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The IMF: Of Words and Actions

May 22, 2015 1 comment

Some comments, and endless twitter discussions on my Blanchard Touch post call for a couple of clarifications.

The first has to do to the most common reaction, that has been: “the IMF may well have made advances in its analysis, but the policy prescriptions are remarkably unchanged. So what good is it?” After all, isn’t the IMF considered an hardliner in the current Troika Institutions‘ negotiation with Greece? No Blanchard touch, there.

These objections are of course justified, but in my opinion they miss an important point: Blanchard is not the IMF executive director. Nor the representative of  a major country. He is “only” the head of the research department, and as such his job is to provide analyses, not to decide the use of these analyses made by a process that (luckily) is political in nature. Does this mean that what Blanchard and his staff do is irrelevant? Of course not. I do think that making the debate evolve is a fundamental task for public figures like Blanchard. One of the strength of the Washington Consensus has been the narrative that accompanied it, the market efficiency hypothesis that laid the theoretical foundations of supply side policies. This is why I believe that the fact that the narrative is crumbling, among other things thanks to the IMF own research, is of paramount importance. The change in narrative is a precondition for a policy change. The hiatus between the Fund’s actions and words will be increasingly visible, and eventually, I hope, it will lead to a change of policies. I cannot believe that the narrative is irrelevant; otherwise I would have chosen a different job.

The second clarification concerns the end of my post:

If I write a paper saying that austerity will not be costly because multipliers are 0.5, and 2 years later retract my previous statement and argue that austerity is in fact self defeating, the impact on the world is zero. If the IMF does the same, during the two years huge suffering will be needlessly inflicted to masses of people. This poses a problem, as research by definition may be falsified. In the past an institution like the IMF would never have admitted a mistake. And we certainly do not want to go back there. Today they do admit the mistakes, but the suffering remains. The only way out to this problem is that the “new” IMF should learn to be cautious in its policy prescriptions, and always remember that any policy recommendation is bound to be sooner or later proven inappropriate by new data and research. We don’t live in a black and white world. Adopting a more prudent stance in dictating policies  would be wise (in Brussels as well, it goes without saying)

By this I surely did not mean that the IMF should refrain from giving policy advice. Nor that governments should follow their guts instead of informed analysis, as one reader very clearly put it. I meant that the first and most important achievement for a policy adviser is to abandon dogmatism, and acknowledge that however robust we believe our knowledge to be, there always is a chance that it will be proved wrong. With such an attitude, policy advice would become “cautious” in the sense of being aware of possible unintended consequences of policies; policies that should therefore be implemented with in mind alternative scenarios. Just to make an example, the IMF could have suggested, as it did, to implement austerity based on the belief that the multiplier was low. But it should have asked governments to do it gradually, in order to be ready to reverse course in case the estimated multipliers would prove (as it did) to be larger. In a sentence, being cautious means avoiding advising for extreme behaviors that could prove to be extremely costly and hard to unwind. Especially in crisis situations, policy makers should look east and cross the river by feeling the stones.

I would also like to add that in the case of the Washington Consensus, we had already, in the past decade, a number of episodes when its prescriptions turned out to be catastrophic. Thus, caution would have been even wiser. But hey, dogmatism is by definition unwise…

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Does Price Stability Entail Financial Stability?

May 4, 2015 3 comments

I reproduce here a post I wrote with Paul Hubert, published on the blog de l’OFCE in English and in French.

Paul Krugman raises the very important issue of the impact of monetary policy on financial stability. He starts with the well-known observation that, contrary to the predictions of some, expansionary monetary policy did not lead to inflation during the current crisis. He then continues arguing that tighter monetary policy would not necessarily guarantee financial stability either. If the Fed were to revert to a more standard Taylor rule, financial stability would not follow. As Krugman aptly argues, “That rule was devised to produce stable inflation; it would be a miracle, a benefaction from the gods, if that rule just happened to also be exactly what we need to avoid bubbles.

Krugman in fact takes position against the “conventional wisdom”, which has been widespread in academic and policy circles alike, that a link exists between financial and price stability; therefore the central bank can always keep in check financial instability by setting an appropriate inflation target.

The global financial crisis is a clear example of the fallacy of this conventional wisdom, as financial instability built up in a period of great moderation. A recent analysis by Blot et al shows that the crisis is no exception, as over the past few decades, in the US and the Eurozone, the link between price and financial stability has been unclear and moreover unstable over time, as shown on the following figure.

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We therefore subscribe to Krugman’s view that financial stability should be targeted by combining macro- and micro-prudential policies, and that inflation targeting is largely insufficient. In another work, Blot et al argue that the ECB should be endowed with a triple mandate for financial and macroeconomic stability, along with price stability. They further argue that the ECB should be given the instruments to effectively pursue these three, sometimes conflicting objectives.