Rethinking Macroeconomics from the perspective of the Millennium Development Goals in the Post-Crisis Era

Posted by Anis Chowdhury on 7 June 2010


Rethinking Macroeconomics from the perspective of the Millennium Development Goals in the Post-Crisis Era


Anis Chowdhury and Iyanatul Islam [1]



The triple crises – the financial crisis of 2007-2008, the Great Recession of 2008-2009 and the energy and food price shocks - have pushed an estimated 200 million more people into extreme poverty.  Such an outcome, while transient at this point, could easily become a more persistent feature of the global economy if broad-based and sustainable recovery does not take place. It is against this sombre prospect the world leaders are meeting this September at the United Nations to review the progress on Millennium Development Goals (MDGs) after two decades since their adoption and to consider actions needed to attain the Goals by the target year of 2015. The report of the UN Secretary General for the forthcoming MDG Summit notes that macroeconomic policies should not narrowly focus on debt stabilization and curbing inflation, but should ultimately support growth of real output and employment. The G20 Summit of Labour and Employment Ministers in April, 2010 also endorsed the notion of putting ‘employment and poverty alleviation at the centre of national and global economic strategies’.[2] This is a rethinking of macroeconomics that is currently underway on various fronts, even within such institutions as the International Monetary Fund (IMF) and the World Bank (WB) which are generally believed to be guardians of pre-crisis orthodoxy.[3]


This note proposes that the new development oriented macroeconomics should use MDG target 1B (‘full and productive employment and decent work for all’) as an anchor. Both monetary authorities and finance ministries in low and middle income countries can make a credible commitment to the attainment of the MDG 1 target IB by incorporating it in their operating guidelines within a framework of price stability and fiscal sustainability. Governments’ commitment to MDG 1B should also be enhanced by ratifying ILO convention No.122 where such ratification has not taken place.[4]  


One possible consequence of making a political commitment to full and productive employment without forsaking macroeconomic prudence is reduced incentives for central banks and finance ministries to be preoccupied with attaining low, single digit inflation and predetermined fiscal targets. In the case of central banks, this would mean identifying ways in which one can enhance equitable access to finance for small and medium-sized enterprises (SMEs) that represent a major source of job creation.[5] In the case of finance ministries, this would mean finding non-inflationary sources of finance – such as raising tax-to-GDP ratio in cases where the tax burden is low - to support much needed public investment in infrastructure.


Current state of rethinking


One can detect a number of strands, ranging from a more radical overhaul to incremental changes. For example, Sachs (2009) proposes that “The new macroeconomics must be structural – concerning itself with poverty, education, food, energy, and climate over the CPI – if we are to find our way to sustainable recovery and development” (p. 8).[6] At the other end of the spectrum, Blanchard et al (2010), in their much-noted paper on ‘rethinking macroeconomic policy’, emphasise incremental adjustments rather than a radical overhaul of the conventional framework.

Blanchard and his colleagues at the IMF do not explicitly discuss the case of developing economies. Sachs’ proclamation to link macroeconomic policy to long-term development concerns is certainly valid, but it takes the agenda away from key macroeconomic aggregates pertaining to employment creation, price stability and fiscal sustainability and hence may seem overly ambitious.


Thus, our proposal to use MDG 1B (full and productive employment) as an anchor for macroeconomic policies seems more pragmatic and in tune with the challenges facing the global development agenda in the post-crisis ear. Adoption of MDG 1B as the goal will have several implications for macroeconomic policy framework.


Monetary and exchange rate policy


Be prepared to be flexible when setting inflation targets. Much of the importance placed on fighting inflation stems from the hyperinflation in several Latin American countries in the wake of the debt crises of the 1980s. But episodes of hyperinflation are rare in history, and only occur in extreme economic and political circumstances. At the same time, there is no evidence that moderate inflation in the range of 5-15 per cent harms growth. Nor is there any convincing evidence that inflation necessarily accelerates to hyperinflation even if it exceeds 20 per cent.  Empirical and historical experiences suggest that as a rule of thumb, this could be set at 10% or close to it.[7]  


Take account of asset price inflation.  This is a direct consequence of the global recession of 2008-2009 that was triggered by the bursting of the housing price bubble in the United States that began to form in the mid-1990s. A number of commentators have argued that the monetary authorities ignored the formation of asset price bubbles even as they were successful in maintaining a low inflation environment. Hence, monitoring asset price bubbles and preemptively dealing with them is now seen as a core function of central banks in reducing the probability of financial crises and thus avoiding the enormous losses in output and employment that flow from them.


