Jubilee Justice

At IMF, the hunt for a new consensus

By Howard Schneider
Washington Post Staff Writer
Monday, March 7, 2011; 10:43 PM 


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.

That view is now changing amid broad acknowledgment that countries in the developing world performed well during a crisis that originated in the United States. The IMF is developing guidelines for those economies to use "capital controls" as a way to buffer themselves from the damaging impact that large, rapid movements of money can have on prices, currency values and other aspects of the economy.

It is just one way that what Guillermo Ortiz, Mexico's central bank governor, referred to as the "Anglo-Saxon concept" of economic policy needs to be adapted to a more diverse and globalized world.

"We really believed that the people of the developed world managing the world economy knew what they were doing," Ortiz said.

There was also a general sense that central banks such as the Federal Reserve need to take a more activist approach - concerning themselves not just with inflation, unemployment and interest rates, but with broader efforts at keeping the economy and financial system stable.

That, and some of the other ideas under discussion, may prove politically difficult to enact, something that the economists in the two-day meeting acknowledged. University of California at Berkeley economist David Romer, among others, noted that U.S. politicians were not leveling with citizens about issues such as the long-run need to curb public debt or about the amount of economic stimulus that might be needed to meaningfully bring down unemployment in the short run.

Neither, said Columbia University professor and Nobel Prize winner Joseph Stiglitz, is there any guarantee that the old orthodoxy won't resurface.

While there is "broad understanding" about the need for more regulation and more government and central bank oversight, "the big issue is whether policy will go back to the way it was but with a bit more rhetorical flourish," he said. Stiglitz added that anyone with faith in regulatory efforts to date, including the recently enacted Dodd-Frank legislation, "has to be on another planet."