Concluding Remarks

Blanchard Olivier

I took a lot of notes during the conference at which all these papers were presented and discussed. I organized my thoughts around the following nine points:

1. We have entered a brave new world. The economic crisis has put into question many of our beliefs. We have to accept the intellectual challenge.

2. In the age-old discussion of the relative roles of markets and of the state, the pendulum has swung, at least a bit, toward the state. We probably have revised our views on the need for regulation and on the limits of regulation. Both are stronger than we thought earlier.

3. The crisis has made it clear that many distortions are relevant for macro, many more than we thought earlier. We had ignored them, thinking that they were the province of microeconomists. But as we start to integrate finance into macro, we are discovering them anew. Agency theory is needed to explain how financial institutions work or do not work and how decisions are taken. Regulation and agency theory applied to regulators is also important. Behavioral economics and its cousin, behavioral finance, are central as well. With capital controls, for example, central issues are why investors are coming in or going out, what is behind their decisions, and how much herding plays a role in their decisions.

4. A theme that emerged from this conference is that macropolicy is a game (in the sense of game theory—policy is serious business) with many targets and many instruments. For example, a recurring theme in monetary policy has been that inflation stability alone is not enough; output stability and financial stability need to be added to the list. With fiscal policy, we have to go from thinking about fiscal policy as just “government spending minus taxes” and an associated multiplier to realizing that there are 100 tools that can be used, that they have their own dynamic effects, and those effects depend on the state of the economy and other policies. I wonder whether we should not move the discussion away from multipliers. Working with multipliers makes you look for one number—if you only knew it, then you would be done—whereas we have to think of complex dynamic responses. Reducing discussions about fiscal policy to what is the right multiplier is not doing service to the issue (a point that Robert Solow makes in chapter 8).

The third example—again, I could choose many—is capital-account management. I like the provocative argument (made by Rakesh Mohan in chapter 15) that it may be possible to achieve the impossible trinity of an open capital account, a fixed exchange rate, and an independent monetary policy by using more instruments. Whether or not it can actually be done, using more instruments allows you to resolve, at least in principle, something that looks impossible with fewer instruments.

5. We may have many instruments, but we are not sure how to use them. In many cases, we are really uncertain about what they are, how they should be used, and whether they will work. Many examples came up during the various sessions at the conference. Liquidity ratios: because we do not know how to define liquidity in the first place, a liquidity ratio is one more step into the unknown. Capital controls: some people believe that they work and some people believe that they do not, and where you end up depends very much on that belief. Another example is Paul Romer’s corollary to what he calls Myron’s law, which is that if you adopt a set of financial regulations and keep them unchanged, the markets will find a way around them, and ten years later, you will have a financial crisis (chapter 12). Yet another example is Michael Spence’s observations about the relative roles of self-regulation and regulation (chapter 19). Both are needed, and how we should combine them is extremely unclear.

6. Although these instruments are potentially useful, their use raises a number of political economy issues.

Some are hard to use politically. For cross-border flows, putting in place a regulatory structure is going to be difficult. Even at the domestic level, some of the macroprudential tools work by targeting a specific sector or a specific set of individuals or firms. This may lead to strong political backlash by the groups that are being directly targeted.

And instruments can be misused. The more instruments there are, the more the scope for misuse. Many people think that although there may be an economic case for capital controls, governments are going to use them instead of what they should be doing, which is choosing the right macroeconomic policy. Dani Rodrik argues for industrial policy as the right tool to increase the production of tradables without getting a current-account surplus (chapter 17). But in practice, the limits of industrial policy have not gone away.

7. Where do we go from here? In terms of research, the future is exciting. Many topics need work—namely, macro issues with (as Joseph Stiglitz, chapter 4, might say) the right microfoundations. For example, on capital controls, thinking of the exact source of distortions (if any) would allow for a much more informed discussion of the issues, a point that Ricardo Caballero makes forcefully in chapter 13.

8. Things are harder, I find, on the policy front. Given that we do not quite know how to use the new tools and they can be misused, how do policymakers go at it? Although we have to have a good sense of where we want to go in the end, a step-by-step approach is probably the way to do it. For example, I was critical of inflation targeting, but I do not think that one should, from one day to the next, give it up and move to a system with, say, five targets and seven instruments. We do not know how to do it, and it would be dangerous. Instead, we should introduce these macroprudential tools one by one or at least at a slow speed, see how they work, and then try to use them in the right way. But that process will take time.

