The IMF on Greek debt – redefining chutzpah?

A definition of chutzpah is murdering your parents and then claiming social benefits as an orphan. It is not widely recognised, but the IMF illustrates similar brazenness in the current debate on Greece’s debt burden.

While not exactly pretending to be an orphan, the IMF is currently getting a lot of sympathy for its position: it has come out increasingly strongly in favour of debt relief for Greece. On realistic assumptions the debt burden is unsustainable. The country can only recover if there is substantial debt relief. Its most recent debt sustainability analysis claims it was forced to provide loans when the euro crisis broke, alongside European institutions, against its better judgement, but now only massive debt relief will work.

Its realism has been welcomed, and contrasted favourably with the EU (and its German paymasters), which against all reason are insisting on more-or-less full repayment of past loans. In so doing the IMF has been feted by Greek commentators, the many EU citizens/taxpayers sympathetic to the plight of Greek citizens, and much informed economics commentary.

One certainly does not need to think of the IMF as a murderer. But one should be aware of three things.  First the IMF was not simply an innocent victim of European pressure. It got its economic forecasts badly wrong and vastly underestimated the size of the multiplier (the negative impact austerity has on output and thus fiscal outcomes). What the IMF deserves credit for is having publicly recognised this.

Second, Greece owes money to the  EU institutions (primarily the ECB and the ESM) and a much smaller amount to the IMF.  Yet when the IMF calls for debt relief, it is referring only to the credits given by EU institutions. The IMF loans, you see, are “senior”, that is they must be paid back first and in full. Because? Well, because they are from the IMF.

Thirdly, the EU institutions accorded substantial debt relief to Greece in 2012 and, belatedly, substantially reduced the rate of interest due on the loans. Loans from the ESM now cost just 0.8%. The interest rate on IMF loans , however, is very substantially higher (up to 5% and averaging over 3%); here. The most important parameter determining whether (public) debt is sustainable in the longer run is the gap between the interest rate on the debt and the nominal growth rate of the economy; the mechanism is explained here even if the numbers are now outdated. If the interest rate is lower than the rate of nominal output growth (i.e. the sum of inflation and real growth) then the debt-to-GDP ratio falls, provided the country achieves a primary balance. No primary fiscal surplus is necessary. And this is true no matter how high the initial debt-to-GDP ratio is; indeed the fall is faster the higher the initial ratio. Thus by charging such a high rate of interest – in a zero-interest world – the IMF is actively undermining Greek debt sustainability, which it wants to see achieved by a haircut on European loans. I think that qualifies as chutzpah.

More important than the IMF’s image, of course, is the question of the right policy direction. What Greece needs most of all is continued very low interest rates (implying the willingness to roll over any capital payments due). In the current interest-rate environment, this is no hardship. It needs a European Central Bank living up to its mandate of delivering 2% inflation at Euro area level, to raise the rate of nominal GDP growth. (That the central bank has failed in its mandate is hardly the Greeks’ fault.) And it needs domestic structural reforms and an EU-backed investment program – perhaps combined with needed support for dealing with the refugee crisis – to raise the rate of real economic growth. The cases of Spain and Ireland suggest that, once austerity is lifted, real economic growth can be rapid while the unemployed are reintegrated into production. With such conditions in place even a primary balance (before interest) of zero – less demanding than the IMF, never mind the Europeans – would suffice to see sharp declines in debt-to-GDP.

Yes, the EU institutions and Member State governments deserve blame for not putting these elements in place. But that doesn’t mean we have to buy the IMF’s chutzpah.