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Reaping the Benefits of Financial Globalization - SNS

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					Rethinking Macroeconomic Policy


 Olivier Blanchard
 Giovanni Dell’Ariccia
 Paolo Mauro
                                           Stockholm, November 21st , 2011
The views in this presentation are those of the authors and do not necessarily
represent those of the IMF
                   Pre-Crisis Consensus
n One target for monetary policy: Low and stable inflation

n One main monetary policy instrument: The policy interest rate

n A limited role for fiscal policy

n No cyclical role for prudential regulation

n The proof of the pudding: The Great Moderation

n Caveat: Differences between and among academics, central banks, politicians

                                                                           2
Monetary Policy: One Target/One Instrument

 n Stable inflation (backed by theory and politics)

 n Low inflation (low prob. of Zero bound, but Japan…)

 n Connected markets and arbitrage (one rate does it all)

 n Expectation channel: Rule based policy

 n Financial intermediation largely ignored (with exceptions)



                                                                3
  Benign Neglect Approach to Boom/Busts


n Asset prices a concern only through their impact on GDP and
  inflation

n Bubbles difficult to identify

n Ex-post policies effective and costs of clean up limited

n Better clean up than prevent
 Financial Regulation Not a Cyclical Tool

n Macro dimension of regulation largely ignored:
   n Focus on soundness of individual institutions
   n Some exceptions in EMs


n Cyclical use of prudential policies discouraged:
   n Seen as mingling with proper market functioning
   n Little thought given to cyclical rules on capital ratios, LTV ratios
     (exceptions: Spain, Colombia)
                The Great Moderation


n Steady decrease in the variability of output and inflation in
  advanced countries

n Sources? Luck, structural changes, improved monetary policy?

n Successful responses to the financial scares. 1987 stock market
  crash, LTCM, Tech bubble burst




                                                                    6
                Then the Crisis Came …


n Bust had enormous consequences

n Standard policies rapidly hit their limits

n Limited effectiveness of less traditional policies

n Large fiscal and output costs
              Reflections on the Crisis


n Stable inflation: Necessary but not sufficient

n Limits of very low inflation

n Reconsider “benign neglect”

n Financial intermediation is macro relevant




                                                   8
Before Crisis Inflation and Growth Looked OK
             Euro area                      United States            Average of other economies1

                 Core CPI Inflation                                    Output Gap2




 1 Japan   omitted.
 2   Estimate of output gap using rolling Hodrick-Prescott filter.
   But Houses Prices Were Rising Rapidly




Note: Real house price falls from recent peaks not shown for Germany and Japan as real price declined
through the 2001:Q4-2006:Q3 period.
And Credit Booms Fueled Vulnerabilities
    Growth Rate of Nominal Credit relative to GDP and Household Quick Ratio
                                    (percent)




                                                                                 Average annual percentage point change in household
                                                                      IRL




                                                                                          quick ratio (liabilities/liquid assets)
                                  NOR                     FIN
                                                                       ESP
                               PRT            NLD               GRC
                        SWE   USA
                     CAN
                           FRA                GBR

                                        ITA
                               AUT
                         BEL                  DEN
   JPN
                        CHE
             DEU




         Average growth rate of nominal credit relative to GDP (2002:1-2006:3)
                                                                                                     11
Limited Monetary Policy Room
   (policy rates in percent)




                               Jun-09
                                12
        Financial Intermediation Matters


n When normal investors exit, markets become segmented

n Arbitrage fails, and prices can deviate far from fundamentals

n Policy rate no longer a sufficient instrument for policy

n Credit easing and quantitative easing can affect rates and asset
  prices, given policy rate



                                                                     13
 What We Should Explore Going Forward



n If low/stable inflation not enough, what should monetary policy
  target?

n If benign neglect is dead, then what?

n More targets means more tools: what role for macroprudential
  policies?




                                                                 14
                    Monetary Policy
n Many targets:
   n Inflation/output gap
   n Exchange rate
   n Asset prices: Housing, stocks, etc

n But also many instruments:

   n Policy interest rate
   n Reserve accumulation
   n Macro prudential instruments
      n Cyclical capital/liquidity ratios
      n Loan to value ratios, margin requirements
                                                    15
Benign neglect approach may be dead, but…

n Problems and trade offs with more interventionist strategy
  remain:

n Bubbles difficult to detect in real time (China real estate)

n Risks with pricking bubbles (including for policy makers)

n Traditional policies may be ineffective (speculative demand))

n And have large costs
Booms in Housing Markets Are Particularly
Dangerous

 n Not all asset-price booms should be target of policy
    n But how to choose?

 n Some consensus emerging that culprit is leverage (Nasdaq
   crash was fine)

 n Housing markets are special:
    n   Leverage (link to crises)
    n   Large storage of wealth
    n   Major supply-side effects
    n   Network externalities
Boom, Leverage, and Defaults
Real Effects of House Busts
 The Policy Rate and House Price Bubbles

n Make borrowing more expensive and may limit leverage and risk
  taking

n But:
   n Too blunt: costly for the entire economy (unless in context of general
     overheating)
   n Issues for small open economies
   n Effect on speculative component may be limited

n Panel VAR suggests impact on house prices at considerable cost
  to GDP growth
   n 100 basis points reduce house price appreciation by 1 but also lead to a
     decline of 0.3 in GDP growth
                 Macro-Prudential Tools

n Most ‘experiments’ in emerging markets, particularly Asia

n Common tools:
   n Maximum LTV/DTI limits
   n Differentiated risk weights on high-LTV loans
   n Dynamic provisioning


n Discretion rather than rule-based

n Mixed evidence on effectiveness
Hong Kong: Limited Effectiveness of LTV
Limits
Korea: Effective LTV Limits, but Difficult
Calibration?
  Macro-prudential policy still in its infancy



n Pragmatic and discretionary, mobilized within existing
  institutional frameworks, targeted at specific markets

n Some evidence of temporary cooling effect on markets and
  building of buffers for bad times

n Too early to judge impact on aggregate cycles and interaction
  with other policies
Tentative Policy Taxonomy for Real-Estate
Booms

 n Macro-prudential tools first line of defense
    n Target leverage
    n Strengthen balance sheets


 n Monetary policy definitely to be involved when there are other
   signs of overheating

 n But may have to come into play anyway if macroprudential
   tools are ineffective
              Important Open Questions

n Who does what?
   n Where should macro-prudential authority reside?

n Relationship among policies?
   n To what extent are these independent tools?


n Rules versus discretion?
   n Far away from IT standards
   n Risks associated with excessively interventionist policy
Conclusions: An evolution, not a revolution


n Low (but how low?) and stable inflation still essential

n Low deficits and fiscal room even more needed than before

n Monetary policy: Many targets and instruments

n New macroprudential tools/ Coordination with monetary policy

n Important questions of institutional design



                                                              27
Thank You




            28
Widespread Declines in Output Volatility




                                       29

				
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