Rethinking macroeconomic policy by IMF
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  • 1. VIDEO  With its near-global membership of 186 countries, the IMF is uniquely placed to help member governments take advantage of the opportunities—and manage the challenges—posed by globalization and economic development more generally. The IMF tracks global economic trends and performance, alerts its member countries when it sees problems on the horizon, provides a forum for policy dialogue, and passes on know-how to governments on how to tackle economic difficulties. The IMF provides policy advice and financing to members in economic difficulties and also works with developing nations to help them achieve macroeconomic stability and reduce poverty. 
  • 2. RETHINKING MACROECONOMIC POLICY Giovanni Dell’ Ariccia, Deputy Chief, financial studies division, IMF Paolo Mauro, Division chief, IMF Fiscal affairs department Chief Economist, IMF Presented at RBS by: Victoria Gnatoka
  • 3. What we thought we knew What we have learned from the crisis Implications for the design of a new policy
  • 4.  One target: stable inflation • It was a mandate of central banks. The benchmark was the new Keynesian model, where constant inflation delivers a zero output gap. • In practice only few central banks cared about inflation only. Most of them practiced the return of inflation to a stable target over period of time. WHAT WE THOUGHT WE KNEW  Low inflation • Target was around 2%. The focus was on the importantce of commitment and the ability of central banks to affect inflation expectations. •The Japanese experience of 1990s with deflation, zero interest rates and a continuing slump was not taken into consideration.
  • 5.  One instrument: the policy rate • The short term interest rate that the central bank can directly control through appropriate open- market operations. • 2 assumptions behind this choice: 1. Real effects of monetary policy took place through interest rates and asset prices. 2. All interest rates and asset prices were linked through arbirtrage. WHAT WE THOUGHT WE KNEW  A limited role for fiscal policy • Wide scepticism about the effects of the fiscal policy. • If monetary policy could maintain a stable output gap there was little reason to use another instrument.
  • 6.  Finacial regulation: not a macroeconomic policy tool • Financial regulation and supervision focused on individual institutions and markets and ignored their macroeconomic implications. • Little thought was given to using regulatory ratios, such as capital ratios or loan-to-value ratios. WHAT WE THOUGHT WE KNEW  The great moderation • The decline in the variability of output and inflation led to greater confidence that a coherent macro framework had been achieved. • The successful responses to the 1987 stock market crash, the LTCM collapse, and the bursting of the tech bubble reinforced the view that monetary policy was also well equipped to deal with asset price busts.
  • 7.  Stable inflation may be necessary but is not sufficient • Macroeconomic fragilities may arise even when inflation is stable WHAT WE HAVE LEARNED FROM THE CRISIS  Low inflation limits the scope of monetary policy in deflationary recessions • Zero nominal interest rate bound has proven costly.
  • 8.  Financial intermediation matters • Interventions either through acceptance of assets as collateral or through their straight purchase by the central bank can affect the rates on different classes of assets for a given policy rates. WHAT WE HAVE LEARNED FROM THE CRISIS  Countercyclical fiscal policy is an important tool • Monetary policy has reached its limits and policymakers had little choice but to rely on fiscal policy. • The recession was expected to be long, so it was clear that fiscal stimulus would have ample time to yield a beneficial impact despite implementation lags.
  • 9.  Regulation is not macroeconomically neutral • Financial regulation contributed to the amplification effects that transformed the decrease in US housing prices into major world economic crisis. WHAT WE HAVE LEARNED FROM THE CRISIS  Reinterpreting the great moderation • The Great Moderation led too many to understate economic risk, ignore tail risks, take positions and relax rules.
  • 10.  Should the inflation target be raised? • Should there be a higher target inflation rate in normal times, in order to increase the room for monetary policy to react to crisis? • Risk – changes in the structure of the economy that increase inflation shocks and reduce the effectiveness of policy action. • Potential benefits – avoiding the zero interest rate bound. • When inflation rate becomes very low – to minimize the likelihood of deflation. IMPLICATIONS FOR THE DESIGN OF THE NEW POLICY
  • 11.  Combining monetary and regulatory policy • Debate about monetary policy – should the interest rate rule be extended to deal with asset prices (leverage, current account positions, measures of systemic risk)? • Together monetary policy and regulation provide a large set of cyclical tools. • How to achieve coordination between authorities? Should the central bank be in charge of both? IMPLICATIONS FOR THE DESIGN OF THE NEW POLICY
  • 12.  Inflation targeting and foreign exchange intervention • In large advanced economies the central banks care about what impact an exchange rate has on inflation, for small countries – also intervene on foreign exchange markets to smooth volatility and to influence the level of the exchange rate. IMPLICATIONS FOR THE DESIGN OF THE NEW POLICY Providing liquidity more broadly •To extend liquidity support to non-deposit-taking institutions and intervene directly (with purchases) or indirectly (through acceptance of the assets as collateral) in a broad range of asset markets.
  • 13.  Creating more fiscal space in good times • A key lesson from the crisis is the desirability of fiscal space to run larger fiscal deficits when needed. IMPLICATIONS FOR THE DESIGN OF THE NEW POLICY  Designing better automatic fiscal stabilizers •To improve automatic stabilizers: the ones that imply a procyclical decrease in transfers or increase in tax revenues and the rules that allow some transfers or taxes to vary based on prespecified triggers tied to the state of the economic cycle.
  • 14. • General policy framework should remain the same. • Goal - to achieve a stable output gap and stable inflation. • To watch many targets: the composition of output, the behavior of asset prices,the leverage of different agents. • 2 promising routes: - the combination of traditional monetary policy and regulation tools, - the design of better automatic stabilizers for fiscal policy.
  • 15. VIDEO In the IMFs World Economic Outlook, the IMF examines the different paths the recovery is taking in advanced and emerging economies. Chief Economist Olivier Blanchard discusses the challenges facing the global economy in the year to come. Olivier Blanchard, Chief Economist, IM