bank has bought an amount of government debt roughly equal to its GDP, yet it remains far more concerned about deflation than inflation. While we could hope to do better on the stimulus front than Japan, inflation is simply not a problem it faces now or even on the distant horizon.

It is especially painful to see these calls from austerity coming from the IMF. This organisation is distinguished not only by its dismal track record in pushing economic policies that don't work; it also is known for the exorbitant benefits that it gives its economists. Under the IMF's pension programme, many staffers can retire in their early 50s with six-figure pensions. Imagine the folks who completely missed the housing bubble or who got it totally wrong on Argentina lounging around the tropics at age 51 on their $100,000 a year IMF pension. When it comes to economic advice, I think I'd rather listen to that honest street drunk.