• TP Sharpe

Updated: Jul 9, 2018

By the end of the 1980s, inflation, high interest rates, and currency and debt crisis were all (theoretically) tied to ‘excessive’ budget deficits (see Fischer 1989). The mainstream political and economic discourse was now firmly geared to budget restraint or sound finance, which did not necessarily imply balanced budgets over the cycle.

At this time, Williamson (1990) outlined the prevailing development model of the IMF, World Bank and US Treasury, known as the Washington Consensus. While the term ‘neo-liberal’ had already infiltrated economic and social policy dialogue, there was no operational definition. The Consensus became synonymous with the neo-liberal policy orientation which emphasised market-based reform such as trade liberalisation, financialisation, deregulation, and privatisation and restrained fiscal policy.

High and persistent unemployment among OECD members during the late 1980s and early 1990s motivated the OECD Jobs Study (1994) and subsequent Jobs Strategy (1995). Influenced by the McCracken Report (1977) and the analytical framework set out by Layard et al. (1991), the labour market outcomes were attributed to an inability to adapt to economic and social changes in view of market deregulation, and rapid globalisation and technological change. Unemployment was interpreted as an individual problem arising from supply-side deficiencies such as insufficient skills, training and education, poor attitudes, and rigid labour markets. The IMF embraced this policy orientation (see, for example, IMF 1999).

The introduction of the Euro as legal currency in 1999 marked Stage Three of the European Monetary Union (EMU) formation set out in the Delors Report (1989).[1] The Report which followed the Hannover Summit (1988) recommended that monetary policy be conducted by a new independent institution (European Central Bank) charged with the primary task of maintaining price stability; the European Currency Unit should become the single currency in Europe (later called the ‘Euro’); and, budgetary discipline was necessary among member states to strengthen economic convergence. The notion of ‘sound’ budgetary positions was formalised as specific government deficit and debt rules within the so called Maastricht criteria, and monitored and enforced by the Stability and Growth Pact which incorporated financial penalties for non-compliant members.

The 1990s through to the early 2000s were characterised by relatively less volatile economic times, the so called Great Moderation. The apparent economic stability was largely attributed to monetary policy geared to low inflation, passive fiscal policy, and deregulated labour and financial markets.

New Consensus Macroeconomics (NCM) dominated mainstream macroeconomic research. NCM models, such as dynamic stochastic general equilibrium (DSGE) models had been developed in response to the Lucas critique (see Woodford 2003). Drawing on the contributions of real business cycle theory (see Kydland and Prescott 1982) and New Keynesian principles (see Mankiw and Romer 1991), the models were driven by individual agents exhibiting optimising behaviour in the presence of market failures, such as incomplete markets, imperfect competition and asymmetric information. While monetary policy geared to price stability could ostensibly stabilise output and employment in NCM models (see Blanchard and Galí 2007), there was no distinct role for fiscal policy in economic stabilisation (see Fontana 2009).

Krugman (2001, quoted in Nevile and Kriesler 2001:1) asserted that ‘[a]lmost all economists agree that monetary policy, not fiscal policy, is the tool of choice for fighting recessions.’ Lucas (2003:1) declared that the business cycle had been solved, and that ‘the potential for welfare gains from better long-run, supply side policies exceeds by far the potential from further improvements in short-run demand management’ [emphasis in original]. Instead, government budgets were likened to that of a household which reinforced fiscal restraint. Buiter (2004:4) is clear: ‘The definition of (in)solvency of the state is, in principle, no different from that of the (in)solvency of any other economic agent … The capacity to tax and to issue legal tender makes the state an unusual borrower, but below the surface, it is subject to the same pains and joys of borrowing experienced by private sector borrowers.’

