The IMF's Missed Opportunity
What’s the value of advice that doesn’t help? In the case of the International Monetary Fund, its recent review of the US economy sounds a mixed message on fiscal policy: the US is working too hard on fiscal consolidation in the short term, but needs a measured plan for budget reform in the medium-term. This message is far too muddy for domestic policymakers and the public, and ignores the biggest short-term risk the US faces: the danger that partisan bickering prevents the debt ceiling from being raised later this fall. This is a recurring theme for the IMF, as its report card in 2011 was also issued at the height of the debt ceiling crisis, and it also fell on deaf ears. The key for the Fund’s surveillance to be more influential moving forward is simpler messaging that outlines the costs and benefits of various economic choices.
The IMF’s economic reviews are annual affairs for all member countries. Fund officials meet with country officials (in the US case, officials from the Fed and Treasury), and draft a report to be discussed by the IMF Executive Board. These consultations give the Fund an opportunity to review the state of a member’s economy and make recommendations designed to keep countries growing.
The IMF suggested that US fiscal policy suffers from a bit of a Goldilocks problem: while in the short term there is too much fiscal consolidation, in the long term there needs to be much more of it. At one level, the tax increases from the fiscal cliff, coupled with the money saved from the sequester, caused real harm to the economy. This blunt contraction of government spending will reduce growth by more than a percentage point and a half this year. Over the long term, the Fund argues increases in interest rates plus health care spending driven by an aging population will cause the budget deficit to widen over the next decade. To forestall this, a medium-term fiscal consolidation plan is necessary, including tax reform and the introduction of a value added tax.
While the message of the review is “do less about the short term, focus more on the long term,” this advice does little to help the Obama White House. It does little to persuade opposition legislators in the House and Senate that the sequester is causing too much harm. After all, deferring fiscal austerity today is only going to make matters worse tomorrow. It is worth noting that the IMF’s own projections do little to sell the case for medium-term fiscal consolidation, as the projected budget balance for 2023 is 3.7% of GDP, which is still less than the White House itself projects for 2014. So the message of a need for reform comes with numbers that do little to suggest a nightmare scenario, which also serves to undermine the central message.
In all of this, the main problem that the US faces – that of a jobless recovery – is only addressed in two paragraphs. Resources to support active labor market policies designed to help the unemployed gain additional skill training and help in finding a job are lower in the US compared to other advanced economies, but advice on how to get the economy moving was short in coming here. In contrast, the OECDs review of the US economy last year recommended drawing lessons from Germany’s experience in connecting the education system and labor markets. So, the sequester is harming growth, but the Fund offers no advice on how to end it, nor advice on how to get Americans back to work.
The biggest liability with this report is that it does not call attention to the debt ceiling crisis certain to emerge this fall. The report’s projections assume that the debt ceiling will be raised without controversy, which is something that few in Washington actually believe. With the Treasury department starting to run out of ‘extraordinary measures’ to meet the government’s obligations, it is essential to raise the debt ceiling to avoid turning decisions about which of the government’s creditors get paid to the White House. Elsewhere in the report the Fund refers to the likelihood that the debt ceiling doesn’t get raised as a low probability event, but this does not reflect the history of the White House and Congress’ dealings in the past, nor does it reflect electoral dynamics that make compromise even less likely this fall. While the Fund misses the potential for a crisis, it does not underestimate the costs of such a crisis were it to take place. The repercussions at home and abroad would be severe. The Treasury Department estimated that the debt ceiling crisis in 2011 cost the US over a billion dollars in higher than expected interest payments, and the Bipartisan Policy Center puts the cost of the 2011 crisis at almost $19 billion dollars over ten years. Agreeing that an event would have negative outcomes is one thing, but offering advice that helps politicians avoid it is quite another. That second step, which is essential for its advice to be effective, remains elusive for the IMF.
Just as we hope that the President and White House learn from 2011 and the unnecessary downgrade of the US credit rating that resulted, we also hope that the Fund learns from the 2011 debt ceiling crisis. Two years ago in July, it also released its review of the US economy. Unlike the present report, it sent a strong message, repeatedly referring to the growth of the national debt as “unsustainable.” Unfortunately, there is little evidence that its advice was heeded, as there were scant references to it in Congressional debates. It failed to send a useful message: proposing a Value Added Tax that would never make it onto the floor of Congress as well as cuts in Social Security that the White House would never propose. If clear messaging doesn’t translate into policy change, then how can we expect the less consistent message in this year’s report to have an impact?
The standard for IMF surveillance ought to be to provide advice that is useful given political constraints, which are both real and omnipresent across the globe. Policymakers need to weigh the costs and benefits of their actions, and a clear report that confronted the debt ceiling head-on would have been more useful to the White House than the fiscal consolidation tango outlined above. The IMF is uniquely positioned to play this role as an impartial observer. A more focused message holds the key to make surveillance more influential moving forward.