28 June 2016

Progress and Confusion

The State of Macroeconomic Policy

Edited by Oliver J Blanchard
2016, MIT Press, 312 pages,
ISBN 9780262034623

Reviewer: Vicky Pryce, Former Joint Head of the Government Economic Service

Similar issues raised in John Taylor’s Policy Stability and Economic Growth are discussed in the volume of essays edited by Olivier Blanchard and others, with John Taylor again making a plea for a return to rules-based policy frameworks and less discretion. Ben Bernanke defends the inflation targeting framework while accepting that unconventional policies may have a limited role to play when need arises. Kenneth Rogoff, former IMF chief economist, puts a lot of the blame for the slow recovery on the pursuit of orthodox fiscal policies that encouraged countries to tighten prematurely.  But at the same time he argues that central banks were if anything too rigid in their inflation targeting. If they had been more aggressive in raising acceptable inflation targets, the zero bound interest rate problem we are encountering now below which we cannot easily move could have been prevented.

But the world has moved a long way, and uncontrolled and extremely volatile capital flows make the job of a policy maker much harder. These inter-connections are not sufficiently taken into account by policymakers in the advanced economies. Exchange rate movements needed to adjust to those flows cannot take the strain alone, nor insulate economies from global financial cycles. Macro-prudential policies may be the answer; otherwise, as Maurice Obstfeld argues in his essay in this volume, reintroducing capital controls may well be the second best solution. What is clear is that moving from today’s low interest rates is difficult. Martin Feldstein argues that we should be using discretionary fiscal policy as a macro tool.  

But the increase of public debt after the original fiscal expansion to deal with the crisis has led to extreme caution in this area. J.Bradford DeLong argues that as interest rates are below growth rates issuing safe long term debt and using the proceeds for productive investment makes sense. Indeed all indicators seem to reinforce Larry Summers’ view, expressed again in this volume, that the main problem keeping growth back is a global excess of savings over investment.

Unfortunately there is still no agreement on what a country’s ‘safe’ debt level should be. And monetary policy has taken the lead in stimulating expansion. But in an era when the world is trying to reduce risks and investors are looking for safe assets as seen in the current record low yields in bond markets the real effects may be limited as ‘riskier’ productive investment is avoided.  Ricardo Caballero in fact argues here that unconventional monetary policies such as quantitative easing and the accumulation of foreign exchange reserves by emerging markets trying to shield themselves from further debt crises have if anything possibly made things worse by reducing the supply of safe long term assets.

The search for what should be the ‘new normal’ will continue. But these two publications take us a long way forward. Over to policymakers worldwide to take note.