Step by step is also the way to proceed in reforming the international monetary system. With SDRs, for example, it seems relatively easy to create a private market in private SDR bonds, see how it functions, and note whether it becomes deep enough to allow for large changes in supply and demand. If it is deep enough, one can think about a next step, such as having the IMF borrow by issuing SDR bonds to the private sector. If this turns out to be feasible, then one can think about the IMF doing this in times of systemic crisis to mobilize the funds needed to respond to large liquidity needs. All these steps have to be taken carefully.

A related point is that, in this new world, pragmatism is of the essence. That comes up, for example, in Andrew Sheng’s discussion of the adaptive Chinese growth model (chapter 18). We have to try things carefully and see how they work.

9. We have to keep our hopes in check. There are going to be new crises that we have not anticipated and are not ready for. Despite our best efforts, we could well have old-type crises again. That is an interesting theme in Adair Turner’s discussion of credit cycles (chapter 11). If we draw the implications from agency theory and put in place the right regulations, can we eliminate credit cycles? Or are they part of basic human nature, so that no matter what we do, they will come back in some form? I tend to be more of the second school than the first. So we need to be modest in our hopes.

A journalist asked me whether the conference on Macro and Growth Policies in the Wake of the Crisis was Washington Consensus 2. It was not intended to be, and it was not. It was the beginning of a conversation and an exploration. Time will tell where it takes us.

Contributors

Olivier Blanchard is the economic counselor and director of the Research Department at the International Monetary Fund.

Ricardo Caballero is the head of the Department of Economics, the Ford International Professor of Economics, and codirector of the World Economic Laboratory at the Massachusetts Institute of Technology and a National Bureau of Economic Research research associate in economic fluctuations and growth.

Charles Collyns serves as the U.S. Department of the Treasury’s assistant secretary for international finance. In this position, Collyns is responsible for leading Treasury’s work on international monetary policy, international financial institutions, coordination with the Groups of Seven, Eight, and Twenty, and regional and bilateral economic issues.

Arminio Fraga is chair and chief investment officer at Gavea Investimentos, an investment management firm based in Rio de Janeiro that he founded in August 2003.

Már Guðmundsson was appointed governor of the Central Bank of Iceland in 2009. Before taking that position, he was deputy head of the Monetary and Economic Department at the Bank for International Settlements and a member of the Bank’s senior management.

Sri Mulyani Indrawati is managing director of the World Bank. She was formerly Minister of Finance of Indonesia (2005–2010).

Otmar Issing is president of the Center for Financial Studies (2006) and chair of the Advisory Board of the House of Finance at Goethe University, Frankfurt (2007).

Olivier Jeanne joined the Johns Hopkins Department of Economics in September 2008, after spending ten years in various positions in the Research Department of the International Monetary Fund.

Rakesh Mohan is professor of the practice of international economics and finance at the School of Management and senior fellow of the Jackson Institute for Global Affairs at Yale University, after serving as Deputy Governor of the Reserve Bank of India for several years.

Maurice Obstfeld is the Class of 1958 Professor of Economics at the University of California, Berkeley, and director of the Center for International and Development Economic Research.

José Antonio Ocampo is Professor at SIPA and Fellow of the Committee on Global Thought at Columbia University and formerly Minister of Finance of Colombia and former Under-Secretary-General of the United Nations for Economic and Social Affairs.

Guillermo Ortiz is Chairman of Grupo Financiero Banorte-IXE. He was governor of the Bank of Mexico (1998–2009, serving two consecutive six-year terms). In addition, he was Chairman of the Board of the Bank of International Settlements and previously served as Secretary of Finance and Public Credit in the Mexican Federal Government.

Y. V. Reddy was governor of the Reserve Bank of India from 2003 to 2008. Subsequently, he was a member of the United Nations Commission of Experts to the President of the U.N. General Assembly on Reforms of International Monetary and Financial System.

Dani Rodrik is the Rafiq Hariri Professor of International Political Economy at the John F. Kennedy School of Government, Harvard University.

David Romer is the Herman Royer Professor of Political Economy at the University of California, Berkeley. From February 2009 to September 2010, he was Senior Resident Scholar at the International Monetary Fund.

