The IMF’s Warnings About Government Policy
This post was written by Karl Whelan
One of the elements of the recent IMF Article IV report that I found a bit strange were the claims that the Fund had warned the government about its fiscal policy prior to the current meltdown. For instance, the first page of the report states
Various commentators and the IMF in its Article IV consultations did warn that the seemingly-unstoppable growth masked serious imbalances, including the fragility of public finances.
In his Irish Times article on Friday, however, Jim O’Leary correctly points out that the IMF are engaging in some pretty serious revisionist history and makes some very good points about the flaws underlying estimates of structural budget deficits (weaknesses that I discussed in my recent TCD-DEW talk about potential output.)
I had also read the previous IMF Article IV report (from 2007) on Friday, prior to reading Jim’s article, and came away with the same impression. The opening sentence is “Economic performance remains very strong, supported by sound policies.” And the summary box on the first page contains the following:
Fiscal policy: Fiscal policy has been prudent, with a medium-term fiscal objective of close to balance or surplus, in line with Fund advice. In the past couple years, windfall property-related revenues were saved and the fiscal stance was not procyclical, in line with Fund advice.
And in relation to financial supervision, the box contained the following:
Financial stability: The Fund supports the supervisory framework, which aims to prioritize resources across sectors based on risk profile. The regulatory and supervisory framework continues to be strengthened in line with the recommendations of the 2006 FSAP Update.
I have huge respect for the staff of the IMF and this year’s Article IV report is excellent. However, on this particular issue, I believe that the government is correct in its position that the IMF did not, in fact, provide substantial warnings about its policies prior to the current recession.
Tags: IMF
July 4th, 2009 at 9:49 pm
@Karl,
2002: http://www.worldbank.org/html/prddr/trans/octnovdec02/pgs20-23.htm
[quote]How long can the Celtic Tiger keep going? The IMF 2002 Staff Report on Ireland warns that “the stellar performance of the Irish manufacturing sector in recent years was partly interrupted in 2001. The main reasons for fairly limited gains were the global economic slowdown, the bursting of the Internet communications technology bubble, and the rapid increase in Irish wage costs.” The IMF also noted that some of the high-tech industries attracted to Ireland in the 1990s were permanently relocating away from the island despite the “astonishing performance of a handful of sectors mostly dominated by multinational companies, whose gains in productivity often result from intangible foreign inputs in production, such as global investment in research, product development and advertising.”[/quote]
2003: http://www.nejtillemu.com/irland.htm
[quote]IMF warns house prices may have risen too high
Irish Times 7/8 2003
There is a significant risk that house prices are overvalued, leaving the property market vulnerable if unemployment rises sharply, the International Monetary Fund (IMF) has warned. The boom in credit could have helped to push house prices to unsustainable levels, it says, leaving purchasers exposed and posing risks for banks and building societies which have lent them money.
In its latest assessment of the Irish economy, the IMF forecasts a pick-up in growth next year, but warns that declining competitiveness could hinder the economy. [/quote]
Financial Stability report 2006:
http://www.imf.org/external/pubs/ft/scr/2006/cr06292.pdf
[quote]While the outlook remains very strong for 2006–07, there are some macro-risks that
could have implications for financial system asset quality. Sustained rapid credit growth,
driven largely by the record increases in mortgage credit which have accompanied the
extended boom in the housing market, has resulted in household debt to GDP ratios that are
now amongst the highest in Europe, raising some concerns about household sector credit
risk. Moreover, a significant slowdown in growth, while seen as extremely unlikely in the
near term, would have adverse consequences for employment, resulting in reduced demand
for housing and a consequent slowing in the construction sector. Both corporate and
household loan quality would be expected to deteriorate under such a scenario, although the
likely magnitudes are uncertain due to the lack of recent experience with a major downturn in
Ireland.[/quote]
And so on.
They wouldn’t say it if they didn’t think it was important…
July 4th, 2009 at 10:20 pm
To the extent one can decipher their cyclical/structural estimates from their charts (since no estimates are provided), they look odd — they seem to be estimating a structurally imbalanced budget for every year since 1993-94. Has any other country had a 15 year actual above structural budget balance?
July 5th, 2009 at 9:11 am
The IMF statement in 2007 on “sound policies” was absolutely stupid, just not in hindsight but at the time - - “Economic performance remains very strong, supported by sound policies.”
