Sunday, August 14, 2016

The IMF is pushing for yet more fiscal consolidation

Brad Setser - the IMF is pushing for yet more EZ fiscal consolidation. This sounds to me more like a failure of the IMF as a policy-setting institution than anything else. Here's the top-level policy recommendation:

The eurozone collectively has a substantial external surplus, and its economy is operating below potential. In the framework set out in the IMF’s external balance assessment, that pretty clearly calls for fiscal expansion:

“Surplus countries that have domestic slack need to rely more on fiscal policy easing, which would address both their output gaps and their external gaps… Meanwhile, deficit countries should actively use monetary policy, where available, to close both internal and external gaps.”

But then the top-level policy recommendation gets countermanded in the fine print:

The capacity for a common eurozone fiscal policy conducted through borrowing by the center doesn’t currently exist, and it realistically isn’t going to materialize next year.

That means the eurozone’s aggregate fiscal impulse is the sum of the fiscal impulses of each of its main economies. What does the IMF recommend there?

In Italy the IMF seems to want about a half a point of structural fiscal consolidation (see paragraph 35 of the staff report).

In France, the same (see paragraph 33 of the staff report).

In Spain, the last IMF article IV called for a half a point of consolidation as well (see paragraph 33). That though is likely to be ratcheted up, as Spain hasn’t done much consolidation over the past two years and now will need to engage in a major consolidation to get to the Commission’s 3 percent of GDP fiscal target in 2018.

Spain, Italy, and France collectively account for a bit more of the eurozone’s GDP than Germany and the Netherlands.

So, is the IMF recommending enough fiscal expansion in Germany and the Netherlands to assure a positive fiscal impulse for the eurozone as a whole? No.

The IMF is now advocating that Germany avoid returning to a structural surplus, and invest any windfall savings from higher than expected revenues or lower interest rates. But the IMF isn’t advocating Germany do any more on net than it already had done. Germany delivered a significant stimulus is 2016, but it was a one and done stimulus. Germany isn’t projected to generate a positive fiscal impulse in 2017.*

The Netherlands needs stimulus on purely domestic grounds given persistent weakness in household demand and an ongoing output gap (see the “Tricky Balance” chart in the IMF’s external balance assessment). And the IMF did recommend a modest fiscal expansion in its last assessment of the Dutch economy. But also it didn’t protest too much when the Dutch government politely declined. See paragraphs 14 and 15 of the 2015 staff report.

Bottom line: Germany’s 2017 fiscal impulse is projected to be neutral. The fiscal expansion the IMF recommended in the Netherlands for 2017 is not likely to be adopted and even if adopted it would be too small to offset the fiscal consolidation the IMF is recommending in Spain, Italy, and France. Given the weight of France, Italy and Spain in the eurozone, this implies the IMF is recommending that the eurozone as a whole consolidate next year.

So, again, it looks like the IMF's top-level realists are being ignored in favour of yet more fiscal retrenchment at the national level of every country.

Either that or they expect Chinese stimulus to carry the world again.

So I guess China's big 2009 stimulus created one hell of a moral hazard that is now resulting in a Western fixation on continuous fiscal consolidation.

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