“At the Fund, I am confronted every day with literally dozens of questions, the answers to which have clear policy implications.”

Olivier Blanchard is the chief economist at the International Monetary Fund. He earned his Bachelor at Paris Nanterre University, and Ph.D. in Economics at Massachusetts institute of Technology in 1977. He taught at Harvard University until 1982 before returning to MIT as a professor. He is currently on leave from MIT, as Economic Counsellor and Director of the Research Department of the IMF.

Blanchard is one of the most cited economists in the world and has worked on a wide set of issues, from the role of monetary policy, to the nature of speculative bubbles, to the nature of the labor market and the determinants of unemployment, to transition in former communist countries. He is a fellow and Council member of the Econometric Society, a past vice president of the American Economic Association, and a member of the American Academy of Sciences.

When and why did you decide to become an economist? Has your view on the role that economists should play in the world changed throughout your career?

In 1968. like many students of my generation, I wanted to change the world… and I thought that, of the social sciences, economics was the discipline most likely to be directly useful. I did not have a clear view of what economics was about, or what economists actually did. I got a better sense of both during the PhD program at MIT.

As to what economists should do, I believe there is a large range of options, depending on comparative advantage. Some have the ability to construct powerful abstractions and have a comparative advantage in doing theory. Others instead have the ability to do detailed and painstaking empirical work. Yet others live somewhere between the two, developing simple frameworks to interpret facts. I would put myself in that last category.

My view has not evolved much. I have, however, followed what I see as a fairly natural life cycle. I started closer to (low brow) theory, and became increasingly interested in policy issues. I think the cycle makes sense. One of
the characteristics of my current job is that I am confronted with too many issues and too little time to think about them. This forces me to run largely on intuition. Hopefully, this intuition is based on the more academic work that I did during the three decades earlier.

Having experienced both sides of the life of a distinguished economist, the life in academia as a faculty member at MIT and the life in policy making as the chief economist at the IMF, could you tell us which of the two you prefer? What are the advantages and disadvantages of each position?

I like both, but the two are extremely different. In academia, you obsess about one issue, sometimes for years. I worked for years on the last paper I did before coming to the Fund (with Guido Lorenzoni and Jean Paul L’Huillier, which just came out in the AER), trying to solve a simple question: In a world where people and firms are solving a signal extraction problem, and we observe their behavior, can we hope to use time series techniques to recover the shocks affecting the economy? I would wake up every morning, try again, and keep running into walls. It was a frustrating couple of years, but the exhilaration of finally solving it nearly beat anything else. At the Fund, I am confronted every day with literally dozens of questions, the answers to which have clear policy implications. Often, the academic literature does not yet provide an answer. The intellectual challenge is then to build on that literature, and rely on simple extensions, instinct (and a great team) to come to the best possible answer. Not having the time to dig deep is frustrating. But the exhilaration of (sometimes) influencing policy through (hopefully) good economics is just as intense as the one I felt as a full time academic.

The IMF faces particular political constraints as one of the world’s key multinational institutions. Do you believe that if the IMF were free to implement public policies without taking into account these constraints then our economic situation over the last decade would have been better, and the recovery much faster?

Policy makers chosen by the people of their country, not the IMF, run policy. They have their own beliefs, and face their own political constraints. In giving advice, one has to accept that fact. I have seen my job at the Fund as first helping define what I believed was the right economic advice, then (and only then) taking into account political constraints, and finally going on a communication campaign. Sometimes, the campaign is successful, sometimes it is less so.

In the IMF World Economic Outlook of October 2012 you publicly stated that the IMF had underestimated the impact of austerity on growth in the rescue packages implemented in some European countries. What do you think the impact of this underestimation was on the recovery of these countries? After experiencing the reaction of the mass media and of the governments and citizens of these countries, do you have second thoughts about whether such a statement should have been made publicly?

Truth, in macroeconomics, is neither known nor eternal. We, be it the Fund, policy makers, or academics, do the best we can, but keep adjusting our beliefs as we learn. The environment changes, new shocks appear, parameters change. When the crisis started, existing estimates for fiscal multipliers varied widely, and we used those that had proven fairly reliable in the past. Soon after, it became clear that, with monetary policy at the zero lower bound, and liquidity constraints affecting many households, multipliers were in fact larger than we had initially assumed. So we revised them, and drew the right policy lessons. Should we have done this under the radar? I do not think so. I believe that intellectual honesty, which includes recognition of our failings, is an essential part of what gives credibility to the IMF’s advice.

What do you feel are the main lessons that economists should keep in mind from the 2008 financial crisis and the consequent Eurozone debt troubles?

There are so many… I have tried to draw some of them, focusing in particular on policy implications in a couple of papers that I have written (with Giovanni dell’Arricia and Paolo Mauro) since the beginning of the crisis. Let me mention two lessons here. The first and the most obvious is the macroeconomic importance of the financial sector. Before the crisis, many macroeconomists, including me, thought we could, as a first approximation, ignore the details of plumbing in the financial sector. We should have remembered the writings of earlier economists, and we should have known better. The second is what I would call generically nonlinearities. Namely, how small shocks can have large effects, how many small distortions can combine to have large macroeconomic consequences. This has major implications for macroeconomic modeling. Before the crisis, a standard modeling strategy was to start with a general equilibrium model with no distortions, and introduce one or two, for example monopolistic competition and nominal rigidities in the New Keynesian model. If what happens at the macroeconomic level is the result of many small distortions, it is not clear that this remains the right strategy.