On the IMF’s Big Fat Greek Woulda-Shoulda-Coulda
It takes a big person to acknowledge he was wrong, and the International Monetary Fund has now repeatedly admitted to the failure of its euro-area rescue policies.
In its latest mea culpa last week, the Washington-based lender released a 50-page critique of the Greek bailout program it devised in 2010, together with the European Commission and the European Central Bank. The IMF’s report highlights how the so-called troika got that bailout wrong.
These admissions should surprise no one who has spoken with IMF officials over the past year -- in private they have expressed deep frustration with the euro-area bailout programs. Those regrets were merely made public last week, and the interesting question is: Why now?
The IMF report admits to three major failings of the Greek program. First, that Greek sovereign debt wasn’t restructured immediately and a haircut on government bonds held by private investors was delayed until March 2012. This gave investors almost two years to reduce their exposure, dumping it on the official sector instead.
Second, the IMF admitted that the underlying macroeconomic assumptions it used in its debt sustainability analyses were wildly optimistic. As the IMF has previously conceded, it underestimated the fiscal multiplier and therefore the impact of austerity and budget cuts on economic growth. With growth estimates way off, deficit and debt-to-gross domestic product ratios were wrong as well. The much sharper than forecast contraction meant that unemployment also soared beyond the IMF’s expectations. We’ve all seen the results.
Third, the IMF said that the troika might not work like a well-oiled machine. The report highlights the difficulty of working with so many disparate interests in the euro area, including the European Commission, the ECB and individual creditors such as Germany.
The report criticizes the commission for failing to do enough to devise the structural reforms Greece needed to recover. It also takes the ECB to task for purchasing sovereign bonds, which made restructuring privately held debt less effective, and for failing to lead on bank supervision in the euro area.
I think we can assume that the next meeting of the troika will be awkward. That may be precisely what the IMF was aiming for -- to provoke the European Commission and ECB into kicking it out of the club. After all, apart from being such a mess, the Greek program is also the largest (relative to the size of the economy) in which the IMF has ever participated. After the IMF’s experience in Argentina, employees are not pleased to be funding another unsustainable debt trap.
I’m not sure, though, that the IMF is looking for a way out of the troika. If it were, it could easily have exited during deliberations to bailout Cyprus. It chose to participate.
Another possibility is that the IMF is simply trying to claw back some of the credibility it lost during the Greek bailout. Privately some IMF officials have questioned the sustainability of Greece’s debt burden, both pre- and post-debt restructuring. This report allowed the fund to confess to these uncertainties and push some of the blame onto its troika partners.
If that is the goal, though, highlighting the errors that the IMF made four years ago seems an odd way to restore credibility, given that the troika made the same mistakes again this year in Cyprus. The assumptions underpinning that bailout are as questionable as those the troika originally used for Greece, making it likely that Cyprus will need to write down some of its debt in a few years.
The best explanation for the IMF’s decision to publish its report was floated by Mark Dow, a former IMF economist and now a private investor. He thinks the IMF is trying to change policy, using lessons about debt restructuring, productivity gains and austerity from existing bailouts to apply to the next bailout(wherever that may be).
Of the troika members, the IMF provides the least cash for the euro-area bailouts -- about one-third of the funds for the Greek, Portuguese and Irish programs, and less for Cyprus. As a result, the IMF has taken a backseat in determining policy responses. Like any backseat driver, however, the IMF has methodically registered its concerns for the past year about front-loaded austerity and its negative effect on growth. The fund has been playing a long game here, chipping away at the euro area’s prevailing wisdom on fiscal adjustment and productivity gains, and waiting for the evidence to mount in favor of its position.
The Cyprus bailout is halfway between how the Greek bailout was set up and how the IMF would like to see things done in the future. There was private-sector participation upfront, with bank bail-ins reducing the size of the bailout. At the same time, it wasn’t enough. The IMF was essentially given the figure for the size of the bailout program and forced to reverse engineer a debt sustainability analysis that could justify that figure.
With the Cypriot bailout a done deal and euro-area markets relatively sanguine, this was the time for the IMF to try to take advantage of the slowly turning tide, pushing euro-area crisis-fighting policies toward upfront debt restructuring and away from front-loaded austerity.
The bigger question is whether the other troika members will take the IMF’s cue. There are signs that the European Commission accepts that front-loaded austerity has been self-defeating -- it relaxed fiscal targets for six euro-area countries on May 29. Still, it looks as though the commission and ECB are unlikely to move much further. Both have responded to the IMF report by defending their roles in the Greek bailout program. The European Commission dismissed the claim that it failed to identify growth-enhancing reforms for Greece as “wrong and unfounded.” When asked whether the ECB thought it had made mistakes in the Greek bailout, President Mario Draghi said: “It’s very hard to pass ex-post judgement about things that happened four years ago.”
I doubt the IMF’s call to action for a substantially different policy approach in Europe will work. We won’t know for sure, though, until another euro-area country asks the troika for help.
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