An Important Starting Point -- With One Gap

Despite economic deterioration, the dire sense of urgency in late 2008 has not increased. Indeed, it has largely disappeared. I find this complacency in the fact of vast, preventable suffering and waste hard to understand.
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I had one major source of unhappiness with last week's IMF conference: the participants were largely silent about the dismal outlook in the advanced economies for the next several years. The current outlook for unemployment in the United States, Europe, and Japan is probably worse than it was in late 2008. Then, mainstream forecasts for 2009-2011 showed unemployment rising sharply -- but generally to levels below what we are experiencing today -- and then returning toward normal at a moderate pace. Today, not only is unemployment higher than most 2008 forecasts of its peak levels, but the expected pace of recovery is weaker.

Despite this deterioration, the dire sense of urgency in late 2008 has not increased. Indeed, it has largely disappeared. I find this complacency in the fact of vast, preventable suffering and waste hard to understand.

With the exception of that one critical omission, I was impressed by the discussion. One striking feature was the consensus that there is no consensus. That is, no one argued that there was widespread agreement about a simple set of rules for achieving macroeconomic stability, robust growth, and shared prosperity. Indeed, no one proposed such a set of rules. The crisis has, appropriately, made macroeconomists and policymakers humble about what we know. Although we must continue to give the best policy advice we can, this is also a time for intensive thought and research. I found the conference to be a valuable contribution to that process. And I thought that the fact that it was the IMF that organized the conference -- and, especially, the wide range of perspectives of the people it invited to participate -- reflects very well on the institution. It is a sign that the Fund understands that it does not have all the answers, and that it needs to look broadly in its efforts to rethink issues that were widely viewed as settled just a few years ago.

On some specific issues, there was, if not unanimity, considerable agreement:

  • Because of asymmetric information, agency problems, and behavioral forces, financial markets do not reliably produce efficient outcomes. Moreover, even well conceived and well implemented microeconomic regulation cannot ensure that financial market imperfections will not lead to adverse macroeconomic outcomes. Thus there is a need for "macro-prudential regulation"--that is, regulation and supervision that address financial risks to the macroeconomy.

  • The idea of "the" fiscal multiplier is not sensible. The impact of a change in fiscal policy is extremely dependent on whether monetary policy is able to respond, and on how it responds if it can. The impact also depends on the state of the economy, the health of the financial system, the time horizon of the change, its specific form, and more.
  • Capital controls should be part of the macroeconomic toolkit. Even speakers who were skeptical of capital controls thought there were circumstances under which they were a reasonable short-term expedient. And others felt they were a fully appropriate response to the prospect of large inflows of short-term capital that could lead to substantial overvaluation of the exchange rate.
  • The simple "one instrument/one target" view of monetary policy (where the instrument is a short-term interest rate and the target is inflation, or a weighted average of inflation and the output gap) is too simple. There are other instruments (exchange market intervention, capital controls, margin requirements, down payment requirements, capital requirements, and more), and other potential targets (notably the exchange rate and indicators of financial risks).
  • Having a domestic central bank--specifically, the U.S. Federal Reserve--be the main provider of emergency liquidity to central banks around the world, as occurred in 2008 through swap lines, does not seem optimal. Finding an arrangement where an international body plays that role would be desirable.
  • The discussion that was started at this conference needs to continue. We, the conference co-hosts, hope to hear your comments.

    Cross-posted from iMFdirect.

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