IMF: We Royally Screwed Up On The Greek Bailout

Oli Scarff/ Getty ImagesIMF Managing Director Christine LagardeThe International Monetary Fund is out with a report reviewing the Greek bailout program that it helped set up in 2010 and maintained through early 2012.

The report is critical of the program set up by the IMF and the “troika” of creditors (the other two members being the European Union and the European Central Bank) for Greece.

For starters, the IMF admits that the projections for the Greek economy that were supposed to result from the implementation of the program turned out to be too optimistic.

From the report:

  • The fiscal multipliers were too low.. The question that arises is whether underestimation of the size of the fiscal multipliers in the SBA-supported program caused the depth of the recession to be underestimated. The program initially assumed a multiplier of only 0.5 despite staff’s recognition that Greece’s relatively closed economy and lack of an exchange rate tool would concentrate the fiscal shock. Recent iterations of the Greek program have assumed a multiplier of twice the size. This reflects research showing that multipliers tend to be higher when households are liquidity constrained and monetary policy cannot provide an offset (see October 2012 WEO), influences that appear not to have been fully appreciated when the SBA-supported program was designed. Aslund (2013) has also argued that there is a habitual tendency of Fund programs to be over-optimistic on growth until the economy reaches a bottom (and thereafter to underestimate the recovery).
  • However, the deeper-than-expected contraction was not purely due to the fiscal shock. Part of the contraction in activity was not directly related to the fiscal adjustment, but rather reflected the absence of a pick-up in private sector growth due to the boost to productivity and improvements in the investment climate that the program hoped would result from structural reforms. Confidence was also badly affected by domestic social and political turmoil and talk of a Greek exit from the euro by European policy-makers. On the other hand, the offset to the fiscal contraction from higher private sector growth that was assumed during the program period appears to have been optimistic (see Section D below), while some of the adverse political developments were endogenous and followed from limited ownership of the program (see Section F below). A larger contraction should probably therefore have been expected, although it should be noted that market forecasters were no more accurate.

However, optimism was not the only sin flagged by the IMF in its new report – it also criticises the actual structure of the bailout program:

  • The adjustment mix seems revenue heavy given that the fiscal crisis was expenditure driven. As discussed earlier, the ballooning of the fiscal deficit in the 2000s was almost entirely due to increased expenditure. The large dose of revenue measures in the SBA-supported program can therefore be questioned, particularly since tax changes constituted almost half of the measures targeted for the first two years of the program. The case for indirect tax increases was that they were quick to take effect and faced less resistance than cuts in spending programs. Moreover, VAT rates were lower than the median level in Europe.
  • The burden of adjustment was not shared evenly across society. The public sector wage bill was cut by lowering wages and bonuses, but specific plans to downsize the number of civil servants were limited to a commitment to replace only 20 per cent of those who retired. The state enterprises also remained generously staffed. By contrast, the private sector sustained enormous job losses partly because wage setting mechanisms were not liberalized. Moreover, little progress was made in checking tax evasion by high income earners. While the program recognised that it would take time to show results from improved tax administration, the absence of quick progress in collecting evaded taxes came at the cost of any demonstrable improvement in the equity of the tax burden.

However, the IMF report is not an unqualified mea culpa.

“Given the danger of contagion, the report judges the program to have been a necessity, even though the Fund had misgivings about debt sustainability,” it reads.

In other words, despite the adverse effects the program had on the Greek economy, it still managed to keep the country in the euro and avoid financial market contagion to other eurozone economies.

Read the whole report here >

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