Despite the apparent success of New Consensus Macroeconomics, the pre-GFC period was characterised by rapid private debt accumulation and real wage repression particularly in the USA which, according to the earlier work of Minsky (1975, 1986), precipitates financial instability. Households became increasingly reliant on tentative lines of credit as underwriting standards were largely eliminated under the so called originate-to-distribute model of modern banking (Wray 2008, 2010). Speculative ‘bubbles’ however were invisible to the NCM models which had been informed by the efficient market hypothesis.[2]

The Global Financial Crisis (GFC) largely emerged from the subprime mortgage crisis and subsequent liquidity crisis in the USA, following the housing market collapse. As lenders became increasingly risk adverse and tightened underwriting standards, the US short-term debt market practically disappeared (Wray 2010). A chain of events ensued, which in 2008 culminated in the US government takeover of Fannie Mae and Freddie Mac, the sale of Merrill Lynch, the collapse of Lehman Brothers and the bailout of AIG by the US Federal Reserve. However the financial crisis quickly became a real economic crisis, as consumer and business confidence diminished and the private sector began to net save to reduce burgeoning debt levels. The Great Recession enveloped the global economy.

Low interest rate conditions, particularly in the Eurozone, and unscrupulous lending activities of poorly regulated financial institutions, particularly in the USA, ostensibly caused the GFC. A flawed theoretical framework however would severely compromise policymakers’ response to the crisis.

[1] The Werner Report (1970) had previously offered blueprints to an economic and monetary union in Europe set out in three stages which included a plan for a fixed exchange rate and common currency among the European Economic Community (EEC) to be achieved within a decade. The EEC, a common market, was established by the Treaty of Rome (1957). However the proposal for lost momentum in the early 1970s as the supply shocks enveloped the global economy. Instead, EEC members implemented snake in the tunnel exchange rate management after the collapse of the Bretton Woods exchange rate system in 1971. This was replaced by the European Monetary System (EMS) in 1979 which established the European Currency Unit and the Exchange Rate Mechanism. The EMS was a further step towards an economic and monetary union as it attempted to improve monetary stability and achieve closer economic convergence among the EEC.

[2] Macroeconomists have, for some time, acknowledged the possibility of speculative bubbles, that is, where asset prices deviate from their intrinsic values. While there are numerous theories of asset price deviations, such as rational growing bubbles, fads and information bubbles, there is no basis for determining when they might ‘burst’.

  • TP Sharpe

Updated: Jul 9, 2018

For many advanced economies, the early post-war period was characterised by full employment, modest inflation and economic prosperity. Under the guidance of the Keynesian model, fiscal and monetary policy was used for economic stabilisation and to achieve low levels of unemployment on a sustained basis.[1]

During this time, newly available macroeconomic data and the development of applied econometric models, largely due to the work of Jan Tinbergen and Lawrence Klein, encouraged empirical analysis. Klein (1947) argued that the micro-foundations of Keynes’s aggregate relationships (e.g. the consumption function) should be established to underpin the large scale macro-models which were under construction. The search for micro-foundations combined with the Hicks-Hansen IS-LM representation of The General Theory defined the neoclassical synthesis which dominated post-war macroeconomic thought.[2]

Extensive empirical analysis of inflation and unemployment dynamics ensued. In particular, Phillips (1958) observed an inverse relationship between money wage growth and unemployment in the UK, known as the Phillips curve.[3] Samuelson and Solow’s (1960) analysis of the Phillips curve as an exploitable trade-off between inflation and unemployment gave it credence for policymaking.[4] During the 1960s it was believed that a stable trade-off existed, so policymakers had a clear set of choices. Unemployment could be reduced via expansionary Keynesian demand-side policy but would likely result in higher inflation. Contractionary fiscal policy was seen as a solution to a supply-side inflation shock since it could move the economy along the Phillips curve. The Keynesian model provided all the necessary levers for economic stabilisation.

