Download Reaping the Benefits of Financial Globalization

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

One target for monetary policy: Low and stable inflation

One main monetary policy instrument: The policy interest rate

A limited role for fiscal policy

No cyclical role for prudential regulation

The proof of the pudding: The Great Moderation

Caveat: Differences between and among academics, central banks, politicians
2
Monetary Policy: One Target/One Instrument

Stable inflation (backed by theory and politics)

Low inflation (low prob. of Zero bound, but Japan…)

Connected markets and arbitrage (one rate does it all)

Expectation channel: Rule based policy

Financial intermediation largely ignored (with exceptions)
3
Benign Neglect Approach to Boom/Busts

Asset prices a concern only through their impact on GDP and
inflation

Bubbles difficult to identify

Ex-post policies effective and costs of clean up limited

Better clean up than prevent
Financial Regulation Not a Cyclical Tool

Macro dimension of regulation largely ignored:



Focus on soundness of individual institutions
Some exceptions in EMs
Cyclical use of prudential policies discouraged:


Seen as mingling with proper market functioning
Little thought given to cyclical rules on capital ratios, LTV ratios
(exceptions: Spain, Colombia)
The Great Moderation

Steady decrease in the variability of output and inflation in
advanced countries

Sources? Luck, structural changes, improved monetary policy?

Successful responses to the financial scares. 1987 stock market
crash, LTCM, Tech bubble burst
6
Then the Crisis Came …

Bust had enormous consequences

Standard policies rapidly hit their limits

Limited effectiveness of less traditional policies

Large fiscal and output costs
Reflections on the Crisis

Stable inflation: Necessary but not sufficient

Limits of very low inflation

Reconsider “benign neglect”

Financial intermediation is macro relevant
8
Before Crisis Inflation and Growth Looked OK
United States
Euro area
Average of other economies1
Core CPI Inflation
4.0
Output Gap2
2
3.5
1
3.0
2.5
0
2.0
-1
1.5
1.0
-2
0.5
0.0
2000
1 Japan
2
02
04
06
08:
Q4
2000
omitted.
Estimate of output gap using rolling Hodrick-Prescott filter.
02
04
06
08:
Q4
-3
But Houses Prices Were Rising Rapidly
80
Change in real house prices (2001:Q4-2006:Q3)
Real house price falls from recent peak
60
40
20
0
-20
ESP
NZL
IRL
FRA
GBR
DEN
SWE
CAN
AUS
FIN
NOR
ITA
USA
GRC
NLD
CHE
PRT
AUT
DEU
JPN
-40
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
0.2
IRL
R2 = 0.60
NOR
ESP
NLD
SWE
USA
CAN
FRA
GRC
0.05
GBR
ITA
BEL
CHE
JPN
0.1
FIN
PRT
AUT
0.15
DEN
0
DEU
-0.05
-5
0
5
10
Average annual percentage point change in household
quick ratio (liabilities/liquid assets)
Growth Rate of Nominal Credit relative to GDP and Household Quick Ratio
(percent)
15
Average growth rate of nominal credit relative to GDP (2002:1-2006:3)
11
Limited Monetary Policy Room
(policy rates in percent)
7
United States
6
United Kingdom
Euro area
5
4
3
2
1
0
Jan-07
Jan-08
Jan-09
Jun-09
12
Financial Intermediation Matters

When normal investors exit, markets become segmented

Arbitrage fails, and prices can deviate far from fundamentals

Policy rate no longer a sufficient instrument for policy

Credit easing and quantitative easing can affect rates and asset
prices, given policy rate
13
What We Should Explore Going Forward

If low/stable inflation not enough, what should monetary policy
target?

If benign neglect is dead, then what?

More targets means more tools: what role for macroprudential
policies?
14
Monetary Policy

Many targets:




Inflation/output gap
Exchange rate
Asset prices: Housing, stocks, etc
But also many instruments:



Policy interest rate
Reserve accumulation
Macro prudential instruments


Cyclical capital/liquidity ratios
Loan to value ratios, margin requirements
15
Benign neglect approach may be dead, but…

Problems and trade offs with more interventionist strategy
remain:

Bubbles difficult to detect in real time (China real estate)

Risks with pricking bubbles (including for policy makers)

Traditional policies may be ineffective (speculative demand))

And have large costs
Booms in Housing Markets Are Particularly
Dangerous

Not all asset-price booms should be target of policy

But how to choose?

