Macroeconomic Uncertainty and Policy Credibility
Many factors, including policy uncertainty, can drive macroeconomic uncertainty (Bloom 2009). Several studies document that monetary and fiscal policy uncertainty can have contractionary effects (Fernández-Villaverde and others 2015; Husted, Rogers, and Sun 2020; Beckmann and Czudaj 2021; Mumtaz and Ruch 2023). This box examines whether rules-based frameworks, or strengthening of policy frameworks more generally, can reduce policy uncertainty
Monetary Policy
Early proponents of monetary policy rules (Henry Simons, Lloyd Mints, Milton Friedman) argued that reducing policy uncertainty and its adverse effects on the real economy (inefficiencies) was the main benefit of such rules. In their view, inflation expectations were stabilized through reduced policy uncertainty (Dellas and Tavlas 2022).1 Empirical evidence shows that enhanced monetary policy credibility can help stabilize an economy by more firmly anchoring inflation expectations to target levels (Park 2023; Beckmann and Czudaj 2024) and that policy rules can play an important role in reducing uncertainty (Cochrane, Taylor, and Wieland 2020, and references therein).2 More generally, the degree of soundness of monetary policy frameworks (regardless of whether they are strictly rules based) may reduce monetary policy
1The modern (that is, since the late 1970s) literature on rules versus discretion proves theoretically that discretion can generate inefficiencies even if it does not increase policy uncertainty. Although this literature places less emphasis on uncertainty, it does not provide evidence regarding, or argue against, the connection between policy rules and uncertainty; it establishes that weaker theoretical conditions are needed to favor rules over discretion (Dellas and Tavlas 2022). 2Policy uncertainty can also increase when the effectiveness of policies comes into question (Carney 2016). Available evidence indicates that high uncertainty can weaken monetary policy transmission (Castelnuovo and Pellegrino 2018; Lakdawala and Moreland 2024). A more uncertain response of the economy to policy stimulus, in turn, exacerbates policy uncertainty, increasing uncertainty surrounding the extent to which policy instruments will need to be adjusted to achieve policy goals.
uncertainty and its effect on downside risk to GDP growth. Figure 2.2.1, panel 1, shows that countries where inflation expectations deviate more from the policy (inflation) targets experience higher levels of economic policy uncertainty. This result suggests that a weaker policy framework or impaired policy credibility can amplify economic policy uncertainty. In addition, in the context of the growth-at-risk framework, Figure 2.2.1, panel 2, shows that increased macroeconomic uncertainty (real or policy related) has a larger effect on downside risk to one-quarter-ahead GDP growth when policy targets were missed by wider margins over the preceding three years (that is, when monetary policy frameworks were weaker). These results support the view that enhanced credibility and reliance on stronger monetary policy frameworks can mitigate the adverse implications of increased uncertainty for macrofinancial stability.
Fiscal Policy
Similar arguments in favor of fiscal rules and their impact on macroeconomic uncertainty apply to fiscal policy. Several studies have analyzed the effects of fiscal policy rules on policy variables (such as budget balances or debt levels), market variables (interest rates and sovereign risk premiums), and output cyclicality, concluding that fiscal rules can reduce fiscal policy uncertainty, fiscal procyclicality, and market volatility and enhance fiscal sustainability (Reuter 2015). Fatas and Mihov (2006), Badinger and Reuter (2017), and Arroyo Marioli, Fatas, and Vasishtha (2024) document that more stringent fiscal rules can reduce overall macroeconomic volatility (and hence real economic uncertainty).3,4
3Discretionary fiscal policy is prone to deficit bias due to political incentives to delay austerity, leading to excessive deficits and debt (Alesina and Drazen 1991). Fiscal rules can help offset this bias by acting as a commitment device to limiting the government’s incentives to exert discretion (Alesina and Tabellini 1990). 4There is also evidence that increased uncertainty can impair the effectiveness of fiscal policy (Jerow and Wolff 2022; Liu 2023), suggesting that policy responses themselves could become more uncertain, potentially magnifying macroeconomic uncertainty
INDUSTRIAL POLICY COVERAGE IN IMF SURVEILLANCE
BACKGROUND PAPER III: RELEVANCE OF AML/CFT TO OTHER FUND POLICIES
