Rewriting the Macroeconomists’ Playbook in the Wake of the Crisis « iMFdirect – The IMF Blog: Before the global economic crisis, mainstream macroeconomists had largely converged on a framework for the conduct of macroeconomic policy. The framework was elegant, and conceptually simple.... The essential goal of monetary policy was low and stable inflation... an interest rate rule... setting the key policy rate that then affected the term structure of interest rates and asset prices, and then to aggregate demand. One could safely ignore most of the details of financial intermediation. Financial regulation was outside the macroeconomic policy framework.... [C]ountries could set an inflation target and float, or instead choose a hard currency peg or join common currency areas... attempting to control exchange rates through capital controls was undesirable. And multilateral coordination was not required. Fiscal policy had a limited role.... Automatic stabilizers... would kick in during downturns, but discretionary policy was more likely to be misused than used well. The focus had to be on the medium run, and on fiscal sustainability.
These were simple principles, and they seemed to work....
Then the crisis came. If nothing else, it forces us to do a wholesale reexamination of those principles. Here are some ideas to guide the conversation:
Economic imbalances: Achieving stable inflation is good, but we can now see it does not guarantee stable output.... Should we think of macroeconomic policy as having three legs—monetary, fiscal, and financial—each with separate authorities? Or should we think of extending both the mandate and the set of tools of monetary policy to cover both output and financial stability? And, if so, what tools do we have and how do we use them?
Interest rates: Early in the crisis, central banks decreased policy rates, until they reached their lower bound––namely zero. From then on... central banks turned to both credit and quantitative easing... would it have helped if nominal interest rates had been higher to start... should we revisit the low inflation targets... central banks had adopted pre crisis?
Fiscal policy: When interest rates reached the lower bound, fiscal policy came back to the fore.... Even though it will be a long time before debt levels are reduced sufficiently, what levels of public debt should countries aim for? Are old rules of thumb, such as trying to keep the debt to GDP ratio below 60 percent in advanced countries, still reliable?
Capital flows: The crisis triggered very large capital flows. Often, these flows had little to do with conditions in the country that they left, and more to do with the need by foreign financial institutions to repatriate funds in a hurry.... How should countries react to large capital inflows? If they want to mute their effect for example, when should they build up reserves and when should they use capital controls?...
International monetary system.... Should benign neglect determine the coordination of monetary policies across countries? Should there be international rules not only with respect to capital controls, but with respect to reserve management, and monetary policy in general?... [D]oes export-led growth remain an acceptable strategy for a multilateral point of view?
Safety net: In a different dimension, the great recession has showed that not only emerging countries, but also advanced countries, can suffer sudden stops. During the crisis, foreign liquidity was provided mostly through swap lines offered by the major central banks. Since then, the IMF has created two new liquidity windows. Is the problem solved, or is more needed?
These questions, and many more, will keep us busy for years to come...