External bodies can be too polite in their published commentaries during apparently good times while internally, there is a reluctance to go against the consensus. To challenge the politicans in power, the bureaucracy and the State broadcaster RTÉ, one has to be prepared to be put on the unofficial enemies list!
The IMF did warn in 2007: “Directors underscored that rapid house price increases and a boom in residential construction have been an important driver of growth and bank lending. While the slowdown of the housing sector has been gradual so far, and will help to rebalance growth and contain inflationary pressures, a sharper correction in house prices could significantly slow economic growth.”
Cowen could also use a comment by Jean-Claude Trichet in May 2007 in Dublin, to strengthen the fig leaf but would only confirm his own incompetence:
“Question: Mr Trichet, I would like to take the opportunity to welcome you to Dublin. While you are here, we would like to ask you about the Irish economy. With low unemployment, you have mentioned before our over-reliance on the property sector and house-building and house prices are falling off. Can you comment on that, please?
Trichet: First of all I have said that to the President of the Republic of Ireland, that very often, I and my colleagues of the Governing Council are mentioning the Irish economy as a role model in many respects for the euro area. In terms of growth, in terms of dynamism, in terms of job creation, in terms of long-standing reform strategy, with economic reforms that are paying off in many respects. And the present levels of figures that we can observe as regards job creation, the diminishing of unemployment, the GDP per capita based on this long-standing growth of the economy are very impressive.
I will also make the remark that what we are deciding ourselves, together with John Hurley and the Vice-President and all our other colleagues, is based upon our judgement on the vast economy that is the euro area, 318 million people – our fellow citizens, 13 countries, from Dublin to Ljubljana, from Lisbon to Helsinki…And I would very much like John to make a comment here.
Hurley: Thank you very much, there is little to add; the decisions that are made here and in Frankfurt in the Governing Council are decisions for the euro area as a whole, as the President has said. In relation to the Irish property market, you probably will recall that last year, house prices in Ireland were rising at about 15% and at that time, I indicated clearly that I thought that that level of increase was too high and I thought that it could not be sustained.
What we have seen since is a reduction in the level of price increases and I think in March, on an annual basis, these prices would now be increasing at about 7%. So it is clear that this year I think the growth in house prices will be down to single figures, low single figures and I think this is a positive thing and I think that it shows we have a soft landing in the Irish property market.”
The main problem was not that beyond the economist shills in financial services, the economic risks being taken were not clear to many insiders but nobody had the cojones to risk their cosy lifestyles.
As McCreevy was cutting taxes and extending property tax incentives in 1999, Maurice O’Connell, the governor of the Central Bank was sending letters to the lenders warning that the excessive rise in house prices had been partly driven by the ready availability of mortgage finance on generous terms.
He warned credit institutions that they had a duty to be aware of the financial and social consequences of an excessively flexible lending policy. O’Connell asked for a detailed reply from the boards of the credit institutions but the politicians and bank chiefs were surely laughing up their sleeves!
In credit to Jim O’Leary, he took a very un-Irish stand in 2002 by resigning from the public benchmarking body, in opposition to the greatest pre-mediated Irish economic crime, since the Civil War.
It is true as Karl Whelan says, “the IMF did not, in fact, provide substantial warnings about its policies prior to the current recession.”
It would not have mattered.
The IMF would just have been added to Bertie’s suicide watch list.
In 2001, when Ahern and McCreevy gave the two fingers to warnings from the European Commission, they won wide support and an Irish Times poll put them on course for victory in the following general election.
http://www.finfacts.ie/irishfinancenews/article_1016709.shtml
Remember the warnings by the Economist on the greatest bubble in history?
Some of their loudest Irish critics are still in the snake oil business!
July 5th, 2009 at 11:15 am
I think you’re very wrong here Karl. If you read the previous consultations going as far back as the year 2000 you’ll see that the Fund were very prescient…. unbelievably prescient actually in pointing out the overheating in property and various structural imbalances, tax problems etc… They were quite correct to say they pointed all this out.
July 5th, 2009 at 2:27 pm
Many sensible dissenting voices were silenced by the duration of the bubble. By 2007, perhaps the IMF felt a little goofy that their earlier warnings had been incorrect at that point. Rather than warning of ever greater problems, they may have worried about their own credibility.
