Posts Tagged international monetary fund
July 24, 2010
On Tuesday (July 20) President Obama met with British P.M. David Cameron. Mr. Cameron stated his intention to cut British government spending by 25 percent in the next three years. Mr. Obama responded that this is not the time to reduce fiscal stimulus. Mr. Cameron’s riposte was that the U.K. was in the same category as Greece when it came to the government budget deficit as a percentage of GDP.
I’ve argued elsewhere that the U.S. fiscal stimulus package took way too long to start the actual spending. And in the same articles I noted that there’s a lot more to fiscal policy than government spending, taxes, and transfer payments. Indeed, it’s becoming apparent that the regulatory environment (current and expected future) has a potentially larger impact than any traditional fiscal policy tools. (Of course, all economists know this. When you make something more costly, people and businesses will do less of it. And when you increase uncertainty about the future, people and businesses will postpone major decisions.)
But I have to agree with Mr. Obama and Dr. Krugman on one issue. This is no time to engage in contractionary fiscal policy. Cuts in government spending, cuts in transfer payments, or tax increases should all be off the table for the next six months.
Of course, that’s another reason for the sluggish U.S. recovery. Many of the Bush tax cuts expire at the end of this year. The Obama administration appears to have no desire to extend them. Anticipating tax increases on January 1, individuals and businesses are taking actions this year to avoid higher taxes next year.
Back to the issue at hand. How do various countries stack up on government debt and the government budget deficit?
Debt as a Percentage of GDP
Using data from the International Monetary Fund’s World Outlook database, we can find out the government debt as a percentage of GDP for many countries. One curious exception is Greece, a country of great interest lately. I approximated the government debt by adding up the Greek government budget deficits from 1980 – 2009. While I could have found more and/or better data, this is good enough for blogging. The graph below tells the tale.
Mr. Cameron’s remarks, however, explicitly used deficit as a percentage of GDP, not debt. And with good reason. It’s clear that Italy, Japan, and Greece are in a different universe from the U.S. and the U.K.
Deficit as a Percentage of GDP
Looking instead at the government budget deficit relative to GDP we can see what Mr. Cameron is talking about:
Actually, Mr. Cameron is guilty of overstating the case somewhat. The U.K. government deficit is around 11 percent of GDP, significantly less than either Greece or the U.S.
What Does It All Mean?
Let me repeat my original point: a recession is no time to worry about government budget deficits or the government debt. Mr. Cameron has stated that he wants to reduce the size of the British government by 25 percent in three years. Fine – but make it four years, not three, and postpone the start for a year.
Somewhere, John Maynard Keynes (a loyal British citizen) is spinning in his grave.
 http://gonzoecon.com/?p=116, http://gonzoecon.com/?p=90, http://gonzoecon.com/?p=22
 If you have any capital gains that are taxable, 2010 is the year to realize them. I’ve sold quite a bit of stock this year, in part because I expect to have to pay a lot more in capital gains taxes next year.
 http://www.imf.org/external/pubs/ft/weo/2010/01/weodata/download.aspx. Accessed July 21, 2010.
 Remember, the figure for Greek government debt is almost certainly too low.
Prof. Olivier Blanchard (of M.I.T., currently at the I.M.F.) has a long history of getting it wrong when it comes to macroeconomic policy. His most recent pronouncement, unfortunately, continues this trend. Even worse, his policy prescriptions are now being made from the lofty pulpit of the International Monetary Fund where he is chief economist.
Let’s see what Dr. Blanchard has to say. This from an interview in the Wall Street Journal:
“So should we change the inflation target?
Blanchard: If I were to choose inflation target today, I’d strongly argue for 4%. But we have started with 2%, so going from 2% to 4% would raise issues of credibility. We should have a discussion about it.”
Blanchard’s argument is that by raising the inflation target, nominal interest rates would be higher. This, he proposes, would give central banks more room to reduce interest rates to stimulate the economy.
Unfortunately, Prof. Blanchard has made an error that should make him blush. It is the real interest rate, not the nominal interest rate, that affects most economic activity. The only way Prof. Blanchard’s model can work is by appeal to the long-discredited “money illusion” hypothesis.
For those who are a bit rusty, recall that the nominal interest rate is made up of two parts. The first is the real interest rate. This is the net transfer of purchasing power from borrowers to lenders. The second part is the expected future inflation rate. Changes in the expected future inflation rate, however, have no – zero – impact on the real rate.
This is especially true if (or when) the central bank announces the new inflation target in advance. Thus by publishing his paper Prof. Blanchard has destroyed any possible impact from the very policy he is advocating.
This stuff ain’t all that hard. Frankly, it’s embarrassing when highly-placed economists get it this wrong.
 Technically his title is Economic Counsellor and Director of the Research Department of the International Monetary Fund. For more biographical information see http://www.imf.org/external/np/bio/eng/ob.htm. Accessed March 9, 2010.
 “Q&A: IMF’s Blanchard Thinks the Unthinkable” by Bob Davis. Wall Street Journal Real-Time Economics blog, February 11, 2010. Available at http://blogs.wsj.com/economics/2010/02/11/qa-imfs-blanchard-thinks-the-unthinkable/?KEYWORDS=Blanchard+IMF. Accessed March 9, 2010. Those who want more details should see Blanchard, Olivier J. ; Dell’Ariccia, Giovanni ; Mauro, Paolo, “Rethinking Macroeconomic Policy,” Staff Position Note No. 2010/03, International Monetary Fund, February 12, 2010. Full text available at http://www.imf.org/external/pubs/ft/spn/2010/spn1003.pdf. Accessed March 9, 2010.