Paul M. Romer is the president of Charter Cities, a research nonprofit focused on the interplay of rules, urbanization, and development and Professor in the Stern School of Business, New York University.

Andrew Sheng has published widely in economics and finance. His latest publications are From Asian to Global Financial Crisis (Cambridge University Press, 2009) and an article on global financial regulatory reform in Global Policy 1(2) (May 7, 2010).

Hyun Song Shin is the Hughes-Rogers Professor of Economics at Princeton University.

Parthasarathi Shome is currently director and chief executive at the Indian Council for Research on International Economic Relations, New Delhi, after serving as Chief Economist at Her Majesty’s Revenue and Customs, United Kingdom (2008–2011), and as Advisor to the Indian Finance Minister (2004–2008).

Robert Solow is professor emeritus at the Massachusetts Institute of Technology.

Michael Spence served as the chair of the Commission on Growth and Development (2006–2010), professor emeritus of management in the Graduate School of Business at Stanford University, a senior fellow of the Hoover Institution at Stanford, and professor of economics at the Stern School of Business at New York University. In 2001, he received the Nobel Prize in economic sciences.

Joseph Stiglitz is University Professor at Columbia University and the winner of the 2001 Nobel Prize for Economics. He served on President Clinton’s economic team as a member and then chairman of the U.S. Council of Economic Advisers in the mid-1990s, and then joined the World Bank as chief economist and senior vice president.

Adair Turner was appointed chair of the Financial Services Authority (FSA) in September 2008 and chair of the Standing Committee on Regulatory Cooperation of the Financial Stability Board. He has combined careers in business, public policy, and academia.

Index

Note: An f or t following a page number indicates a figure or table.

Africa, growth in, 158, 163, 163f, 164

Asian countries. See also China; India; Indonesia; growth in, 158–159, 163, 163f

policy levers in managing crisis, 68–69

Asset-price bubbles, 38, 178; creation, 31

identification, 27

policy response, 3, 4, 21, 26–27, 31, 34

Asset prices; bubbles (see Asset-price bubbles) cycles, 105, 105t, 109

interest-rate policy and, 4, 38

monetary policy and, 3, 4, 26–27, 34

reserve accumulation and, 218

targeting, 20–21, 26

Banking, cross-border, 191, 193–195

Banks; bailouts, 39

central (see Central banks)

failures, 20, 102–105, 104t, 105t

global wholesale funding, 91–100

public-sector, 84

too-big-to-fail, 87–88, 104

Bernanke, Ben S., 139–140

Bonds, 38, 96, 96f, 106, 106f

Brazil; appreciation problem in, 130

capital outflows, 133

economic recovery, 179

inflation rate, 17

macroeconomic policies, 134

reserves, 220

swaps from Federal Reserve, 205–206, 205f

Bubbles. See Asset-price bubbles

Capital account. See also Capital-account management; liberalization, 139–140

open, 139, 140–141, 226

Capital-account management. See also Capital inflows; as avoidance strategy, 130

capital flows and, 201, 204, 212

capital market development, 139–140

China, 200–204

costs, 130, 133, 139

as countercyclical tool, 148

effectiveness, 133, 148–149, 201, 204, 226

impossible trinity and, 140–141, 148, 226

macroeconomic policies and, 127–128, 138, 140–141, 146–148

macroprudential measures and, 128, 140, 155, 226–227

Capital-account management (cont.); multilateral rules, 128, 131, 204, 211–212

optimal, 137–138, 211–212

price-based, 149

rationale, 139, 141–142

second-best policy, 129–131, 133–134

temporary, 134, 149, 211

Capital controls. See Capital-account management

Capital inflows; benefits, 139

causes, 141–142, 211

currency appreciation and, 99

cyclicality of, 145–149

to emerging-market economies, 91, 98, 98f, 133–134, 139, 211

exchange rate appreciation and, 138

in financial crisis, 139–140

financial-sector development and, 86

growth spurts and, 164, 165f

impact on business cycles, 145–147

interest-rate differentials and, 149

large, 127–128, 187

outflows, 133, 142, 187

precrisis, 140

regulations and, 133–134, 226–227

risks, 137

rules for, 157, 203–204

taxing, 130

United States and, 95–96, 96f

volatility of, 129, 141, 142, 146, 209

Cash-transfer programs, 69

Central banks. See also Inflation targeting; Monetary policy; balance sheet expansion, 5, 22, 37–39, 142–143, 193

