John Maynard Keynes had once famously retorted to a critic: “When the facts change, I change my mind. What do you do, sir?”
The facts have changed ever since the financial crisis, and it now seems that economists are using the same Keynesian logic to change their minds about how economies should be managed by governments and central banks. Many parts of the old orthodoxy are being chucked out of the window.
The new mood of introspection was evident during the first international conference hosted by the Reserve Bank of India in Mumbai last week. The participants were central bankers, monetary economists and senior officials from the International Monetary Fund (IMF). For example, Nobel Prize winner Michael Spence told Mint that developing nations such as India would do well to keep some capital controls in place, actively manage the exchange rate and ensure that the banking sector is largely domestically owned—“so that you have some control over the volatility of the prices that determine the way you interact with the rest of the world”.
Spence was not the only person who spoke in defence of tactical moves to keep out some short-term capital inflows or trying to manage the exchange rate as part of a bigger attempt to prevent either overheating of an economy or a bout of panic.
The process of reconsidering the old orthodoxy is especially relevant to the rich nations that were at the epicentre of the financial earthquake. Indian financial authorities neither fully embraced the notion that a central bank should focus on inflation control through manipulating the short-term interest rate—the one-target, one-instrument monetary strategy—nor did they allow huge amounts of leverage to be built into the financial system.
Yet the emerging debate in the West needs to be followed in India as well since there is much to be learnt from what scholars and practitioners there say, even as the latter, for perhaps the first time ever, are paying closer attention to what Indian policymakers are up to.
IMF economists Olivier Blanchard, Giovanni Dell’Ariccia and Paolo Mauro have mapped the lessons from the crisis in a new staff position note: (Rethinking Macroeconomic Policy.) In an interview with IMF Survey, an in-house magazine of the multilateral lender, Blanchard has spoken about the quintessence of the new policy parameters. First, he said that not all that has been learnt in the past decades is irrelevant for policy design: “The basic elements of the pre-crisis policy consensus still hold. Keeping output close to potential and inflation low and stable should be the two targets of policy. And controlling inflation remains the primary responsibility of the central bank. But the crisis forces us to think about how these targets can be achieved.”
And then he talks about some of the new learnings: “The crisis has made clear, however, that policymakers have to watch many other variables, including the composition of output, the behaviour of asset prices, and the leverage of the different participants in the economy. It has also shown that they have potentially many more instruments at their disposal than they used before the crisis. The challenge is to learn how to use these instruments in the best way. The combination of traditional monetary policy and regulatory tools, and the design of better automatic stabilizers for fiscal policy, are two promising routes.”
As in the case of Spence, Blanchard and his co-authors also come out with a more sympathetic view of how Asian central banks have behaved in recent years, as they have intervened in the foreign exchange market to prevent strong capital controls either making exports uncompetitive or feeding inflation or blowing an asset bubble. Sterilized intervention—when a central bank buys foreign exchange, releases domestic currency into the economy in exchange and then mops up this money through the sale of bonds—now seems to be getting a more sympathetic hearing from international academic and policy experts than before.
“In many emerging market countries, while monetary authorities describe themselves as inflation targeteers, they clearly care about the exchange rate beyond its effect on inflation. They probably have good reasons to do so. Isn’t it time to reconcile practice with theory, and to think of monetary policy more broadly, as the joint use of the interest rate and sterilized intervention, to protect inflation targets while reducing the costs associated with excessive exchange rate volatility?”
Such endorsements do lead to the risk of hubris in Asian policy circles, including our own. There is already a lot of vague talk about how the Washington Consensus needs to be replaced by a Beijing Consensus or even a New Delhi Consensus. Such hubris is uncalled for, however, since India needs to move ahead with financial reform, though on its own terms and at its own pace.
Niranjan Rajadhyaksha is managing editor of Mint. Your comments are welcome at firstname.lastname@example.org