Macroeconomics: The Academic Agenda
The second-best thing on this I have seen--second to Barry Eichengreen's "The Last Temptation of Risk":
Olivier Blanchard, Giovanni Dell'Ariccia, Paolo Mauro: Rethinking macro policy: The global crisis forced economic policymakers to react in ways not anticipated by the pre-crisis consensus on how macroeconomic policy should be conducted. Here the IMF’s chief economist and colleagues (i) review the main elements of the pre-crisis consensus, (ii) identify the elements which turned out to be wrong, and (iii) take a tentative first pass at outlining the contours of a new macroeconomic policy framework.
The great moderation... lulled macroeconomists and policymakers alike in the belief that we knew how to conduct macroeconomic policy. The crisis clearly forces us to question that assessment.... [W]e thought of monetary policy as having one target, inflation, and one instrument, the policy rate. So long as inflation was stable, the output gap was likely to be small and stable and monetary policy did its job. We thought of fiscal policy as playing a secondary role, with political constraints limiting its usefulness. And we thought of financial regulation as mostly outside the macroeconomic policy framework. Admittedly, these views were more closely held in academia; policymakers were more pragmatic. Nevertheless, the prevailing consensus played an important role in shaping policies and institutions. Stable and low inflation was presented as the primary, if not exclusive, mandate of central banks. This resulted from the reputational need of central bankers to focus on inflation rather than activity and the intellectual support for inflation targeting provided by the New Keynesian model. In the benchmark version of that model... [when] policymakers cared about activity, the best they could do was to maintain stable inflation. There was also consensus that inflation should be very low (most central banks targeted 2% inflation).
Monetary policy focused on one instrument, the policy interest rate. Under the prevailing assumptions, one only needed to affect current and future expected short rates, and all other rates and prices would follow. The details of financial intermediation were seen as largely irrelevant. An exception was made for commercial banks, with an emphasis on the “credit channel.” Moreover, the possibility of runs justified deposit insurance and the traditional role of central banks as lenders of last resort. The resulting distortions were the main justification for bank regulation and supervision. Little attention was paid, however, to the rest of the financial system from a macro standpoint.
Following its glory days of the Keynesian 1950s and 1960s, and the high inflation of the 1970s, fiscal policy took a backseat... scepticism about the effects... concerns about lags and political influences... the need to stabilize and reduce typically high debt levels. Automatic stabilizers could be left to play when they did not conflict with sustainability.
Financial regulation and supervision focused on individual institutions and markets and largely ignored their macroeconomic implications....
The decline in the variability of output and inflation led to greater confidence that a coherent macro framework had been achieved. In addition, the successful responses to the 1987 stock market crash, the LTCM collapse, and the bursting of the tech bubble reinforced the view that monetary policy was also well equipped to deal with asset price busts....
What we have learned from the crisis:
Macroeconomic fragilities may arise even when inflation is stable.... Low inflation limits the scope of monetary policy in deflationary recessions.... Financial intermediation matters.... Countercyclical fiscal policy is an important tool.... Regulation is not macroeconomically neutral....
If the conceptual framework behind macroeconomic policy was so flawed, why did things look so good for so long? One reason is that policymakers had to deal with shocks for which policy was well adapted....
The bad news is that the crisis has shown that macroeconomic policy must have many targets; the good news is that it has also reminded us that we have many instruments, from “exotic” monetary policy to fiscal instruments, to regulatory instruments. It will take some time, and substantial research, to decide which instruments to allocate to which targets. It is important to start by stating that the baby should not be thrown out with the bathwater. Most of the elements of the pre-crisis consensus still hold. Among them, the ultimate targets remain output and inflation stability. The natural rate hypothesis holds, at least to a good enough approximation, and policymakers should not assume that there is a long-term trade-off between inflation and unemployment....
The following are important questions for economists to work on:
Exactly how low should inflation targets be?... How should monetary and regulatory policy be combined?... Should liquidity be provided more broadly?... How can we create more fiscal space in good times?... Can we design better automatic fiscal stabilizers?...
References:
- Blanchard, Olivier, Giovanni Dell’Ariccia and Paolo Mauro (2010). “Rethinking Macroeconomic Policy”, IMF Staff Position Note, SPN/10/03, 12 February 12.
- Gali, Jordi and Luca Gambetti (2009). “On the Sources of the Great Moderation,” American Economic Journal: Macroeconomics, 1(1): 26–57.