Last week Mervyn King, Bank of England governor, and Dominique Strauss Kahn, managing director of the International Monetary Fund spoke about international policy co-ordination. Both speeches are worth reading. Though this is not their intention, both speeches also highlight how difficult it will be to get an agreement on a co-ordinated solution to global imbalances.
Remember, global trade imbalances were an important contributor to the financial and economic crisis because huge amounts of money, which flowed to the US searching for yield, ultimately found its way to borrowers who were wholly unsuitable via lots of dodgy dealing in the financial sector.
In the depth of the crisis, world leaders came together to co-ordinate economic policy to ensure that recession did not become depression. Protectionism was largely avoided; monetary policy moved to unorthodox territory, and fiscal policy moved into super-stimulus mode. As Mr Strauss Kahn said:
“In sum—during the heat of the crisis, the benefits from co-operation were evident, and the costs of cooperation were small.”
But such co-operation diminished as recession became recovery and squabbling has replaced co-ordinated activity at the G20 level. Countries are now engaged in a tortuous discussion of how to measure global imbalances because this distracts them from having to disagree about what to do about them. Read more
Malaysia might be the next in a long series of central banks turning to reserve requirements. The central bank held the overnight policy rate today at 2.75 per cent for the third meeting, as expected. Inflation ran at just 2.2 per cent in the year to December.
Bank Negara Malaysia signalled, however, that it would consider tools other than rate rises to mop up excess liquidity. “Large and volatile shifts in global liquidity are leading to a build up of liquidity in the domestic financial system,” said the Bank, continuing: Read more
Keeping the show on the road became the G20′s main achievement at the acrimonious Seoul summit in November. But if you have to keep pedaling to stop the global trade imbalances bicycle from toppling, a new speech by Andy Haldane of the Bank of England demonstrates that the road ahead is uphill.
It is difficult to say much fresh about trade imbalances. Everyone knows they are big; they are a threat to the global economy; they played a part in the recent crisis; and countries fundamentally disagree over who is responsible for their existence and who should change policies to reduce their threat.
But Mr Haldane has an interesting stab at the subject, showing he has ambitions extending considerably outside his current responsibility for financial stability.
As a current account deficit must, by definition, also represent a situation where investment is greater than savings (and vice versa), he Read more
In September 2009 I blogged about the similarities between the Pittsburgh G20 framework for strong, stable and balanced global growth and the 2007 International Monetary Fund multilateral consultations, noting that when global leaders were wrong to say their commitments to get rid of imbalances were new or made significant progress.
Today it is genuinely déjà vu all over again as the “Seoul Action Plan” papers over long-standing divisions on currencies and trade imbalances. Leaders have been doing their best to say the summit was not a failure and that the engine of global economic cooperation is still firing on all cylinders.
What is the evidence? According to the G20 it is this new passage about indicative guidelines in the communique. Read more
The renminbi is 17 per cent undervalued against the dollar while the yen is 8 per cent overvalued…
William Cline and John Williamson at the Peterson Institute for International Economics have done a service to the currency wars debate by releasing an update to their estimates of fundamental equilibrium exchange rates (FEERs) for various countries against the dollar in a very interesting policy brief. Read more
China’s trade surplus is beginning to rise again and the government has made only “limited progress” in rebalancing its economy towards domestic consumption, the World Bank said on Wednesday. The bank also upgraded its forecast for growth this year by half a percentage point to 10 per cent, but said that interest rates needed to rise further if inflationary expectations were to be kept in check.
The bank’s quarterly report on China is closely watched and was largely upbeat on the short-term prospects for the economy, despite fears over the summer about a possible hard landing. However, amid fierce international debates about China’s currency policy which could come to a head at next week’s G20 summit in South Korea, the bank cautioned that China needed to make a big push on its agenda of structural reforms if it was to reduce its large external surplus. “Rebalancing will not happen by itself – it will require substantial policy adjustment,” the report said.
There are two massive fixed exchange rate blocs operating in the world economy today, and both of them face severe strains and conflicts. The eurozone is beset by problems which are typical of fixed rate blocs in the past, with the main surplus country (Germany) refusing to increase aggregate demand, thus forcing the deficit countries to reduce demand in order to stay within the currency arrangement. This, they appear willing to do, or at least to try.
Meanwhile, the China/US bloc also has a (nearly) fixed exchange rate, and once again the surplus country (China) is refusing, or is unable, to expand domestic demand enough to eliminate the trade imbalance. But, in this case, the deficit country (the US) is increasingly unwilling to accept the consequences, and is adopting policies which are designed to break up the bloc altogether. Two blocs with somewhat similar problems, but very different responses and outcomes for the deficit countries.
In making this analogy, it is of course important to accept that the institutional arrangements surrounding the world’s two major blocs could hardly be more different, with the eurozone established as a single currency area, while the Sino/US bloc is officially a linked but flexible exchange rate area. But the critical feature of both areas is that nominal exchange rate adjustments are not permitted to equilibrate trade imbalances within either of the two blocs, so a persistent pattern of large current account imbalances has emerged. Germany and China are the two economies where chronic surpluses have emerged, while the Club Med economies and the US have the corresponding chronic deficits. Read more
Stephanie Flanders reminds us that it takes two to tango in her latest blog post. The story concerns proposals that might fine euro members for failing to keep public finances within certain boundaries. Over to Ms Flanders:
There would be fines in the region of 0.2% of GDP for countries who borrow too much, and also smaller financial penalties for countries that don’t try hard enough to improve their competitiveness.
I’m told that competitiveness would be measured by a “persistent current account imbalance”. But as this blog has pointed out many times, it takes two to create a current account gap: if one country has a deficit, someone else must have a surplus.
In fact, all the signs are that the new system will have the same asymmetry that we see in the global economy more generally. Countries with deficits are pressured to reform, but the countries with surpluses are under no pressure to change their policies at all.
Somewhat as predicted, or at least predicted by me, Tim Geithner went as far as he could go in suggesting that various options were on the table for trying to push the Chinese into letting the exchange rate rise without giving any hostages to fortune.
The Murphy-Ryan bill (similar to Schumer-Graham in the Senate) got respectful attention and the possibility of support, though no commitment. Naming China as a currency manipulator, though, seems still to be off the table. Read more
“A strengthening in the fiscal balance by 1 percentage point of GDP is, on average, associated with a current account improvement of 0.2–0.3 percentage points of GDP.” This is the conclusion from a top notch set of researchers, posted on VoxEU.
With renewed focus on global trade imbalances, this may be of interest to policymakers currently looking at exchange rates. The finding holds across emerging and developed economies, though the “association is significantly higher when output is above potential.” Food for thought.