Blanchard on the Future of Macroeconomic Policy
Summarizing an IMF conference, Olivier Blanchard lists nine points. I will make extended comments below the fold. Here is a crucial sentence:
Monetary policy has to go beyond inflation stability, adding output and financial stability to the list of targets, and adding macro-prudential measures to the list of instruments.
Thus does over thirty years of academic thinking on monetary policy get thrown under the bus. Draw a cartoon with Scott Sumner lying under the wheel, screaming in agony.Blanchard writes,
In the age-old discussion of the relative roles of markets and the state, the pendulum has swung–at least a bit–toward the state.
Are we talking about the broader public or about the elites? I think that the broader public might have felt that way early on during the crisis, but once the actual policies were put into place that began to change. I think that the public distrusts both markets and the state, and that is understandable.
Among elites, I think there was a lot of tendency toward closed-mindedness. That is, pro-market forces dug in harder and anti-market forces dug in harder. The way I see it, the anti-market forces were given a larger share of the bully pulpit at the IMF conference, which would account for the impression that the pendulum swung that way.
The crisis made it clear that there are many distortions relevant for macroeconomics, many more than we thought earlier. We had ignored them, thinking they were the province of the micro-economist. As we integrate finance into macroeconomics, we’re discovering distortions within finance are macro-relevant. Agency theory–about incentives and behavior of entities or “agents”–is needed to explain how financial institutions work or do not work and how decisions are taken. Regulation and agency theory applied to regulators is important. Behavioral economics and its cousin, behavioral finance, are central as well.
True enough. The phrase “agency theory applied to regulators” sounds like MIT-speak for Public Choice.
I am troubled by the ever-present implicit assumption that the knowledge problem does not exist. Blanchard writes as if technocrats can figure out where the markets are messing up and fix them. Actual experience be damned.
Paul Romer made the point that, if you adopt a set of financial regulations and keep them unchanged, the markets will find a way around, and ten years later, you’ll have a financial crisis.
I wonder if anyone really wrapped their arms around that point. For my similar take, see The Chess Game of Financial Regulation.
Pragmatism is of the essence. This was a general theme that came up, for example, in Andrew Sheng’s discussion of the adaptive Chinese growth model. We have to try things carefully and see how they work.
That may sound innocuous. But Jonah Goldberg has warned me that pragmatism (the topic of his next book, if he ever finishes it) is dangerous as applied in politics. It means rulers using the ruled as guinea pigs for social experiments. When a firm conducts an experiment in the context of the market, it usually bears the consequences of bad outcomes. Not so much when you are spending other people’s money. We have been conducting experiments using government money to fund “alternative energy” for decades, with no good results. See also the John Goodman piece cited on this blog by David Henderson.
My complaint about the conference is that it did not question some basic assumptions.
1. That there is something called the macroeconomy, which can be controlled using policy levers. As you know, I suggest instead that we interpret events in terms of the evolution of Patterns of Sustainable Specialization and Trade.
2. That technocrats can know enough to regulate financial markets successfully. Instead of seeing bad outcomes as a series of market imperfections, we might look at the interaction between market weaknesses and unintended consequences of policies. And, for whatever policy you propose, do not assume away unintended consequences.