Retinking macroeconomic policy

IMF STAFF POSITION NOTE
February 12, 2010
SPN/10/03

Rethinking Macroeconomic Policy

Olivier Blanchard, Giovanni Dell’Ariccia, and Paolo Mauro

INTERNATIONAL MONETARY FUND

INTERNATIONAL MONETARY FUND Research Department Rethinking Macroeconomic Policy1 Prepared by Olivier Blanchard, Giovanni Dell’Ariccia, and Paolo Mauro Authorized for Distribution by Olivier Blanchard February 12,2010

Disclaimer: The views expressed herein are those of the authors and should not be attributed to the IMF, its Executive Board, or its management.

The great moderation lulled macroeconomists and policymakers alike in the belief that we knew how to conduct macroeconomic policy. The crisis clearly forces us to question that assessment. In this paper, we review the main elements of thepre-crisis consensus, we identify where we were wrong and what tenets of the pre-crisis framework still hold, and take a tentative first pass at the contours of a new macroeconomic policy framework.

JEL Classification Numbers: E44, E52, E58, G38, H50 Keywords: Macroeconomic policy, macroprudential regulation, inflation targets, automatic stabilizers Authors’ Email Addresses: oblanchard@imf.org ;gdellariccia@imf.org ; pmauro@imf.org

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One of the series of “Seoul papers” on current macro and financial issues. Olivier Blanchard is the IMF’s Economic Counsellor and Director of the Research Department; Giovanni Dell’Ariccia is an Advisor in the Research Department; Paolo Mauro is a Division Chief in the Fiscal Affairs Department. Helpful inputs from Mark Stone, Stephanie Eble, AdityaNarain, and Cemile Sancak are gratefully acknowledged. We thank Tam Bayoumi, Stijn Claessens, Charles Collyns, Stanley Fischer, Takatoshi Ito, Jean Pierre Landau, John Lipsky, Jonathan Ostry, David Romer, Robert Solow, Antonio Spilimbergo, Rodrigo Valdes, and Atchana Waiquamdee for their comments.

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Contents

Page

I. Introduction............................................................................................................................3 II. What We Thought We Knew ................................................................................................3 A. One Target: Stable Inflation......................................................................................3 B. LowInflation.............................................................................................................4 C. One Instrument: The Policy Rate ..............................................................................5 D. A Limited Role for Fiscal Policy ..............................................................................5 E. Financial Regulation: Not a Macroeconomic Policy Tool ........................................6 F. The GreatModeration................................................................................................7 III. What We Have Learned from the Crisis..............................................................................7 A. Stable Inflation May Be Necessary, but Is Not Sufficient........................................7 B. Low Inflation Limits the Scope of Monetary Policy in Deflationary Recessions ....8 C.Financial Intermediation Matters ..............................................................................8 D. Countercyclical Fiscal Policy Is an Important Tool..................................................9 E. Regulation Is Not Macroeconomically Neutral.........................................................9 F. Reinterpreting the GreatModeration.......................................................................10 IV. Implications for the Design of Policy................................................................................10 A. Should the Inflation Target Be Raised? ..................................................................10 B. Combining Monetary and Regulatory Policy..........................................................11 C. Inflation Targeting and...