With this year being the 100th anniversary of the legislation creating the Federal Reserve, there are bound to be many commemorative programs considering issues related to monetary policy in relationship to the 100 years of history that lies behind the aggressive quantitative easing (QE) policies the Fed is now pursuing. This article is the first of three based on recent conferences at the American Enterprise Institute (AEI) on central bank history and policy.
The first conference, titled “Printing Pressure: Global Currency War and the Global Recovery,” on March 18, featured a presentation by Jeffrey Frankel, the James W. Harpel Professor of Capital Formation and Growth at Harvard University’s Kennedy School of Government, who downplayed the notion that there is a currency war by placing it in a historical context of policy choices by governments to seek to maintain weak currencies. Frankel was followed by four experts — two from the public sector and two from the private sector.
Frankel and other commentators have traced the expression “currency war” to a 2010 statement by Brazilian Finance Minister Guido Mantega that such a war had broken out. Other commentators have remarked that the expression must date back much farther, because the resort to devaluations is such an old and common policy among nations.
Frankel explained that the context of the remark included efforts by the United States to enlist Brazil and other countries as allies in its contest with China, but Brazil responded that the dollar was just as big a problem for international financial markets as the Chinese renminbi. Even Frankel referred to the term “competitive devaluation” as describing the widespread practice of devaluation in the 1930s.
Frankel concluded that devaluation is a fairly benign practice if it is working for a given country, one that does not need to be invested with loaded appellations such as “manipulation.” The moderator, AEI’s Desmond Lachman, asked Frankel whether the Fed’s QE policy had encouraged risk-on trades in countries like Brazil and Turkey, which have recently experienced higher inflation that will be complicated by other problems whenever the Fed unwinds this policy. Frankel replied that monetary policy is too easy in Brazil and Turkey, but for reasons unrelated to their choice to follow expansionary monetary policies along with the Fed.
The first commentator, Anne Krueger, a professor of international economics at Johns Hopkins who was previously managing director of the International Monetary Fund (IMF), agreed with Frankel that the United States and other countries have adopted expansionary monetary policies for domestic reasons and not to pursue a currency war with their trading partners.
She raised the issue of fiscal policy and the idea that the source of imbalances comes from the fiscal side. In theory, periods of ease should, in times of slow economic growth, be offset by tighter policies during good times, but the authorities in the respective countries have “forgotten” to do this. She argued that the complaint of Brazil is unwarranted and that Brazil, Turkey and some other emerging countries have been pursuing unbalanced fiscal policies, with the notable exception of Chile.
Rakesh Mohan, an executive director at the IMF and professor at Yale, generally agreed with Krueger, but chose to focus on the roles of capital flows and exchange-rate policy. He reviewed the history of volatility in debt and equity markets over the past several decades as the world experienced the recycling of petrodollars and the Latin American debt crisis in the 1970s, followed by the Asian debt crisis in the late 1990s and what he calls the North Atlantic financial crisis of recent years.
While he agreed that loose monetary policy might be appropriate for countries pursuing domestic policy objectives, he warned that these policies could create increased volatility in capital flows that may need to be dealt with by measures such as stricter regulation of bank lending.
Alberto Musalem, a former official of the IMF who now works for a private hedge fund, agreed with the other panelists that the term “currency war” is “exaggerated and misplaced.” He added that it is “perfectly natural” for the Fed to try to reduce the interest rate on 10-year government securities in order to stimulate demand and improve the performance of the economy.
Musalem suggested that measures such as those Mohan discussed that would manage capital flows should only be used when more conventional tools, such as fiscal and monetary policies, have already been tried. He warned that the adoption of expansive monetary policies by coordinated actions of most of the largest trading blocs has suppressed fluctuations in currencies that should occur and has created artificially low short-term volatility that is fomenting credit imbalances and bubbles.
If the occasion arises where IMF enforcement action might be called for, the institution would be found to be weaker than in previous crises and unable to enforce countries to take actions needed to resolve global imbalances in an orderly manner.
John Makin of the AEI, who is a former consultant to the IMF, observed that in what he called the current post-financial crisis situation, “More people are trying to extract rents” from “a feast of policy bungling that presents opportunities and provides a lively economics laboratory.”
He reviewed the policies of various countries from the standpoint of the choices some made on the fiscal side to go along with monetary easing. For example, Greece has been forced to adopt fiscal austerity in a bid to help save the euro, when actually it should be leaving the euro. He concluded, “I doubt the euro will survive, and it shouldn’t.”
For readers looking for a more pointed analysis of the role of the Fed in managing and perhaps compounding global economic crises, the next article on “The Global Curse of the Fed” should be more satisfying.
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