Today we have a guest contribution written by Jeffrey Frankel, Harpel Professor of Capital Formation and Growth at Harvard University, and former Member of the Council of Economic Advisers, 1997-99. This post is an extended version of a column that appeared in Project Syndicate.
Calls for International coordination of macroeconomic policy are back, after a 30-year hiatus. The heyday of coordination in practice was the decade 1978-1987, beginning with a G-7 Summit in Bonn in 1978 and including the Plaza Accord of 1985, of which this year is the 30th Anniversary.
Economists were able to provide a good rationale for coordination based in game theory: because each country’s policies have spillover effects on its trading partners’ economies, countries can in theory do better when agreeing on a cooperative package of policy adjustments than in the non-cooperative equilibrium where each tries to do the best it can while taking the policies of the others as given.
Then coordination fell out of fashion. The Germans, for example, regretted having agreed to joint fiscal expansion at the Bonn Summit; reflation turned out to be the wrong objective in the inflation-plagued late 1970s. The Plaza Accord and associated intervention in the foreign exchange market were successful in bringing down an overvalued dollar, but the Japanese came to regret the appreciated yen. Some of the other G-7 summit communiques had little effect, for better or worse. As the economies and currencies of Emerging Market (EM) countries became increasingly important, their lack of representation in global governance became problematic.
Since the Global Financial Crisis of 2008, attempts at coordination have made a come-back. The larger EM countries got more representation when the G-20 became the pre-eminent leaders group, especially when it agreed on coordinated economic expansion at the London Summit of April 2009. The G-20 leaders agreed at the Seoul in 2010 to give EMs quota shares in the IMF that would be more commensurate with their economic weight (though the US congress has yet to pass the necessary legislation, to its shame).
Many calls for coordination lament the outbreak of “currency wars,” a phrase coined by Brazil’s Finance Minister in 2010 for the old phenomenon of competitive depreciation. The concern recalls the competitive devaluations of the 1930s. The idea is that a single country can depreciate its currency, gain international competitive for its exporters and thus improve its trade balance; but if all countries try to do this at the same time they will fail. One form that this concern has taken has been foreign exchange intervention by China and other EM countries to prevent their currencies from rising. Another form arose from successive rounds of quantitative easing by the Federal Reserve in 2010-11, the Bank of Japan in 2012-13, and the European Central Bank in 2014-15; the results were in turn depreciations of the dollar, yen and euro, respectively.
The US has led some international attempts to address competitive depreciation, including an agreement among G-7 ministers in February 2013 to refrain from foreign exchange intervention and a November 2015 side-agreement to the Trans-Pacific Partnership to address currency manipulation. But critics are agitating for a stronger agreement backed up by the threat of trade sanctions.
The most recent fear — articulated, for example, by Raghuram Rajan, Governor of the Reserve Bank of India in 2014 — is that the US central bank will not adequately take into account adverse impacts on EM economies when it raises interest rates.
To interpret the various calls for coordination in terms of game theory is challenging, in that some players think they are playing one game and other players seem to think they are playing another game. Consider, first, fiscal policy. When the US urges German fiscal stimulus, as at the G-7 Bonn Summit of 1978, the G-20 London Summit of 2009; and the G-20 Brisbane Summit of 2014, it has in mind the “locomotive game.” The assumption is that fiscal stimulus has positive “spillover effects” on trading partners. Each country is afraid to undertake fiscal expansion on its own, for fear of worsening its trade balance, but the world can do better if the major countries agree to act together as locomotives pulling the global train out of recession.
But Germans think they are playing a “discipline game.” They view budget deficits as creating negative externalities or “spillover effects” for neighbors, due for example to the moral hazard of bailouts, not positive externalities. Their idea of a cooperative equilibrium is the Fiscal Compact of 2013 under which euro members agreed yet again to rules for limiting their budget deficits.
When two players sit down at the board, they are unlikely to have a satisfactory game if one of them thinks they are playing checkers and the other thinks they are playing chess. Think of the “dialog of the deaf” that took place between the Greek government elected in January 2015 and its euro partners.
Interpretations vary just as much when it comes to monetary policy. Some think monetary expansion in one country shifts the trade balance against its trading partners, due to the exchange rate effect; but others think it is transmitted positively, via higher spending. Some think that the problem is competitive depreciation and too-low interest rates; others that the problem is competitive appreciation or too-high interest rates. Some think that the way to solve competitive depreciation for good is to fix exchange rates, as the architects of Bretton Woods did in 1944. Others, such as some US politicians today, think that the way to do it is the opposite: an agreement against seeking to influence exchange rates at all, even enforced by trade penalties.
Yes, regular meetings of officials can be useful. Consultation can minimize surprises. Exchange of views might help narrow differences in perceptions. But some calls for international coordination are less useful, particularly when they blame foreigners in order to distract attention from domestic constraints and disagreements.
Two examples of calls for coordination obscuring domestic problems. First: Brazil’s budget deficit was too large in 2010. The economy overheated. Private demand was going to be crowded out one way or another: if not via currency appreciation then via higher interest rates. When Brazilian officials blamed the US and others for a strong real, it may have been a way to divert attention so as to avoid confronting the domestic issue. Second: US politicians’ ongoing efforts to ban currency manipulation in trade agreements may be rhetorical attempts to scapegoat Asians for stagnation in the real incomes of American workers. Officials would often be better advised to improve their own policies, before they tell others what to do.
This post written by Jeffrey Frankel.