What are the factors that ensure a successful and durable completion of a financial assistance programme? Past experience with IMF-supported adjustment programmes underlines the importance of external conditions but also of fiscal consolidation, financial repair and structural reforms. These findings vindicate the strategy pursued in recent adjustment programmes in the euro area: putting the fiscal house in order and making the economy fitter through structural reforms are conducive to a sustainable recovery.
With very few exceptions in post-WWII history, IMF-supported adjustment programmes have been an ‘extra-European affair’. The post-2007 crises marked a clear shift when. In 2011, at the height of the sovereign debt crisis four euro-area countries – Greece, Ireland, Portugal and Cyprus – were in full economic adjustment programmes. As a result, the question of how to implement macroeconomic adjustment during a crisis has provoked a heated debate. Clearly, idiosyncrasies and the environment a country operates in matter. Nevertheless, learning stylized facts from past crisis episodes and assessing the chances of success of on-going or recently completed programmes is a valid strategy.
Since 1993 the IMF extended more than 170 General Resource Account (GRA) supported programmes to around 60 countries. Significant adjustment programmes also take place without any IMF-support. However, relying on IMF-supported programmes makes for a clear-cut and sufficiently large sample.
There are three ways of defining success of an adjustment programme: (i) an ‘accounting’ definition whereby a programme is considered a success if compliance with policy conditions is high; (ii) a ‘market-based’ definition that looks at whether market access is regained during or at the end of the programme; and (iii) a ‘macroeconomic’ definition assessing the economic performance during and after the completion of a programme. Ideally, the three definitions should be complementary: Success should go along with a consistent policy compliance, a return to market financing and a favourable macroeconomic performance. In practice, however, things are more complex. Not all policy conditions are equally relevant and market confidence proved to be volatile. Thus, we assess success on the basis of two key macroeconomic indicators: average real GDP growth and general government debt in percent of GDP in the years following the onset of a programme.
Our results suggest that ‘hard work’, notably policy actions such as fiscal adjustment and more stringent policy conditionality, especially in the structural area, increases the chances of success. The positive link between fiscal adjustment and success might seem at odds with the lately popular view that during a financial crisis fiscal austerity has a bigger impact on economic activity or can even be self-defeating. What reconciles the two views? The debate about the size of the fiscal multiplier focuses on the very short term. Our analysis, by contrast, looks at the medium term. Hence, during a severe financial crisis a fiscal contraction may produce a bigger effect on economic activity over one year. But then, fiscal consolidation triggers an adjustment process, typically via the labour market, which over the medium term has a positive impact on a country’s competitiveness and, ultimately, its aggregate level of economic activity.
The positive role of structural reforms emerging from our analysis is less of a surprise. Well-designed reforms make economies more competitive and more flexible without large or no budgetary costs. In fact, we find that the implementation of structural policy conditions (policy measures that are meant to correct disruptions to the supply side of the economy) have a statistically significant impact on the probability of success. We also find that the probability of success increases in the number of structural reforms undertaken under an IMF-supported programme.
Interestingly, we also find that a banking crisis does not necessarily impact negatively the outcome of an adjustment programme. This contrasts with existing studies, in particular Leaven and Valencia (2012) which suggested that a banking crisis would significantly weigh on the prospect of economic recovery. Our analysis indicates that only when a banking crisis leads to a protracted lack of credit, the recovery is hurt. This again underscores importance of the ‘hard work’ part, this time taking the form of decisive financial sector repair.
Turning to ‘external help’, common expectations are confirmed with some interesting qualifications. Starting with the common priors, we find that external demand as measured by average real world GDP growth in the years following the start of the IMF-supported programme has a positive association with the likelihood of success. This hypothesis is further supported by the fact that chances of success increase with the degree of openness of the economy. International investors’ risk attitudes also matter. They appear to influence perceptions of a country’s creditworthiness beyond what its economic fundamentals would suggest. A higher implied volatility, as measured by the widely used VIX indicator, is negatively associated with successful adjustment.
Flexible exchange rate regimes are generally found to be helpful for economic adjustment too. However, a depreciation may also have unfavourable effects through higher debt servicing costs if government debt is denominated in foreign currency. To investigate the relative importance of this channel we included the percentage change of the nominal effective exchange rate (NEER). Our results show that a depreciation of the home currency is negatively associated with success. The negative effect of depreciation on debt servicing costs seems to outweigh short-run gain in competitiveness.
All our main findings are robust to a wide range of sensitivity checks. We modify our criteria for success, we control for cyclical effects on fiscal adjustment, we change the reference year of programme start, apply gradual cut-offs in terms of income levels to our sample, sequentially exclude countries from a specific region (e.g. Asia, Africa, Latin America) and yet our main results still hold up.
Our findings have important implications for the on-going or recently completed adjustments in the euro area. Global conditions are forecast to improve over the next years compared to the early days of the crisis, when the programmes for Greece, Portugal and Ireland were launched. Nevertheless, while external conditions, such as external demand and risk-appetite, will certainly help, it is still crucial to complete fiscal consolidation, financial sector repair and structural reforms.
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 Broadly speaking, we consider a recovery successful as regards economic growth if average real GDP growth in the five years after the launch of the programme reaches 2/3 of average growth in the 5 years preceding the onset of the programme. As regards general government debt success is measured as a 5% decline in the GDP ratio in the five years following the onset of the programme. The complete definition is provided in our paper.
 See Alesina and Perotti (1995) for an early contribution to this field, as well as were Hernandez de Cos and Moral-Benito (2014) and Lamo et al. (2014) for recent and specific evidence of this labour market or competitiveness channel.