Friedman (1948) however was critical of the short-run nature of Keynesian analysis which he argued eschewed the long-run objectives of economic stabilisation policy. Friedman (1948:263) began to outline a ‘stable framework of fiscal and monetary action, [which] largely eliminates the uncertainty and undesirable political implications of discretionary action by governmental authorities’. Here, Friedman was critical of the long and variable lag time associated with fiscal policy in particular but of discretionary policy in general. Friedman’s framework however only promised reasonable full employment and a reasonable degree of stability.

While fiscal policy was generally emphasised over monetary policy by post-war (neo-) Keynesians, Friedman’s (1956) restatement of the classical quantity theory of money challenged Keynesian policy prescriptions and re-asserted the role of money and monetary policy (i.e. Monetarism). While distinct from Fisher’s (1911) earlier transaction version, Friedman argued that controlling the money stock was the most effective means of controlling inflation, and rejected any role for macroeconomic policy in stabilising real variables, such as output and employment in the long-run. Tobin (1972) recalls that Friedman had set out his theoretical framework using the widely accepted Hicks-Hansen IS-LM model. In doing so, debate regarding the role of fiscal and monetary policy was largely reduced to an econometric debate about empirical magnitudes (see Friedman and Schwartz 1963, 1970, 1982).

In the 1970s, global supply shocks, notably the 1973 oil crisis and the 1979 energy crisis, resulted in many economies experiencing stagflation, characterised by high unemployment and high inflation, following contractionary macroeconomic policies designed to reduce inflation. Stagflation was inconsistent with the Phillips curve trade-off which was already under attack by economists, particularly Edmund Phelps and Milton Friedman.

Phelps (1967, 1968) and Friedman’s (1968, 1977) hypothesis distinguished between nominal and real wages, and the short- and long-run outcomes of an unanticipated change in nominal demand. The latter would lead to conflicting perceptions among employers and employees regarding real wage adjustments which would permit a temporary deviation in the unemployment rate from its so called natural rate. Once inflation expectations are fully incorporated, however, the initial employment effects disappear as the unemployment rate returns to its natural rate. Expectations were formed adaptively, a notion which had been revived by Friedman’s (1957) work on the consumption function.

The key implications of the Phelps-Friedman natural rate hypothesis were that unanticipated inflation, not inflation per se matters; there is no permanent or stable trade-off between inflation and unemployment; and, unemployment can be kept below the natural rate only by accelerating inflation or above it only by accelerating deflation (Friedman 1977). Hence, the long-run expectations-augmented Phillips curve was vertical and unemployment would tend towards its natural rate. The latter is consistent with real forces and accurate perceptions. Lowering the natural rate would require policies which increased the competitiveness and flexibility of labour markets, such as reducing the power of trade unions, enhancing labour mobility, and minimum wage reforms. Keynesian demand-side policy could neither temporarily nor permanently reduce the natural rate.

The natural rate of unemployment (NRU) was later replaced by the non-accelerating inflation rate of unemployment (NIRU/NAIRU, see Modigliani and Papademos 1975). Full employment is now largely associated with the unemployment rate consistent with the NAIRU. But, unlike the Beveridge (1944) full employment definition of the early post-war period, the NAIRU does not imply equality between the number of job vacancies and the number of unemployed persons.

The anti-Keynesian revolution gained serious momentum following the stagflation episode. Monetarists had established monetary policy as the dominant instrument for economic stabilisation. According to Friedman and other Monetarists’, for example, Allan Meltzer and Karl Brunner, the conduct of monetary policy should be guided by simple, fixed rules. Targeting (narrow) monetary aggregates was recommended by Monetarists who were critical of targeting market interest rates as suggested by the Radcliffe Report (1959).

