IMF Survey : Blanchard: Looking Forward, Looking Back

IMF Chief Economist Blanchard to step down end September

Financial crisis raises potential existential crisis for macroeconomics

Need to address longer term issues of low productivity growth, increasing inequality

Olivier Blanchard will step down as Economic Counsellor and Director of the IMF's Research Department at the end of September.

INTERVIEW WITH OLIVIER BLANCHARD

He will join the Peterson Institute for International Economics in October as the first C. Fred Bergsten senior fellow, a post named for the founder of the influential 35-year-old, Washington-based think tank.

When French-born Blanchard, a former chairman of the economics department at the Massachusetts Institute of Technology, joined the IMF on September 1, 2008, little did he realize that he would be at the center of a global economic storm. Two weeks later, Lehman Brother’s bank collapsed, marking what many consider the start of the 2008-09 global financial crisis.

“The crisis was a traumatic event during which we all had to question many cherished beliefs,” said Blanchard. This included questioning various assumptions on the role of fiscal policy, including the size of fiscal multipliers, the use of unconventional monetary policy measures and macroprudential tools, capital flows and measures to control them, labor market policies and the role of micro and macro flexibility. “And being in a position to question gave me the opportunity to make a difference,” he said.

Blanchard says he now wants to take the time to research fewer issues more intensely.

“For the past seven years, he says “I’ve been answering a thousand questions, but not in a very deep way. I want to take ten of these thousand questions and answer them more deeply.” One of the issues he plans to examine is the various measures countries can use to control and mold capital flows.

IMF Survey interviewed Blanchard about global economic issues, the IMF's role in furthering economic and financial stability, and what it was like to be in the hot-seat job of chief economist.





IMF Survey: You have at times pushed the envelope of IMF thinking and policy positions. How has this been received inside and outside the IMF?

Blanchard: It would have been intellectually irresponsible, and politically unwise, to pretend that the crisis did not change our views about the way the economy works. Credibility would have been lost. So, rethinking, or pushing the envelope was not a choice, but a necessity.

The fact that the economic counsellor, or the research department, has a view on a particular topic does not move things very much by itself. An essential part of the job is to convince, or try to convince, the rest of the building, from management to the department desks, of that view. This can be hard work. To treat all countries in a consistent way, the Fund must have a corpus of beliefs, and this corpus is not easily changed. Ideas do not only need to be developed, they need to be sold to the rest of the building. It does not happen overnight.

With respect to outside, the issue I have been struck by is how to indicate a change of views without triggering headlines of “mistakes,’’ “Fund incompetence,’’ and so on. Here, I am thinking of fiscal multipliers. The underestimation of the drag on output from fiscal consolidation was not a ``mistake’’ in the way people think of mistakes, e.g., mixing up two cells in an excel sheet. It was based on a substantial amount of prior evidence, but evidence which turned out to be misleading in an environment where interest rates are close to zero and monetary policy cannot offset the negative effects of budget cuts. We got a lot of flak for admitting the underestimation, and I suspect we shall continue to get more flak in the future. But, at the same time, I believe that we, the Fund, substantially increased our credibility, and used better assumptions later on. It was painful, but it was useful.

IMF Survey: In pushing the envelope, you also hosted three major Rethinking Macroeconomics conferences. What were the key insights and what are the key concerns on the macroeconomic front?

Blanchard: Let me start with the obvious answer: That mainstream macroeconomics had taken the financial system for granted. The typical macro treatment of finance was a set of arbitrage equations, under the assumption that we did not need to look at who was doing what on Wall Street. That turned out to be badly wrong.

But let me give you a few less obvious answers:

The financial crisis raises a potentially existential crisis for macroeconomics. Practical macro is based on the assumption that there are fairly stable aggregate relations, so we do not need to keep track of each individual, firm, or financial institution—that we do not need to understand the details of the micro plumbing. We have learned that the plumbing, especially the financial plumbing, matters: the same aggregates can hide serious macro problems. How do we do macro then?

As a result of the crisis, a hundred intellectual flowers are blooming. Some are very old flowers: Hyman Minsky’s financial instability hypothesis. Kaldorian models of growth and inequality. Some propositions that would have been considered anathema in the past are being proposed by ``serious’’ economists: For example, monetary financing of the fiscal deficit. Some fundamental assumptions are being challenged, for example the clean separation between cycles and trends: Hysteresis is making a comeback. Some of the econometric tools, based on a vision of the world as being stationary around a trend, are being challenged. This is all for the best.