Some consensus emerging that culprit is leverage (Nasdaq
crash was fine)

Housing markets are special:




Leverage (link to crises)
Large storage of wealth
Major supply-side effects
Network externalities
Boom, Leverage, and Defaults
Real Effects of House Busts
Figure 2. House Price Run-Up and Severity of Crisis
Cumulative decline in GDP f rom start to end of recession
10
IND
0
AUS
CHN
NZL
CAN
FRA
GRC
CHE CYP
PRT
AUT
USA
KOR
NLD
CZE HRV
HUN
DNK SWE
BGR
FIN
SVN
-10
ZAF
ESP
GBR
NOR
ITA
POL
y = -0.0416x - 4.1152
R² = 0.1496
IRL
ISL
UKR
EST
-20
Bubble size shows the change in bank
credit from 2000 to 2006.
LTU
LVA
-30
-20
0
20
40
Source: Claessens et al (2010).
60
80
100
120
140
160
Change in house prices from 2000 to 2006
180
200
220
240
The Policy Rate and House Price Bubbles

Make borrowing more expensive and may limit leverage and risk
taking

But:




Too blunt: costly for the entire economy (unless in context of general
overheating)
Issues for small open economies
Effect on speculative component may be limited
Panel VAR suggests impact on house prices at considerable cost
to GDP growth

100 basis points reduce house price appreciation by 1 but also lead to a
decline of 0.3 in GDP growth
Macro-Prudential Tools

Most ‘experiments’ in emerging markets, particularly Asia

Common tools:



Maximum LTV/DTI limits
Differentiated risk weights on high-LTV loans
Dynamic provisioning

Discretion rather than rule-based

Mixed evidence on effectiveness
Hong Kong: Limited Effectiveness of LTV
Limits
160
New loans approved
Prices
170
150
150
140
130
110
90
70
2009 - Mar 2009 - May
August 2010:
LTV for properties over HK$12 million
lowered to 60 percent, applications for
mortgage insurance exceeding 90% LTV and
50% DTI suspended, maximum loan size for
mortgage insurance eligibility if LTV>90%.
October 2009:
Maximum LTV for properties over
HK$20 million lowered to 60
percent, maximum loan size for
mortgage insurance eligibility
reduced and non-owner-occupied
properties disqualified.
130
120
110
2009 - Jul
2009 - Sep 2009 - Nov 2010 - Jan
2010 - Mar 2010 - May
2010 - Jul
Korea: Effective LTV Limits, but Difficult
Calibration?
6%
6
Month-on-month house price changes in 'speculation zones' (LHS)
5%
Policy rate (RHS)
5
September 2002:
Introduced LTV limits
4%
4
3%
2%
September 2009:
Tightened DTI
October 2003:
Lowered LTV in
speculative areas
1%
3
February 2007:
Tightened DTI
2
0%
June 2003:
Lowered LTV in
speculative areas
-1%
-2%
2000 - Jan
July 2009:
Lowered LTV in
non-speculative
areas
August 2005:
Introduced DTI limits
1
0
2001 - Apr
2002 - Jul
2003 - Oct
2005 - Jan
2006 - Apr
2007 - Jul
2008 - Oct
2010 - Jan
Macro-prudential policy still in its infancy

Pragmatic and discretionary, mobilized within existing
institutional frameworks, targeted at specific markets

Some evidence of temporary cooling effect on markets and
building of buffers for bad times

Too early to judge impact on aggregate cycles and interaction
with other policies
Tentative Policy Taxonomy for Real-Estate
Booms

Macro-prudential tools first line of defense


Target leverage
Strengthen balance sheets

Monetary policy definitely to be involved when there are other
signs of overheating

But may have to come into play anyway if macroprudential
tools are ineffective
Important Open Questions

Who does what?


Relationship among policies?


Where should macro-prudential authority reside?
To what extent are these independent tools?
Rules versus discretion?


Far away from IT standards
Risks associated with excessively interventionist policy
Conclusions: An evolution, not a revolution

Low (but how low?) and stable inflation still essential

Low deficits and fiscal room even more needed than before

Monetary policy: Many targets and instruments

New macroprudential tools/ Coordination with monetary policy

Important questions of institutional design
27
Thank You
28
Widespread Declines in Output Volatility
7
3.5
Emerging Markets and Developing Countries
Selected Advanced Economies
6.5
US
6
3
Africa and the
Middle East
5.5
5
2.5
Latin America
4.5
4
2
EU15
3.5
3
1.5
2.5
Asia
2
1
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1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006
29