Global Economy

DANIEL LACALLE is chief economist at hedge fund Tressis and author of “Freedom or Equality,” “Escape from the Central Bank Trap,” and “Life in the Financial Markets.” Daniel Lacalle

IMF Proves Its Own Advice Is Wrong

The IMF's empirical studies show that radical-left proposals don't work

The latest international Monetary Fund (IMF) global economic outlook has just been published, and, like all of them, it has many interesting aspects.

It acknowledges the economic slowdown in many economies and has dramatically increased the IMF’s inflation estimates. Global growth is now “projected to slow from an estimated 6.1 percent in 2021 to 3.6 percent in 2022 and 2023. This is 0.8 and 0.2 percentage points lower for 2022 and 2023 than projected in January.” Estimates of inflation projections for 2022 have risen to “5.7 percent in advanced economies and 8.7 percent in emerging market and developing economies—1.8 and 2.8 percentage points higher than projected last January.”

The IMF outlook highlights the reality of poor growth and massive inflation. And why such poor growth and high inflation? It’s in no small part because of the previous recommendations of the IMF to spend without control and monetize debt with central bank money supply growth.

Realizing that the previous estimates were all too optimistic and that the third consecutive slash of growth estimates and hike of inflation projections spell trouble for the global economy, the IMF, as always, has made a series of recommendations that won’t surprise anyone: raise taxes, and it doesn’t make a single mention of excess spending or unproductive subsidies.

The IMF recommended that governments spend without control, harming potential growth in the process, and now that debt has ballooned, it wants the same governments to raise taxes to mitigate the disaster created by its own recommendations. Either way, taxpayers and the productive sectors suffer.

The IMF reports would be extremely interesting and very valid if they didn’t incorporate excessively optimistic predictions of growth from government spending and, above all, recommendations that rarely work, because the IMF too often underestimates government malinvestment and perverse incentives to bloat government budgets with unproductive current spending.

While the IMF has numerous studies showing that the multiplier effect of government spending is very low and that in open and indebted economies it’s even negative, the board continues to recommend massive spending in periods of crisis. And when it doesn’t work, as always, and debt soars, it suggests massive tax hikes. The available economic literature shows the poor fiscal multiplier of government spending, and IMF studies themselves conclude that multipliers are negative, particularly in the longer term and when public debt is high.

The IMF has ample and detailed literature showing the negative effect on growth of enormous government spending plans, the poor effectiveness of tax hikes to achieve fiscal consolidation, and the risk of rising inflation from monetizing deficit spending programs.

Why does the IMF board recommend something it knows won’t work? Because the pressure from politicians is enormous. The IMF seems to be indirectly forced to propose unorthodox and counterproductive measures so no one can accuse it of defending austerity, even if the suggestions are doomed to fail, as all of us knew in 2020.

The problem is that the results of the previous recommendations are hugely disappointing, and the remedies proposed—massive tax hikes to curb rising debt—are even more negative. The IMF knows from its own 2010 report that tax hikes won’t reduce debt effectively because governments will keep spending above receipts, but those hikes will hurt growth, jobs, and investment.

Now the radical left is quoting the IMF constantly in its messages warning against tax competition and defending a minimum corporate tax, even when vast literature shows that both tax competitiveness and adjusting fiscal policies to the reality of each country have proven far more effective at reducing poverty and boosting growth than massive government spending plans.

The IMF board seems to have forgotten the poor results of its recent spendand-debt recommendations, and finds that it may be politically more acceptable to pass the bill to taxpayers and, when the next crisis comes, propose more spending and debt.

The radical left proposals haven’t been vindicated or sanctioned by the IMF. The IMF’s excellent empirical studies have proven that the radical left and the IMF board’s proposals don’t work.