currency wars - perception and reality. eichengreen, barry
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Global Financial Institute
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Currency Wars: Perception and Reality
May 2013 Pro. Barry Eichengreen
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Author
Pro. Barry Eichengreen
George C. Pardee and Helen N.
Pardee Proessor o Economics
and Political Science
Department o Economics
University o Caliornia, Berkeley
Email:
Web Page:
Click here
2
Barry Eichengreen is the George C. Pardee and
Helen N. Pardee Proessor o Economics and
Proessor o Political Science at the University
o Caliornia, Berkeley, where he has taught
since 1987. He is a Research Associate o the
National Bureau o Economic Research (Cam-
bridge, Massachusetts) and Research Fellow o
the Centre or Economic Policy Research (Lon-
don, England). In 1997-98 he was Senior Policy
Advisor at the International Monetary Fund. He
is a ellow o the American Academy o Arts
and Sciences (class o 1997).
Proessor Eichengreen is the convener o the
Bellagio Group o academics and economic
ocials and chair o the Academic Advisory
Committee o the Peterson Institute o Inter-
national Economics. He has held Guggenheim
and Fulbright Fellowships and has been a
Global Financial Institute
ellow o the Center or Advanced Study in the
Behavioral Sciences (Palo Alto) and the Insti-
tute or Advanced Study (Berlin). He is a regu-
lar monthly columnist or Project Syndicate.
Proessor Eichengreen was awarded the Eco-
nomic History Associations Jonathan R.T.
Hughes Prize or Excellence in Teaching in
2002 and the University o Caliornia at Berke-
ley Social Science Divisions Distinguished
Teaching Award in 2004. He is the recipient
o a doctor honoris causa rom the American
University in Paris, and the 2010 recipient o
the Schumpeter Prize rom the International
Schumpeter Society. He was named one
o Foreign Policy Magazine s 100 Leading
Global Thinkers in 2011. He is Immediate Past
President o the Economic History Associa-
tion (2010-11 academic year).
mailto://[email protected]://emlab.berkeley.edu/~eichengr/biosketch.htmlhttp://emlab.berkeley.edu/~eichengr/biosketch.htmlmailto://[email protected] -
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Table of contents3
Table o contents
Introduction to Global Financial Institute
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Introduction ............................................. .............................. 04
1. History Lessons ................................................ ..................... 06
2. Reasoning by Analogy ................................................... .... 08
3. The Fog o War ................................................. ..................... 11
4. Reerences ................................................ .............................. 12
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Introduction
4
The problem o currency wars emerged as both a
major concern and a source o conusion in early 2013.
This once obscure term, rst uttered by Brazilian Finance
Minister Guido Mantega in response to the initial round
o quantitative easing in the United States, came into
widespread use ollowing the ormation o a new Japa-
nese government under Prime Minister Shinzo Abe in
late 2012. Mr. Abe indicated his intention o pursuing
more aggressively refationary monetary and exchange
rate policies. This caused the yen to all by 16% against
the dollar and 19% against the euro between the end o
September, when it became likely that Mr. Abe would
take power, and mid-February 2013, when his appoint-ment o a new Bank o Japan governor was imminent.
Both the term and the concerns to which it reerred
thereore migrated to the ront pages o the nancial
press. A host o additional policymakers some rom
emerging markets, such as Alexei Ulyukyev, rst deputy
chairman at the Russian Central Bank, and Bahk Jae-
wan, South Koreas nance minister, and others rom
advanced countries, like Bundesbank President Jens
Weidmann warned o the adverse consequences o
currency manipulation, Mr. Weidmann reerring omi-
nously to an undesirable politicisation o exchange
rates.1 The currency-war problem then became a key
topic at the meetings o the Group o Seven and Group
o Twenty this February, where it was the subject o a
careully crated set o communiques.2
But careully crated is not the same as clearly under-
stood. The conusion stems rom the act that there is
no widely accepted denition o a currency war. The
term is not ound in the leading textbooks o econom-
ics. There is the implication that a currency war is to be
understood by analogy with the concept o a trade war,
in which countries use trade policy to shit spending
toward products produced domestically at the expense
o their neighbours a process that is ultimately utile
insoar as it provokes retaliation. The only dierence is
that in the case o a currency war, it is currency policy
rather than trade policy that is being deployed. There
is, however, the analytical problem that while trade
warare destroys trade, creating a deadweight loss, o-
setting devaluations simply return bilateral exchange
rates to their initial levels with no enduring relative price
eects. It is not clear that the analogy holds water, in
other words.
