Download The Portuguese bailout experiment

The Portuguese bailout experiment:
does the IMF learn?
José Castro Caldas
Centro de Estudos Sociais
Coimbra University, Portugal
Ana Costa
Dinâmia-CET
ISCTE-IUL, Portugal
Paulo Coimbra
Centro de Estudos Sociais
Coimbra University, Portugal
ECONOMIC EXPERTISE AND THE “REAL WORLD”, 6th CES International Seminar on the Foundations of Economics,
Lisbon 28th September, 2015
“The crisis was a traumatic event during which we all had to
question many cherished beliefs”
“It would have been intellectually irresponsible, and
politically unwise, to pretend that the crisis did not change
our views about the way the economy works”
Olivier Blanchard
(Interview with Olivier Blanchard, IMF SURVEY, 31 AUGUST 2015)
How deep was the belief revision?
To what extent does it affect the IMF policies and practices?
The Portuguese bailout as a field experiment
The Portuguese bailout was a “field experiment” on
how to “adjust” within a currency union?
“… academic economics employs another method for
advancing and testing its arguments. It is sometimes able to
use the world as a laboratory” (Mitchell, 2005)
The program: grounded on “scientific” (economic)
“consensus views” (“common or widespread views
of economists and policy makers”, (IMF, 2013a))
The architecture of the Portuguese
bailout
Internal
devaluation
(competitivene
ss)
Fiscal
consolidation
(public deficit
and debt)
Recapitalization of the
banking system
(stability of the financial
system)
The architecture of the Portuguese
bailout: potential internal inconsistencies
• Internal devaluation vs fiscal consolidation
• Recessive effects of internal devaluation leads to less fiscal revenues
and more public spending
• Internal devaluation vs stability of financial system
• Recessive effects of internal devaluation leads to more non-performing
loans
• Stability of financial system vs fiscal consolidation
• In the absence of the access of banks to market solutions,
recapitalization becomes a burden to the public budget
• Fiscal consolidation vs stability of financial system
• Recessive effects of fiscal consolidation leads to more non-performing
loans
Theoretical devices to overcoming internal
inconsistencies (“scientific underpinings”)
(Expansionary) Internal devaluation (Jaumotte F.
and P. Sodsriwiboon, 2010)
“internal devaluation”, mimics a real
devaluation by reducing labor costs at home
relative to trading partners. One instrument …
lowering social security contributions financed by
increasing VAT rates … Other instruments:
reducing indexation of wages to inflation….
The (possibly) recessive effect of internal devaluation
might be offset by the improvement of the external
balance
Theoretical devices to overcoming internal
inconsistencies (“scientific underpinnings”)
(Expansionary) Fiscal consolidation (Alesina and Perotti
1995, 1997; Alesina and Ardagna 1998, 2009, 2010;
Alesina 2010; Barro 1974, Giavazzi and Pagano 1990):
a fiscal adjustment may be expansionary if agents believe that
the fiscal tightening generates a change in regime that
“eliminates the need for larger, maybe much more disruptive
adjustments in the future” [the wealth effect of expectations of
lower taxes and lower interest rates in the future spurs present
spending and investment].
The (possibly) recessive effect of internal devaluation
might be offset by the expansionary effect of fiscal
consolidation
The Portuguese bailout as a field
experiment: main surprises
On the downside:
“The current level of unemployment is higher than the historic relationships
with output would suggest - in line with findings for balance sheet
recessions” (fourth review, July 2012)
“a larger-than-expected decline in investment” (fifth review, October 2012)
“evidence of higher fiscal multipliers at work in Portugal” (fifth review,
October 2012) … “recession is now set to be deeper than previously
envisaged” (seventh review, June 2013)
“The debt peak has been revised upward and is now set to have peaked
below 129.5 percent of GDP in 2013 [115.3%, MoU]” (tenth review, February
2014)
On the upside:
“external position has improved much faster than expected” (fifth review,
October 2012)
IMF’s Staff reassessment (IMF 2013)
Pre-crises "consensus view“
Reassessment
Advanced Economies are not at risk The crisis exposed shortcomings in the euro area
of a fiscal crises
institutional architecture
Multiple equilibria can emerge even at low levels of
Financial markets discipline
debt…, a smaller move in interest rates can shift
government finances
the sovereign from solvency to insolvency
Central bank financing of the
budget could undermine its
independence and its control of
inflation
Central bank purchases of government debt have
turned out to be useful to allow for a more gradual
fiscal adjustment
Discretionary fiscal policy has a
limited role to play in fighting
recessions
Fiscal policy can ... have powerful effects on the
economy in the short run
IMF’s Staff reassessment (IMF 2013)
Pre-crises "consensus view“
Reassessment
Positive confidence effects can
Most famous episodes of expansionary
dominate the adverse mechanical contractions observed in Europe in the 1980s and
effects of cuts in spending or
1990s were typically driven by external demand
increases in revenues, and lead to more than by a surge in internal private demand on
“expansionary fiscal consolidations" the back of confidence effects
Frontloaded fiscal consolidation is
the most effective approach to
restoring the health of public
finances
Excessive frontloading can hurt growth to the point
that it undermines social and political cohesion,
and weakens rather than strengthens market
confidence… frontloaded efforts may even be “self
defeating,” and fail to achieve the consolidation
targets in the short run due to negative growth...
