Independent monetary policies, synchronised outcomes
Espen Henriksen, Finn Kydland, Roman Šustek 02 October 2013
The monetary policy for Eurozone members is one-size-fits-all in an economic area rife with economic differences. Does this really make a difference? This column argues that even if each EZ member state had a fully independent monetary authority, monetary policies would likely still appear highly synchronised across EZ members.
The recession in the Eurozone has given new life to optimal-currency-area thinking. The argument goes that the disadvantages of a single currency come from the loss of flexibility and ability to use monetary policy to respond to “asymmetric shocks” (Krugman and Obstfeld 2009). The often-unarticulated presumption is that countries with independent monetary policies would make different policy decisions as long as contemporaneous shocks to output and employment were asymmetric.
Exchange rates Monetary policy
inflation, monetary policy, EMU, Central Banks, capital controls, exchange-rate policy
Is there a dilemma with the Trilemma?
Michael W Klein, Jay C. Shambaugh 27 September 2013
The ‘financial trilemma’ – that open capital markets and pegged exchange rates mean a loss of monetary autonomy – has recently been challenged. Some argue that even flexible exchange rates cannot assure monetary autonomy without capital controls, while others argue even countries with fixed exchange rates can gain autonomy through temporary capital controls. This column argues that free floating exchange rates do in fact allow autonomy, and partially floating ones allow partial autonomy. For countries with fixed exchange rates, capital controls provide monetary autonomy when they are widely applied and longstanding, but not when they are temporary and narrowly targeted.
In the Handbook of Safeguarding Global Financial Stability, the chapter “Capital Mobility and Exchange Rate Regimes” begins “Forced to state all the insights of international macroeconomics while standing on one leg, one could do worse than raise a foot off the ground and say something like:
- ‘Governments face the policy trilemma – the rest is commentary.’”
Admittedly, that entry was written by one of us.
Exchange rates Monetary policy
monetary policy, global crisis, capital controls, exchange-rate policy
Fixed versus flexible exchange-rate regimes: Do they matter for real exchange-rate persistence?
Paul Bergin, Reuven Glick, Jyh-lin Wu 04 October 2012
For many observers, one central flaw of the Eurozone is that countries lose the ability to manipulate their exchange rates to suit their needs. But this article argues that flexible exchange rates are often more likely to make things worse than make things better.
Flexible exchange rates have been praised in economic theory as a mechanism for helping relative prices adjust between countries in response to shocks to relative supply and demand (Friedman 1953). In this view, fluctuations in the real exchange rate, measuring the relative cost of living across countries, are a welcome thing. However, an alternative explanation for fluctuations in the real exchange rate is the presence of shocks arising in the financial market that move the nominal exchange rate, which then are passed on to the real exchange rate due to sticky prices.
Europe's nations and regions Monetary policy
The limits of a purely intra-euro rebalancing strategy
Zsolt Darvas 05 September 2012
The need to rebalance the debts of several Eurozone members is a major root of the current crisis. This column argues that a purely intra-euro rebalancing strategy has its limits and that a weaker euro would help. It urges the European Central Bank to adopt looser monetary policy, which is anyway justified in a highly recessionary environment.
The perceived failure of Greece, Portugal, and Spain to achieve sustainable external positions and economic growth inside the Eurozone is a major factor behind the current crisis. Their trade deficits should be turned to sizeable surpluses in which real exchange rate developments should play a role. Some adjustments, both in trade balances and real exchange rates, have already taken place in the past few years. Is the remaining adjustment a purely intra-Eurozone issue or does the external value of the euro play a role?
EU policies Europe's nations and regions Monetary policy
Spain, Greece, exchange-rate policy, Eurozone crisis, Portugal
Small open economies have to be managed differently: devaluation is contractionary in both the short and long run
DeLisle Worrell 23 June 2012
If Greece leaves the euro, it can devalue its currency and start an export-led recovery – or so the popular argument goes. This column provides some hands-on insights from another small open economy, Barbados. It argues that for these economies that rely heavily on imports, devaluation will never be a viable option.
There is a fallacy at the root of most of the discussion of the European economic crisis, and it is that countries like Greece would have the option to grow their economies through exchange rate depreciation, were they outside the Eurozone. In reality, exchange-rate depreciation always depresses output in small open economies, because there is zero elasticity of substitution between internationally traded goods and services and domestically produced goods and services, either in consumption or in production.
Europe's nations and regions Global economy Monetary policy
Greece, exchange-rate policy, Eurozone crisis, Barbados
Foreign-exchange intervention and the fundamental trilemma of international finance: Notes for currency wars
Michael Bordo, Owen F Humpage, Anna J Schwartz 18 June 2012
The so-called trilemma of international finance maintains that a country cannot simultaneously peg an exchange rate, maintain an independent monetary policy, and permit free cross-border financial flows. At best, only two of the three are feasible. This column argues that despite their best efforts, countries are set to learn this lesson again and again.
In the mid-1990s, many of the large developed countries ended their activist approach to foreign-exchange-market intervention. Yet while these operations faded, they never disappeared. The Great Recession recently piqued interest in them, as exchange-rate volatility increased and threats of currency wars were heard (see Neely 2011). Still, then, the key question remains: Do sterilised interventions allow countries a way around the fundamental trilemma of international finance by providing them with a means of systematically affecting exchange rates independent of their monetary policies?
exchange-rate policy, financial trilemma
On Inflation Targeting and Forex Intervention: Are Two Targets Better Than One?
Jonathan D Ostry, Atish R Ghosh, Marcos Chamon 27 May 2012
Before the global crisis, central banks could reply ‘inflation targeting’ to virtually any question about their policymaking and the ‘Great Moderation’ seemed to back them up. The crisis has put a stop to this smugness. Central banks are now engaged in emergency evasive manoeuvres and are scrambling for new intellectual anchors. This column argues that emerging market central banks should target price stability while being mindful of disequilibrium exchange rate movements.
The global financial crisis has reminded emerging market economies, if they needed reminding, that capital flows can be highly volatile and that crises need not be home grown. Emerging markets have been affected in a variety of ways, not least by the sharp ups and downs in exchange rates that volatile capital flows engender. These ups and downs may be less benign in emerging markets than they might be in advanced economies for a number of reasons:
monetary policy, emerging markets, exchange-rate policy
How should Japan’s current exchange rate be viewed?
Takatoshi Ito, Junko Shimizu 20 March 2012
Last year, the yen reached a post-war high against the dollar and a record high against the euro. This column looks at the recent trend in the Japanese currency and outlines what Japan’s policymakers should do about it.
Japan is frequently cited by US and European commentators as a warning of what could happen to their economies (see, for instance, Muellbauer and Murata 2011). We hear less, however, about what is happening now. The yen-to-dollar exchange rate briefly reached its post-war high of 75.95 on 19 August 2011 in the New York Foreign Exchange Market and stayed at that level for the rest of the year.
Global crisis International finance International trade
Japan, exchange-rate policy
The renminbi’s prospects as a global reserve currency
Eswar Prasad, Lei (Sandy) Ye 16 February 2012
Is China’s currency destined to become the dominant global reserve currency? This column argues that despite not yet having a flexible exchange rate or open capital account, China’s government is pursuing ‘liberalisation with Chinese characteristics’. It argues that the renminbi will become a reserve currency within the next decade, eroding but not displacing the dollar’s dominance.
Popular discussions about the prospects of China’s currency – the renminbi – range from the view that it is on the threshold of becoming the dominant global reserve currency to the concern that rapid capital-account opening poses serious risks for China.
International finance International trade
China, globalisation, renminbi, exchange-rate policy