Optimistic That Alarm Could Inspire an Answer

By Steven Mufson
Washington Post Staff Writer
Friday, October 10, 2008

The chief economist of the International Monetary Fund, Olivier Blanchard, asserts that he is an optimist -- though that is a relative term during a week that has seen free-falling stock markets, frozen credit markets and talk of another Great Depression.

"We're not heading toward a depression," the French-born Blanchard said in an interview. "We've learned a few things in 80 years."

Just how much the world's economic policymakers have learned will be put to the test this weekend at meetings of the IMF, World Bank and the Group of Seven industrial nations in Washington.

"This is not a crisis where we are completely lost," said Blanchard, who will be deeply involved in the talks. "We are surprised by the facts, [but] we understand what the solutions are and how to use them. When governments are scared enough, they will use them correctly."

He thinks that they might be scared enough to pull together at this weekend's meetings. "That's why I am fairly optimistic about the future," he said.

But Blanchard isn't as optimistic as he or the IMF have been in the past. On Wednesday, he unveiled a new World Economic Outlook that lowered the fund's world growth forecast to 3.0 percent in 2009, 0.9 percentage points lower than the July forecast. And he said that the pain of the slowdown would be felt most acutely in the United States and other developed countries, where he said that growth would be "very close to zero or even negative until at least the middle of 2009 with a slow recovery during the rest of the year."

Unlike the majority of IMF chief economists, who have been Americans, Blanchard is a citizen of France. He has, however, lived in the United States since attending graduate school at the Massachusetts Institute of Technology, where he was until recently an economics professor. He joined the IMF in August.

On the issue of his economic philosophy, Blanchard said "it's fairly obvious that financial markets, if left to themselves, are fairly fragile. And when things break down, you need serious government intervention."

This has been the IMF position since even before Blanchard's arrival. In fact, he said that the fund had urged the Treasury in the early spring to adopt a more aggressive program, similar to the rescue package that the United States recently adopted. In a report in April, the IMF recommended that U.S. policymakers "prepare contingency measures in the financial sector -- for example, with the Treasury stepping in to support market liquidity with longer-term asset swaps."

"IMF thought something like this could happen," Blanchard said.

He added that a systemic solution now needs "three legs" -- massive liquidity injections, a plan for recapitalizing insolvent institutions with both private and public money, and the purchase of troubled bank assets -- "with clear rules so that people understand pricing."

"If you do it soon enough, we can get through this," he said, adding that "anytime last week would have been good."

He concedes that even these measures "are going to take time," and that will mean an expansion of government guarantees to bank depositors and interbank lenders similar to guarantees given in Ireland. Asked how governments would disentangle themselves from such sweeping guarantees, Blanchard said, "Call me when we're out of the crisis."

How much of a role the IMF will play remains unclear, but there are signs that it could get involved soon. The British government has been urging the IMF to step in Iceland, whose banks have assets worth 10 times as much as the tiny country's gross domestic product.

Blanchard said the IMF could also help coordinate policies, not only among developed countries but in emerging economies. "The investors are going to look for the angles," he said. "If there are differences [in policies], then you are going to see money going to country A from country B" in what he said would be an "arbitrage" of uncoordinated policies. For example, Ireland's decision to unilaterally guarantee all bank deposits probably sucked money out of banks in other E.U. countries.

"Piecemeal approaches leave open too many loose ends to inspire confidence and have proven ineffectual to mitigate the financial crisis," he said Wednesday at a news conference to release the fund's Economic Outlook.

In an article published in August, the same month he joined the IMF and after the U.S. government had taken over Fannie Mae and Freddie Mac, Blanchard warned that financial institutions were still in danger.

"Because financial intermediaries are likely to have specific expertise about the loans they have made and the assets they hold, they may find it difficult or even impossible to sell these assets to third parties," he wrote in a publication of the National Bureau of Economic Research.

He also took polite aim at central banks' focus on long-term inflation expectations. "One may reasonably ask," he wrote, "whether a price setter, choosing prices for the next month or the next quarter, will change his decisions depending on what his expectation of inflation is, say, in five years."

Asked yesterday whether the Fed had been too cautious because of long-term inflation concerns, Blanchard said "the Fed was less obsessed with inflation than some other central banks." He also called Wednesday's coordinated rate cut "a step in the right direction."

Blanchard said that central banks weren't alone in the failure to spot the trouble ahead. "Three months ago . . . all the academics were writing about 'the Great Moderation' . . . and how inflation targeting was the key to good health. If we did this, then the world would be a marvelous place forever."

"What's interesting is that we've had a number of models that basically described what has happened very well," Blanchard said. ". . . Nobody believed that it would happen on that scale."