Fifty years ago, Milton Friedman articulated the natural rate hypothesis. It was composed of two sub-hypotheses: First, the natural rate of unemployment is independent of monetary policy. Second, ...there is no long-run trade-off between the deviation of unemployment from the natural rate and inflation. Both propositions have been challenged. The paper reviews the arguments and the macro and micro evidence against each. It concludes that, in each case, the evidence is suggestive, but not conclusive. Policymakers should keep the natural rate hypothesis as their null hypothesis, but keep an open mind and put some weight on the alternatives.
This paper reexamines the behavior of inflation and unemployment and reaches four conclusions: 1) The U.S. Phillips curve is alive and well (at least as well as in the past). 2) Inflation ...expectations however have become steadily more anchored. 3) The slope of the curve has substantially declined. But the decline dates back to the 1980s rather than to the crisis. 4) The standard error of the residual in the relation is large, especially in comparison to the low level of inflation. Each of the four conclusions presents challenges for the conduct of monetary policy.
We explore empirically models of aggregate fluctuations in which consumers form anticipations about the future based on noisy sources of information and these anticipations affect output in the short ...run. Our objective is to separate fluctuations due to changes in fundamentals (news) from those due to temporary errors in agents' estimates (noise). We show that structural VARs cannot be used to identify news and noise shocks, but identification is possible via a method of moments or maximum likelihood. Next, we estimate our model on US data. Our results suggest that noise shocks explain a sizable fraction of short-run consumption fluctuations. (JEL D84, E13, E21, E32)
This lecture focuses on the costs of public debt when safe interest rates are low. I develop four main arguments. First, I show that the current US situation, in which safe interest rates are ...expected to remain below growth rates for a long time, is more the historical norm than the exception. If the future is like the past, this implies that debt rollovers, that is the issuance of debt without a later increase in taxes, may well be feasible. Put bluntly, public debt may have no fiscal cost. Second, even in the absence of fiscal costs, public debt reduces capital accumulation, and may therefore have welfare costs. I show that welfare costs may be smaller than typically assumed. The reason is that the safe rate is the risk-adjusted rate of return to capital. If it is lower than the growth rate, it indicates that the risk-adjusted rate of return to capital is in fact low. The average risky rate however also plays a role. I show how both the average risky rate and the average safe rate determine welfare outcomes. Third, I look at the evidence on the average risky rate, i.e., the average marginal product of capital. While the measured rate of earnings has been and is still quite high, the evidence from asset markets suggests that the marginal product of capital may be lower, with the difference reflecting either mismeasurement of capital or rents. This matters for debt: the lower the marginal product, the lower the welfare cost of debt. Fourth, I discuss a number of arguments against high public debt, and in particular the existence of multiple equilibria where investors believe debt to be risky and, by requiring a risk premium, increase the fiscal burden and make debt effectively more risky. This is a very relevant argument, but it does not have straightforward implications for the appropriate level of debt. My purpose in the lecture is not to argue for more public debt, especially in the current political environment. It is to have a richer discussion of the costs of debt and of fiscal policy than is currently the case.
Rethinking fiscal and monetary policy in an economic environment of high debt and low interest rates. Policy makers in advanced economies find themselves in an unusual fiscal environment: debt ratios ...are historically high, and—once the fight against inflation is won—real interest rates will likely be very low again. This combination calls for a rethinking of the role of fiscal and monetary policy—and this is just what Olivier Blanchard proposes in Fiscal Policy under Low Interest Rates. There is a wide set of opinions about the direction that fiscal policy should take. Some, pointing to the high debt levels, make debt reduction an absolute priority. Others, pointing to the low interest rates, are less worried; they suggest that there is still fiscal space, and, if justified, further increases in debt should not be ruled out. Blanchard argues that low interest rates decrease not only the fiscal costs of debt but also the welfare costs of debt. At the same time, he shows how low rates decrease the room to maneuver in monetary policy—and thus increase the benefits of using fiscal policy, including deficits and debt, for macroeconomic stabilization. In short, low rates imply lower costs and higher benefits of debt. Having sketched what optimal policy looks like, Blanchard considers three examples of fiscal policy in action: fiscal consolidation in the wake of the Global Financial Crisis, the large increase in debt in Japan, and the current US fiscal and monetary policy mix. His conclusions hold practical implications for economic and fiscal policy makers, bankers, and politicians around the world.