Chinese, 201

credibility, 29

European, 22, 27, 28

foreign exchange reserves (see Reserves)

governance, 39–40

independence of, 11, 39–40, 67

lender of last resort, 191–195, 205, 216–217

objectives, 34–35

regulatory/supervisory role of, 19–20, 31, 83–89, 135

swap lines, 193, 204–206, 217, 221

China; capital-account policies, 200–203

currency undervaluation, 134, 167, 210–211

current-account surplus, 200

exchange-rate policy, 18

fiscal expansion, 60, 178–179

growth model, 169–173, 181, 200–203

renminbi internationalization, 202–203

saving rate, 201–202

Credit, 27, 28, 33–34, 37–38, 103

Credit cycles, 103–110, 228

Crisis of 2008; causes of, 31–32, 79–80, 83–85, 139–140, 169, 177–178

impact on emerging markets, 15, 16f, 19, 68, 178–179

impact on capital flows, 187 lessons from, 3–5, 25–29, 45–47, 57–63, 70–71, 79–82, 87–88, 99–100, 127–128, 153–155, 177, 187–189, 195, 225–228

Current-account balances, 188–189, 199–201, 200f

Deleveraging, 99, 103, 104f, 108–109

Developing countries, 67–71, 145–147,157–167, 177–179. See also Emerging-market economies labor productivity in, 160–161, 161f

DSGE models (dynamic stochastic general equilibrium models), 57, 63–64n1

Emerging-market economies (EME) capital-account management (see Capital-account management; Capital inflows); during crisis of 2008, 15, 16f, 19, 52–54, 67–71, 83, 178–179

with current-account surpluses, 167, 200–203, 210

exchange rate policy, 11–13, 18, 127–128, 130, 135–136, 137, 140–141, 147–148, 201, 210–211

financial regulation in, 83–89

foreign-exchange reserves, 142–143, 217

growth model, 158, 169–173, 177, 179–181, 209–210

monetary policy in, 11–12, 12f, 15–19, 16f, 23, 25, 67, 136–143, 145–149

in Latin America, 138, 140–141, 164

Equity cycles, vs. debt cycles, 108

Equity instruments, 80, 96, 96f, 107

European Central Bank, 21, 22, 27, 28

Euro zone, 216f, 220, 222

Exchange rates See also Impossible trinity; Monetary policy; appreciation, 127–128, 129–130, 147, 178, 180, 203, 210–211

intervention, in emerging-market countries, 18

macroprudential levy and, 99

managed, 135–136

overvaluation, 135, 164

surveillance, 212

underevaluation, 164, 166f, 167, 203, 210–211

Federal Aviation Administration (FAA), 116–118, 121–122

Federal Reserve; bailout packages, 89

balance sheet, 193

during crisis, 18

dollar swap lines, 18, 22, 194, 205–206, 205f, 217

global liquidity, 194

as lender of last resort, 193, 217

quantitative easing, 5, 31, 37–39, 128, 131

term auction facility, 95, 95f

Financial instability, 35, 54

Financial institutions See also Financial intermediation; big, 87–88, 169

cross-border activities, 88–89, 91–98, 195

dollar funding of, 91–92

incentive problems in, 40, 101–102, 107, 134

systemically important, 87–88, 104, 105t, 107, 169

Financial intermediation; allocative efficiency, 101, 109–110

bank balance sheet expansion, 98, 103f, 108, 192, 193

credit (see Credit)

instability, 49, 101–109, 134

leverage, 36–37, 99, 109

maturity transformation, 107–109, 191–192, 217

optimal, 101–110

regulation of, 83–84, 86–87, 99

services, provision of, 85

social value, 80, 85–86, 89

supervision/regulation, 80–81, 140

Financial regulation. See also Capital-account management; design of institutions, 81, 87–88

