Olivier Blanchard: Rethinking Macroeconomic Policy
Olivier Blanchard:
Rethinking Macroeconomic Policy: Rethinking and reforms are both taking place. But we still do not know the final destination, be it for the redefinition of monetary policy, or the contours of financial regulation, or the role of macroprudential tools. We have a general sense of direction, but we are largely navigating by sight. I shall take six examples….
Navigating by sight. Financial regulation. There is no agreed vision of what the future financial architecture should look like, and by implication, no agreed vision of what the appropriate financial regulation should be. You may remember the famous quote by Paul Volcker that the only useful financial innovation of the last 40 years has been the ATM machine. This is surely an exaggeration. But we are still unsure about the right role of securitization, the right scope for derivatives, the role of markets versus banks, and the role of shadow banking versus banking. Still, we all agree that some things should change… [an] increase in required capital ratios…. capital flows… Helene Rey… showed how surprisingly meager the hard econometric evidence is on the benefits of portfolio flows. I was also struck by Stanley Fischer’s rhetorical question: what is the usefulness of short term capital inflows?….
Navigating by sight. The role of the financial sector. It has become cliché to say that macroeconomic thinking understated the role of financial factors in economic fluctuations…. [I]s there a credit and financial cycle… should we think of financial shocks as another source of disturbance?… Was Stephan Gerlach right when he asked whether we should really reconsider all of macroeconomics for an event that may happen once every hundred years? Or, instead, are financial shocks and the financial system so central to macroeconomic fluctuations that the IS-LM model—which, as you will recall, does not include an explicit financial system—is not an acceptable port of entry?… By implication, there is no agreement on how or even whether to integrate financial stability and macro stability in the mandate of central banks….
Navigating by sight. Macroprudential tools. At our first Rethinking Macroeconomic Policy conference in 2011, macroprudential tools were, to use Andrew Haldane’s phrase, very much the new kid… the two standard tools, fiscal and monetary policy, were not the right ones… is macroprudential policy going to be the third leg of macroeconomic policy, or just a crutch to help the first two?….
Navigating by sight. Governance and allocation of tasks between microprudential, macroprudential, and monetary policy or, as Avinash Dixit has nicely called them, MIP, MAP, MOP. How should microprudential and macroprudential regulation be coordinated?… I see macroprudential regulation requiring higher capital ratios from more systemically important banks, or for higher capital ratios when aggregate credit growth appears too high…. The United Kingdom’s approach, with the creation of a Financial Stability Committee which can impose capital ratios that vary over time and across sectors, seems like a good way to proceed….
Navigating by sight. The sustainable level of debt. The rate of fiscal consolidation depends, upon other things, on what we think a sustainable level of debt is. Many countries are going to be managing levels of debt close to 100 percent of GDP for many years to come. There is a standard list of textbook answers as to why high debt is costly, from lower capital accumulation to the need for higher, distortionary taxes. I suspect the costs are elsewhere…. The first is debt overhang. The higher the debt, the higher the probability of default, the higher the spread on government bonds, and the harder it is for the government to achieve debt sustainability…. Higher sovereign spreads affect private lending spreads, and in turn affect investment and consumption. Higher uncertainty about debt sustainability, and accordingly about future inflation and future taxation, affects all decisions…. Reduced form regressions of growth on debt can take us only so far. The second related cost is the risk of multiple equilibria. At high levels of debt, there may well be two equilibria, a "good equilibrium" at which rates are low and debt is sustainable, and a "bad equilibrium" in which rates are high, and, as a result, the interest burden is higher, and, in turn, the probability of default is higher. When debt is very high, it may not take much of a change of heart by investors to move from the good to the bad equilibrium…. Martin Wolf asked a provocative question: why are the spreads so much higher for Spain than for the United Kingdom?… Could the answer lie in the difference in monetary policy? In the case of the United Kingdom, investors expect the Bank of England to intervene if needed to maintain the good equilibrium, whereas they believe the European Central Bank does not have the mandate to do?…
Navigating by sight. Multiple equilibria and communication. In a world of multiple equilibria, announcements… matter…. The recent announcement by the Bank of Japan that it intends to double the monetary base is even more interesting. What effect it will have on inflation depends very much on how Japanese households and firms change their inflation expectations…. The motivation for this dramatic monetary expansion is thus largely to give a psychological shock, and shift perceptions and price dynamics….
The conference has left us with a clear research agenda. We, at the IMF, fully intend to take up the challenge.