Most central banks perceive a trade-off between stabilizing inflation and stabilizing the gap between output and desired output. However, the standard new Keynesian framework implies no such ...trade-off. In that framework, stabilizing inflation is equivalent to stabilizing the welfare-relevant output gap. In this paper, we argue that this property of the new Keynesian framework, which we call the divine coincidence, is due to a special feature of the model: the absence of nontrivial real imperfections. We focus on one such real imperfection, namely, real wage rigidities. When the baseline new Keynesian model is extended to allow for real wage rigidities, the divine coincidence disappears, and central banks indeed face a trade-off between stabilizing inflation and stabilizing the welfare-relevant output gap. We show that not only does the extended model have more realistic normative implications, but it also has appealing positive properties. In particular, it provides a natural interpretation for the dynamic inflation-unemployment relation found in the data.
Rethinking Macroeconomic Policy BLANCHARD, OLIVIER; DELL'ARICCIA, GIOVANNI; MAURO, PAOLO
Journal of money, credit and banking,
September 2010, Volume:
42, Issue:
s1
Journal Article
Peer reviewed
Open access
The great moderation lulled macroeconomists and policymakers alike in the belief that we knew how to conduct macroeconomic policy. The crisis clearly forces us to question that assessment. In this ...paper, we review the main elements of the precrisis consensus, identify where we were wrong and what tenets of the precrisis framework still hold, and take a tentative first pass at the contours of a new macroeconomic policy framework.
In the 1970s, large increases in the price of oil were associated with sharp decreases in output and large increases in inflation. In the 2000s, even larger increases in the price of oil were ...associated with much milder movements in output and inflation. Using a structural VAR approach, Blanchard and Gali (in J. Gali and M. Gertler (eds.) 2009, International Dimensions of Monetary Policy, University of Chicago Press, pp. 373–428) argued that this reflected a change in the causal relation from the price of oil to output and inflation. They then argued that this change could be due to a combination of three factors: a smaller share of oil in production and consumption, lower real wage rigidity, and better monetary policy. Their argument, based on simulations of a simple new-Keynesian model, was informal. Our purpose in this paper is to take the next step, and to estimate the explanatory power and contribution of each of these factors. To do so, we use a minimum distance estimator that minimizes, over the set of structural parameters and for each of two samples (pre- and post-1984), the distance between the empirical SVAR-based impulse response functions and those implied by a new-Keynesian model. Our empirical results point to an important role for all three factors.
The State of Macro Blanchard, Olivier
Annual review of economics,
01/2009, Volume:
1, Issue:
1
Journal Article
Peer reviewed
For a long while after the explosion of macroeconomics in the 1970s, the field looked like a battlefield. Over time, however, mainly because facts do not go away, a largely shared vision both of ...fluctuations and of methodology has emerged. Not everything is fine. Like all revolutions, this one has come with the destruction of some knowledge, and it suffers from extremism and herding. None of this is deadly, however. The state of macro is good.
To understand the diverse impact of the crisis across emerging market countries, we explore the role of two shocks—the collapse in trade and the sharp decline in financial flows—in the transmission ...of the crisis from the advanced economies. We first develop a simple open economy model, which allows for imperfect capital mobility and potentially contractionary effects of currency depreciation due to foreign debt exposure. We then look at the cross-country evidence. The data suggest a strong role for both trade and financial shocks. Perhaps surprisingly, the data give little econometric support for a central role of either reserves or exchange rate regimes. We end by presenting case studies for Latvia, Russia, and Chile.
PDF