Similarly, there is the implication that a currency warcan be said to have broken out when one or more
countries engages in beggar-thy-neighbour competi-
tive currency depreciation. But it is not clear in this
case whether all policies that result in currency or
exchange-rate depreciation are necessarily competitive
or beggar-thy-neighbour. Just because a country sees
its exchange rate depreciate, is it necessarily engaged
in a currency war?
Probably the most widely accepted denition o what
constitutes a currency war is what countries did in the
1930s. Starting in 1931, one country ater another
depreciated its currency. Since currencies were
pegged to gold rather than to one another, countries
depreciated by abandoning their pre-existing gold pari-
ties and allowing the domestic currency price o gold
to rise. This consequently had the eect o also raising
the domestic currency price o oreign currencies still
pegged to gold at prevailing parities.3
As the story is conventionally told, this enhanced the
competitiveness o countries depreciating their curren-
cies but worsened that o the remaining gold-standard
Currency Wars: Perception and RealityPro. Barry EichengreenMay 2013
Currency Wars: Perception and Reality Global Financial Institute
1Quoted in Randow and Schneeweiss (2013).2 See Group o Seven (2013) and Group o Twenty (2013).3The gold parity reerred to the weight o gold o specied purity in the national monetary unit as specied by law or
statute o a country said to be on the gold standard.
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5 Currency Wars: Perception and Reality
countries. This saddled the latter with overly strong
exchange rates, creating pressure or them to respond
tit or tat, as they ultimately did. Ater ve years o com-
petitive devaluations, exchange rates had returned to
levels very close to those prevailing in early 1931. No
country succeeded in engineering a sustained improve-
ment in competitiveness or, it is argued, achieved
aster economic growth. But there were a variety o
other adverse consequences ranging rom height-
ened exchange rate uncertainty that disrupted trade
and production to the imposition o trade barriers and
exchange controls by countries with overvalued curren-
cies and weakened balances o payments.4 It is not an
exaggeration to say that popular accounts blame the
currency wars o the 1930s or aggravating the political
tensions that made it more dicult or countries to col-
laborate in averting the military and diplomatic conficts
that led ultimately to World War II.5
In act, this conventional narrative is oversimplied and
misleading in important respects. This in turn meansthat todays debate over currency wars, because it is
heavily inormed by that narrative, is itsel oversimpli-
ed and misleading. The modern literature empha-
sises that the policy changes associated with currency
depreciation in the 1930s were not actually zero sum.
To the contrary, those policy changes let all countries
better o relative to the status quo ante, in which policy
did not change and exchange rates did not move. But
this was not well understood at the time. As a result,
the point is not understood today by those advancing
the conventional story.
In part, contemporary misunderstanding arose rom
the act that interwar governments did a poor job o
communicating their intentions. In part it arose rom
the act that they did a poor job o implementing their
policies; they could have done much more to accentu-
ate the positive-sum aspects. And in part it arose rom
the act that policymakers continued to view their cur-
rent situation through the lens o past problems, ailing
to acknowledge that circumstances and thereore the
appropriate policies had changed.
The same actors are again present today, once more distort-
ing the debate over currency policies. Policymakers have
done a poor job communicating their intentions. They could
have done more to accentuate positive-sum aspects o their
actions. And, along with market participants, they have had a
tendency to view policies through the distorting lens o pastproblems rather than current circumstances. Understanding
these shortcomings o the present debate and correcting the
resulting misapprehensions would go a long way toward solv-
ing the currency war problem.
4These negative side eects were highlighted by Ragnar Nurkse (1944) in his infuential contemporary account, which
helped to clear the way or the Bretton Woods System o pegged-but-adjustable exchange rates. A recent, somewhat
revisionist treatment is Eichengreen and Irwin (2010).5 See or example Kennedy (1999).
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1. History Lessons
6 Currency Wars: Perception and Reality
The background to the currency and exchange rate
problems o the 1930s was, o course, the depression
and defation that started in 1929. In turn, that depres-
sion and defation must be understood in the context o
the gold standard, the monetary regime providing the
structure or global monetary and nancial aairs.6
The 1920s monetary regime was a gold-exchange stan-
dard rather than a pure gold standard. Central banks
and governments operated under statutes obligat-
ing them to back their monetary liabilities with gold
and convertible oreign exchange.7 Other than this
provision or holding reserves in the orm o oreign
exchange, the regime had many o the eatures o a text-
book gold standard. International nancial fows were
unrestricted. With the capital account o the balance
o payments open, domestic interest rates could not
deviate signicantly rom those in the rest o the world.
