With a pause in the crisis, top IMF economists look inward


The International Monetary Fund (IMF) cut its global growth forecast and urged European policy makers to use "aggressive" monetary policy as a second year of contraction leaves the euro area's recovery lagging behind the rest of the world. (Andrew Harrer/BLOOMBERG)

In the scope of a few years, economists have had to discard their prevailing theory about the wisdom of financial markets and were surprised when “risk-free” government bonds threatened to destroy otherwise healthy banks.

Their understanding of inflation and unemployment hasn’t held up, and neither has their understanding of how government spending cuts effect economies. Just ask Greece.

If ever a profession needed to take stock.

“We don’t fully understand what’s happening in advanced economies,” Lorenzo Bini Smaghi, a former member of the European Central Bank governing board, said in remarks at a conference called at the International Monetary Fund to discuss the lessons learned since the 2008 collapse of Lehman Bros. wrecked the financial system.

Basic economic relationships seem to have broken down, “central banks are cornered” into ever more monetary experimentation, Smaghi said, and economists have been left with the conclusion that “the models we use have serious limitations.”

The IMF and World Bank are wrestling with such issues as they hold their spring meetings this week during what may be a lull in the troubles that began in the United States, spread around the world and still, chronically and stubbornly, afflict the euro zone.

It is probably too early to call it a turning point. New economic forecasts from the IMF were temperate both in tone and substance. Expectations for world growth were marked down a bit, but mostly because of the hangover from last year’s near crack-up of the euro zone and the uncertainties around the U.S. “fiscal cliff” — big risks that have been avoided. But overall, the developed world is growing smartly, Japan’s adventurous new economic policy got an IMF blessing, and the fund expects growth in the United States to pick up in the second half of the year. Europe remains a problem — France is flirting with recession and the banks are still a mess — yet does not seem likely to implode.

Even if the clouds are lifting a bit, that has not made people such as IMF chief economist Olivier Blanchard sanguine about the future — or about his ability and that of the economics profession at large to do better next time.

The IMF has been criticized for not doing more to raise warnings about some of the financial trends that led the United States into trouble. Since then, Blanchard and others at the agency have tried to assess where they erred. They are looking at mistakes in the calculation of “fiscal multipliers,” for example, and trying to get ahead of the curve in determining how the massive monetary stimulus undertaken by central banks in recent years might cause problems down the road.

Blanchard this week is hosting the second such exercise in as many years, gathering central bankers, academics, investors and others to see what set of policies might replace those that created an era known as “the Great Moderation” before it immoderately blew up in 2008.

If loose central bank policies were needed in the short run, what are the risks they are creating in the long run through their massive asset purchases and low interest rates? Are the tradeoffs worth it? Are politicians being let off the hook because those central bank measures let them avoid tougher fiscal or structural choices?

“By relieving market pressures, the central bank can play a political role,” Bini Smaghi argued as part of a panel on monetary policy. Other sessions were to examine debt, financial regulatory issues and other matters.

But in an introductory paper, Blanchard said there was little sense yet of a new orthodoxy to replace the old one.

“Five years from the beginning of the crisis, the contours of a new macroeconomic policy consensus remain unclear,” he wrote.

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