VoxEU Column Global crisis

Rethinking macroeconomic policy: Getting granular

The Global Crisis has shaken the consensus on how to run macroeconomic policy. Three years ago, the authors discussed this issue on VoxEU.org. This column takes a more granular look at new efforts to rethink macroeconomic policy. It takes stock of early results and provides a more detailed agenda for the key issues that should keep policymakers and academic macroeconomists busy in the next few years.

The global economic crisis has kept forcing policymakers and academics to rethink macroeconomic policy. First was the Lehman crisis, which showed how much they had underestimated the dangers posed by the financial system, and the limits of monetary policy. Then it was the euro crisis, which forced them to rethink the workings of currency unions, and fiscal policy. And, throughout, they have had to improvise, from the use of unconventional monetary policies, to the initial fiscal stimulus, to the speed of fiscal consolidation, to the use of macroprudential instruments.

As the evidence begins to be analysed through theory and early empirical analysis, several efforts have been made to take stock of what we have learned thus far, amid events that continue to develop (prominent examples include Bernanke 2011, Perotti 2011, Svensson 2009, Woodford 2012).

Since we first looked at the issues roughly two years ago (Blanchard et al. 2010) policies have been tried, and progress has been made, both theoretical and empirical. Here we sketch an update of the status of the debate (see also Blanchard, Dell’Ariccia and Mauro 2013; Akerlof 2013; Blanchard 2013; Romer 2013; and Stiglitz 2013), which summarise the takeaways from the ‘Rethinking Macroeconomic Policy II’ conference held at the IMF in April 2013 . This column highlights what we think are the (many) main questions, and (few) early lessons to date, in somewhat greater detail.

Policymaking if the ‘Divine Coincidence’ is no longer with us

Since the crisis began, it has become apparent that it is no longer possible for central banks to focus only on keeping inflation at a desired level and hope that, as a by-product, economic activity will stay close to its potential. The relationship between output and inflation appears to have changed. By nearly all estimates, most advanced economies still suffer from a large output gap – yet, inflation, rather than turning to deflation, has largely stabilised. The crisis has also made it clear that sectoral and financial risks can grow under a seemingly calm macroeconomic surface. The policy rate seems too blunt a tool to keep the macroeconomy on an even keel and simultaneously address other imbalances. Moreover, with the policy rate at the zero lower bound, central banks’ only remaining options are to engage in quantitative or targeted easing of monetary policy.

The tentative implications include the following:

  • Should the relation between inflation and output remain weak beyond the aftermath of the crisis, central banks will have to target activity more explicitly than they are doing today;
  • Given the limited power of monetary policy in the liquidity trap, the issue of how to stay away from the trap, and by implication the issue of the optimal rate of inflation, will not go away;
  • Macroprudential policies can decrease but are unlikely to fully eliminate financial risks. The issue of whether and how to use monetary policy instruments to deal with financial stability will remain.
A role for macroprudential instruments

Macroprudential tools can decrease financial risks. Cyclical capital requirements, leverage ratios, or dynamic provisioning can in principle lead banks to build buffers during booms against losses in bad times. Similarly, limits on loan-to-value ratios or debt-to-income ratios can reduce the incidence of credit booms and decrease the probability of financial distress. And, while these are the instruments that have been used so far, we can probably design other instruments to deal with other aspects of the financial system.

In practice, however, several implementation issues arise. For example:

  • How to make micro prudential regulators take account of systemic risk and the state of the economy?

The solution explored in the UK, where the macroprudential authority will be able to vary the capital ratios to be applied by the microprudential regulators seems promising.

  • How to combine monetary and macroprudential policies, given that both affect risk and economic activity?

With separate agencies, the Nash equilibrium might be one where, for example, the central bank cuts rates too aggressively while the financial authority makes macroprudential regulation too stringent. Having the two agencies under one roof makes sense. Again, the UK solution, which houses both monetary and financial stability committees at the Bank of England, seems like a way forward.

Fiscal policies in an era of high government debt and low economic growth

The crisis has shown that what appeared to be safe levels of government debt were in fact not so safe. Two aspects have been highlighted:

  • First, the realisation of contingent liabilities (in the banking system, but also in public enterprises or guarantees on public-private partnerships) can result in rapid and large increases in government debt;
  • Second, the possibility of self-fulfilling debt crises is real.