Friedman’s views had been gaining traction among policymakers since, at least, the late 1960s (see, for example, Francis 1968).[5] The US Federal Reserve, under the guidance of Paul Volcker, implemented Monetarist theory in 1979 by targeting the growth in the money supply. The apparent correlations between the money stock and inflation however disappeared due to financial innovation and deregulation. The experiment was subsequently abandoned in 1982.[6]

The theoretical foundations of Keynesian macroeconomics were also under attack by the New Classical economics of Lucas, Sargent and Wallace. Drawing on Muth’s (1961) rational expectations, Lucas (1976) argued that aggregate relationships would change with each policy initiative given adjustments to the decision problems of individual agents (i.e. the Lucas critique; see also Goodhart 1975).[7] The Lucas critique had a profound effect on the direction of modern (mainstream) macroeconomics. In particular, the simulation of policy outcomes using large-scale macro-models was called into question; it encouraged the development of small formal macroeconomic models (e.g. the ‘econometrics without theory’ approach of Sims 1980); and, it strengthened the view that micro-foundations (e.g. tastes, technology) and forward-looking expectations were essential to dynamic economic modelling.

Meanwhile, policymakers became increasingly concerned with the rising budget deficits which followed the supply shocks. Academic debate largely echoed the political shift towards deficit and debt reduction or fiscal discipline. The efficacy and sustainability of government net spending came under intense scrutiny.

For Monetarists, restraint in government spending was considered important to avoid the need for central banks to finance the deficits and, in doing so, generate excessive money growth which would threaten price stability. Notwithstanding this, restraint in government spending had been necessary due to government commitments to the Bretton Woods exchange rate system (1944-1971).

While balanced budgets over the cycle were considered broadly appropriate, the government budget constraint, an accounting identity, was interpreted as set of ex ante financing choices for government net spending (see Patinkin 1956; Christ 1968). That is, government could raise taxes, borrow or issue high-powered money (‘print money’). Monetarism had already warned against the latter, and the other financing options for government generated a revival of crowding-out theory and Ricardian equivalence.

Crowding-out could take various forms, yet Blinder and Solow (1972:3) asserted that financial crowding-out was ‘disputed by almost no one’. Drawing on classical loanable funds theory, it was argued that government debt would compete with private debt in financial markets, put upward pressure on interest rates and therefore reduce interest-sensitive private expenditures.

Barro’s (1974, 1989) Ricardian equivalence maintained that under a certain set of (restrictive) assumptions an increase in government spending would be offset by an increase in current private savings as the private sector anticipated higher future taxes. Thus national savings, real interest rates, investment, and the current account balance would remain unchanged. This was a special case of Modigliani and Brumberg (1954) and Friedman’s (1957) earlier work on the life-cycle theory/permanent income hypothesis.

The long-term consequences of budget deficits or fiscal sustainability was analysed in terms of the debt dynamics, which had already been presented by Domar (1944). While there was (is) no operational definition of fiscal sustainability, numerous econometric investigations of the so called present value budget constraint were developed to assess the sustainability of fiscal balances (see Hamilton and Flavin 1986; Trehan and Walsh 1988, 1991; Hakkio and Rush 1991). Most investigations focused on the US with mixed evidence in favour of fiscal sustainability. The policy implications however were limited since the estimates relied on historical data. Instead, policymakers required forward-looking measures which motivated the development of fiscal indicators, such as primary gap, tax gap and net worth indicators. These methods, largely due to the work of Buiter (1985, 1995), Blanchard (1990) and Buiter et al. (1993), underpin the European Commission’s S1 and S2 fiscal indictors currently used to assess fiscal sustainability.

The 1981 tax cuts of the Reagan administration characterised the shift in political and economic opinion regarding fiscal policy. Drawing on the so called Laffer curve and emerging supply-side economics, the tax cuts were an attempt to increase tax revenue. The budget deficit, however, increased which precipitated the Gramm-Rudman-Hollings Deficit Reduction Act (1985) to formally constrain government spending.

[1] The Beveridge Report (1942) in the UK, Australia’s White Paper on Full Employment (1945) and the US Employment Act (1946) highlighted the strength of Keynesian principles in influencing policymakers. Policymakers also benefited from Lerner’s (1943) work on functional finance.

