Forgetful IMF economists should remember their financial crisis failures

Paul Ormerod
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IN THE boom decade of the 2000s, corporate rebranding was all the rage. Some were successful. Others are best forgotten, like PwC’s proposal to call its consulting arm Monday. But as the world’s economic recovery gathers momentum, perhaps it is time to revive the practice.

A prime candidate is the International Monetary Fund (IMF). The brand has global reach, so why not intensify its name to IMFSquared or IMFF for clarity? But a change of initial doesn’t get us very far. IMFF should stand for Intellectually Massive Flip Flops.

The Fund is up to its old trick of completely changing its mind. Having backed austerity enthusiastically, its economists are altering tack. The latest IMF World Economic Outlook claims that the impact of changes to fiscal policy has been substantially underestimated. In short, keeping a tight grip on the public sector deficit does not work. More, not less, spending is needed to boost the economy.

The IMF has serious form on this matter. In August 2008, its chief economist Oliver Blanchard published a working paper on the state of academic macroeconomics. This is what he had to say: “For a long while after the explosion of macroeconomics in the 1970s, the field looked like a battlefield. Over time, however, largely because facts do not go away, a shared vision both of fluctuations and of methodology has emerged. The state of macro is good.”

The shared vision Blanchard referred to is the superbly named, but wholly useless, dynamic stochastic general equilibrium model. During the 1990s and 2000s, mainstream economics in academia and central banks reverted to the old idea that economies have an in-built tendency to move towards equilibrium. On this basis, in August 2008 the Fund’s chief economist believed that “the state of macro is good”. Just a few weeks later, the collapse of Lehman Brothers shattered the illusion.

To be fair to Blanchard, the terrifying events of the autumn of 2008 made him change his mind. By January 2009, he was writing that the crisis was caused by “institutions financing their portfolios with less and less capital, thus increasing the rate of return on that capital. What were the reasons behind it? Surely, optimism and the underestimation of risk was part of it.”

So instead of a theoretical world in which rational decision makers moved effortlessly towards equilibrium, we had the reality in 2007 and 2008 of grossly optimistic expectations about the future – and completely mispriced risks.

This sounds a pretty plausible story. But only a few months before the IMF believed that “macroeconomics was going through a period of great progress.” Until recently the IMF thought fiscal tightening did not have much impact. Now it thinks austerity is wrong. IMFF rules OK.

Paul Ormerod is an economist at Volterra Partners LLP, a director of the think-tank Synthesis and author of Positive Linking: How Networks Can Revolutionise the World.