Rewriting the Macroeconomists’ Playbook in the Wake of the Crisis

By Olivier Blanchard

Before the global economic crisis, mainstream macroeconomists had largely converged on a framework for the conduct of macroeconomic policy. The framework was elegant, and conceptually simple. Caricaturing just a bit, it went like this:

  • The essential goal of monetary policy was low and stable inflation. The best way to achieve it was to follow an interest rate rule. If designed right, the rule was not only credible, but delivered stable inflation and ensured that output was as close as it could be to its potential.
  • This was achieved by setting the key policy rate that then affected the term structure of interest rates and asset prices, and then to aggregate demand. One could safely ignore most of the details of financial intermediation. Financial regulation was outside the macroeconomic policy framework.
  • On currencies, countries could set an inflation target and float, or instead choose a hard currency peg or join common currency areas. In general, in a world in which central banks followed inflation targeting, there was no particular reason to worry about the level of the exchange rate or the current account balance. Certainly, attempting to control exchange rates through capital controls was undesirable. And multilateral coordination was not required.
  • Fiscal policy had a limited role at best, at least in the short run. With the right use of monetary policy, it was not really needed. Automatic stabilizers, such as unemployment benefits, would kick in during downturns, but discretionary policy was more likely to be misused than used well. The focus had to be on the medium run, and on fiscal sustainability.

These were simple principles, and they seemed to work. From the early 1980s on, macroeconomic fluctuations were increasingly muted, and the period became known as the “Great Moderation”. Then the crisis came. If nothing else, it forces us to do a wholesale reexamination of those principles. Here are some ideas to guide the conversation:

  • Economic imbalances: Achieving stable inflation is good, but we can now see it does not guarantee stable output. Before the crisis, steady output growth and stable inflation hid growing imbalances in the composition of output and in the balance sheets of households, firms, and financial institutions, as well as growing misalignments of asset prices. These imbalances ended up being very costly. The question now is how best to address such imbalances. Should we think of macroeconomic policy as having three legs—monetary, fiscal, and financial—each with separate authorities? Or should we think of extending both the mandate and the set of tools of monetary policy to cover both output and financial stability? And, if so, what tools do we have and how do we use them?
  • Interest rates: Early in the crisis, central banks decreased policy rates, until they reached their lower bound––namely zero. From then on, interest rate policy could not be used to prop up aggregate demand, and central banks turned to both credit and quantitative easing.  This raises many questions. First, would it have helped if nominal interest rates had been higher to start, giving more margin of maneuver to central banks? Put another way, should we revisit the low inflation targets, and the associated low average nominal interest rates, that central banks had adopted pre crisis? Second, are credit and quantitative easing policies just for exceptional times, or can they work and do they make sense in more tranquil times?
  • Fiscal policy: When interest rates reached the lower bound, fiscal policy came back to the fore. Going beyond automatic stabilizers, most countries adopted fiscal stimulus programs to increase aggregate demand, but debates about the size and even the sign of multipliers associated with different fiscal measures made clear how little work had been done on fiscal policy, and how much needed to be done. The large increase in debt since the beginning of the crisis (an increase which is overwhelmingly due to the loss of output and the implied loss in revenues rather than to the fiscal stimulus programs themselves) also raises many issues. Even though it will be a long time before debt levels are reduced sufficiently, what levels of public debt should countries aim for? Are old rules of thumb, such as trying to keep the debt to GDP ratio below 60 percent in advanced countries, still reliable?
  • Capital flows: The crisis triggered very large capital flows. Often, these flows had little to do with conditions in the country that they left, and more to do with the need by foreign financial institutions to repatriate funds in a hurry. More recently, capital has gone back to emerging market countries, sometimes with such force as to trigger complaints of ‘currency wars,’ leading to intense discussions about capital account management. How should countries react to large capital inflows? If they want to mute their effect for example, when should they build up reserves and when should they use capital controls? Should each country be left to do what it feels is best for itself, or should there be international rules of good behavior?
  • International monetary system: Talking about international rules of good behavior, the crisis raises both old and new questions about the international monetary system. Should benign neglect determine the coordination of monetary policies across countries? Should there be international rules not only with respect to capital controls, but with respect to reserve management, and monetary policy in general? Should countries be free to run the current account deficits or surpluses they want, or should there be restrictions on what they should do? Before the crisis, a number of emerging market countries had relied on low exchange rates and export-led growth. As these countries get larger and the competitiveness effect on other countries becomes more visible, does export-led growth remain an acceptable strategy for a multilateral point of view?
  • Safety net: In a different dimension, the great recession has showed that not only emerging countries, but also advanced countries, can suffer sudden stops. During the crisis, foreign liquidity was provided mostly through swap lines offered by the major central banks. Since then, the IMF has created two new liquidity windows. Is the problem solved, or is more needed?

