Person:

Tucker, Paul

I have been asked to write something about the appropriate institutional structure for monetary, macroprudential and fiscal policies in an environment of persistently low interest rates. That is one important plausible scenario the macroeconomic regime needs to be capable of coping with, but not the only one as we are being reminded by recent inflationary cost shocks and excess demand. There are others too, such as banking crises.

At a high level of abstraction, we can say two things about institutions in general, and so about policy regimes. First, they must be incentive compatible for the key actors; incentive-compatible things happen, incentive-incompatible things do not. Second, they must be values compatible, by which I mean that they must be compatible with the deep political values that animate a state's highest-level institutions. Otherwise, economic institutions will not be resilient in the face of disappointments, setbacks and unreasonable demands.

Adding a legitimacy test to economists' more familiar mechanism-design demands means addressing the division of labour between elected and unelected power. It cannot simply be a case of allocating the various parts of a benign social planner’s optimal plan to whichever organs of the state are most capable of executing each of them. That banal thought matters because central banks’ latent capabilities are extraordinary.

Powerful states should avoid using their power and international organisations they dominate to prescribe general measures to developing-economy states because we have not yet overcome our own obvious problems. Doing so also harms our position in the world. Good policies can speak for themselves. We can usefully try to describe our mistakes, problems, and what we think we have learned. There are important illustrations in the 2022-23 inflationary and banking problems. They are rooted in moral hazard within and across organs of the state, which are problems still largely ignored within political economy and science.