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Unedited Transcript
Pedro da Costa: Hi, I'm Pedro da Costa, Editorial Fellow here at the Peterson Institute for International Economics. I'm joined by Olivier Blanchard. He's a Senior Fellow here and till recently former Chief Economist at the IMF. Thank you for joining me.
Olivier Blanchard: Pleasure.
Pedro da Costa: So, we're here to discuss your latest policy brief, which is a kind of assessment of the state in play in advanced economies and there's been a lot of debate surrounding this issue. Because at first, everyone thought that economies had slowed as a product of the financial crisis and its aftermath, and now enough time has elapsed that everyone fears that that slowdown has become more permanent. What's your view in that debate?
Olivier Blanchard: So, I think at the beginning just after the crisis, the acute part of the crisis it was easy to explain why things were improving slowly. There were all kinds of reasons, fiscal austerity, banks in bad shape and so on people scared. Five years out, it's a bit more difficult. So we have to look for something else because indeed demand is weak. And so, I think the explanation is just in front of us, which is that what has happened is that productivity GOF has been dismal and it looks as if it's likely to be quite bad in the future.
So, I think what's happening now is that the breaks are not the result of the past and the result of what we see when we look forward. We see a mediocre future. This leads us to consume less maybe or to adjust consumption plans down. It leads firms to revise investment plans. And so, I think, that's a source of weakness.
So, in just one sentence, productivity GOF is both reasons for being worried about the future, but also an explanation for why we are not doing so well today.
Pedro da Costa: Sure. And so, in the context of your paper, you talked about the various policy tools available to the economic authorities and of course, you delve into the debate about how much more room that exist in monetary policy. And actually, monetary policy, it's generally agreed that it was very useful and now as an immediate response to the crisis that it saved us from a second great depression, but has it proven perhaps, a less useful tool in getting us out of the low-growth rut that we've been in. How close to the limit are we on how much countries can do on monetary policy?
Olivier Blanchard: I think we can use it more but it's likely to come with increasing collateral damage. In that note, I go into an example, which is when the Fed, for example, wants to buy long-term bonds, long maturity bonds. Initially, it's going to buy them from people who don't care too much about whether they have 5-year bonds or 7-year bonds or 10-year bonds. So, these people are going to be willing to sell without the price having to increase much, which is going to work, but not very well.
As you keep going, you buy more and more from people who really want say 10-year bonds. There is a good reason why they wanted to have those and to get them to sell it; you have to offer a good price, which means that you're low yield. So which means actually that monetary policy works kind of better and better the more you use it, that kind of asset purchase monetary policy. So that's the good part.
So I think people will say, "We are decreasing returns," just missed the boat. At the same time, you have to look at the other side, which is that there was a reason why these people were holding 10-year bonds, presumably it was ahead kind of 10-year liabilities on the other side. Now, they had been willing to sell it to you because the price was right, but they're much more exposed, so you've increased their risk, which is one example. But I think the more you use monetary policy, that kind of monetary policy, the more it works. At the same time, the more risk it creates.
The other channel is clearly as we go into negative rates, you do things to the profits of banks, so that you have direct effects on demand, you have indirect effects on the health of banks, this may lead to contraction in credit supply. Again, there's a limit here.
Bottom-line, I don't think we are at the point where we should stop doing it but it's clear that there's not an infinite margin to use.
Pedro da Costa: Sure. What's interesting is that it's almost taken getting to those outer boundaries of monetary policy for these tools of fiscal policy to even come back into the fold as a viable alternative in advanced economies. Is this tool little too late? I mean, shouldn't this discussion—shouldn't the two tools have ideally been applied collectively or together?
Olivier Blanchard: Yes. But then I think there was a -- it's a good question. I think there was a trauma due to the large increase, the initial use of fiscal policy, which came because I think policymakers were so scared in 2009 then they would have done anything. So, they had much larger deficits, which was the right thing to do but the result was an increase in debt. And then, I think that was kind of for--
Pedro da Costa: Stick or shock phenomenon.
Olivier Blanchard: Yeah, exactly, stick or shock or terror and the notion that then was very high and so then the motto was fiscal austerity. We should have had--we tried to have more intelligent discussion, but that was not the time. I think it was important part, we have the time to show that we were not going to continue to have enormous deficit, but we probably went much too far, the other way like these policymakers did.
Now that the recovery is slow that monetary policy is coming to not its limits, but doesn't maybe not going to be used as much. Then the discussion is coming back.
Pedro da Costa: Yeah.
Olivier Blanchard: Yeah, too late. But better, still [overlapping conversations 00:05:48] better.
Pedro da Costa: And so, of course, you're probably responsible for pushing the needle a little bit in that direction.
Olivier Blanchard: Not enough.
Pedro da Costa: And, well, now that we're here, what countries do you see as having room to act and what countries are kind of in the neutral range in the advanced world?
Olivier Blanchard: So, I think there are many countries, which have room to act. And many countries which have a need to act. So I think if you take the US, we're probably more or less back to where we want to be so there is no need for a major fiscal expansion. But at the same time, public infrastructure is in disarray and so we should probably have more public investment, finance probably by that.