These questions, and many more, will keep us busy for years to come. To take stock of the questions, and start exploring the answers, David Romer, Michael Spence, Joseph Stiglitz, and I have organized a conference on these issues. This conference will take place on March 7 and 8 at the IMF. While the conference is by invitation only due to space constraints, it will be webcast live. To follow it, and get more information please visit the conference website.

After the conference, we shall open a discussion site, and continue the discussion online. I hope many can join us and contribute as we continue to search for new approaches to the world’s changing macroeconomic and growth challenges.

2017-04-15T14:28:03+00:00March 4, 2011|


  1. Per Kurowski March 4, 2011 at 5:08 pm

    Whoa, and you are leaving out what detonated the crisis, the fact that the bank regulators in the Basel Committee empowered to harmonize regulations around the world proceeded to disharmonize regulations acting like the risk-managers of the world and through the use of risk-weights that arbitrarily set the capital requirements based on perceived risks and sent of the banks to the triple-A rated waters where the sharks of the real economy were waiting for them. Excuse me… where have you been?

  2. Angus Cunningham March 4, 2011 at 5:09 pm

    Regarding capital flows, I notice that the initiating post does not mention “financial reform”. Was that a deliberate exclusion?

    It seems to me that the IMF has a lot of URGENT work to do to make sure that rent-seeking, whether deliberate or unwitting, by financial intermediation is not siphoning off funds from the easy credit now being supplied by Western central banks. We know from recent history of successfully prosecuted scandals that much rent-seeking has been going on and that, in particular, it has been occurring in the domain of derivative contract design, promotion, rating, insuring, and that this rent-seeking has been facilitated by high-frequency trading. Yet the reading I get of the G20 process in which IMF officials are arguably the most consistently research-based and impartial contibutors of opinion and recommendation, is that it is not making much progress in this field, and may be unwittingly distracting themselves with the new debates on international monetary reform. In 2000-8 it was speculation in housing. Now the same thing appears to be happening in commodities.

    Please do not interpret this as a pretext for ignoring international monetary reform issues. It is NOT. Rather it is to express many, many people’s concerns that insiders in the financial system are not in touch with the pain caused by myopicly short-sighted and simplistic philosophies such as those that allowed — some cynics would say facilitated — the 2007-8 credit crunch to get to a scale where it nearly mired us all in financial arteriosclerosis.

    A paper on the derivative aspects of financial reform is accessible at:

    Its summary is as follows:

    Derivative contracts can rationally be classified – prospectively, from the perspective of the economy as a whole — as either functional or very likely to be dysfunctional, although “the Street” pretends
    otherwise. Therefore a charge levied at the writing or exchange of very-likely-to-be-dysfunctional derivative contracts would usefully inhibit dysfunctional trading without throwing the “good functional derivative
    babies out with the dirty bath water of dysfunctional derivatives”. Financial instability would be lessened and coherence between financial and real sectors would grow again. This paper, by a coach to a manager of trading at a major international bank, explains how derivative transactions can be classified either as likely to be functional or as very likely to be dysfunctional for the economy as a whole. It then sketches how such a charge might be calibrated in practice to bring about critical financial reform objectives.

  3. FT Alphaville » Further further reading March 4, 2011 at 5:15 pm

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  5. […] Thoma links us to Rewriting the Macroeconomists’ Playbook in the Wake of the Crisis by Oliver Blanchard of the […]

  6. margaret beresford March 6, 2011 at 7:11 pm

    At this time I have only one question and I hope there will be a response. Who do you primarily focus on——financial/corporate interests or nation states?

  7. […] Chief econ- OLiver Blanchard writes: […]

  8. […] a blog post on the IMF website, Blanchard, on leave from the Massachusetts Institute of Technology, offers his […]

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  11. René Christian Moya March 7, 2011 at 4:53 pm

    Dr. Blanchard,

    You wrote:

    From the early 1980s on, macroeconomic fluctuations were increasingly muted, and the period became known as the “Great Moderation”. Then the crisis came.

