The IMF Admits Its Advice To Greece On Austerity Was All Wrong. Trust The Money Men To Screw Up Again

James Anderson writes from Washington: The International Monetary Fund (IMF) has just apologised to Greece.

Yes, that’s so, you’ve read me right. The experts from the IMF have admitted to Athens that they have got their sums all wrong. For years they’ve been banging on that austerity is the best medicine – and it works. They claimed that for every one per cent cut in spending the loss to the economy would only be 0.5 per cent. In other words, reduce budget outlays by 10 per cent and the economy would only shrink by 5 per cent.

That was before. But guess what the IMF boys are saying now? Oops, our maths were wrong, they say. For every one per cent cut in the budget the economy shrinks not by 0.5 per cent but by a whopping 1.7 per cent. So what the IMF is basically saying is that if budgetary outlays are reduced by 10 per cent, the economy slumps by 17 per cent. In simple language, austerity sucks and a new approach has to be devised. (Pay attention, Mr George Osborne.)

But here’s a corker question: why should we trust the IMF at all? It might come back next year and say that this year’s calculations are inaccurate as well.

So what’s wrong with modern economics and finances? At a time when everyone desperately wants to know how to escape the present downturn, economists are liable to make matters worse with their advice. Sir Mervyn King, Governor of the Bank of England, in a moment of candour, said that economic forecasting is a ‘mug’s game’. Hold on a minute!  The Bank of England sets the base rate that determines interest rates in the country. Sir Merv is conceding that the Monetary Policy Committee is clueless about future trends in the economy. So the rate is a ‘stab in the dark’. Dear help the Brits.

Why is it impossible to construct a mathematical model that can predict accurately future trends in the economy? Because men and women take rational decisions one moment but irrational decisions the next. Mathematical models are based on the assumption that people act rationally. They cannot cope with irrationality.

Daniel Kahneman, a Nobel Prize winner in economics, has some prescient things to say about this. As a psychologist he studies institutional decision making. He has discovered that all institutions are unfit for purpose. They are based on models of rational decision making. But as everyone knows, people do not conform to that dream world. So what is the answer?

Economic textbooks talk about a perfect market and rational decision makers who maximise their own utility. Economists are trained to calculate profit maximisation, marginal utility and the like. They leave out the behaviour of the average human being. So behavioural economics has emerged. It attempts to understand why some of our decisions are rational and others the opposite. It is a tough, new discipline. There are no easy mathematical models which explain human behaviour. It has to be based on surveys and trends in the market.

So the European Union, in recession, has to face the awful truth. The course they have been plotting for the last four years may be the wrong one. No, not may be the wrong one but IS the wrong one. Beware of false prophets. Paul Krugman, a Nobel Prize winner in economics, and Professor Lord Richard Layard have come up with a panacea: spend, spend, spend. Remember Layard was the economist who wrote a book predicting that Russia in the 1990s would go boom, boom, boom. What happened? It went bust, bust, bust. He has learned nothing since. He is still coming up with panaceas. But wait a moment. How do I know he is chasing the pot of gold at the end of the rainbow? Economics as a discipline is in such disarray that he might turn out to be correct. Better to pass judgement later.

So if you are hoping for enlightenment about the economy, just ignore the big name economists. Use your common sense instead. You will almost certainly be proved right.

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