Ten Take Aways from the "Rethinking Macro Policy: Progress or Confusion?"
IMF Blog, May 1, 2015
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Bibliographic details
- Authors: Olivier Blanchard
- Published: May 1, 2015
Conference context
- The IMF organized the third conference on "Rethinking Macro Policy" on April 15-16.
- Personal take aways by Olivier Blanchard, May 1, 2015.
1. What will be the "new normal"?
- Two contrasting views presented:
- Ken Rogoff: adjustment phase of the “debt supercycle”; debt overhang slows recovery and requires low interest rates for some time; eventual return to something like the old normal (more so in the Euro zone than in the United States).
- Larry Summers: secular stagnation hypothesis — chronic excess of saving over investment may require very low or even negative real interest rates; real interest rates had started declining long before the crisis and declined further since last year.
- Blanchard’s assessment: debt overhang plays a role (varying across countries and type of debtor) and the decrease in real rates visible before the crisis is likely to persist; closer to Summers (though not certain negative rates will be needed).
2. What the new normal will be matters a lot for policy design
- If equilibrium real interest rates are very low or negative, the zero lower bound (or “nearly zero” lower bound) constrains monetary policy.
- Fiscal policy may be more appropriate if low rates persist or if low rates induce excessive risk taking.
- Brad DeLong’s provocative point:
- If the rate at which the government can borrow (r) is less than the growth rate (g), then governments should increase, not decrease, current debt levels.
- If r < g and people value safety so much, the state could issue safe debt for productive investment; debt-to-GDP ratio will decrease even if the government never repays the debt.
- Limits and concerns highlighted: persistence of r < g, determinants of demand for safe assets, potential indication of dynamic inefficiency or distortion, increased probability of multiple equilibria, rollover crises and sudden stops with high debt.
3. Can we hope to limit systemic financial risk?
- Consensus: new regulations (Basel III, Dodd Frank) have reduced banking risk, but views differ on whether risk has been successfully reduced overall.
- Key points:
- Anat Admati: current measures are far from enough.
- Risk shift: some argue systemic risk has been largely shifted to the shadow banking system.
- Viral Acharya (Vlab at NYU): progress in defining and measuring systemic risk via real time measures for major banks.
- Robert Rubin and Philipp Hildenbrand: heterogeneity of shadow banking; regulatory approach should focus on functions/activities (maturity transformation, liquidity mismatch, leverage) rather than entities.
- Unintended effects: incorrect regulatory risk weights may have kept systemic risk too high in European banking; regulation reduced the role of traditional market makers and decreased market liquidity.
4. Should monetary policy go back to its old ways?
- Ben Bernanke’s view: yes — once economies exit the zero lower bound, most crisis-era programs should be shelved and the policy rate (federal funds) should again be the main instrument; possibly combined with repo rate and rate on excess reserves if the central bank maintains a larger balance sheet.
- Issues raised:
- Composition and size of central bank balance sheets in the new normal (raised by Bernanke; discussed by Ricardo Caballero).
- Safe asset shortage: should central banks hold large amounts of safe assets or hold other assets and leave safe assets to the private sector?
- If central banks can supply safe assets uniquely, should they do so?
- Caballero on demand for safe assets:
- If demand is for hedges against macro fluctuations, long bonds may be safer and central bank should hold short bonds (leave long bonds in private hands — the old normal).
- If demand is for assets with known collateral value, investors prefer short bonds and central bank conclusions reverse.
5. Instrument rules
- John Taylor: Fed deviation from rules-based policy (too loose pre-crisis) and regulatory rule-breaking were key factors in the crisis; advocates quick return to rules-based "renormalizing monetary policy."
- Ben Bernanke: in a complex world the “right rule” would be very complex; rigid adherence to a simple rule could be counterproductive; judge central bank on how it fulfills its mandate rather than require a simple rule.
- Blanchard concurs with Bernanke.