I domestic policymakers sought to depress rates ur-
ther, capital would migrate to oreign nancial markets
where they were higher, causing the central bank tolose gold and oreign exchange reserves, and threaten-
ing the maintenance o gold convertibility. This is the
standard open-economy trilemma.8 With exchange
rates pegged and capital markets open, central banks
had limited monetary policy room or manoeuvre.
The gold-exchange standard had been put back in place
in the 1920s ater roughly a decade o suspension, dur-
ing which a number o current and ormer belligerents
had suered high infation.9 That experience in turn
shaped their expectations o risks and outcomes in the
event that gold convertibility was again suspended.
As it happened, defation rather than infation turned
out to be the immediate danger.10 When it developed
ater 1929, central banks and governments had little
reedom o action. As long as they remained on the
gold standard, they could not unilaterally take steps
to stem the all in prices. They could not unilaterally
cut interest rates to encourage borrowing and spend-
ing. Injecting liquidity in order to support a distressed
banking system threatened to atally weaken the cur-
rency. Running budget decits rekindled ears, inher-
ited rom the 1920s, that central banks would be pres-
sured to monetise public debts. Governments were
thereore orced to cut public spending and raise taxes
in order to preserve condence in their exchange rate
commitments.
It might be thought that these policies o austerity, pur-
sued in the ace o depression and defation, could not
be sustained indenitely. Indeed, they could not. Brit-
ain was the rst major country to abandon them and
depreciate its currency. It had a Labour government
that could not agree on budgetary economies and high
unemployment that rendered the central bank reluctant
to raise interest rates urther in order to stem capital
fight.11 It suspended gold convertibility in September
1931, and the pound quickly ell rom $4.86 to a low o
$3.40, rom which it recovered modestly beore stabi-lising. Some two dozen other economies, principally
members o the Commonwealth and Empire and British
trading partners, quickly ollowed suit. The next shoe
to drop was Japan, whose nance minister Korkiyo
Takahashi implemented an aggressively expansion-
ary monetary policy that pushed down the yen start-
ing in December. President Franklin Delano Roosevelt
embargoed gold exports on March 5th, 1933, his rst
ull day in oce. He made that embargo permanent
in April and actively pushed up the dollar price o gold
(pushed down the dollar exchange rate) rom October.
A number o U.S. trade partners, principally in Latin
America, ollowed the dollar down. In January 1934,
when the dollar was again stabilised against gold, the
sterling/dollar exchange rate was back to roughly the
level prevailing beore September 1931.
These eorts by Britain, the U.S., and Japan to depre-
ciate sterling, the dollar, and the yen made lie more
6
As I argued in Eichengreen (1992), on which the remainder o this section draws.7Typically at ratios o 33 to 40 per cent.8 See Obsteld, Shambaugh and Taylor (205).9 The hyperinfations in Germany, Austria, Hungary, and Poland being extreme cases in point.10 Describing the origins o the global defation would take us too ar aeld; in this, see Bernanke (1995) and Eichen-
green (2004).11 That Labour government was succeeded by a National government which agreed on budgetary economies in August,
but by this time it was too late.
32
48
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7 Currency Wars: Perception and Reality
dicult or countries still on the gold standard. (That
these are the same three countries currently under
attack or being engaged in currency war is presum-
ably a coincidence.) Having lost international competi-
tiveness, these so-called gold-bloc countries saw their
balances o payments accounts weaken and gold fow
out o their central banks. Forced to raise interest rates
to deend the reserve position rather than cutting them
to support the economy, their depressions deepened.
The result was not an equilibrium in either the eco-
nomic or political sense. Economically, the condition
o domestic nancial institutions continued to worsen.
Politically, opposition welled up against policies o aus-
terity. The remaining members o the gold bloc pro-
gressively ell by the wayside. Czechoslovakia and Italy
devalued in 1934, Belgium in 1935, Poland, France, the
Netherlands, and Switzerland in 1936, returning their
exchange rates to roughly the same levels against the
dollar and sterling that prevailed beore 1931. These
competitive devaluations gave rise to a good deal o
damaging exchange rate and nancial volatility, but atthe end o the day, it is said, they changed nothing.
