In July, the International Monetary Fund’s Independent Evaluation Office released a major report on how the Fund handled the euro crisis after 2010. The IEO report is critical of Fund behavior; but, as with previous IMF self-evaluations, it misses many substantive issues. Specifically, the IEO argues that the Fund was captive to European interests – hardly surprising, given that Europeans constitute onethird of the Fund’s executive board. Moreover, the Fund was mistaken in assuming that “Europe is different,” and that “sudden stops could not happen within the euro area.”
In a financial crisis, authorities must act fast to address the problems that caused it and restore confidence. The United States government did just that in the fall of 2008; European leaders, meanwhile, dithered – a point the IEO neglects to mention. The IEO report also doesn’t assess IMF programs’ effectiveness. Consider Greece, where the Fund’s response was clearly insufficient.
In 2009, the Greek budget deficit was 15 percent of GDP; with an IMF program, the deficit fell in 2010, but only to 11 percent of GDP. Meanwhile, the three Baltic countries – Estonia, Latvia, and Lithuania – carried out budget tightening of 9 percent of GDP in 2009. The Fund and the European Union have long been oblivious to many EU countries’ excessive fiscal burdens.
The Fund was lenient toward Greece because Greece is a eurozone member; but this favoritism was unjustified and ultimately costly. Greek public expenditures have fluctuated between 50 percent and 59 percent of GDP since 2010, creating a massive debt overhang and hindering growth. By comparison, Germany and the United Kingdom have kept public expenditures at a reasonable 44 percent of GDP.
The IEO report ignores this and focuses instead on the need to restructure public debt, in order to make it sustainable. But this didn’t necessarily apply to Greece in 2009, when its public debt was high — at 127 percent of GDP — but not unsustainable. Greek debt surged and became insurmountable only under the IMF’s financing plan concluded in May 2010. At the end of 2015, Italy’s public debt was 133 percent of GDP, and the ratio for Portugal was 129 percent. Should Italy and Portugal now be forced to restructure their debt, too?
The European economy grows slowly because it is overtaxed and overregulated. Rather than being told to restructure debt, European countries should be told to deregulate markets for labor, products, and services; and southern countries such as Italy, Greece, Spain, and Portugal should be told to expand secondary education and vocational training. As the Baltic example shows, quicker fiscal adjustments can drive structural changes. Instead, policymakers miss the forest for the trees, as the IEO report shows. Any accounting of European economic oversight in recent years should ask why the Greek crisis erupted in the spring of 2010, almost two years after the global financial crisis.
The answer is that when the European Central Bank flooded eurozone countries with cheap liquidity, governments dispensed with serious reforms and splurged instead. This was partly because, in the fall of 2008, the G20 and the Fund issued desperate appeals for debt-financed fiscal stimulus. Many European countries heeded the call; but, rather than stimulating economic growth, deficit spending jeopardized several countries’ financial stability. Before it was all over, at least eight of the then 27 EU member states required IMF financing and restructuring programs.
The obvious lesson should have been that fiscal expansion does not stimulate economic growth when there is financial instability. But the IMF, blinkered by its Keynesian orthodoxy, still refuses to acknowledge this fact. Many EU countries were vulnerable because they had accumulated excessive and unnecessary public debts by maintaining budget deficits during the pre-crisis boom years. By the end of 2007, the average public debt in the eurozone was 65 percent of GDP, five points above the ceiling set in the Maastricht treaty for countries seeking eurozone membership. This partly reflected the decision by France, Germany, and Italy in 2003 to violate and later “reform” the Maastricht rules, effectively declaring them null and void.
The IMF did not object to these countries’ flouting of the public debt rules. In fact, if one compares the Fund’s own positions with that of its internal watchdog, they are strikingly similar, raising doubts about the IEO’s independence in writing its report. The IMF and the IEO both ignore the same central problems in the official response to the euro crisis so far. A financial crisis should be met with swift action, and budget deficits should be slashed instantly, mainly through spending cuts. Rapid fiscal adjustments drive structural reforms, which lead to faster economic growth.
The IMF’s acronym used to stand informally for “It’s Mostly Fiscal.” Following its inadequate response to the euro crisis, the Fund should admit that the time has come to return to its roots.
Senior fellow at the Atlantic Council in
Washington, and the author of Ukraine:
What Went Wrong and How to Fix It