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Managing macroeconomic risks and protecting the vulnerable
Posted by Anis Chowdhury on 15 August 2010
Managing macroeconomic risks and protecting the vulnerable
Iyanatul Islam and Anis Chowdhury[1]
The manner in which the Great Recession caught most macroeconomists by surprise highlights in a dramatic fashion how relatively long periods of a low inflation environment and short, shallow business cycles as well as the rapid growth of the global economy during 2002-2007 can breed a sense of collective complacency about the future.[2] The community of professional economists and development practitioners now has an obligation to advocate guidelines for improving the management of macroeconomic risks. This note outlines such guidelines that have both prudential and protective dimensions.
Prudential measures to mitigate risks
The objective of a prudential approach is to limit the risk of episodes of financial crises because they produce significant losses of real output and employment. By identifying the common exposures to risks and their systemic nature, a prudential approach would have a better chance of securing financial stability, identifying vulnerabilities and calibrating policy responses than the conventional inflation targeting (IT) approach.
The prudential approach to macroeconomic risk management suggests the following.
Protective measures against macroeconomic risks
Protecting the poor and the vulnerable is crucial in equitably sharing the adjustment costs of macroeconomic crises. This is not just an issue that is germane to only developing and emerging economies. Disaggregated analysis of current unemployment rates in theUS has shown that the global recession has hurt the poor and the near-poor while leaving the affluent largely unaffected.[8] One of the lessons that have been learnt from past crisis episodes is that a well-functioning protective approach to managing macroeconomic risks requires preparedness on the part of governments. This means, in effect, the need to make investments in a social protection system that is both comprehensive and has components that can behave as ‘automatic stabilizers’, with expenditures on social protection rising in a recession and declining in a boom without recourse to discretionary interventions. It is well known that social protection systems in developing countries fall far below this ideal, but even in developed countries key aspects of the social protection system, such as unemployment compensations, are not as comprehensive as they could be.[9] Here is a suggested list of ideas on what needs to be done to implement a well-functioning protective approach to managing macroeconomic risks.
Concluding remarks
In the current re-thinking on macroeconomics that is underway, there is a growing recognition that the low inflation/fiscal prudence approach has underperformed in anticipating gathering financial storms and their long-lived, deleterious effects on the real economy, especially on employment. The most recent estimates show that, based on past crises episodes, it can take 5.5 years for employment to return to pre-crisis levels in developed countries and about 3 years in developing countries to achieve the same outcome. Furthermore, in the case of developing countries, informal employment often increases during crisis episodes. Such increases can take years to reverse.[14] Therefore, much greater attention needs to be given to the management of macroeconomic risks by harnessing a combination of prudential and protective tools. This means installing early warning systems, periodic ‘stress tests’, complementary investments in data collection and dissemination, the use of self-insurance schemes and counter-cyclical policy instruments during booms and normal periods, and the adoption of the agenda of a global social protection floor.
[1] Iyanatul Islam, ILO,Geneva and Griffith University , Australia . Anis Chowdhury, UN-DESA , New York and University of Western Sydney , Australia . The views expressed here are strictly personal and do not necessarily reflect the views of the United Nations or the ILO.
[2] The complacency is captured in the so-called ‘Great Moderation’ hypothesis. Blanchard et al acknowledge this. See See Blanchard, O, Giovanni, D and Mauro, P (2010) ‘Rethinking Macroeconomic Policy’, IMF Staff Position Note (SPN/10/03).See also Bernanke, B (2004) ‘Remarks by Governor Ben S.Bernanke: The Great Moderation’, Speech made at the meetings of the Eastern Economic Association’, Washington D.C, February 20.
[3] Reinhart, C and Rogoff, R (2009) This Time is Different: Eight Centuries of Financial Folly, Princeton andOxford : Princeton University Press
[4] Blanchard et al support the need to for ‘building fiscal capacity in good times’. See also Ocampo, J.A (2010) ‘Symposium: The Return of Counter-cyclical Policy- Editorial Preface’, Journal of Globalization and Development, 1(1), Article 10.
[5] Ocampo (op.cit)
[6] The IMF has now recognised the importance of prudent capital account management. See Ostry, J.D et al (2010) ‘Capital Inflows: The Role of Controls’, IMF Staff Position Note (SPN/10/04), February 19 and the Global Monitoring Report 2009.
[7] See Cordero, J.A and Montecino, J.A (2010) ‘Capital Controls and Monetary Policy in Developing Countries’, April,Washington D.C: Center for Economic and Policy Research.
[8] Sum, A and Khaiwada, I andPalma , S (2010) ‘Labor Market Underutilization Problems of US Workers Across Household Income Groups at the End of the Great Recession’, February, Center for Labour Market Studies, Boston University
[9] See ESCAP (2010) ‘Strengthening Social Protection Systems inAsia and the Pacific in the Aftermath of the Global Financial Crisis’, Macroeconomic Policy Brief No.3, June. For a sample of 30 countries in the region, the median coverage rate by programme (labour market programmes, assistance to the elderly, health care, social assistance, access to micro-credit, assistance to disabled, children’s protection) varies from 57% (social assistance) to 5 per cent (health care). The ILO’s global database for social security shows that unemployment benefits reach less than 60 per cent of the eligible population even in high income countries.
[10] This point is emphasised by Cavallo, E and Izquierdo, A (2009: chapter 1) Dealing with an International Credit Crunch: Policy Responses to Sudden Stops in Latin America, Washington D.C: Inter-American Development Bank. They call it the need to engage in ‘fire drills’.
[11] Department of Statistics, ILO,Geneva .
[12] Kanbur, R (2010) ‘Macro Crises and Targeting Transfers to the Poor,’ Journal of Globalization and Development: Vol. 1, Issue 1, Article 9 explores the traditional theory of targeting and highlights its limitations. He argues for the case of a more comprehensive approach to social protection. See also Commission on Growth and Development (2010) Special Report, Part 5,Washington D.C. The vulnerability of the developing world’s ‘middle class’ (those above USD 2 a day) is analysed in Ravallion, M (2009) ‘The Developing World’s Bulging (but Vulnerable) Middle Class’, World Bank Policy Research Working Paper No.4816. Birdsall, N (2010) ‘The (Indispensable’) Middle Class in Developing Countries’, Working Paper No.207, March, Washington D.C: Center for Global Development, provides new evidence on the middle class using higher standards than the conventional US 2 a day.
[13] ILO (2009) ‘Social Security for All’, Social Security Policy Briefing No.7,Geneva :ILO
[14] International Institute of Labour Studies and ILO (2009; chapter 1) The World of Work Report,Geneva