discretion in, 80–81, 86–87

diversity of, 84

macroprudential, 9–11, 36, 99, 145, 227

principle-based vs. process-based, 111–123

Financial stability; central banks and, 19–20

causes of instability, 101–102, 107

monetary policy and, 7–9, 29, 35, 225

policies for, 29, 99, 109–110, 134

Fiscal multipliers; limitations of, 225–226

size of, 45–46, 49, 50–51, 50f, 54, 58–60, 73–75

Fiscal policy; Brazil, 130

capital inflows and, 147

central banks and, 135

consolidation need, 46–47, 136

consolidation strategy, 49–55, 53t, 70–71

discretionary, 57–58, 71, 73, 76

effectiveness of, 58–60

fiscal space (see Fiscal space)

formula flexibility and, 75–76

international cooperation, 70, 76

monetary policy and, 3, 4, 21–22

multipliers (see Fiscal multipliers)

political economy, 61–62

responses to crisis, 67–71

role in stabilization, 45–46, 57–58

stabilizers, automatic, 69, 75, 76, 99

stimulus, 45–46, 49–50, 50f, 57–63

Fiscal space, 46–47, 60, 63, 68

Foreign banks, 91, 92f-95f, 93–95

Foreign exchange reserves. See Reserves

Glass-Steagall Act, repeal of, 40

Global economy, 179, 183

Global imbalances, 167, 199–200, 204, 205

Globalization, financial, 111, 215–216, 222

Global reserve holdings, 218, 218f

Group of Twenty (G20), 70, 99–100, 145, 204, 210, 212

Growth; advanced countries structural

problems, 179, 182–183

in Africa, 158, 163, 163f, 164

in Asia, 170–173

comparative advantage and, 164, 166f

convergence, 153–154, 157–161, 159f

in developing countries, 157

exchange rate policy and, 164

export-led, 153–154

financial liberalization and, 155

industrial policy and, 154

ingredients, 157, 176, 178

institutions and, 154

labor market policy and, 164

labor productivity and, 160–161, 162f, 163

long-run path, 177

natural resources and, 164, 165f, 166f, 169–170, 177

replicability of process, 173

supply chain and, 170–173

structural transformation and, 160–164, 162f, 163f, 164, 165f, 166f, 167, 177

undervaluation and, 164, 166f, 167

Growth Report, The: Strategies for Sustained Growth and Inclusive Development (Spence), 158

Iceland, 60, 191–193

IMF. See International Monetary Fund

Impossible trinity, 140–141, 148, 226

India, 49–51, 52, 53t, 54, 87–88, 139

Indonesia, 67, 69, 70

Industrial policy, growth and, 154, 227

Inflation; exchange rate and, 11–12

stable output gap and, 7–12, 8f—10f, 12f, 34–35, 225

targeting (see Inflation targeting)

Inflation differential, 141–142

Inflation targeting; credibility, 83–84

criticisms of, 26, 28, 227

effectiveness, 17

elements in, 25–26

in emerging markets, 11–12, 12f, 15, 16f, 17–19, 25, 67

exchange rate and, 11–12, 12f

financial stability and, 35

flexible, 3, 8, 25, 26

forecast, 26

number of targets, 10, 10f, 13

postcrisis, 15, 16f, 17–19

precrisis, 3, 7, 8f

time horizons, 26

Interest rates; capital flows and, 147

differentials, 142, 149

increases in, 27–28, 35

low, 38–39, 91, 132

macroprudential regulation and, 36

zero lower bound (see Monetary policy)

International Monetary Fund (IMF), 148, 204, 221–222; Financial Stability Contribution, 99–100

international monetary system reform and, 194, 209, 212–213

surveillance, 212–213

swap lines, 22–23, 187–188, 194–195, 205, 220–222

International monetary system. See also Reserves; demand for reserves, 142–143, 200f, 217–220

financial globalization, 215–216

global financial safety nets, 199–200, 200f, 204–206, 205t

global imbalances, 199–200, 200f

global liquidity provision, 187–188

IMF role and, 209, 212

reforms, 209–213, 227

role of SDR (see Special drawing rights)

