Blog Post

Reorienting macroeconomic policy

What’s at stake: The IMF, at the forefront in recommending the policy response to the global economic crisis, has entered the debate about how macroeconomic policy should be adjusted in the future, drawing lessons from the worst global recession in 60 years. Olivier Blanchard, the IMF’s chief economist, and a couple of other Fund economists […]

By: Date: February 16, 2010 Topic: Global economy and trade

What’s at stake: The IMF, at the forefront in recommending the policy response to the global economic crisis, has entered the debate about how macroeconomic policy should be adjusted in the future, drawing lessons from the worst global recession in 60 years. Olivier Blanchard, the IMF’s chief economist, and a couple of other Fund economists released a paper on Friday about how macroeconomic policy might be reoriented.

Drawing lessons from the Great Recession

Olivier Blanchard says economists and policymakers alike were lulled into a false sense of security by the apparent success of economic policy ahead of the crisis. In the piece, Blanchard and co. lay out some key questions about the design of macroeconomic policy frameworks and also develop some ideas on how those frameworks might be strengthened. The basic elements of the pre-crisis policy consensus still hold. Keeping output close to potential and inflation low and stable should be the two targets of policy. And controlling inflation remains the primary responsibility of the central bank. But the crisis forces us to think about how these targets can be achieved. The crisis has made clear that policymakers have to watch many other variables, including the composition of output, the behaviour of asset prices, and the leverage of the different participants in the economy. It has also shown that they have potentially many more instruments at their disposal than they used before the crisis. The challenge is to learn how to use these instruments in the best way. The combination of traditional monetary policy and regulatory tools, and the design of better automatic stabilizers for fiscal policy, are two promising routes.

Free exchange notes the contrast between this paper and his “state of macro” paper from August 2008 is striking. The assessment of the former paper was that, "the state of macro is good." Interestingly, the older paper is not among the list of references in the new one. Blanchard and co.’s list of the oversights and mistakes of "Great Moderation" macroeconomics makes it harder to see why, a month before Lehman Brothers collapsed, Blanchard was saying that the state of academic macroeconomics was good.

Olivier Coibion and Yuriy Gorodnichenko argue that it is misleading to consider the dramatic end to the Great Moderation as particularly damning for “good policy” explanations of the Great Moderation. The authors argue that the current recession, while clearly severe by historical standards, does not seem to imply a return to the levels of volatility observed in the 1970s and that good policy does deserve credit for the decrease in inflation levels.

The case for higher inflation

Eurointelligence notes that the most surprising conclusion is the idea that central banks have been setting their inflation targets too low. Policy would have been more optimal if we started to cut interest rates from a higher nominal rate. To achieve this you need higher inflation. Blanchard says the 2% inflation targets most central banks seem to have opted for have no reason in theory. If this had to be done over again, he would advocate an inflation target of 4%. He says there is not much between 2 and 4% in terms of price stability, but it gives the central banks more room for manoeuvre to cut interest rates during a crisis.

Paul Krugman very much agrees with Blanchard. He even goes further and writes that there’s another case for a higher inflation rate – an argument made most forcefully by Akerlof, Dickens, and Perry. It goes like this: even in the long run, it’s really, really hard to cut nominal wages. Yet when you have very low inflation, getting relative wages right would require that a significant number of workers take wage cuts. So having a somewhat higher inflation rate would lead to lower unemployment, not just temporarily, but on a sustained basis. This point is especially important in the European context as the period 2000-2008 saw a huge divergence in price levels between the capital-inflow nations of the European periphery and the European core. Almost surely, that divergence now has to be reduced. Yet with a low overall inflation rate for the eurozone, that means large-scale deflation in the overvalued economies if convergence is to happen any time in, say, the next 5-10 years. The task would be a lot easier if the eurozone had 4 percent inflation instead of 2.

Georges Soros’ initiative

Not directly linked but somewhat telling about the current mood in macroeconomic thinking is the veteran investor call for a change in how economics is taught in academic institutions, with the emphasis moving away from the widely accepted mantra that markets are always efficient. He has set up the Institute for New Economic Thinking with a $50 million pledge, to explore why prevailing economic theory failed to predict the financial crisis. The advisory board includes George Akerlof, Alexander Mirrlees, Michael Spence, Joseph Stiglitz, Willem Buiter, Simon Johnson, Kenneth Rogoff and Jeffrey D. Sachs amongst others.

*Bruegel Economic Blogs Review is an information service that surveys external blogs. It does not survey Bruegel’s own publications, nor does it include comments by Bruegel authors.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article More by this author
 

Blog Post

It’s hard to live in the city: Berlin’s rent freeze and the economics of rent control

A proposal in Berlin to ban increases in rent for the next five years sparked intense debate in Germany. Similar policies to the Mietendeckel are currently being discussed in London and NYC. All three proposals reflect and raise similar concerns – the increase in per-capita incomes is not keeping pace with increases in rents, but will a cap do more harm than good? We review recent views on the matter.

