Given all the chatter and consternation today about Japan's attempts to keep its currency cheap, it was nice to be reminded by Barry Eichengreen (via Mark Thoma) that we have seen this competitive devaluation story before and it actually turned out okay. Specifically, he points us to the 1930s (my emphasis):
In the 1930s, it is true, with one country after another depreciating its currency, no one ended up gaining competitiveness relative to anyone else. And no country succeeded in exporting its way out of the depression, since there was no one to sell additional exports to. But this was not what mattered. What mattered was that one country after another moved to loosen monetary policy because it no longer had to worry about defending the exchange rate. And this monetary stimulus, felt worldwide, was probably the single most important factor initiating and sustaining economic recovery.
Eichengreen goes on to say that coordinated devaluations would be better since they would minimize volatility in exchange rates and thus in global trade. Whether or not this coordination happens, the key insight here is that some currency devaluation may be exactly what the world economy needs right now. Ryan Avent agrees:
A bit of inflation in Japan wouldn't just be a good thing. It would be a really, really great thing. And if other countries react to Japan's intervention by attempting to print and sell their own currencies in order to toss the deflationary potato to someone else, well then so much the better...Not every country can simultaneously depreciate its currency. But everyone can nonetheless benefit from the attempt, if currency interventions lead to expanded money supplies and rising inflation expectations.
It would be nice to bring some international coordination into play here. Of course, coordinated interventions can have their drawbacks too. Many folks blame Japan's asset bubbles in the mid-to-late 1980s (and by implication its subsequent bust) on the 1987 Louvre Accord. In fact, intervention on this level makes me a little nervous along the lines of Hayek's The Fatal Conceit. Still, if currency devaluation becomes the new game in town it is probably best that it be done thoughtfully and that requires international coordination.
I guess so...except that this discussion is framed in the context of the old way of thinking about macroeconomics, ie in terms purely of monetary policy. I think one crucial lesson emerging from the GFC is that this is wrong - monetary policy has to be integrated with financial stability policy, you cannot separate them. That is where the NK Taylor rule dominated paradigm came spectacularly unstuck, as the BIS folks were warning.
ReplyDeleteSo I wonder what devaluations do to financial stability, given the massive globalization of banking that we have today, with banks holding massively more internationally diversified portfolios these days. I wonder what work has been done on that? Do you know of any?
Good question. Another way of saying it is as follows:would the added global monetary easing provide enough benefits to offset the added costs it might create in the financial system (i.e. via the risk-taking channel)? Maybe the folks at the BIS have something on this.
ReplyDeleteThe Louvre Accord being, of course, the inevitable result of the Fedlstein/Reagan policies of the 1980s, which were partially inspired (as it were) by the currency shiftings of the early and mid-1970s.
ReplyDeleteThe good thing is the weapon is available; the unfortunate thing is that once it's used once, it tends to be used again and again. Still, much better than the alternative.