The International Monetary Fund admits it underestimated the damage that austerity would inflict on Greece, offering key evidence in the global debate about cutbacks versus stimulus.
The group should have insisted on cutting Greece's crippling debt earlier in the crisis that spread rapidly across Europe over the past several years, the IMF says in an assessment that includes its own miscalculations.
The IMF report published Wednesday covers its handling of the crisis that plunged Greece into the western world's deepest and longest recession since the 2008 credit crunch. The IMF and the European Union sponsored two bailouts of Greece, the first in 2010, the second last year, neither of which restored the country's health.
The contents of the report, first leaked to the Dow Jones Newswire, will be welcomed by many Greek politicians, labour leaders and economists, who had argued for years that harsh austerity was the wrong treatment for an economy in free fall.
Their arguments were supported by international economists, including American Nobel prize winner Paul Krugman, who said growth policies and stimulus – not aggressive cuts to spending and tax hikes – would spare Greece and other struggling countries from enduring economic misery.
The report does not come as a complete surprise.
Both the IMF and the EU have implicitly acknowledged that their austerity programs might have been excessive in some cases. The IMF recently said it may have underestimated the "multiplier effect" of austerity measures on growth, that is, the degree of predicted economic contraction as government and private spending was sliced away.
The IMF's assumptions for the Greek economy can "be criticized for being too optimistic," its report said.
In April, Spain, whose banks have received a bailout, was given another two years to meet its budget deficit targets, reflecting fears that its jobless rate, now at a record 27.2 per cent, would keep soaring if were not given some leeway. France is getting a similar grace period.
Some high-profile Greek officials were critical of austerity measures even as they were forced to support them as a condition of the bailout aid. In an interview with The Globe and Mail in February, George Provopoulos, Governor of the Bank of Greece, said, "Fiscal consolidation meant more taxes and less spending, and that means you depress economic activity. Structural reforms are the only way to counteract."
Earlier this year, Greek Finance Minister Yannis Stournaras asked the IMF, led by Christine Lagarde, to explain why its forecasts for Greek growth and unemployment were consistently wrong. The IMF placed a lot of the blame on Greece itself. At one point, it said publicly that "the structural transformation of Greece's economy continues to proceed at a slow pace (outside of the labour market), and this is making Greece's adjustment more costly."
The IMF acknowledged that Greece's debt-reduction exercise – the central condition of its second bailout, worth €172-billion ($233-billion) last year – should have occurred earlier. Last spring, a "haircut" on Greek sovereign bonds held by the private sector, mostly banks, reduced the country's debt load by about €100-billion. But the IMF said it was "politically difficult" to cut the debt earlier because of resistance from the euro zone banks which held a lot of Greek debt.
The IMF has said several times that it considers Greece's post-bailout, post-haircut debt is "sustainable." But its assessment described the Greek rescue as "so significant that staff was unable to vouch that public debt was sustainable with a high probability."
Dow Jones reported that the IMF bent its own rules to make the debt seem sustainable and that Greece had failed three of the four IMF criteria to qualify for assistance. The Greek rescue, however, was necessary to prevent extensive damage to the rest of the euro zone, the IMF argued.
It does not appear that the IMF's evaluation will trigger a rollback in Greek austerity measures. The bulk of the spending cuts and tax hikes have already been accomplished, though a massive cull of public servants is just beginning. Recently Ms. Lagarde urged Greece to improve its tax-collection system and ensure the independence of its tax administration.