Such is the conventional narrative. The modern litera-
ture on exchange rate policy in the 1930s, beginning
with Eichengreen and Sachs (1985), disputes this view
that the exchange rate policies o the 1930s were with-
out positive eect. While currency depreciation did
switch demand toward domestic goods and away rom
their oreign substitutes, this was not its exclusive or
even its principal impact. Rather, abandoning the com-
mitment to peg the exchange rate allowed countries
to replace the defationary measures o the preceding
period with refationary monetary policies. Going o
the gold standard was a credible way o signaling this
commitment to prioritise price stability over exchange
rate stability.
Thus, six months ater abandoning the gold standard,
the Bank o England began cutting interest rates; by
July 1932 these had reached the historically low level
o 2%, inaugurating a new era o cheap money. The
Swedish government and Riksbank replaced the gold
standard with an explicit price level target. In Japan,
Takahashi supplemented his refationary monetary
policy with an increase in public spending and instruc-
tions that the Bank o Japan purchase the resulting
increase in the public debt. In the U.S., FDR used his
bombshell message to the World Economic Coner-
ence o June-July 1933 to signal that he was unwilling
to restore the gold standard. He was not prepared to
privilege exchange rate stability (what he reerred to in
that message as the old etishes o international bank-
ers). The bombshell message may have made interna-
tional cooperation on trade policy, security policy, and
other matters more dicult, but it was a strong signal
o a durable change in the monetary regime.
These new policies had other important eects apart
rom their impact on exchange rates. Lower inter-
est rates encouraged interest-rate sensitive orms o
spending, in the U.K. or example, where the literature
reers to the housing boom o the 1930s. 12 They put
upward pressure on asset prices which, other things
equal, stimulated investment spending. By haltingdefation, they stemmed the rise in debt burdens and
squeeze on prots. By creating expectations o higher
uture prices, they encouraged households to shit
consumption rom the uture to the present. By giv-
ing central banks more reedom o action, they allowed
them to intervene as lenders o last resort to limit bank
distress.13 And insoar as the policies had these stabi-
lising eects on the initiating country, they encouraged
residents to spend more on oreign as well as domestic
goods. Currency devaluation by an individual country
may have had negative spillovers on its neighbours via
the exchange rate channel, but it had positive spillovers
via these interest rate, asset price, and expectations
channels. Even i the negative exchange rate spillovers
dominated when a single policy was taken in isolation,
once the entire round o exchange rate changes was
complete those negative spillovers were gone and only
the positive interest rate, asset price, and expectation
eects remained.
These conclusions are, o course, inconsistent with the
presumption that monetary policy was impotent in the
1930s because interest rates were at the zero lower
12 See Middleton (2010) or reerences.13 The cross-country evidence can be ound in Grossman (1994).
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8 Currency Wars: Perception and Reality
bound.14 Cross-country comparisons, calibration exer-
cises, and national case studies, all using data rom the
1930s, have combined to overturn this presumption.15
These studies highlight that interest rates were still
signicantly above zero prior to the change in policy
regime; the change thereore gave central banks ur-
ther room to cut. They remind us that even when nomi-
nal interest rates are near zero, central banks can still
aect the real interest rates on which allocation deci-
sions depend through the expectations channel by
using orward guidance and asset purchases to create
expectations o infation rather than defation. FDRs
gold purchases and Takahashis government bond pur-
chases can be thought o as analogous to quantitative
easing, while the Bank o Englands commitment to
keep interest rates low and the Riksbanks commitment
to target the price level can be thought o as orward
guidance.
Modern studies thus conclude that countries abandon-
ing the gold standard and allowing their currenciesto depreciate recovered most quickly rom the 1930s
depression. Recovery was, however, less than vigor-
ous. Countries abandoning the gold standard and
depreciating their currencies were reluctant to imple-
ment aggressively refationary policies. In Britain, or
example, the Bank o England, concerned that the ster-
ling exchange rate could collapse in the absence o its
golden anchor, took three ull quarters to convince itsel
that cheap money was sae and to cut interest rates to
2%. Even then it remained reluctant to cut them ur-
ther. FDR, although depreciating the dollar by 50%, put
the U.S. back on the gold standard at the now higher
gold price in January 1934, contrary to the advice o
John Maynard Keynes and others. In the subsequent
period, the Treasury repeatedly sterilised gold infows,
limiting the growth o money and credit. Central banks
and governments could not ree themselves o the
specter o the 1920s infations and thus were reluctant
to make ull use o their newound monetary room or
manoeuvre.
As a result, the beggar-thy-neighbour eect o currency
depreciation tended to dominate the positive spillovers
transmitted through now lower interest rates and infa-
tionary expectations. And the ailure o policymakers
to more clearly explain their intentions which were
not to beggar their neighbours but to stabilize their own
prices, economies, and nancial systems caused their
motives to be widely misunderstood.