Finally, there is a clear swing of the pendulum away from markets towards government intervention, be it macro prudential tools, capital controls, etc. Most macroeconomists are now solidly in a second best world. But this shift is happening with a twist—that is, with much skepticism about the efficiency of government intervention.

IMF Survey: How about longer-term economic worries? And how would these longer-term issues affect the Fund’s policy advice?

Blanchard: There is a good chance that we have entered a period of low productivity growth. There is a chance that we have entered a period of structurally weak demand, which will require very low interest rates. And low growth combined with increasing inequality, is not only unacceptable morally, but extremely dangerous politically.

In assessing policies, we cannot just concentrate on short run issues, and we have to address these longer run issues. In doing so, we have to realize two things. First, that this is not our natural expertise, and we have to work with other institutions like the OECD, the World Bank. Second, that there are no magical solutions: We have to be realistic as to what structural reforms are politically feasible, and what they can reasonably achieve.

IMF Survey: From your interactions with policymakers, do you get the sense that the Fund would be more effective as a trusted confidential advisor or as a key player in shaping public national and international debates?

Blanchard: I think it can and should definitely be both. In the World Economic Outlook, the Global Financial Stability Report, and other surveillance documents, the Fund should be clear about the implications of major policy choices. In the bilateral assessment of a country’s economy—the so-called Article IVs—it should translate general propositions in specific policy advice. For some issues, it may make sense to take them up privately, at least first. But sometimes, making them public may be the only way to start an important discussion.

To take a familiar example, I believe that, in the context of the Greek program discussions, it made good sense to argue for debt relief first in private. We did. And when we thought our argument was not getting through, it made good sense to then go public. It would have been wrong to go public from the start, or to never go public.

IMF Survey: How do you see the IMF's role evolving, particularly if there were fewer crises?

Blanchard: I believe the IMF’s traditional roles of surveillance, adjustment programs, liquidity provision, and technical assistance, will still be the right ones to carry out in the future.

Surveillance. “Surveillance’’ is an awful word, but what lies behind the word is terribly important. The Fund is in a unique position to work on and describe the interactions between economies. It is in a unique position to define or at least suggest rules of the international game. Given the richness of its country experiences, and the depth of its information, it is a unique position to do essential work on open economy macroeconomics. An example: The work on capital flows we have done during the last seven years.

Adjustment programs. Their design itself needs adjustment. Given the increasing gross external asset and liability position of countries, there is a need to limit how much of the program funds go to pay short-term creditors. The reforms being now discussed at the Fund, namely the wider use of the debt rescheduling option, and the elimination of the systemic exemption, are really important.

Liquidity provision. Again, the gross asset and liability positions create the risk of very large sudden stops, and the need for international liquidity provision on a very large scale. The current haphazard combination of central bank swap lines and Fund liquidity programs is a strange contraption. It should be improved, if only to eliminate the role of political factors in who gets what. The two should be better integrated, and integrated with regional agreements.

Technical assistance. Through my seven years at the Fund, I have been struck at how invaluable our technical assistance and capacity building can be. Given its knowledge and its close relation with its members, the Fund is in a unique position to provide advice, from how to design an inflation targeting regime to how to improve tax collection. Doing even more would be good.

IMF Survey: How do you think an economic counselor should balance the duties of spokesperson of the IMF and the role of an academic/ researcher generating new ideas, especially when such ideas conflict with IMF orthodoxy?

Blanchard: I have not found this to be an issue. Not once in my seven years have I felt I had to avoid or fuzzy up a position I held, or had to present a position I did not believe in. If I had, I suspect I would have offered to resign.

People who expect me to bare my soul after I leave the Fund will be disappointed. What you got is what you’ll get.

IMF Survey: You will not be going too far. What will you focus on at Peterson Institute?



Blanchard: I want to go back to doing research on a few specific issues. For the past seven years, I’ve been answering a thousand questions, but not in a very deep way. I want to take ten of these thousand questions and answer them more deeply.

I want to go back and examine what happened in Portugal, in Ireland, in Iceland, in Greece, and do the in-depth work that none of us has the time to do. I want to think harder about the various measures countries can use to control and mold capital flows. In short, I want to continue to “rethink macro’’…