If this happens, that might take the economy above potential output increase demand not the end of the world. This will allow the Fed to increase interest rates to have a much more balanced recovery. So even in the US, where there's not a big output gap may make sense to do it.
In Europe, surely there are needs as well and there's an output gap, so I think there the case is stronger but then the point is they are starting from very high levels of debt. And so, people say, "Well, if you're going to spend more and increase debt, investors are going to stop pointing to hold your bonds, you're going to have large spreads."
I don't think that's right. I mean, if you take Spain or take a country which has a debt to GDP ratio of above 100%, at this stage, investors don't seem to be very worried and actually they are right because the interest burden, which is the interest times the debt is relatively low. But they have concluded that Spain is qualitatively responsible. The debt is high, it's not great, but they are willing to hold Spanish debt at very low spread.
Now, suppose the Spanish government comes and says, "We have all these public investment projects. We could do infrastructure investment." They make sense, they are going to increase growth, they are going to make the budget better in the future. And we're going to maybe do 2% more of GDP for two years, which means that if everything goes well given the multipliers, output will increase. So this would increase debt from say 120% to 122%. I'm an investor. At the 120%, I was happy. At least I was not worried. I've heard that this goes and I see that that will be 122%, I'll still be fine.
So, I think that if you choose the projects, which makes sense, which do something to GOF which are needed and you do it in a responsible manner, yeah, you're going to increase debt a little bit, but the markets are now getting to penalize you. Now, if you decide to double the wages of public sector employees, that's a completely different story.
So, the notion of fiscal space is very much--what is this that you do with the money? Nothing.
Pedro da Costa: It has to be spent. So it has to be spent productively in other words.
Olivier Blanchard: Right.
Pedro da Costa: So, as far as the United States is concerned, of course, fiscal policy is going to depend on the outcome of the election, so we won't touch that one. But as far as the Federal Reserve is concerned, what should the Fed be doing? Because there's been a lot of debate about it raising interest rates even though inflation has been below its target for a long time and the unemployment rate while close to full employment is still seemingly undershooting on the other end. What do you think?
Olivier Blanchard: From this, I don't think anybody should have the very strong view. I think there are pros and cons to increasing interest rates and it's probably a 51-49 type situation. So, the way I see it is say go back 10 years and because 10 years ago, we had the macroeconomic configuration that we have today. So, unemployment was roughly at the natural rate, inflation was roughly at target, GOF was roughly a potential GOF. What should the Fed then do?
I think everybody would have said, "Well, your interest rates are very low. It stopped to increase. It's time to increase it." So, that would have been no discussion.
Now, why is the discussion today? I think for two reasons. The first one is hysteresis. This ugly word that I've looked at with --
Pedro da Costa: A notion [overlapping conversations 00:10:20].
Olivier Blanchard: A notion that if you run the economy below potential for a long time, something bad happens more apparently, so some people just lose their jobs, never get a new one, our productivity doesn't increase as much. I think it's symmetrical.
So, I think in a context in which we've had this very long period of output below potential, it may make sense to actually want to run the economy above potential for a while. Do we unfranchise workers who have dropped out to increase productivity maybe beyond what would have happened otherwise. So I think there is a good argument for that. Come prove it, but I think that the odds that this would work are fairly good.
The other is the discussion, which has taken place between say Larry Summers and Janet Yellen, which is that we'll get a recession at some point in the future. No reason to think it's going to come now, but it's going to come, and we want to be ready to actually kind of be ready for it. And, given the current rate of inflation, there is not a whole lot of room.
So, if we get the economy to overheat a bit, first, it decreases the risk of a recession in the short run and it will lead to high inflation rate, which means that when the recession comes, we'll have more room to play with. We'll be better able to deal with the recession. So, this inflation is an insurance policy against the recession.
Now, I can see how some people would say, "Well, in 2007, this is what we would have done with those data and let's just increase the rates." And I can see people on the other side saying, "Well, it's worth taking the risk of going a bit above." I myself would go a bit above but I can understand the other side.
Pedro da Costa: Thank you so much. Little wonder we had the three of dissents in the last minute, so certainly it's [overlapping conversations 00:12:13].
Olivier Blanchard: Exactly. I actually think--so that's an interesting comment. I don't know if you want to discuss this.
Pedro da Costa: Absolutely.
Olivier Blanchard: But it is presented as an issue, there are now dissenters and my sense is that's actually a very good development because in a situation like this, what you would expect is that is there is a distribution of use at the FOMC and it moves. But this means that there are some people who work enough against it and are going to be for it. And the fact that three people dissent it is giving the market the indication that probably next time there'll be more people and the chair will change her position. It will not change, but it will change her position.
And so, I think it gives a much smoother signal. It should not be presented as Janet has lost three votes. It should have been presented as, well, that is an evolution. And clearly, this tells us that it's more likely to happen next time and it's a good thing.
So, again, I think the Fed could do a much better PR on that than they do and I think it's very healthy to see dissenters.
Pedro da Costa: Well, thank you so much for your time, I appreciate it.