Having Added to Greece's Woes, the IMF Demands More of the Same

People make their way past the headquarters of the Bank of Greece in Athens on Monday. The Greek government stuck to demands on Monday that its creditors propose less harsh terms for a cash-for-reforms deal after talks collapsed, bringing Athens one step closer to a default that could tip it out of the eurozone. Alkis Konstantinidis/Reuters

It is difficult to understand the logic of the International Monetary Fund's (IMF) present negotiating position in its dealing with the Greek government.

Having acknowledged that excessive fiscal tightening within a euro straitjacket had played an important part in Greece's horrendous economic performance over the past six years, the IMF is now prescribing very much the same policies for the period immediately ahead.

This has to beg the question as to why the IMF believes that policies that it admits had failed in the past will now work in the future.

Two years ago, against the backdrop of the literal collapse of the Greek economy, in a rare moment of candor, the IMF admitted that it had grossly underestimated the size of the fiscal multipliers in its design of the IMF's Greek financial support program. Rather than being 0.5, as the IMF had calculated earlier, the IMF then estimated that the fiscal multiplier was more likely to be in the range of 0.9 to 1.7.

The implication of this admission was that the large-scale budget belt-tightening that the IMF had demanded from Greece as a loan condition had played a very important role in the collapse of the Greek economy. It had also played a role in Greece's failure to reduce its public debt to GDP ratio.

Fast-forward to June 2015. Political uncertainty has again tipped the Greek economy into recession and Greece's primary budget balance has now moved again to a deficit of around 1 percent of GDP.

Yet as judged from a blog post by Olivier Blanchard, the IMF's chief economist, the IMF is now insisting that Greece takes budgetary measures to generate a primary budget surplus of 1 percent of GDP in 2015 and 3.5 percent of GDP over the medium term.

These targets, which are to be attained through consolidation of value-added tax rates at a higher level and through cuts in pension outlays, would imply fiscal policy tightening of around 2 percentage points of GDP in 2015 and 4.5 percentage points of GDP over the medium term.

It would seem that the one lesson that the IMF should have drawn from its experience with a 25 percent collapse in the Greek economy over the past six years is that excessive fiscal policy tightening within a euro straitjacket, which precludes an independent monetary or exchange rate policy, is not a good idea.

This would especially be the case considering the IMF's own estimates of the relatively large size of the fiscal multipliers. Yet the IMF is now again insisting on massive fiscal tightening for Greece both in 2015 and in the medium term. And it is doing so without any credible explanation as to how the Greek economy is to experience growth with such a strong fiscal policy headwind this time around when it failed so spectacularly to do so the last time around.

Most physicians, when they see that their prescription for an illness is not working, do not insist on prescribing the same medicine. Seeing that its plan A is not working, one has to ask why the IMF is not beginning to work on a plan B for Greece that might have a better chance of working.

And in considering such a plan B, one would hope that the IMF will not rule out the option of providing financial and technical support to Greece for an orderly exit from the euro, which has proved to be such an unmitigated disaster for that country.

Desmond Lachman is resident fellow at the American Enterprise Institute. This article first appeared on the AEI site.