[2] Concerns raised by members of the Cambridge Circus (e.g. Kahn, Robinson, Sraffa) about the use of aggregate production functions in the modelling of growth and income distribution were ignored with the development of large-scale, though single-sector IS-LM models.

[3] Another important empirical relationship was Okun’s (1962) ‘law’ which reports an inverse relationship between unemployment and output. Ball et al. (2013) suggests that the ‘law’ continues to offer a strong and stable heuristic for most countries.

[4] The empirical work of Phillips, which focused on the long-run relationship between unemployment and inflation, was inappropriately interpreted as an expression of a short-run policy trade-off to compensate for the obliteration of Keynes’ own approach to price and wage dynamics. The latter was set out in Keynes’ Z and D curve analysis in The General Theory, but had been obscured by debates over the nature of respective elasticities in the IS-LM model.

[5] Monetarist views were particularly influential to the Carter and Reagan administrations in the US, and Thatcher’s conservative economic agenda in the UK.

[6] While the Monetarist experiment failed, the theory offered the blueprints for modern day central banking. In particular, the argument that monetary policy can only target nominal quantities was the foundation to inflation-targeting, which first began in New Zealand in the late 1980s and is now widely practiced by central banks within advanced economies. In addition, the Monetarist argument that central banks should be independent and guided by transparent rules remains pervasive. The notion of central bank independence was reinforced by Kydland and Prescott’s work on time-inconsistency.

[7] Keynes’ Z and D curve analysis was compatible with rational expectations regarding the short-run proceeds from the sale of output. However, Keynes questioned the applicability of rational expectations to long-run returns on financial and non-financial investments given fundamental uncertainty.

  • TP Sharpe

Updated: Jul 9, 2018

The resignation letter of Peter Doyle, a senior IMF economist, has added to recent controversy surrounding the embattled Fund. While reports of ‘suppressed’ policy advice are telling, unfortunately it’s of no real surprise and will not disrupt the IMFs’ policy agenda. Notwithstanding the nature and causes of the Global Financial Crisis (GFC), the IMF continues to espouse fundamentally flawed policy advice, as the institution seeks to maintain its relevance and legitimacy despite becoming largely redundant following the collapse of the Bretton Woods (fixed exchange rate) system in 1971.

Background, crisis and rhetoric

The International Monetary Fund (IMF) was established in 1944, at Bretton Woods, to engender postwar economic growth, prevent a relapse into autarky (closed economy) and protectionism, and to facilitate the international payment system in the context of fixed exchange rates. Following the collapse of the Bretton Woods system, many economies transitioned to a flexible or floating exchange rate regime which allowed the foreign exchange market to determine a currency’s value and therefore eliminate the need for intervention by policymakers. Consequently the IMF sort to reinvent its operations, focusing more on policy advice and so called ‘surveillance’.

Neo-liberal economic policies began to gain traction among policymakers during the 1970s, and have since dominated the mainstream discourse. IMF polices echoed the paradigm shift, whereby, active fiscal (government) policies to promote growth and reduce unemployment was replaced by the neo-liberal free-market approach which included deregulation and privatisation policies, and monetary policy geared to low-inflation. In essence, the policy consensus became one of ‘sound’ fiscal management rather than ‘functional’ fiscal policy. Since this time, the effective use of monetary policy has largely dominated the IMFs’ discourse, with discussions of fiscal policy reduced to notions of discipline and sustainability.

The GFC marked the worst global downturn since the Great Depression. The IMF concedes that the crisis ‘uncovered a fragility in the advanced financial markets’. It is interesting to note, in the aftermath of the Asian Financial Crisis (1996-7), the IMF allegedly ‘drew several lessons that would alter its responses to future events.’ Of these, the Fund realised that ‘it would have to pay much more attention to weaknesses in countries’ banking sectors and to the effects of those weaknesses on macroeconomic stability’ (see here).