rules of the game, 128, 203–204

sovereign insolvency, 222

Triffin paradox, 219–220

Ireland, 93–94, 215, 216, 220

Japan, 91, 92f-93f, 93, 179, 216f

Korea; equity and banking sector, 96, 97f, 98, 98f

fiscal expansion, 60

interest rates, 134

swaps from Federal Reserve, 205–206, 205f

trade with China, 179

Labor productivity, growth and, 160–161, 162f, 163

Latin America; emerging-market economies, 138, 140–141, 164

inflation in, 16f, 17

per capita income, 158, 159f

productivity growth, 163, 163f

Lehman Brothers collapse, 98, 142, 146–147, 191, 194

Lender-of-last-resort. See Central banks

Liquidity, global, 91–100. See also Swap lines; foreign currency, 192–194

international monetary system and, 215–222

leveraging-deleveraging cycle and, 99

shortages, 187

Macroeconomic models, flaws in, 7–11, 32–34, 39–41, 57, 101–102

Macro-Minsky school, 102

Macroprudential policies, 145; capital flows and, 99, 128, 226–227

effectiveness, 19, 21, 36, 84, 226–227

financial stability and, 9–11, 9f, 10f, 36, 102, 109–110

political aspects, 227

Market failures, regulatory failures and, 84

Mexico, 17–18, 205–206, 205f

Microstructuralist school, 101–104

Modigliani-Miller theorem, 37

Monetary policy; asset price targeting, 3, 5, 20–21, 26–28

asymmetric approach, 26–27, 134

in emerging markets, 11–13

exchange rate role in, 11–13, 18

financial stability and, 7–9, 27

financial supervision and, 3, 5, 9–11, 39, 80–81, 86–87

Monetary policy (cont.); fiscal policy and, 3, 4, 21–22

independent, 140–141, 226 (see also Impossible trinity)

inflation stability and output gap stability, 7–8, 19–20, 225

inflation target, appropriate, 28–29

inflation targeting, 4, 25–26

instruments (see Monetary policy instruments)

international coordination, 22–23

and macroprudential policies, 9–11, 19–20, 36

money and credit, role of, 27–28, 32–34

objectives, 34–35, 127

postcrisis, 3–5, 7, 15, 16f, 17–23

precrisis, 3, 7–8, 8f

quantitative easing (see Monetary policy instruments)

Taylor rule and, 74

volatility and, 134, 142

zero lower bound, 3, 4, 18–19, 27–28, 57, 58, 64n2, 74

Monetary policy instruments. See also Macroprudential policies; credit, 27, 28, 33–34

interest rates (see Interest rates)

macroprudential, 9–10, 9f, 10f, 35–36, 135, 227

number of, 7–11, 9f, 10f, 12–13, 12f, 226

quantitative easing, 18–19, 31, 37–39, 128, 131

sterilized intervention, 12–13, 12f

Money, credit and, 27, 28, 33–34

Myron’s law, 112, 226

Nash equilibrium, 39

Occupational Safety and Health Administration (OSHA), 115, 119–122, 123

Output gap, inflation stability and, 7–12, 8f—10f, 12f, 35, 225

Political economy, 11, 46, 61–63, 88, 99, 226–227

Price stability, 18, 19, 84; financial stability and, 29

inflation targeting and, 83–84

interest rates and, 39

Quantitative easing. See Monetary; policy instruments

Quote stuffing, 114

Renminbi, 134, 201, 202–203

Reserve currency; dollar as, 91, 189, 221–222

special drawing rights (SDRs) as, 189, 194, 195

Reserves; accumulation of, 128, 217–219

and balance sheet expansion, 142–143

pooling, 221

Rules; costs and benefits, 122–123

effects of scale, 113

in FAA, 116–118

in Federal Reserve, 118

Myron’s Law, 112, 226

in OSHA, 119–122

in U.S. Army, 119

“Spear-phishing” attack, 113

Special drawing rights (SDRs); basket definition of, 221

bonds, 227

international monetary system reform and, 187, 188

as reserve currency, 189, 194, 195

Stock market flash crash of 2010, 114–115

Supply chains, 170–173, 182

Swap lines; central-bank, 193, 221

Federal Reserve, 18, 22, 194, 205–206, 205f, 217

international liquidity and, 192–194, 205

Taxes, 54, 61, 69

Taylor rule, 74–75

Triffin paradox, modern, 219–220

Unemployment, 57, 179

United Kingdom, 49, 51–52, 52t, 104, 216f

United States; capital flows, 95–96, 96f

currency, 91, 189, 217, 221–222

debt as percentage of GDP, 101, 102f

economic recovery of, 182–183

structural changes, postcrisis, 182

in global banking system, 91, 92f, 93–94, 94f

monetary policy as global monetary policy, 94

Volcker rule, 85

World Trade Organization (WTO), 167, 177, 222