Personally I thought property was too expensive in the late nineties. That prices continued increasing for several years was unbelievable to me. I stopped sharing my personal opinion with friends as I was wrong yoy (and potentially losing them ‘money’). All sorts of gibberish was uttered about demographics being the fundamentals. To me, it was a credit bubble. Banks scrambled to find ways to extend more credit to the borrower. Would property prices have ballooned in the absence of credit? Perhaps future Regulators should ensure that credit should have a neutral impact on asset prices.
July 5th, 2009 at 7:15 pm
@Ahura
I remember telling a colleague he was taking a risk buying an ordinary house for £250k in 1996. Told him prices were getting out of control!
Like you I shut up after a while, but prices did seem to defy gravity.
Now the question is where everything will settle and what will happen after that. Having got it completely wrong in 1996 I expect to be completely wrong now.
July 5th, 2009 at 9:34 pm
@karl w: I agree with you totally on this, although its kind of sad that we should need IMF guidance in order to make sound decisions to begin with.
btw: I have a new question for you - my last one had a get out clause you got straight away at the conference (that of near divine power), here ya go:
If you had 12-18 months to fix the structural deficit, and you have only mortal powers to do so, what policies would you enact?… the incentive is that if you fail you go before a firing squad
July 5th, 2009 at 9:57 pm
Some of the media and official stuff needs very cautious reading and analysis. If its staid and turgid - its probably to disguise something, or put it is esoteric terms that is incomprehensible.
Fact: This state is insolvent. Many, many of out tax-paying citizens are rapidly losing the discretionary element of the wage/salary/pension. Less money - less economic activity. Simple math - well its simple if you neglect the Exponential Function. No need for pages of waffle.
Fact: Energy and some raw material supplies are precarious. East Asia has a massive oversupply of labour, sufficient plant and capital - sucks in more resources (to grow!) -less for us! Simple physics and math.
Could we have some debate/discussion of the economic problem of trying to ‘compete’ with economies that have wage and cost structures at much lower levels than ours. We cannot. Hence we are in for a very torrid time indeed.
Brian P
ps. I am too busy at present, but could someone do some research on how people lived in Ireland during the 1930’s - when they had much less technology available - ie. their life-styles. I think we may need some of this information in the not too distant future.
bpw
July 5th, 2009 at 10:30 pm
@Karl
Did someone suggest here or elsewhere that there was a change in the IMF staff covering Ireland during the last 10 years?
The 1999 IMF report suggested that countercyclical policies were in order along with trying to learn from other countries that had asset price bubbles etc.
“Staff expressed concern about the effects of rapid credit growth and sharp increases in asse prices on the health of the financial system and the quality of the banks portfolios, particularly those exposed to the housing and property markets” (par 41 p.19)
http://www.imf.org/external/pubs/ft/scr/1999/cr9987.pdf
@Michael Hennigan
Question - Was Jim O’Leary right, tactically, to resign from the benchmarking body? Was anyone else inside the body casting a cold eye on what is clearly another case of irrational exuberance?
Suggestion - If he had stayed and written a minority report, it might have had the influence that a minority report had in economic policy making here eg. there was a minority report attached to Judge Kenny’s 1974 report on the control of development land prices. In short nothing was done.
Any lessons there for other participants in such bodies?
July 6th, 2009 at 9:39 am
@Donal
Jim O’Leary subsequently with two colleagues, used ESRI data to make comparisons for similar jobs in the public and private sectors.
He was working for Davy when on the benchmarking body. So I assiume that he would not have had time to do the necessary research to support his case. Although McCreevy’s decision to exclude pensions from the benchmarking remit, meant it was a farce from the start anyway.
The genesis of the fraud was the dot-com boom and newspaper stories of a small number making killings from floatations and business sales triggered by McCreevy’s cut in capital gains tax to 20%.
Public-Private Wage Differentials in Ireland,
http://www.esri.ie/UserFiles/publications/20070725110234/QEC2004Sum_SA_Boyle.pdf
G.Boyle, R.McElligott and J.O’Leary, ESRI Quarterly Economic Commentary, Summer 2004.
July 7th, 2009 at 7:27 pm
On a point of information, Jim O’Leary was already at Maynooth when he resigned from the Benchmarking body, although I think he was appointed to it before he arrived at Maynooth.