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Possible theoretical developments
In the upcoming period, feverish endeavor is ahead economists. In particular in macroeconomics, new models are possible to be developed. In some macroeconomic models, financial sector does not take place even as a detail. Considering what the earthquake in financial sector put world through, this approach must lose ground.
Obviously, economic units do not know what the value of variables they consider when making consumption and investment decisions will be over their decision horizons. Therefore, they set expectations. There are various models on how these expectations are set. But, currently they are proven deficient. However, important economic policy decisions are made on the basis of these deficient models. So, probably we will witness new searches in this area.
Monetary policy is also prone to new developments. Before the crisis, how bubbles in asset prices would be dealt with was one of the issues discussed widely. Former FED Chairman Greenspan is criticized extensively for his role in the emergence of the factors leading to the crisis. He must have forecasted what he will be faced with in advance; see what he says in the inauguration speech of an important annual conference participated by academics and central bank officials, in 2002:
"Since the mid-1990s ...the Federal Reserve considered a number of issues related to asset bubbles. --that is, surges in prices of assets to unsustainable levels. As events evolved, we recognized that, despite our suspicions, it was very difficult to definitively identify a bubble until after the fact--that is, when its bursting confirmed its existence. Moreover, it was far from obvious that bubbles, even if identified early, could be preempted short of the central bank inducing a substantial contraction in economic activity--the very outcome we would be seeking to avoid."
Developing policies to tackle bubbles faces two challenges: First, it should be decided whether or not the upward trend in the price of an asset is a 'normal' trend; i.e. whether or not it results from economic fundamentals. If it is a development least related with economic fundamentals, its being a bubble will be a high possibility: Deciding this is too hard.
Let us say that you decided that is a bubble; then comes the second challenge: you have to think through on how to burst that bubble and how to do this giving the smallest damage possible because you are to take a highly risky policy decision.
In the coming period, those studying on monetary policy will work extensively on this issue. Another important field of study for monetary theorists will definitely be the future of inflation targeting. Inflation targeting is already faced with important criticisms. It will either be renewed and strengthened in the face of these criticisms, or it will lose functionality and lose ground as monetary targeting, which was once the most popular monetary policy regime, did.
For now, the second possibility seems week. Inflation targeting regime has aspects to be discussed on also in our terms. Among these, the most important is as to whether an inflation targeting regime that takes into account competitiveness of Turkey can be devised. I have opened this issue to discussion at this column before the emergence of the global crisis. Considering the low level of inflation and given that Turkey's exports do not reflect a bright picture for the future, it is wise to initiate this discussion.
The second issue that should occupy the agenda in countries like Turkey is the dependence of monetary policy on developments in developed countries. In particular interest rate movements in developed countries and changes in the risk appetite of financial investors affect the monetary policy decisions taken in 'our countries'. We have to make effort to reduce or manage better this interaction.
This commentary was published in Radikal daily on 30.08.2009