    This claim–that macroeconomic fluctuatuations were increasingly muted–is an odd one. In the 1980s alone you had severe crises in Mexico, Brazil, Chile and Argentina, to say nothing of crises in some African states–and you had the IMF sweep in to pick up the pieces. You had the Savings and Loan crisis in the United States–a small preview of the mess to come. You had the Swedish and Japanese crises in the early 1990s. You had a second Mexican peso crisis in the 1990s. You had the crisis in East Asia in 1997-1998, which rocked the global economy and lead to the Russian financial crisis. You had a crisis in Brazil in 1999, the collapse and default of Argentina in 2002, the collapse of the dot-com bubble (which lead to recession), the Enron and WorldCom débacles….and now, the global (really, WESTERN) financial crisis. Why does it take a major crisis in the core capitalist states for ‘international institutions’ to consider the failure of an oft-failing economic paradigm?

    This doesn’t read to me like a history of stable macroeconomic development. It’s a litany of failure, speculation and crisis, which has critically affected the lives of tens of millions of people across the globe. (Consider The Lancet’s research suggesting the ‘neoliberal’ shock implemented in Russia post-1991 had a colossally negative impact on the demographics of that country.) What makes the period 1980-2008 more successful than, say, the post-1945 boom (roughly until 1973) which came to an end thanks to a combination of American decisions (Vietnam, the debt explosion, and the subsequent de-coupling with gold) and–more importantly–the two oil shocks of 1973 and 1979?

  12. Roger McKinney March 7, 2011 at 8:58 pm

    Is anyone willing to revisit monetary theory? Hayek wrote in the 1930’s that monetary policy was stuck at that time in the third generation worrying about price inflation. It is still stuck there today. There has been no progress in monetary theory in 80 years.

    Hayek’s fourth generation of monetary theory would examine the way that changes in interest rates distort prices, especially the price relationship between capital goods and consumer goods. The production of consumer goods and capital goods must be in balance for a smooth running economy. When prices become distorted the ratio changes and too many capital goods or too few consumer good get produced. When the imbalances become great enough they trigger a depression.

    Such an imbalance happened with housing and many capital goods products before the latest depression.

  13. Der IWF denkt nach « Redrockreason March 8, 2011 at 4:29 am

    […] Der Internationale Währungsfond (IWF) denkt über makroökonomische Politik und die Lehren aus der …. Es ist schön zu sehen, dass der früher so dogmatische IWF inzwischen sehr viel pragmatischer über viele Dinge denkt – und redet. […]

  14. Chadi BOU HABIB March 8, 2011 at 5:31 am

    Dear Dr Blanchard. I enjoyed reading your text as much as I have enjoyed reading the SPN of February 2010 to which you have contributed. I have however to confess that I feel some deep discomfort. You start your text by summarizing the views of what you call “mainstream macroeconomists”. I wonder if you consider yourself as mainstream macroeconomist or not? If you were a mainstream macroeconomist, or following the mainstream, and the crisis pushed you to revisit your concepts or allowed you to express different views, then this understandable and highly respectable. But, as a reader, I think that what is still missing in your new writings is the recognition of the contribution of pre-crisis non-mainstream macroeconomists and the reference to them. Many of these persons were simply marginalized and excluded from key positions in national and international organizations and even academia where mainstream thinking was, and sometimes is, dominating. We owe them tribute and we should remain humble in front of the pain suffered by millions around the world because of the global crisis.

  15. Per Kurowski March 8, 2011 at 7:47 am

    @Roger McKinney “examine the way that changes in interest rates distort prices, especially the price relationship between capital goods and consumer goods.”

    More important is to examine how the introduction of the regulatory discrimination against the perceived risk of default of bank borrowers, has so completely distorted the capital allocation process of the banks, and led to much excessive financing of what is conventionally perceived as “not risky” and to very insufficient financing of what is perceived as “risky”, like the small businesses and entrepreneurs who are central to the dynamism of our economies.

