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Schizophrenia at the IMF

At long last, the International Monetary Fund has begun to recognize that the best way to reduce sovereign debt is by boosting economic growth, rather than insisting on fiscal retrenchment. But this new understanding is being undermined by a lingering adherence to growth-inhibiting austerity policies.

NEW DELHI – It has taken far too long, but it seems that the International Monetary Fund has finally internalized some hard truths about sovereign-debt reduction. Chief among them is that growing economies have an easier time repaying. As such, fiscal consolidation – the organization’s favored strategy – undermines efforts to reduce debt-to-GDP ratios because it inhibits economic growth.

To be sure, this is hardly a new insight. John Maynard Keynes emphasized it nearly a century ago, and many have reiterated it ever since. It was certainly known to the negotiators who crafted the London Debt Agreement of 1953, which dramatically reduced West Germany’s burden of public debt. The agreement between Germany and 20 of its external creditors provided favorable repayment terms linked to the country’s future exports, creating the conditions for its postwar economic boom.

Still, better late than never. The IMF’s latest World Economic Outlook presents the results of its own investigation into various debt-reduction programs undertaken by 33 emerging-market economies and 21 developed economies between 1980 and 2019. “On average,” the authors note, “consolidations do not lead to a statistically significant effect on the debt ratio.” Instead, they find that higher GDP growth – “as captured by positive demand and supply shocks together” – is “an important force” responsible for roughly one-third of the observed debt reduction during that period. The analysis even recognizes that fiscal expansion improved debt ratios in several cases, largely due to its positive effect on GDP growth.