Olli Rehn’s Blame Game II: this time it’s personal
European Commissioner suggests IMF's research on fiscal multipliers has damaged eurozone confidence.
The game of smash-up the likes of hedge funds for banking crises, sovereign debt nightmares, political fragmentation, the Hindenburg disaster...is over. Now blame the economists. European Commission vice president Olli Rehn in a letter to European finance minister did just that on Friday:
|“I would like to make a few points about a debate which has not been helpful and which has risked to erode the confidence we have painstakingly built up over the last years in late night meetings. I refer to the debate about fiscal multipliers, ie the marginal impact that a change in fiscal policy has on economic growth. The debate in general has not brought us much new insight.”|
That's quite a rebuke to IMF chief economist Olivier Blanchard, who, with apt irony, delivered a report in Tokyo on the occasion of the IMF meeting last October predicting Japan-style global economic stagnation in the years ahead, exacerbated by austerity in Europe and higher-than-expected fiscal multipliers.
|“Olli’s letter then launches into an amateur referee report on the Blanchard-Leigh paper. His first critique of their result is that the actual amount of fiscal consolidation was larger than planned, so the IMF paper is over-estimating fiscal multipliers. However, pages 13 and 14 of the paper contains a detailed discussion of this issue and concludes “on average, actual consolidation was neither smaller nor larger than expected.” So, as far as I can tell, this issue was dealt with in the original analysis.
Olli’s second critique stems from the fact that the largest growth shortfalls occurred in 2010 when many countries were still implementing temporary fiscal stimulus. He asserts (without providing any evidence) that permanent consolidation is associated with lower fiscal multipliers, suggesting that the kind of fiscal consolidation that occurred in Europe in 2011 and 2012 will not have contributed to unexpectedly low growth. But Figure 2 of the Blanchard-Leigh paper also shows strong negative relationships between fiscal consolidation and growth forecast errors for 2011 and 2012 so this point does not appear correct..”
And Whelan's conclusion:
|“In terms of who to believe here, you can choose to trust Olli the Confidence Man who believes debate about fiscal policy is unhelpful or the IMF’s chief economist who also happens to be the world’s tenth best economics researcher. I know who my money is on"|
Jonathan Portes in the Not Treasury View blog launches a scathing attack:
|".., it is quite true that on its own the Fund analysis doesn't demonstrate that the Commission and Mr Rehn (and here the Treasury, Bank and OBR) are wrong. But the whole weight of the evidence, both theoretical and empirical, does. Our estimates of the impact of self-defeating austerity are here.
...While Blanchard's analysis is far from the end of the story, it is a professional piece of work by one of the world's leading empirical macroeconomists. The Commission's rebuttal, by contrast, would, as I say here, shame a first-year Masters' student. [Briefly, for nerds, including sovereign yields as a "control variable" for growth outcomes is so obviously misspecified - yields are an outcome, not an exogeneous independent variable - as to be a straight fail.] "
As we wrote last year, Rehn can draw a source of rare comfort from research from the Centre for European Policy Studies, which suggested that the spikes in borrowing costs for eurozone countries has a lot to do with sentiment, rather than fundamentals. As we said last July:
Supporting CEPS's hypothesis are the two graphs below:
|"If you look at the two graphs, you can see that post-2008 a eurozone country’s debt-to-GDP ratio has had a clear positive correlation with its spreads, whereas before 2008 there is little observable relationship between the two. In contrast, the relationship between spreads and debt-to-GDP ratios in stand-alone countries hasn’t really changed since 2008.
This suggests that the markets are unsurprisingly treating eurozone sovereigns differently to sovereigns with monetary flexibility, and in a fashion that isn't causally dependent on those sovereigns debt-to-GDP ratios. CEPS comes to the conclusion that the only explanation for a number of surges in eurozone sovereign spreads is panic in the markets engendering a mispricing of risk "
But with last Friday's letter, Rehn has only succeeded in provoking the charge that the eurozone is embroiled in a self-defeating policy of austerity.