The Future of Macroeconomic Policy: Nine Tentative Conclusions
IMF Blog, March 13, 2011
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- Authors: Olivier Blanchard
- Published: March 13, 2011
Overview
- Author: Olivier Blanchard
- Date: March 13, 2011
- Context: Reflections and concluding thoughts from a conference on post-crisis macroeconomic policy, organized around nine points.
Nine tentative conclusions (summary of major findings and observations)
- 1. We’ve entered a brave new world in the wake of the crisis; a very different world in terms of policy making and we just have to accept it.
- 2. In the age-old discussion of the relative roles of markets and the state, the pendulum has swung—at least a bit—toward the state.
- 3. The crisis made it clear that there are many distortions relevant for macroeconomics, many more than we thought earlier. We had ignored them, thinking they were the province of the micro-economist. As we integrate finance into macroeconomics, we’re discovering distortions within finance are macro-relevant. Agency theory—about incentives and behavior of entities or "agents"—is needed to explain how financial institutions work or do not work and how decisions are taken. Regulation and agency theory applied to regulators is important. Behavioral economics and its cousin, behavioral finance, are central as well.
- 4. Macroeconomic policy has many targets and many instruments (that is, the tools we use or variables to implement policy). There are many examples of this that were discussed at the conference, but here are two.
- Monetary policy has to go beyond inflation stability, adding output and financial stability to the list of targets, and adding macro-prudential measures to the list of instruments.
- Fiscal policy is more than just "G minus T" and an associated "multiplier" (the proportion or factor by which changes in government spending or taxes affect other parts of the economy). There are potentially dozens of instruments, each with their own dynamic effects that depend on the state of the economy and other policies. Bob Solow made the point that reducing discussions about fiscal policy to what is the right multiplier does not do service to the issue.
- 5. We may have many policy instruments, but we are not sure how to use them. In many cases, we are uncertain about what they are, how they should be used, and whether or not they will work. Again, many examples came up during the conference.
- We don’t quite know what liquidity is, so a liquidity ratio is one more step into the unknown.
- It was clear that some people believe capital controls work and some don’t.
- Paul Romer made the point that, if you adopt a set of financial regulations and keep them unchanged, the markets will find a way around, and ten years later, you’ll have a financial crisis.
- Mike Spence talked about the relative roles of self-regulation and regulation. Both are needed, but how we combine them is extremely unclear.
- 6. While these instruments are potentially useful, their use raises a number of political economy issues.
- Some instruments are politically hard to use. Take cross border flows. Putting in place a multilateral regulatory structure will be very difficult. Even at the domestic level, some macro-prudential tools work by targeting specific sectors, sets of individuals, or firms, and may lead to strong political backlash by those groups.
- Instruments can be misused. The more there are, the more the scope for misuse. It was clear from the discussion that a number of people think that, while there may be an economic case for capital controls, governments could use them instead of choosing the right macroeconomic policies. Dani Rodrik argued for using industrial policy to increase the production of tradables—goods or services that can be traded among countries—without getting a current account surplus. But in practice we know the limits of industrial policy, and they haven’t gone away.
- 7. Where do we go from here? In terms of research, the future is exciting. There are many topics on which we should work—namely macro issues with, as Joe Stiglitz said, the right micro foundations.
- 8. Things are harder on the policy front. Given we don’t quite know how to use the new tools and they can be misused, how should policymakers proceed? While we have a good sense of where we want to get to, a step-by-step approach is the way to do it.
- Take inflation targeting. We can’t, from one day to the next, just give it up and have, say, a system with five targets and seven instruments. We don’t know how to do it and it would be unwise. We can, however, introduce gradually some macro-prudential tools, testing the water to see how they work.
- Increasing the role of Special Drawing Rights in the international monetary system is another example. If we go in that direction, we can move slowly from, say, creating a market in private SDR bonds to exploring the possibility for the IMF to issue SDR bonds to the private sector and then, if feasible, issuing them to mobilize funds in times of systemic crisis.
- Pragmatism is of the essence. This was a general theme that came up, for example, in Andrew Sheng’s discussion of the adaptive Chinese growth model. We have to try things carefully and see how they work.
- 9. We have to keep our hopes in check. There are going to be new crises that we have not anticipated. And, despite our best efforts, we could have old-type crises again. That was a theme in Adair Turner’s discussion of credit cycles. Can we, using agency theory and the right regulations, get rid of credit cycles? Or is it basic human nature that, no matter what we do, they will come back in some form?
Policy implications and recommended approach
- Accept structural change in policymaking after the crisis; avoid expecting a return to pre-crisis norms.
- Recognize a larger role for the state relative to markets in some domains.
- Integrate finance, agency theory, behavioral economics, and regulation into macroeconomic analysis and policy design.
- Expand monetary policy objectives to include output and financial stability alongside inflation stability; add macro-prudential instruments.
- Treat fiscal policy as a multi-instrument toolkit beyond "G minus T" and simple multiplier thinking.
- Proceed cautiously with new instruments: introduce macro-prudential tools gradually, test their effects, and be mindful of political economy constraints and potential misuse.
- Explore incremental international measures such as expanding the role of Special Drawing Rights through staged steps (private SDR bond markets, IMF issuance to private sector, issuance to mobilize funds in systemic crises).
- Embrace pragmatism and step-by-step experimentation rather than rapid, wholesale regime shifts.
- Keep expectations realistic about the possibility of unforeseen crises and recurring credit cycles.
Olivier Blanchard, March 13, 2011.
Content in this bundle
- Is the Chinese Growth Model Replicable?
- Measures of Increasing Financial Intensity; Remarks by Adair Turner; March 7 and 8, 2011
- Growth in the Post-Crisis World — Michael Spence
- The Dynamics of Rules
- Beyond the Washington Consensus - Finance & Development - September 2003 - Jeremy Clift