Fiscal multipliers, a cause worth fighting for

It was in the IMF’s October 2012 World Economic Outlook (WEO), in Box 1.1 with the title “Are We Understanding Short-Term Fiscal Multipliers” that Olivier Blanchard and Daniel Leigh presented for the first time the findings of their study into the impact of fiscal consolidation on economic activity.

Using data from 28 different economies – G20 and EU member countries – for the years 2010 and 2011, they concluded that there is strong evidence that the fiscal multipliers used since the Great Recession that started in 2008 were systematically miscalculated by a range of 0.4 to 1.2. The implicit 0.5 multiplier used in international organizations’ models to forecast economic growth – which was based on empirical evidence from the three decades prior to 2009 – might be significantly higher, between 0.9 and 1.7, they found. In simple terms, it had previously been thought that cutting a euro from the government deficit would have an impact of 50 cents on economic output but their findings suggest that the damage on the real economy can be more than three times than initially thought, with a euro of deficit reduction coming at a cost of between 90 cents and 1.70 euros on the economy.

Safe as houses

It was Friday September 2^nd, 2011 when the troika of Greece’s creditors left Athens after two weeks of negotiations that failed to bridge the gap between the Greek government and the representatives of the IMF, the European Central Bank and the European Commission.

Their last unscheduled departure was in June 2011 when Papandreou’s government went through a month of hell: it had failed in an attempt to form a coalition government with Antonis Samaras, thousands of protesters gathered almost daily on the streets outside the Parliament and Syntagma square was occupied by Greece’s indignados. The events peaked with the vote in Parliament on June 29^th of the Medium Term Fiscal Program worth 28 billion euros in austerity measures, a day that neither the Greek state nor the police should be proud of because of the practices used against demonstrators.

Two months later and the projections of the newly agreed program were falling apart. The austerity measures that were implemented over the previous twelve months had now a proper grip on an economy that was sinking much faster than anyone anticipated or wanted to admit. The signs were gathering that GDP would drop by more than 5% compared to the 3.75% that was projected in June, making it impossible for Greece to meet the target of 7.5% of GDP deficit.