Tuesday, October 9, 2012

IMF Fiscal Multipliers and Ireland

The release of the October 2012 World Economic Outlook by the IMF has attracted some attention.  In particular is a three-page box-out by Blanchard and Leigh on pages 41-43.  A report on this featured on the front-page of today’s Irish Examiner.

IMF: We got effect of austerity wrong

The IMF has admitted it completely underestimated the effects of austerity on the Irish economy and believed the tax increases and spending cuts would not have cost so many jobs.

I had read box-out and glanced through the WEO before I saw today’s papers and I was surprised to see the above reporting of it.  Yes, the findings suggest that the IMF had been applying fiscal multipliers that were too small but this was based on an analysis of 28 countries rather than just Ireland.

From what I can tell the report makes no specific references to any IMF estimates of the “effects of austerity on the Irish economy”.  The finding that the IMF’s fiscal multipliers were too small was based on this graph.

Fiscal Consolidation and Growth Forecast Errors

The horizontal axis is the IMF forecast of the change in the primary structural balance as a percent of GDP for 2010-11. The vertical axis is the error in the IMF’s growth forecast for 2010-11 compared to the actual 2010-11 growth outcomes.  Both forecasts are from April 2010.

It can be seen that Ireland was second only to Greece in being expected to introduce budgetary measures leading to an improvement in the structural balance. 

The trend line shows that when the structural balance was forecast to deteriorate, on average, the IMF tended to underestimate the growth outcome, and that when the structural balance was forecast to improve, on average, the IMF tended to overestimate growth performance.  The implication being that the IMF were understating the effect of fiscal loosening/tightening on economic performance in 2011.  This conclusion is based on the linear regression line shown in the graph.

The box-out reports the IMF forecasters were using fiscal multipliers of 0.5 when multipliers of around 1.0 may have been more appropriate.

And what about Ireland?  The actual data used to generate the graph is here.  For Ireland, the IMF expected fiscal consolidation of 3.2% of GDP and when their 2011 growth forecast was examined they made a growth forecast error of –0.1%, which to all intents and purposes is zero.

Across the 28 countries in the sample, the analysis indicates that the IMF was underestimating the impact of fiscal adjustment.  The sample includes eight countries where there was expected to be fiscal loosening and 20 countries where there was expected to be fiscal tightening.

Of the eight countries with fiscal loosening, seven of them recorded growth surprises above the IMF forecast (only Denmark fell short of its growth forecast) and the growth outcome for five of the countries places them above the trend-line.

Of the 20 countries with fiscal tightening, 16 of them under-performed relative to the IMF’s growth forecasts, though for many of these either or both of the expected fiscal consolidation and growth forecast errors were small as represented by the large grouping in the middle.

The box-out is interesting but it says nothing specific about the IMF’s estimates of “the effects of austerity on the Irish economy”. 

In fact if the IMF had used larger fiscal multipliers for their 2010-11 growth forecast for Ireland the forecast should have been lower.  The IMF forecast in April 2010 was that real growth in Ireland would average 0.2% in 2010-11.  If this was based on the assumed fiscal multiplier of 0.5 then using a multiplier of 1.0 as inferred from the analysis of Blanchard and Leigh the IMF should have made an average growth forecast of around –1.5% for the two years, given the scale of the fiscal adjustment that was anticipated to be introduced in Ireland.  

If this higher fiscal multiplier had been used it would have been the case that Ireland would have significantly over-performed its IMF growth forecast as according to the CSO real growth in 2010 was –0.8% and in 2011 it was +1.4%, for an average of +0.3%. 

The analysis doesn’t tell us anything about the appropriate fiscal multipliers for Ireland now but using the numbers inferred above a re-write of the first paragraph of the Irish Examiner piece might be:

The IMF completely underestimated the effects of austerity on global economies and based on that made growth forecasts for Ireland that were far too high.  The IMF’s growth forecasts for Ireland should have been much lower as it underestimated the cost of tax increases and spending cuts on jobs. However, when the actual economic performance is analysed the impact of austerity in Ireland was not in line with the new IMF forecasts and growth turned out to be significantly higher than revised fiscal multipliers and growth models predicted.

I doubt that verbiage would get on the front page though.


  1. Seamus,

    Could you do me a favour? What is a Fiscal Multiplier? Is there an example of one available? Are FMs 'real' or virtual?

    The term is often used, but never explained nor exampled. Thanks.


    1. The Fiscal Multiplier is the number for the ratio between an increase in government spending and the resultant increase in antional income. If the government spending has a stimulant effect, the number will be more than 1.

  2. Seamus,

    Michael Burke in a comment on the other place (http://bit.ly/WU4syO) suggested that using GNP rather than GDP would undermine your argument. (He would not have seen yours at the time; he was responding to a similar remark by Philip Lane)

    Do you have a response ?

    1. Hi Fergus,

      The point is simply that the average IMF forecast for Irish GDP over the two years was pretty accurate. We can assume that the IMF are aware of the different aspects of the Irish economy that go into the GDP figure.

      If we do look at the IMF forecasts of domestic demand we see that Michael Burke's argument has some merit but the reasons for this bear examination. Table 4, page 31 gives the average IMF forecasts for the components of real domestic demand for 2010-11.

      The IMF projected that real final domestic demand would fall by an average of 1.7% per annum over the two years. The CSO figures in Annex 3A on page 11 that the average drop was actually 4.7%. Thus, while their GDP number was about right, it seems that they completely underestimated the continued fall in the domestic economy. Going a bit deeper shows the following about the components of domestic demand where the first figure is the IMF forecast and the second is the actual outcome.

      Private Consumption: -0.3% -0.7%
      Public Consumption: -1.3% -5.4%
      Investment: -6.3% -17.6%
      Final Domestic Demand: -1.7% -4.7%

      The main reason the IMF forecast for domestic demand is out is because Investment has continued to plummet (the biggest driver of the collapse of Investment has been the household sector). Government expenditure on goods and services also undershot the IMF forecast but that is austerity rather than the effect of austerity.

      The largest component of domestic demand is consumption (now two thirds) and the IMF forecast of that was pretty accurate.