IMF’s Staff reassessment (IMF 2013)
Pre-crises "consensus view“
Reassessment
Expenditure-based consolidations The crisis has not offered conclusive lessons
are more durable than revenueregarding the relative size of revenue and
based ones
government spending multipliers
A large and protracted fiscal consolidation is likely
to exacerbate income inequality
Adjustment packages should be carefully designed
to limit their negative social effects and improve
their sustainability
Keeping rules simple and
Fiscal rules should be made more binding in good
transparent helps enforcement via economic times, while allowing room to maneuver
market discipline and public
when the economy is weak
pressure
The Portuguese bailout as a field
experiment: rhetorics of justification
‘Immunization against falsification’:
 ‘Strategic uncertainty’ - statements which are put on conditional
manner cannot be wrong:
“downside risks are significant, especially in the near term. The global market turmoil
has heightened risk aversion, and funding problems could intensify, especially for
banks.” (first review, September 2011)
“Delayed fiscal implementation would undermine fiscal sustainability and confidence
in the program.” (first review, September 2011)
“Sustained social and political support is necessary for the comprehensive structural
reform program. Strong vested interests could weaken reforms, or reform fatigue could
set in” (first review, September 2011)
“The intensification of euro area stress is a major risk factor to the attainment of the
program’s key objectives.” (fourth review, July 2012)
“the program’s success will also critically depend on improvements in the euro area
economic environment and, more specifically, implementation of the steps being
considered to strengthen the incomplete economic architecture of the currency union”
(fifth review, October 2012)
The Portuguese bailout as a field
experiment: rhetorics of justification
‘Immunization against falsification’:
 ‘Strategic uncertainty’ - statements which are put on
conditional manner cannot be wrong:
“it remains unclear whether these [structural] reforms will prove adequate
to engender the relative price adjustment required to raise competitiveness,
employment, and potential growth rapidly enough to avoid adjustment
through a drawn-out economic depression. The mission urged the
authorities to continue exploring options to reduce production costs and
compress mark-ups in the non-tradable sector and boost productivity.” (fifth
review, October 2012)
“some of the fiscal measures under the program could be challenged on
constitutional grounds” (sixth review, January 2013)
“migration of contingent liabilities from either state-owned enterprises or
the private sector to the sovereign balance sheet remains a possibility” (sixth
review, January 2013)
The Portuguese bailout as a field
experiment: rhetorics of justification
‘Immunization against falsification’:
 ‘Moving targets’ - economic indicators related to GDP
performance, public deficit or debt are always under
continuous adjustment:
The bailout’s moving targets
The bailout’s moving targets
The bailout’s moving targets
The bailout’s moving targets
The bailout’s moving targets
The Portuguese bailout as a field
experiment: rhetorics of justification
‘Firewalling’ - (division of labor) within the IMF:
 Research (scope for exploration, and some expression of dissent)
 Policy (sticking to old habits)
“The fact that the economic counsellor, or the research department, has a view
on a particular topic does not move things very much by itself. An essential part of
the job is to convince, or try to convince, the rest of the building, from
management to the department desks, of that view. This can be hard work. To
treat all countries in a consistent way, the Fund must have a corpus of beliefs, and
this corpus is not easily changed. Ideas do not only need to be developed, they
need to be sold to the rest of the building.”
Olivier Blanchard
(Interview with Olivier Blanchard, IMF SURVEY, 31 AUGUST 2015)
The Portuguese bailout as a field
experiment: rhetorics of justification
‘Accommodation’:
 ‘Materialization of risks’:
 “Social and political resistance to adjustment has heightened.” (fifth
review, October 2012)
 “fiscal adjustment measures need to meet legal criteria that are at times
difficult to anticipate” (sixth review, January 2013) …
 “the Constitutional Court in August ruled against a key public expenditure
reform, effectively limiting the government’s scope to dismiss public sector
employees. More recently, the Court also overturned labor reforms that
had softened at the margin Portugal’s rigid employment protection rules
for dismissing individual workers with permanent contracts.” (eight and
ninth reviews, November 2013)
 “the fiscal gap … reflects a structural shift in the composition of output
towards net exports.” (fifth review, October 2012)
The Portuguese bailout as a field
experiment: rhetorics of justification
‘Accommodation’:
 ‘Implementation errors’:
 “An alternative policy package to the fiscal devaluation earlier proposed by staff
would considerably improve growth prospects and deliver a significant narrowing of
external current account deficit in the near-term. Such a package could include
deeper labor and product market reforms. In its absence, the program unavoidably
relies on front loaded fiscal adjustment, increasing the risk of undermining growth
in the near-term. … staff calls on the authorities to continue urgently exploring
swiftly implementable alternatives to the fiscal devaluation that would tilt the
relative price structure in the economy towards tradable activities, and reduce the
risks of a purely demand-driven adjustment.” (third review, April 2012)
 ” The composition of the package, however, has changed: the yield from the
horizontal measures (cross-cutting reforms of wages and pensions) has been
reduced by almost a half (to 0.9 percent of GDP), with higher sector-specific
savings—which mainly include targeted nonrenewals of fixed-term contracts and
cuts in intermediate consumption—picking up the slack. Staff regretted this
rebalancing, as implementation of horizontal measures is easier to enforce, monitor,
and maintain.” (eight and ninth reviews, November 2013)
The Portuguese bailout as a field
experiment: rhetorics of justification
‘Accommodation’:
 ‘Modifications of conventions of quantification’:
 “Debt is now expected to peak at some 118.5 percent of GDP in 2013,
some 3 percentage points higher than at the time of the third review.
