Case study presentation

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.
 http://www.youtube.com/watch?v=Hg9Uma7y_JU

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
http://www.youtube.com/watch?v=5YXCLDZQfoA

16. THANK YOU!
ANY QUESTIONS?
PLEASE CONTACT:
oblanchard@imf.org
gdellariccia@imf.org
pmauro@imf.org