  16. Angus Cunningham March 8, 2011 at 8:52 am

    Dear Mr. BOU HABIB:

    Thank you for expressing what I think many people reading and contributing to this forum have been feeling. The need of world decision-makers is always for simplicities enabling them to act in publically endorsed ways, so their need for a mainstream orthodoxy is ever present in the minds of what has sometimes been called “the chattering classes of professionally schooled economists”. Nowhere is that need better filled than by an “IMF mainstream”. Yet the real need of the millions to whom you refer is for present insight in high places and contemporary practical wisdom related thereto; and rarely in economic decision-making is that greater need met by a mainstream orthodoxy.

  17. William Allen March 9, 2011 at 2:06 pm

    Dr Blanchard,

    I watched the live streaming with anticipation during the recent conference 7-8 Mar 2011 for a re-think of macro policies. I was hoping that someone would raise questions about the Fund working with governments to determine what their overall macro objectives should be. For example, I was hoping to see some discussion about commitments to full employment, non-polluting resource usage, sustainability of growth, income distribution, resolution of trade imbalances,…the items that form the basis of Lerner’s Functional Finance. I was disappointed that mainly I heard only tweaks on the same old tired themes of price stability. This was certainly not Keynes’ — nor, I believe, H D White’s — idea for the Fund. Although I applaud your effort and support for this conference, in my opinion, this was a missed opportunity to revisit these important macro issues.

  18. […] IMF is encouraging awholesale re-examination of macroeconomic policy principles in the wake of the global economic crisis, starting with a […]

  19. […] IMF is encouraging a wholesale re-examination of macroeconomic policy principles in the wake of the global economic crisis, starting with a high […]

  20. […] us to question our most cherished beliefs about the way we conduct macroeconomic policy. Earlier I had put forward some ideas to help guide conversations as we reexamine these beliefs. I was heartened by the wide online […]

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  22. Mind-Changing Events - March 19, 2011 at 2:08 pm

    […] much accepted the “elegant, and conceptually simple” framework described recently by Olivier Blanchard. Basically, I thought that conventional monetary policy could do the job of stabilizing the […]

  23. Unemployed Finn March 20, 2011 at 2:33 pm

    Nobody remembers Finnish crisis of the 90’s, where GDP contracted fourteen percent and unemployment rose to 19,6%. That’s how good Finnish politicians have been hiding the mess they made.

    But for those of us who have been unemployed ever since it never went away. We have been robbed any chance to have normal lives.

  24. […] one blog leading up to the Conference (March 4, 2011) – Rewriting the Macroeconomists’ Playbook in the Wake of the Crisis – Blanchard wrote that the obvious and revealed effectiveness of fiscal policy in reducing […]

  25. […] más arraigadas acerca de la forma en que ejercemos la política macroeconómica. Anteriormente, yo había expuesto algunas ideas para orientar las conversaciones dedicadas a reexaminar esas creencias. Me sentí alentado por el […]

  26. […] banking, and finance — the news comes directly from the top guns in science (see also here, here, here, and here.)   What killed it? A series of empirical and conceptual anomalies — […]

  27. […] was a privilege to participate in the IMF conference devoted to rethinking policy frameworks in the wake of the crisis. Highly encouraging was the openness of the discussion, the range of […]

  28. […] was a privilege to participate in the IMF conference devoted to rethinking policy frameworks in the wake of the crisis. Highly encouraging was the openness of the discussion, the range of […]

  29. […] us to question our most cherished beliefs about the way we conduct macroeconomic policy. Earlier I had put forward some ideas to help guide conversations as we reexamine these beliefs. I was heartened by the wide online […]

  30. […] la conférence, j’avais couché sur le papier quelques idées directrices facilitant les entretiens. (Retrouvez sur le site de la conférence les contributions des intervenants) A l’issue de ce […]

  31. […] Johnson’s opposition to appeasing corrupt and overreaching financial elites could be constructive advice for his former institution. Historically, the IMF’s decades-old, pro-elite prescriptions for Latin America include unnecessary and harmful interest rate hikes, sacrificing economic progress and employment to keep inflation far below the levels where it might harm the economy, cutting health and education spending, allowing unfettered capital mobility, initiating massive privatizations, and engaging in pro-cyclical policies during downturns. Johnson’s successor at the IMF, Olivier Blanchard, as well as his predecessor, Raghuram Rajan, have already bucked some of the institution’s harmful, longstanding orthodoxies. […]

  32. […] 155, “financial crisis of 2008″: An interesting read is Rewriting the Macroeconomists’ Playbook in the Wake of the Crisis, by Olivier […]

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