Take account of ‘supply-side’ sources of inflation. The role of ‘global forces’ in influencing domestic inflation should be explicitly acknowledged. A classic case is the food and energy price shocks that badly hit developing countries in the late 2000s just before the onset of the global recession. Central banks should refrain from using the policy interest rate to deal with such supply side forces. Interventions by the government to enhance food security represent much more appropriate responses.


Focus on real exchange rate stability. This point has been argued by a number of macroeconomists and by UNCTAD.[8] Such an approach moves away from the so-called ‘corner solutions’ on exchange rate policy that became fashionable after the 1997 Asian financial crisis.[9] In the case of developing economies that have attained a significant degree of trade and financial integration, the real exchange rate plays a key role in driving export growth, structural change and employment creation. Country-level experiences suggest that the implementation of inflation targeting can lead to painful trade-offs because the use of a single instrument (the policy interest rate) makes it difficult for monetary authorities to simultaneously meet the twin targets of low, single digit inflation and real exchange rate stability.[10]


Actively manage the capital account. This will enhance governments’ policy space to cope with global economic volatility.[11] The increased importance of equity flows has increased the effective scope for capital account management. A capital account can be open to equity flows, especially for FDI, but closed to volatile short-term flows or to excessive external borrowings by the private sector.


Monetary and exchange rate policies should play a supportive role for development activities and counter-cyclical measures. This means more active coordination between fiscal and monetary authorities and limiting central bank independence.  Confidence of the private sector in macroeconomic policies rests more on the credibility of the government’s commitment to counter-cyclical measures and long-term development, rather than on having a fixed low inflation target. While central banks can use the traditional instrument of interest rates (or instruments such as reserve requirements) attain a moderate rate of inflation, specialized credit regulation can be a second instrument for employment creation and poverty reduction.


Fiscal Policy


Fiscal policy must be dominant at all times, not just when monetary policy loses its effectiveness. The orthodox approach was unable to attenuate the marked pro-cyclical nature of macroeconomic policies in developing countries. The basis for professional bias against discretionary fiscal policy is the Ricardian equivalence or the crowding out thesis. However, the empirical evidence in favour of the either was weak.[12] Even in very open developing economies, the fiscal multiplier is found to be non-zero (0.70 – 0.75).[13]


Public expenditure must give priority to primary health-care, universal basic education and infrastructure. Both the level and composition of government expenditure can have significant impacts on growth, poverty and inequality.[14] It means abandoning the narrow concept of “sound” finance. Instead, the concept of “functional” finance, which evaluates government finance based on its impact, should be adopted.[15] This means debt will be sustainable if government expenditure is both productivity- and growth-enhancing.


Create and expand fiscal space. There has to be a renewed commitment to domestic resource mobilization in developing countries. They should accumulate fiscal resources during boom periods and use such resources to finance expansionary policies or targeted interventions during downturns. The goal is to create the necessary fiscal space to sustain investments in human capital and basic infrastructure across business cycles and to scale up passive and active labour market policies (such as job guarantee schemes) as well as social protection to minimize the impact of external shocks on poverty.


The government must assume responsibility as an “employer of last resort”.[16] This is the only credible way to commit to MDG 1B and ILO convention No. 122. This could include various job guarantee schemes ranging from rural public works to professional jobs subsidised by the government. If governments are forced to bail-out big businesses and banks, they can at least make their support contingent on maintaining employment levels. Workers are less likely to become demoralised and deskilled due to lay offs, while employers do not have to look for skilled workers or retrain them when the economy rebounds.


Concluding remark


After decades in which orthodox macroeconomics held sway and the notion of full employment became marginalized in the operational guidelines of central banks and finance ministries across the world, there is a case for rethinking macroeconomics. With the achievement of MDGs by 2015 at stake, there should be a renewed commitment to full employment as a core goal of macroeconomics within a framework of price stability and fiscal sustainability. The place to start is to MDG target 1B the anchor for macroeconomic policies.