Nevertheless, the IMFs’ steadfast view on the conduct of fiscal policy wavered as the recession deepened and the primary policy instrument, monetary policy, became largely ineffective. By 2009 the IMF began to advocate fiscal stimulus, conceding that ‘past experience suggests that fiscal policy is particularly effective in shortening the duration of recessions caused by financial crisis’.

In 2010, the IMF admitted ‘we were wrong’ with respect to the importance of (counter-cyclical) fiscal policy. Furthermore, the Fund conceded that while ‘[t]he crisis was not triggered primarily by macroeconomic policy…it has exposed flaws in the pre-crisis policy framework…’

Since the advent of the GFC the IMF has slightly moderated it stance on (discretionary) fiscal policy, particularly regarding its effectiveness during economic downturns (i.e. for stabilising purposes). However, the use of fiscal policy is still heavily qualified by concerns of fiscal sustainability. For this reason, the IMF continues to advocate fiscal austerity or consolidation measures, albeit, in light of the poor economic outcomes with some caution regarding the timing of these programs.

The use of certain terminology has formed a particularly important feature of IMF policy documents. Language such as sound public finance, fiscal sustainability, fiscal space and fiscal credibility typically accompany IMF discussions of fiscal policy. However these terms are often left undefined which, firstly, reflects the lack of consensus among economists regarding operational definitions, secondly, the language is used to portray a depth of understanding and sense of authority, and finally, the IMF strategically use vagueness and rhetorical tautology to render its policy statements ostensibly unfalsifiable.

Notwithstanding the policy rhetoric, the principle flaw within IMF policy advice is a failure to adequately distinguish between a sovereign and non-sovereign economy which has important implications for the conduct of fiscal policy. Modern Monetary Theory makes the distinction.

Sovereign vs. non-sovereign

A sovereign economy operates with its own (fiat) non convertible currency and a flexible exchange rate (e.g. the U.S., U.K., Japan and Australia). A non-sovereign economy does not possess these characteristics (e.g. Eurozone economies, such as Greece, Spain, Ireland and Portugal). In essence, one must distinguish between a currency ‘user’ (non-sovereign economy) and a currency ‘issuer’ (sovereign economy).

Unlike sovereign economies, Eurozone (non-sovereign) economies do face financing constrains. They are users of a currency and must borrow that currency (e.g. Euros) if tax revenues are not enough to cover government expenditures. Thus, these economies become exposed to pressures from bond market investors and credit-rating agencies since the use of, what is effectively, a foreign currency implies these economies can become insolvent with respect to obligations denominated in that currency. Recently the threat of insolvency has materialised within the Eurozone as rising interest rates on long-term government debt. By contrast, sovereign economies maintain very low long-term interest rates, including Japan which, according to OECD data, has a (gross) government debt to GDP ratio now in excess of 200 percent (the highest ratio in the world). Thus, equating these different economic arrangements in terms of IMF policy advice is a fundamental flaw. A sovereign economy cannot become insolvent with respect to obligations denominated in its own currency, and can always purchase goods and services available in its own currency. Hence, mainstream notions of fiscal sustainability are irrelevant to the conduct of fiscal policy in sovereign economies. Rather, policies to reduce government deficits and debt (i.e. fiscal austerity) within sovereign economies such as the U.K., U.S. and Australia, is entirely voluntary, unnecessary and ideologically motivated. The reasons are largely political and may reflect a long standing fear of ‘big’ government or any government intervention which ‘threatens’ private sector activity (see here).

Furthermore, in their policy statements, the IMF tend to trivialise the conduct of fiscal policy by implying that, like prudent households, all national governments are budget constrained. Thus, a government in pursuit of ‘responsible’ or ‘sound’ fiscal policy by reducing deficits and debt appear to be prudent managers of ‘taxpayer’ funds. While these claims have no economic foundation within a sovereign economy, such statements play on the entrenched (neo-liberal) beliefs within society and therefore may prove useful as an election strategy (e.g. Australia’s ‘surplus fetish’ politics, see here).

