Austerity doesn't work: New IMF report details the damage

What's the cost of austerity?

The actual cost of severe austerity can't be calculated'the number of lives lost or dreams killed because of families free-falling into poverty isn't an easy number to add up. Now, a new report from the International Monetary Fund has at least quantified the economic damage of austerity ... and it's a number that will shock you.

First, some background. Back in October 2012, this is what the IMF reported:

Earlier this week, the International Monetary Fund made a striking admission in its new World Economic Outlook. The IMF's chief economist, Olivier Blanchard, explained that recent efforts among wealthy countries to shrink their deficits ' through tax hikes and spending cuts ' have been causing far more economic damage than experts had assumed. (emphasis added)

At the time, Brad Plumer at The Washington Post explained the importance:

Economists tend to agree that tax increases and spending cuts hurt growth. The question is how much they hurt growth'a variable that usually changes at different points in time.

This matters a lot for policy. If tax hikes and spending cuts only hurt growth a little bit, then a government with debt problems will want to enact some austerity measures. If a tax increase, on average, raises $10 in revenue but reduces output by $6, that might be painful, but it will ultimately shrink the deficit. (Indeed, those are basically the numbers that policymakers in Britain and elsewhere had been using.) [...]

Blanchard is now arguing that the fiscal multiplier appears to have been much higher over the past few years than policymakers, including the IMF, had assumed. It's not 0.6. It's somewhere between 0.9 or 1.7. If true, then countries in Europe and the United States should have been pursuing stimulus measures to boost growth'and not insisting on budget cuts. (Not surprisingly, Paul Krugman is claiming vindication, since this was his view all along.) (emphasis added)

Now, a new IMF working paper released today details the true damage of austerity:

In a new paper published Thursday, IMF Economic Counsellor Olivier Blanchard and research-department economist Daniel Leigh show the IMF recommended slashing budgets too fast early in the euro crisis, starving many economies of much-needed growth.

In 'Growth Forecast Errors and Fiscal Multipliers,' Messrs. Blanchard and Leigh calculate IMF and European economists underestimated the euro-for-euro effect of cutting government budgets. While economists expected that cutting a euro from the budget would cost around 50 cents in lost growth, the actual impact was more like 1.50 per euro.

You can read the paper here and Howard Sneider's take on it over at The Washington Post here.

In Greece, which has implemented draconian austerity measures at the request of the IMF, the European Commission and the European Central Bank in order to receive bailout funding, the results are seen on the streets where a middle class has plummeted into poverty. One out of three Greeks now lives in poverty and average salaries have been slashed to just several hundred net euros a month. Homelessness, which was rarely seen in that country, is now endemic in certain parts of Athens. The unemployment rate has reached a record 26 percent, with more than 50 percent of Greece's youth out of a job.

Greece received billions of euros in bailout funds, but a large part of why austerity didn't work in Greece is because it wasn't offset by any growth strategy. In a shocking example of how twisted reality became, Greece's bailout funds at one time were simply wired into an escrow account that the government couldn't touch and then wired back for debt service to European banks just days later (read the NYT report here). In other words, not only was there painful cuts, but any money coming into the country was spent almost exclusively on debt reduction rather than on stimulating the economy.

You would think that politicians and analysts here in the United States would take a lesson from the tragedy that has befallen Greece. Instead, as Media Matters documents today, pundits are using the situation there to call for more austerity here at home. (More great stuff from Albert Kleine over at Media Matters here.)

Some politicians recognize that austerity without a corresponding growth strategy is a recipe for disaster. Today, Portugal's president fought back:

President Anibal Cavaco Silva called for urgent action to halt the 'recessionary spiral', warning Europe's leaders that the current course had become 'socially unsustainable'.

In a speech to the nation, he said Portugal would 'honour its international obligations', but in the same breath called for a tough line with the European Union-International Monetary Fund Troika over the pace of fiscal tightening under Portugal's '78bn (£63bn) loan package. 'We have arguments, and we should use them firmly,' he said.

'Fiscal austerity is leading to declining output and lower tax revenue. We must stop this vicious circle,' he said, cautioning the Troika that there would be no way out of the crisis until policy was set in the interests of the 'Portuguese people' as well as foreign creditors.

Portugal's president has also "asked the constitutional court to rule on the legality of tax rises that come into force this January as well as on further moves to dismantle the welfare state in the 2013 budget," saying that "[t]here are well-founded doubts over whether the distribution of sacrifice is just."

Austerity born on the backs of the 99 percent doesn't work. It not only doesn't fix the problem, it makes it worse by exacerbating a country's economic problems. The fact that austerity in Europe resulted in 1.50 euros of lost growth for every euro cut should serve as a major wake-up call to American politicians here at home. Giving in to the debt fetishists and cutting simply for the sake of cutting'and cutting from society's safety nets'while neglecting at the same time to push forward any robust pro-growth strategy ensures a nightmare situation. The middle class can't be sacrificed in an attempt to bring a country's books into the black.