IMF Bursts Its Own Bubble

February 13, 2010

Blanchard, tells it like it is

According to the Guardian’s Richard Adams, the IMF has announced a “stunning” turnaround in its views on inflation. Apparently, “Olivier Blanchard, the IMF’s chief economist, now suggests that higher inflation, help for the poor and greater government involvement might do a better job helping protect countries from financial turmoil” while “new set of policies includes the need for active intervention to puncture dangerous asset bubbles, such as occurred in the housing market.”

Such ideas would once of been seen as heresy. The IMF spent decades building a consensus within its ranks that inflation was anathema – to be avoided and suppressed at all costs (so to speak). Governments around the world followed suit, echoing the mantra that low inflation was the way to achieve economic growth and stability, with Gordon Brown chief among them. The EuroZone stipulated an inflation target of just 2 percent, leaving its members little wriggle room in monetary policy.

But now, as Adams reports, the IMF “reassement most controversially includes the possibility of raising the target for consumer price inflation to around 4%, rather than the 2% level that policymakers, including the European Central Bank, Bank of England and UK Treasury, have adopted.”

Despite boasting of conquering boom and bust by keeping inflation low, Brown’s theory is being abandoned by what was the world’s pre-eminent supporter of such views. Viewing the catastrophic effects of such policy, Blanchard now notes that “Higher average inflation, and thus higher nominal interest rates to start with, would have made it possible to cut interest rates more, thereby probably reducing the drop in output and the deterioration of fiscal positions.”

That is, policies focusing on low inflation accentuated the economic fall when asset bubbles burst, achieving the precise opposite of what was claimed. It made the crisis, when it came, far, far worse.

What Blanchard is hinting at, however, is not a crystal-clear alternative to monetary orthodoxy. His ideas are merely the starting point for a “debate” within the IMF and those who take their lead from it, on the effects of low inflation-centred policy making. He is merely gesturing in the dark – betraying how little we know about how to make “macroeconomic” policy which ensures stability. He is, in short, outlining the nature of capitalism, which guarantees periodic slumps and crises – and there is no known macroeconomic cure for this.

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