By: Inês Goncalves Raposo Topic: Macroeconomic policy Date: July 8, 2019
Read article More on this topic
 

Blog Post

The breakdown of the covered interest rate parity condition

A textbook condition of international finance breaks down. Economic research identifies the interplay between divergent monetary policies and new financial regulation as the source of the puzzle, and generates concerns about unintended consequences for financing conditions and financial stability.

By: Konstantinos Efstathiou and Bruegel Topic: Banking and capital markets Date: July 1, 2019
Read article More on this topic
 

Blog Post

The June Eurogroup meeting: Reflections on BICC

The Eurogroup met on June 13th to discuss the deepening of the economic and monetary union (EMU) and prepare the discussions for the Euro Summit. From the meeting came two main deliverables: an agreement over a budgetary instrument for competitiveness and convergence and the reform of the European Stability Mechanism (ESM) treaty texts. We review economists’ first impressions.

By: Bruegel and Inês Goncalves Raposo Topic: Macroeconomic policy Date: June 24, 2019
Read article More on this topic
 

Blog Post

The campaign against ‘nonsense’ output gaps

A campaign against “nonsense” consensus output gaps has been launched on social media. It has triggered responses focusing on the implications of output gaps for fiscal policy under EU rules, especially for Italy. But the debate about the reliability of output-gap estimates is more wide-ranging.

By: Konstantinos Efstathiou and Bruegel Topic: Macroeconomic policy Date: June 17, 2019
Read article More on this topic
 

Blog Post

The inverted yield curve

Longer-term yields falling below shorter-term yields have historically preceded recessions. Last week, the US 10-year yield was 21 basis points below the 3-month yield, a feat last seen during the summer of 2007. Is the current yield curve a trustworthy barometer for future growth?

By: Inês Goncalves Raposo and Bruegel Topic: Global economy and trade Date: June 11, 2019
Read article More on this topic
 

Blog Post

The 'seven' ceiling: China's yuan in trade talks

Investors and the public have been looking at the renminbi with caution after the Trump administration threatened to increase duties on countries that intervene in the markets to devalue/undervalue their currency relative to the dollar. The fear is that China could weaponise its currency following the further increase in tariffs imposed by the United States in early May. What is the likelihood of this happening and what would be the consequences for the existing tensions with the United States, as well as for the global economy?

By: Inês Goncalves Raposo and Bruegel Topic: Global economy and trade Date: June 3, 2019
Read article More on this topic
 

Blog Post

The next ECB president

On May 28th, EU heads of state and government will start the nomination process for the next ECB president. Leaving names of possible candidates aside, this review tries to isolate the arguments about what qualifications the new president should have and what challenges he or she is likely to face.

By: Bruegel and Konstantinos Efstathiou Topic: Macroeconomic policy Date: May 27, 2019
Read article More on this topic More by this author
 

Blog Post

The latest European growth-rate estimates

The quarterly growth rate of the euro area in Q1 2019 was 0.4% (1.5% annualized), considerably higher than the low growth rates of the previous two quarters. This blog reviews the reaction to the release of these numbers and the discussion they have triggered about the euro area’s economic challenges.

By: Konstantinos Efstathiou Topic: Macroeconomic policy Date: May 20, 2019
Read article More by this author
 

Blog Post

Is an electric car a cleaner car?

An article published by the Ifo Institute in Germany compares the carbon footprint of a battery-electric car to that of a diesel car, and argues a higher share of electric cars will not contribute to reducing German carbon dioxide emissions. Respondents rejected the authors’ calculations as unrealistic and biased, and pointed to a series of studies that conclude the opposite. We summarise the article and responses to it.

By: Michael Baltensperger Topic: Digital economy and innovation, Green economy Date: May 13, 2019
Read article More on this topic More by this author
 

Blog Post

All eyes on the Fed

Last week the US Federal Reserve left the federal funds rate unchanged and lowered the interest rate on excess reserves. We review economists’ recent views on the monetary policy conduct and priorities of the United States’ central bank system.

By: Inês Goncalves Raposo Topic: Global economy and trade Date: May 6, 2019
Read article More on this topic More by this author
 

Blog Post

Is this blog post legal (under new EU copyright law)?

How new EU rules on using snippets from news publishers and on copyright infringement liability might affect circulation of information, revenue distribution, market power and EU business competitiveness.

By: Catarina Midões Topic: Macroeconomic policy Date: April 8, 2019
Read article More on this topic
 

Blog Post

Secular stagnation and the future of economic stabilisation

Larry Summers’ and Łukasz Rachel’s most recent study documents a secular fall in neutral real rates in advanced economies. According to the authors, this fall would be even more marked in the absence of offsetting fiscal policies. Policymaking in a world of permanently low interest rates may be hard to navigate, especially in troubled waters. We review economists’ views on the matter

By: Inês Goncalves Raposo and Bruegel Topic: Macroeconomic policy Date: April 1, 2019
Load more posts