[1] Iyanatul Islam begin_of_the_skype_highlighting     end_of_the_skype_highlighting, 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 any of its agencies/funds/programs.

[2] G20 Labour and Employment Ministers’ Recommendations to G2O Leaders’, April 21, 2010, Pittsburg

[3] Blanchard, Oliver, David Giovanni and Paul Mauro (2010) “Rethinking Macroeconomic Policy”, IMF Staff Position Note (SPN/10/03). White, William (2009:15) “Modern Macroeconomics is on the Wrong Track”, Finance and Development, December.

[4] This is the employment policy convention No.122 which was promulgated in 1964. It calls for ‘aims to stimulate economic growth based on full, productive and freely chosen employment’. So far, 101 countries have ratified the convention. ILO (2010) General Survey Concerning Employment Instruments, Geneva: ILO

[5] Business environment surveys (covering 10,000 firms in 80 countries) consistently show that lack of bank finance is one of the most important constraints on the growth of SMEs. de Ferranti, David and Anthony Ody (2007) “Beyond Microfinance: Getting Capital to Small and Medium Enterprises to Fuel Faster Development”, March, Policy Brief No.159, The Brookings Institution.

[6] Sachs, Jeffery (2009) “Rethinking Macroeconomics”, Capitalism and Society, 4(3), Article 3.

[7] A number of studies highlight a non-linear relationship between inflation and growth, implying that as inflation increases from a very low rate, this is associated with faster growth. Khan, Mohsin and Abdelhak Senhadji (2001) “Threshold Effects in the Relation between Inflation and Growth”, IMF Staff Papers, 48(1):1-21. Some studies suggest that, in the case of many African countries, the very low inflation environment that prevailed in the 2000s was associated with actual output being below potential output. See Njuguna, Angelica and Stephen Karingi (2007) “Macroeconomic Policy Space and African Economies: An Empirical Sifting Through Rhetoric and Reality”, Paper prepared for the African Economic Conference (AEC), Addis Ababa, 15-17 November, Ethiopia

[8] Epstein, Gerald and Erinc Yelden (2008) “Inflation targeting, employment creation and economic development: assessing the impacts and policy alternatives”, International Review of Applied Economics, Vol. 22(2):131 – 144;  Frankel, Jeffery (2010) “What’s In and Out in Global Money”, Finance and Development, September; Frenkel, Roberto and Martín Rapetti (2010) “A Concise History of Exchange Rate Regimes in Latin America”, April, Washington D.C: Center for Economic and Policy Research; UNCTAD (2010) “Global Monetary Chaos: Systemic Failures Need Bold Multilateral Responses”, Policy Briefs No.12, March

[9] The advocates of ‘corner solutions’ argue that developing countries should either go for fully floating or fully fixed exchanged rates. Maintaining real exchange rate stability means active management of the nominal exchange rate either through rules or discretion. UNCTAD favours the use of a ‘constant real exchange rate rules’ (CRER) in which nominal rates are automatically adjusted on the basis of inflation differentials between a country and its major trading partners..

[10] Frankel (op.cit), Epstein and Yelden (op.cit)

[11]Even the Bretton Woods institutions do not now look at capital account restrictions so unfavourably as they used to a decade or so ago. World Bank (2009). Global Monitoring Report 2009: A Development Emergency. Washington, DC: World Bank: 47-48)

[12] See Richard Hemming, Michael Kell and Selma Mahfouz (2002) “The Effectiveness of Fiscal Policy in Stimulating Economic Activity – A Review of Literature”, IMF Working Paper 02/208. 

[13] Ilzetzki, Ethan, Enrique Mendoza and Carlos Vega (2009), “How big are fiscal multipliers? New evidence from new data”, 1 October,

[14] See Domar, Evsey (1944) “The ‘Burden of the Debt’ and the National Income”, American Economic Review, 34: 798-827).

[15] See Lerner, Abba (1943), “Functional Finance and the Federal Debt”, Social Research, vol. 10(1): 38-57.)

[16] See Beveridge, William (1945)The Full Employment in a Free Society. New York: W.W. Norton & Co. for the original idea. For an analysis of its applicability in developing countries, see Randall Wray (2007). “The Employer of Last Resort Programme: Could it Work for Developing Countries?”. Economic and Labour Market Paper No. 7, Employment Analysis and Research Unit, ILO, Geneva.