6. Macroprudential tools or financial regulation
- Paul Tucker’s definition: "the choice of dynamically adjusting regulatory pararameters so as to maintain systemic resilience."
- Distinction: macro prudential tools are dynamically adjusted; financial regulation typically is not.
- Debated issues:
- When to use dynamically adjusted tools versus tougher, constant regulation (e.g., variable capital ratios vs higher constant capital ratios) was not fully resolved.
- Tucker: use macroprudential tools to deal with "exuberance," not fine-tuning in normal times.
- Rubin: difficulty distinguishing exuberant times from normal times.
- Monetary policy vs macroprudential tools:
- Shin: both affect demand and supply of credit.
- From financial viewpoint: monetary policy is general, macroprudential is specific.
- Lars Svensson: simple cost-benefit analysis (Swedish case, using Riksbank estimates) suggests monetary policy is a very poor instrument to deal with financial risk because the unemployment cost of raising rates far exceeds benefits from lowering crisis probability/severity.
7. Should central banks keep their independence?
- Central banks face increased responsibilities (financial regulation, supervision, macroprudential tool use) beyond traditional monetary policy.
- Distributional implications of regulation and macroprudential tools (e.g., loan-to-value ratios) are more salient than for traditional monetary policy.
- Consensus: central banks should retain full independence on traditional monetary policy, but independence cannot fully extend to regulation or macroprudential tools.
8. Little progress on the design of fiscal policy
- Traditional objection to discretionary fiscal policy: recessions are short and delays make discretionary measures ineffective.
- Martin Feldstein: some recessions (notably those with financial crises) are long enough that discretionary fiscal policy can and should be used; fiscal activism can come via composition changes (e.g., increase investment tax credit financed by higher corporate taxation) rather than overall deficit changes.
- Little action on improving automatic stabilizers despite interest (e.g., chapter 2 of the April 2015 Fiscal Monitor referenced).
- Focus of governments remains on debt reduction and the right speed of fiscal consolidation; little work or action on fiscal rule design.
- Marco Buti: excessive number and complexity of European Union rules partly reflects relative weakness of the European commission in enforcing implementation.
9. The complex effects of capital flows
- Recognition: capital flows have complex effects beyond exchange rates; they affect domestic financial systems positively or negatively.
- Implications:
- Hands-off policies are not the solution.
- Macroprudential tools can mitigate adverse effects on banking systems.
- FX intervention can stabilize exchange rates — pragmatic approach advocated by Luiz Pereira da Silva (Brazil).
- No consensus on capital controls:
- Agustín Carstens: against capital controls for Mexico (highly integrated with the United States); costs likely exceed benefits.
- Blanchard: capital controls are not fundamentally different from macroprudential tools; investor rules must be clear ex ante and ex post.
10. How much can the international monetary system be improved?
- Ricardo Caballero: emerging market demand for safe assets; argued for better provision of international liquidity by the IMF and by central banks; would raise the world safe real rate and alleviate secular stagnation concerns.
- Maury Obstfeld: no exchange rate arrangement is perfect, but managed float is probably best for most countries.
- Two main issues:
- National central bank mandates versus spillover effects on other countries; Jaime Caruana: argue for "enlightened self interest" where originating countries consider “spillbacks” of their policies.
- Nature of spillovers and global coordination: Zeti Akhtar Aziz: spillovers are poorly understood; better understanding could reduce disagreements and frictions between advanced economies and emerging markets.
- Question posed in formal terms: is the Nash equilibrium (each central bank fulfilling its national mandate) suboptimal relative to a cooperative equilibrium?
Bottom line
- Many questions raised were not fully settled.
- Answer to "Progress or Confusion?": both — progress is undeniable, confusion is unavoidable given complex remaining issues.
Source: Olivier Blanchard, "Ten Take Aways from the 'Rethinking Macro Policy: Progress or Confusion?'", May 1, 2015.
Content in this bundle
- Inflation targeting and leaning against the wind
- Mundell
- Chapter 3: Perspectives on Global Real Interest Rates