The Eurozone

The establishment of the Eurozone (or European Monetary Union) included an attempt by policymakers to formally constrain fiscal policy in terms of the Stability and Growth Pact (SGP) requirements (i.e. 60% gross debt to GDP and 3% general government deficit to GDP). When joining the Eurozone an economy, firstly, surrenders monetary sovereignty (e.g. setting interest rates) to the European Central Bank (ECB). Secondly, the (nominal) exchange rate can no longer freely fluctuate to buffer country specific economic shocks. Finally, fiscal policy is subjected to ‘formal’ constraints and therefore becomes inherently pro-cyclical.

In essence, a governments’ budget is an outcome which reflects the spending decisions of the non-government (private and external) sector. During an economic recession, a budget deficit may occur as unemployment increases, social security transfers rise and tax revenues fall. This is a normal process which indicates that the automatic stabilisers are working to offset the economic slowdown. However, the budget outcome may conflict with voluntarily adopted SGP requirements. Consequently, Eurozone economies have pursued fiscal austerity programs which target a reduction in government expenditure and/or tax increases. Furthermore, fiscal austerity has formed an important feature of IMF, EC and ECB (i.e. Troika) supported loans.

While the government pursues fiscal austerity in an attempt to meet SGP requirements, the return to economic growth requires a private (or external) sector led recovery. During a recession, business confidence may be low, and the private sector may be unwilling to increase its consumption or investment expenditures, perhaps choosing instead to save, delay investment projects, or pay down debt. For example, OECD data reveals that U.S. household net saving rates (as a percent of disposable household income) more than doubled between 2007 and 2008 (i.e. the start of the GFC) from 2.4 to 5.4 percent. In this context, rather than reducing government deficits and debt, fiscal austerity will increase these outcomes. Harsher fiscal austerity measures may then be pursued by policymakers, or such measures may be required as a condition of a Troika bailout (and the vicious cycle continues).

Thus IMF assertions that fiscal policy can be effective as a counter-cyclical device (i.e. stimulate during a downturn), but then recommending (austerity) measures to ensure specific fiscal targets are achieved or budget deficits are reduced, which have increased because of the downturn (i.e. pro-cyclical policy), is clearly problematic. In this vein, the IMF ostensibly promotes an extreme form of neo-liberal macroeconomic policy, the continuation of which will only exacerbate and extend the Eurozone malaise.

Moving forward

Governments within sovereign economies should now be engaging in well targeted expenditure programs (fiscal stimulus) to boost employment and economic growth. For Eurozone economies, two broad options are apparent: First, abandon the Euro and re-establish a sovereign currency system. Second, create a fiscal union including the establishment of a Eurozone Treasury which could spend like a sovereign government. The latter however may pose a significant challenge to the democratic process.

Despite the outcome, current unemployment rates, for example exceeding 20 percent in Spain and Greece, is unacceptable, irresponsible and avoidable as long as the government restores its currency sovereignty and uses fiscal policy effectively to stimulate employment and growth. In this vein, MMT advocates promote a Job Guarantee otherwise known as Employer of Last Resort as a full employment strategy (see here and here).

Conclusion The IMFs failure to adequately distinguish between sovereign and non-sovereign economies has corrupted policy inference. However, reforming the IMF is problematic since its policies largely reflect the prevailing neo-liberal economic agenda.

Notwithstanding this, national policymakers, unlike IMF officials, have an elected obligation to advance the public purpose and maintain full employment. The pursuit of accounting fundamentals (i.e. targeting specific or reduced government deficits and debt ratios) must not override, conflict or inhibit a concerted policy effort to reduce unemployment and alleviate poverty. For this reason, national governments must be accountable for their failure to provide adequate employment opportunities and promote growth in the aftermath of the GFC.