## 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

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### 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**
  - [Inflation targeting and leaning against the wind (Markdown version)](/files/papers/inflation-targeting-and-leaning-against-the-wind-paper-sarb.pdf.md){rel="alternate" type="text/markdown"}
  - [Inflation targeting and leaning against the wind (PDF)](/files/papers/inflation-targeting-and-leaning-against-the-wind-paper-sarb.pdf){rel="external" type="application/pdf"}
- **Mundell**
  - [Mundell (Markdown version)](/external/np/res/seminars/2014/arc/pdf/Mundell.pdf.md){rel="alternate" type="text/markdown"}
  - [Mundell (PDF)](/external/np/res/seminars/2014/arc/pdf/Mundell.pdf){rel="external" type="application/pdf"}
- **Chapter 3: Perspectives on Global Real Interest Rates**
  - [Chapter 3: Perspectives on Global Real Interest Rates (Markdown version)](/external/pubs/ft/weo/2014/01/pdf/c3.pdf.md){rel="alternate" type="text/markdown"}
  - [Chapter 3: Perspectives on Global Real Interest Rates (PDF)](/external/pubs/ft/weo/2014/01/pdf/c3.pdf){rel="external" type="application/pdf"}

---

## References

- [Rethinking Macro Policy.](http://www.imf.org/external/np/seminars/eng/2015/macro3/)
- [last year](http://www.imf.org/external/mmedia/view.aspx?vid=2821294542001)
- [financial regulation](http://www.imf.org/external/mmedia/view.aspx?vid=4175702375001)
- [monetary policy](http://www.imf.org/external/mmedia/view.aspx?vid=4176910915001)
- [macro prudential tools"](http://www.imf.org/external/mmedia/view.aspx?vid=4175702372001)
- [session](http://www.imf.org/external/mmedia/view.aspx?vid=4176918085001)
- [Fiscal Monitor](http://www.imf.org/external/pubs/ft/fm/2015/01/fmindex.htm)
- [capital flows](http://www.imf.org/external/mmedia/view.aspx?vid=4176918093001)
- [international monetary system](http://www.imf.org/external/mmedia/view.aspx?vid=4179179480001)
- [blog](http://blogs.imf.org/2015/04/02/contours-of-macroeconomic-policy-in-the-future/)

_Source: https://www.imf.org/en/blogs/articles/2015/05/01/ten-take-aways-from-the-rethinking-macro-policy-progress-or-confusion_