IMF and Austerity

Olivier BlanchardThe annual meeting of the American Economic Association in January gave rise to a groundbreaking communication by two “chief economists.” Olivier Blanchard and Daniel Leigh brought to light an error in the mathematical formula used to calculate the impact of austerity policies imposed on national economies, particularly in Europe, in 2012.


These forecasts were based on a multiplier effect (initially estimated at 0.5) to assess the impact of public spending reductions on a country’s GDP. However, the report by the two economists points out that this impact is actually 1.6, i.e., three times greater. The result is a drop in economic output of more than one euro for each euro of deficit reduction. Several factors can explain this error, including the fact that this multiplier tends to be higher in periods of recession.


In practice, each euro of austerity-based spending cuts should have generated a reduction of only €1 in the country’s wealth (GDP). In the end, however, the result was €3: a triple recession. The negative effects of austerity policies were thus unduly underestimated.


This state of affairs had been criticized by veteran economists, countries such as Greece, and even the President of Portugal, Aníbal Cavaco Silva. After a heartfelt mea culpa and acknowledgement that Nobel Prize laureate Paul Krugman’s repeated criticisms were justified, the IMF continues to follow a chaotic and contradictory path. On the one hand, the organization’s aid remains subject to continual assaults on social protection, while on the other hand it recognizes the negative effects of excessive austerity. In November 2012, it even went so far as to warn against the social and political risks inherent to its own policies.