This is due to a lower nominal GDP path and reclassification of
liabilities.” (fourth review, July 2012)
 “the upcoming introduction of the ESA 2010 accounting rules in
2014 may lead to the inclusion of certain state-owned enterprises
that are currently outside the general government perimeter. “(eight
and ninth reviews, November 2013)
The Portuguese bailout as a field
experiment: rhetorics of justification
‘Belief revision’:
 “recent experience, both within Portugal and elsewhere,
suggests the need for caution in this regard—indeed Portugal’s
output has been broadly in line with projections but the degree
of fiscal adjustment has been lower, suggesting the possibility
of a higher multiplier. Staff and the authorities therefore
agreed to use a higher multiplier for the incremental fiscal
adjustment being undertaken in 2013” (fifth review, October
2012)
The Portuguese bailout as a field
experiment
What should count as evidence of the (un)success
of the experiment is an ex post rationalization,
disputed in the public space:
 “the evidence never seems complete enough to establish
conclusive arguments”
 “how facts about the economy are produced” (Mitchell, 2005,
p. 297)
The Portuguese bailout as a field
experiment
‘Partial belief revision’ - qualifications giving
scope to conservation in policy:
 “The crisis has provided evidence that fiscal policy is an
appropriate countercyclical policy tool… Nevertheless, a
number of reservations regarding the use of discretionary
fiscal policy tools remain valid…” (IMF, 2013)
 “The design of fiscal adjustment programs, and particularly
the merit of frontloading, has returned to the forefront of the
policy debate. [But] frontloading is more justifiable in
countries under market pressure…” (IMF, 2013)
“With respect to outside, the issue I have been struck by is how to
indicate a change of views without triggering headlines of
“mistakes,’’ “Fund incompetence,’’ and so on. Here, I am thinking
of fiscal multipliers. The underestimation of the drag on output
from fiscal consolidation was not a “mistake’’ in the way people
think of mistakes, e.g., mixing up two cells in an excel sheet. It was
based on a substantial amount of prior evidence, but evidence
which turned out to be misleading in an environment where
interest rates are close to zero and monetary policy cannot offset
the negative effects of budget cuts. We got a lot of flak for admitting
the underestimation, and I suspect we shall continue to get more
flak in the future. But, at the same time, I believe that we, the Fund,
substantially increased our credibility, and used better assumptions
later on. It was painful, but it was useful.”
Olivier Blanchard
(Interview with Olivier Blanchard, IMF SURVEY, 31 AUGUST 2015)
The Portuguese bailout as a field
experiment
The controversy is not only about a quarrel
between different theoretical economic
approaches … it is a political issue
 Credibility
Trust - conditions for the exercise of justification
????
References
Alesina, A. (2010), “Fiscal adjustments: lessons from
recent history”, Prepared for the Ecofin meeting in Madrid
April 15 2010.
IMF (2013), “Reassessing the role and modalities of fiscal
policy in advanced economies”, IMF policy paper,
September 2013
Jaumotte F. and P. Sodsriwiboon (2010), “Current Account
Imbalances in the Southern Euro Area”, IMF WP/10/139
The bailout’s excel equilibria
The bailout’s moving (double?) criteria
Sixth review:
“[a]ll performance criteria for which data are available and structural
benchmarks for the 6th review have been met” (IMF, 2013a1: 4)
“the 2012 deficit would be about 1⁄4 percentage points of GDP higher than the [revised
from 4,5%] target of 5 percent of GDP (including receipts from the sale of an
airport concession)” (IMF, 2013a1: 7).
Seventh review:
“general government deficit [2012] for program purposes is estimated at 4.7
percent of GDP, smaller than the 5 percent foreseen at the time of the last review” (IMF,
2013b: 9).
The ESA-definition deficit for 2012 is estimated at 6.4 percent of GDP, reflecting a
number of one-off transactions that were were “excluded from the program
deficit measure because they either are related to banking sector support or
represent accounting reclassifications and not discretionary activity of the
government (IMF, 2013b: 9)”
The Portuguese bailout as a field
experiment
“On the Fund’s part, we are favorably considering that
this be done in as timely and flexible a manner as
possible: slowing the pace of fiscal adjustment where
needed; focusing on measures rather than targets
(…)” By Christine Lagarde, Managing Director,
International Monetary Fund
https://www.imf.org/external/np/speeches/2012/092412.htm