At IMF, the hunt for a new consensus
Tuesday, March 8, 2011
It was a fitting eulogy for the economic orthodoxy that once governed the world, given by one of the men who helped develop it.
"Before the crisis, we had converged on a beautiful construction" to explain how markets could protect themselves from harm, said Olivier Blanchard, an economics counselor at the International Monetary Fund. "But beauty is not synonymous with truth."
That beautiful construction held that central banks need only control inflation and that markets would virtually govern themselves with a light touch from government. It largely blinded mainstream economists from foreseeing the ugly depths of the 2008 downturn. Blanchard himself, upon assuming his IMF position in September 2008, projected there would be "limited cost in terms of real [economic] activity."
Now the list of discredited theories is lengthy.
The efficient-market hypothesis, which argued that smart investors would be on their own guard against undue risk, lost face during the subprime mortgage crisis. Mainstream central bank policy is being tested in the recovery. The ability of developed economies to sustain low unemployment is in doubt. A globalized world, it turns out, linked companies and economies together in ways not fully understood.
What's less certain - and the focus of Blanchard and a panel of top world economists who gathered at the IMF this week - is whether a new consensus can be salvaged out of the ashes of the old.
It is no mere academic debate. World governments are being asked to cooperate on economic policy at a level never seen before. Some of the ideas being discussed could affect everything from long-run unemployment rates in the United States to the extent of welfare benefits in Europe or the availability and cost of home mortgage loans.
Global bank regulators are talking of rules to limit asset bubbles - possibly making it more difficult for home values in the United States to recover their previous levels. They are developing lists of large institutions that need more regulation - a potential constraint on the financial industry as a whole. In Europe, some are pushing for a kind of shared sovereignty that would limit a country's ability to make its own decisions on government spending.
The economists driving the policy discussion, however, say they are far from developing a new playbook.
"We realize that many of the things we thought with certainty we cannot anymore," said Kemal Dervis, head of the global economics program at the Brookings Institution and a longtime World Bank and Turkish government official. "But from there to an overall consensus on how monetary and fiscal and growth policies are linked - we are very far off."
Some underlying principles are emerging, largely surrounding the need for government and central banks to be more interventionist.
The IMF, for example, has typically discouraged countries from imposing restrictions on the flow of capital, arguing that global markets work best when investment is free to move.