Wednesday, 15 May 2013

Akerlof, Blanchard, Romer and Stiglitz (et al) on the state of macro

An impressive group of economists shared thoughts on rethinking macroeconomic policy. Last month in Washington D.C., the IMF has held a conference on the first steps and early lessons on macroeconomic policy with respect to the ongoing crisis. Simply by looking at the title one would say: a quite common topic that has occupied a majority of space and attention in policy-oriented conferences in the last couple of years. Everywhere you turn you will run into some form of a discussion featuring a variety of economists and non-economists (which ones are more interesting?) on the lessons from the crisis, offering their "unique" solutions on how to emerge from it and achieve a robust recovery. However, when such a conference is being held at the IMF headquarters and the speakers are Nobel prize winners or notable economists like Blanchard, Romer, Roubini, Perotti, Tirole, Fischer, Woodford or policymakers like Mervyn King, Andres Borg and John Vickers, then the credibility of the whole thing suddenly increases (I wonder why Rogoff wasn't there?). The four economists from the title were the ones to close the conference with a panel discussion from which they have summarized their comments on VoxEU last week. 


All the speeches are available at the conference webpage (I watched the one on fiscal policy with Borg, Perotti and Roubini). As for the four panelists, here are some of their most interesting thoughts:

George Akerlof draws on some of the findings from the paper by Jorda, Schularick and Taylor (2011): 
"Not only are financial recessions deeper and slower in recovery than in normal recessions, they also have slower recovery the greater is the credit-to-GDP ratio.That is the history. How do their findings reflect on the current crisis? Curiously, it depends upon the measurement of credit outstanding: With bank loans to the private sector as the measure of credit, the US recovery is about 1% of GDP better than mean recovery for financial recessions; When, in addition, the measure of credit also includes credit granted by the shadow banking system, we are about 4% better than the median recovery in financial recessions"
He justifies all the stimuli and bailout policies claiming that they did exactly what they were supposed to - stopped a financial meltdown and led to a recovery which is in his own words much better than how we perceive it: 
"We should have led the public to understand that we should measure success not by the level of the current unemployment rate, but by a benchmark that takes into account the financial vulnerability that had been set in the previous boom"
So Akerlof feels that economics hasn't done anything wrong, calling the macro policies "trial and success", and advocating the same approach for future shocks as well. I couldn't disagree more. 

Olivier Blanchard is much more down to earth:
"Rethinking and reforms are both taking place. But we still do not know the final destination, be it for the redefinition of monetary policy, or the contours of financial regulation, or the role of macroprudential tools. We have a general sense of direction, but we are largely navigating by sight."
He focuses on 6 different policy areas which require new macro tools: financial regulation (in favour of increasing capital ratios), financial sector (whether or not the credit and financial cycles are separated from the business cycle or was it all just a simple AD shock; he also expressed concerns with Woodford's nominal income targeting, and emphasized the crucial role of financial stability), on macroprudential tools (which he rightly points out haven't been particularly successful so far), governance (in coordinating microprudential, macroprudential and monetary policy tools), sustainability of debt (particularly with respect to the Eurozone problems and implications of the ECB), and finally communication (on how credibility of policy-makers can be crucial in certain times). As the typical representative of the "establishment" (as defined by Kling), Blanchard is careful in his conclusions and is committed in acknowledging everyone's views and reaching a sort of a consensus. 

David Romer is more concerned in attempts to avert the next financial crisis. He stresses out evidence that the financial sector is a continued source of shocks (he mentions quite a few examples to verify this) implying that they are more common than we would think, and very hard to predict. This is why Romer is focused entirely on reforming the financial system in order to ease the shock it bears on the real economy; on one side to decrease the risk exposure of financial institutions with the following measures: 
... I am thinking of stronger capital and liquidity requirements, special rules for institutions that create more systemic risk, and restrictions on the form or capabilities of what financial institutions can do, such as ring fencing in the United Kingdom and the Volcker rule in the United States... 
...it is hard to believe that the relatively modest changes along these dimensions ... are really big enough to give us a financial system that is so robust that it is not going to periodically cause severe problems. Shadow financial institutions may escape the rules altogether; rules can be gamed; and shocks can be so large that they overwhelm the moderate changes that were being discussed.... 
There were occasional mentions of very large capital requirements; for example, Allan Meltzer noted that at one time 25% capital was common for banks. Should we be moving to such a system? Amir Sufi and Adair Turner talked about the features of debt contracts that make them inherently prone to instability; should we be working aggressively to promote more indexation of debt contracts, more equity-like contracts, and so on? We can see the costs that the modern financial system has imposed on the real economy; It is not immediately clear that the benefits of the financial innovations of recent decades have been on a scale that warrants those costs. ... The fact that shocks emanating from the financial system sometimes impose large costs on the rest of the economy implies that there are negative externalities to some types of financial activities or financial structures, which suggests the possibility of Pigovian taxes.
...and on the other side to make the real economy more resilient to frequent financial shocks (with some standard measures but also calling for fiscal rules and constraints). Altogether Romer asked a lot of questions and made a lot of decent implications for deeper thinking on the issue of preventing future shocks. It's not that all of his suggestions would work (in my opinion), but he is correct in that the standard solutions to these issues need to be reexamined. 

And last but not least, Joe Stiglitz focuses on reforming faulty, inefficient economic models. He too notes that financial instabilities and crises are a common occurrence. 
In a very fundamental sense, the crisis is still not fully resolved – and there’s no good economic theory that explains why that should be the case. Some of this has to do with the issue of the slow pace of deleveraging. But even as the economy deleverages, there is every reason to believe that it will not return to full employment. We are not likely to return to the pre-crisis household savings rate of zero – nor would it be a good thing if we did. Even if manufacturing has a slight recovery, most of the jobs that have been lost in that sector will not be regained. ... 
Economies that have had severe financial crises typically recover slowly. But the fact that things have often gone badly in the aftermath of a financial crisis doesn’t mean they must go badly. This is more than just a balance sheet crisis. There is a deeper cause: The United States and Europe are going through a structural transformation. There is a structural transformation associated with the move from manufacturing to a service sector economy. Additionally, changing comparative advantages requires massive adjustments in the structure of the North Atlantic countries.
What Stiglitz describes here is a typical structural shock that hit our economies. I agree with his assessment completely (some of my previous texts on this issue: see here, here or here). He correctly emphasizes that reforms currently undertaken were insufficient and half-way measures (e.g. the too-big-to-fail problem is now even worse). The set of reforms he calls upon concern (1) the provision of credit, (2) stability (lower exposure to risk - similar to Romer's suggestions), (3) distribution (of income), (4) stronger government correction of market failures, and (5) quantitative not price interventions. Stiglitz unfortunately fails to mention any of the institutional reforms that are necessary to adapt to the technological shock and the change in compartivie advantages that he recognizes. All the proposals he stresses out are just an adjustment in my opinion, they don't offer the necessary and much needed change of the growth model.

Altogether, it is always enjoyable to encounter a wide variety of different and prudent ideas on macroeconomic policy. I look forward to more attempts such as these. Perhaps by over-thinking about some of the issues we may reach a new equilibrium of thought? Just perhaps... 

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