The evolution of Spanish and Italian sovereign bond yields can be seen in this light, with the ECB’s commitment to intervene in these markets having reduced the risk of a bad equilibrium. Some other Eurozone members, such as Belgium, have benefited from low rates despite high levels of debt and political challenges. How much of the difference in yields across Eurozone members is explained by fundamentals or by multiple equilibria is an open question. It also leads one to ask whether the perception of countries such as the US or Japan as safe havens might change abruptly.

With government debt in the advanced economies at its highest level in peacetime, there is little doubt that the next decade will be characterised by fiscal adjustment (and perhaps, slow growth). Is there a risk of fiscal dominance? Surely there will be a temptation to lean on central banks to money finance deficits and keep real interest rates very low. In this context, it is essential that monetary policy decisions continue to be the sole purview of the central bank which, in turn, should base its decisions on the way the debt situation and fiscal policy impact inflation, output, and financial stability. The risk of fiscal dominance seems less prominent in the Eurozone, where no single government can force the ECB to change its monetary policy. But it may be more relevant elsewhere, for years to come.

At what rate should public debts be reduced? Much of the debate has focused on fiscal multipliers. The debate is likely to continue, though our reading of the evidence is that multipliers have been larger than in normal times, especially at the start of the crisis (Blanchard and Leigh 2013), with little evidence of confidence effects (Perotti 2011). This said, in practice, cross-country differences in the speed of fiscal adjustment have been largely determined by market conditions. To convince markets of a country’s commitment to fiscal adjustment, medium-term plans can be beneficial. Such plans can be made more robust by explaining upfront how they would respond to shocks, such as declines in economic growth (Ivanova, Martin, and Mauro 2011). Existing automatic stabilisers are useful, but far from optimal. Better design of stabilisers should also be on the agenda – so far it is not.


As a result of policy experimentation in the aftermath of the crisis, the relative roles of monetary policy, macroprudential policy, fiscal policy, and their interactions are still evolving. Looking forward, we can think of two alternative scenarios: a conservative one with a return to flexible inflation targeting and limited use of fiscal and macroprudential policies; and a more ambitious one with expanded monetary policy targets and tools, and a more active role of macroprudential and fiscal policies. We suspect the first is more likely than the second. But it may be not be enough to prevent the next crisis.


Akerlof, George A (2013) “The cat in the tree and further observations: Rethinking macroeconomic policy”, VoxEU.org, 9 May.

Bernanke, Ben (2011), “The Effects of the Great Recession on Central Bank Doctrine and Practice”, keynote address at the Federal Reserve Bank of Boston 56th Economic Conference ‘Long Term Effects of the Great Recession’, Boston, 18–19 October.

Blanchard, Olivier (2013), “Rethinking macroeconomic policy”, VoxEU.org, 9 May.

Blanchard, Olivier, Giovanni Dell’Ariccia, and Paolo Mauro (2013), “Rethinking Macroeconomic Policy II: Getting Granular”, IMF Staff Discussion Note 13/03.

Blanchard, Olivier, Giovanni Dell’Ariccia, and Paolo Mauro (2010), “Rethinking Macroeconomic Policy”, Journal of Money, Credit, and Banking 42 (supplement), 199-215.

Blanchard, Olivier and Daniel Leigh (2013), “Fiscal Consolidation: At What Speed?”, VoxEU.org, 3 May.

Borio, Claudio, and Ilhyock Shim (2007), “What Can (Macro-)prudential Policy Do To Support Monetary Policy?”, BIS Working Papers No. 242.

Ivanova, Anna, Paolo Mauro, Edouard Martin (2011), “Chipping away at public debt – Sources of failure and keys to success in fiscal adjustment”, VoxEU.org, 9 November.

Perotti, Roberto (2011), “The ‘Austerity Myth’: Gain Without Pain?”, NBER Working Paper No. 17571.

Romer, David (2013), “Preventing the next catastrophe: Where do we stand?”, VoxEU.org, 9 May.

Stiglitz, Joseph (2013), “The lessons of the North Atlantic crisis for economic theory and policy”, VoxEU.org, 9 May.

Svensson, Lars (2009), “Flexible Inflation Targeting: Lessons from the Financial Crisis”, speech delivered at De Nederlandsche Bank, Amsterdam (September).

Woodford, Michael (2012), “Methods of Policy Accommodation at the Interest-Rate Lower Bound”, Presented at the Jackson Hole Symposium, “The Changing Policy Landscape”.


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