Thinking Beyond the Crisis: Themes from the IMF’s 10th Annual Research Conference

By Olivier J. Blanchard 

We celebrated the 10th anniversary of the IMF’s research conference with an outstanding group of presenters and a record number of participants. The main topic of this year’s conference was “Financial Frictions and Macroeconomic Adjustment.”

Two days of scholarly exchange among researchers and policymakers focused on various themes related to the crisis. I’ve summarized here some of these themes along with their implications for future research.

1.      Household leverage played a critical role in shaping the dynamics during the current U.S. recession. The first paper of the conference provided convincing evidence that the U.S. counties where household leverage had grown the most during the boom were also the ones that experienced the largest busts as measured by home prices, defaults, auto sales, and unemployment. Future research should focus on the policy implications of these findings, especially in the context of the role of monetary policy in mitigating the adverse effects of asset bubbles. 

 

U.S. counties where household leverage had grown the most during the boom were also the ones that experienced the largest busts (photo: Aurelia Ventura/La Opinion)

2.   New insurance mechanisms are needed for the prevention of , and responses to,  financial crises. The Mundell-Fleming lecture by Ricardo Caballero (MIT) drew a striking parallel between a sudden cardiac arrest and a financial crisis. The best option during a sudden cardiac arrest is to use a defibrillator. Ricardo argued that, using the analogy between the two events, we need to have “financial defibrillators” readily available during financial crises as well. It is beyond the scope of this blog to discuss the pros and cons of the clever insurance mechanism Ricardo designed, but it is obvious that we need to undertake more research to develop alternative mechanisms and clearly articulate their practical implications.

3.      Balance sheet adjustment has come with reallocation of assets across financial players. One of the conference papers focused on the buying and selling of asset-backed securities during the current recession. It reported that sectors dependent on repo financing, including hedge funds and broker dealers, reduced their holdings of such securities, while the commercial banking sector increased during the past two years. While acknowledging the imprecise nature of these findings, the paper argues that  government financing helped commercial banks  absorb asset-backed securities. The greater message of the paper is that it is necessary to delve deeper  into the details of the data in order to undertake a rigorous analysis of balance sheet adjustment. We need more of this type of research in order to have a better grasp of balance sheet adjustment over the business cycle.

4.      Global banking flows play a critical role in the spread of the crisis. Another paper showed how large banks, both in the United States and elsewhere, had created and sold short-term asset backed securities worth more than one trillion dollars, and used the proceeds to invest in longer term assets. When the crisis came, these banks had to adjust, and this adjustment process determined how the crisis spread around the world. Global banks, not global imbalances, the paper concludes, are what led to the rapid spread of the crisis.

5.      Debt overhang can have major macroeconomic effects. One of the conference papers presented a nice theoretical analysis of the interactions between debt overhang problems in the household and banking sectors. If households are underwater, consumption and saving decisions are no longer efficient. If banks are underwater, financing of new investments dwindles. The interactions between these can amplify shocks and prolong downturns. The paper argues that government bailouts of financial institutions can improve economic efficiency, but as the discussion of the paper makes it clear we now need more than ever good quality research about the policy implications of debt overhang.

6.      There are two-way linkages between the dynamics of financial intermediaries’ balance sheets and fluctuations in asset prices. Another conference paper explained how financial intermediaries’ balance sheet management can amplify asset price movements. Balance sheet positions of intermediaries determine their risk appetite, which in turn affects the supply of credit. Although monetary policy can influence the supply of credit through its impact on financial intermediaries’ balance sheets, our knowledge about the quantitative implications of different policy actions through this channel for the real economy is still in its infancy.

The conference also featured lively debates about the effectiveness of various policy interventions that took place during the crisis. These debates were a part of a broader discussion, triggered by the financial crisis, among economists about of the state of macroeconomic research over the past year. The climax of these debates took place at the concluding session of the conference, which featured an Economic Forum onMacro-Financial Policies After the Crisis.”

As the Managing Director observed in his opening speech, one of the most important lessons we learned from the crisis is that we need to have a much better understanding of macro-financial linkages. This requires us to undertake rigorous, policy relevant research in both academia and research institutions around the world. This year’s Annual Research Conference provided an excellent collection of research papers serving exactly this purpose.

I thank the presenters, discussants, and participants for making the conference a great success.

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