Thus, to the extent that there was a currency problem
in the 1930s, it stemmed not rom the decision o coun-
tries abandoning the gold standard to refate, but rom
the ailure o the countries o the gold bloc to do like-
wise. That ailure was rooted, as noted above, in ear-
lier experience with high infation in France, Belgium,
Poland, and the Central European countries that now
clung to the gold standard with the help o exchange
control.16 Policymakers and their constituents contin-
ued to perceive current economic and nancial circum-
stances through the lens o past problems, with pro-
oundly negative consequences.
The problem in the 1930s, then, was not too much cur-
rency warare, but too little.
Many o these points have analogues in the current
debate. First, there is the view, implicit in the critiques
o emerging market policymakers, that the unconven-
tional monetary policies o advanced-country central
banks are ineectual. Monetary policy, they allege, has
lost its potency now that interest rates are at the zero
lower bound, just as it allegedly lost its potency in the
1930s. Only the negative side-eects, it ollows, are
let.
While there is less than ull consensus on the ecacy
o unconventional monetary policies at the zero lower
bound, a growing body o literature studying dierent
episodes suggests that such policies are not entirely
without eect. Oda and Ueda (2005) and Ugai (2006)
14 A presumption that is popularly cited as explaining Keyness discovery o the importance o using activist scalpolicy in a liquidity trap.15 See, respectively, Bernanke and James (1991), Eggertsson (2008), and Romer (1992) or examples.16 In the cases o Switzerland and the Netherlands, an additional motive was the desire not to jeopardise the position o
Zurich and Amsterdam as international nancial centres and the power o the banking lobby.
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9 Currency Wars: Perception and Reality
analyse the impact o the Bank o Japans experience
with quantitative easing between 2001 and 2006 and
conclude in avor o small but noticeable impacts on
medium- and long-term interest rates. Gagnon, Raskin,
Remarche, and Sack (2011) report evidence, derived
using a variety o methodological approaches, o posi-
tive eects o quantitative easing in the United States.
Krishnamurthy and Vissing-Jorgensen (2010) look at
low requency variations in the supply o long-term
Treasury bonds like those that would ollow rom quan-
titative easing and identiy eects on interest rates on
other relatively sae assets. Krishnamurthy and Vissing-
Jorgensen (2011), disaggregating urther, nd evidence
o a signaling channel, an expected infation channel,
and a demand-or-long-term-sae-assets channel trans-
mitting eects o both the rst and second rounds o
quantitative easing by the Federal Reserve. Looking
back at Operation Twist in the 1960s, Swanson (2011)
nds a small but signicant impact on long-term inter-
est rates operating through the portolio rebalancing
channel. Joyce, Lasaosa, Stevens, and Tong (2010)similarly nd evidence o the operation o the porto-
lio rebalancing channel in the response o gilt prices
to large-scale asset purchases by the Bank o Eng-
land starting in March 2009. In a companion paper,
Kapetanios, Mumtaz, Stevens, and Theodoridis (2010)
conclude that those Bank o England purchases had an
eect on the level o real GDP o around 1 % and
raised the annual rate o CPI infation by about 1 per-
centage points at its peak. Dierent studies consider
dierent episodes and arrive at dierent point esti-
mates, but as a group they are inconsistent with the
view that unconventional monetary policies are with-
out eect. This casts doubt on the assertion by some
observers based in emerging markets that such policies
should simply be abandoned.
Second, there is the view that unconventional monetary
policies operate only by pushing down currencies, with
beggar-thy-neighbour consequences or other coun-
tries. To be sure, the exchange rate channel can be
important or switching expenditure toward domestic
goods. Insoar as this channel dominates, the eect
will be to beggar thy neighbour. Just as in the 1930s, to
the extent that central banks ail to complement open
mouth operations pushing down the real exchange rate
with open market operations and other asset purchases
pushing down real interest rates, their neighbours will
have correspondingly more reason to complain about
the spillover eects on output and employment in other
countries.
But the exchange rate channel can also be important
or signaling the policy authorities commitment to
do what it takes to hit their infation target. Svensson
(2003) reers to the combination o a price-level target
path, a zero interest rate commitment and, importantly,
currency depreciation and a commitment to maintain-
ing a level or the exchange rate as the oolproo way
o ending defation. Insoar as ending the defation and
avoiding the extended period o economic stagnation to
which it can give rise is good not just or the initiating
country but also its trade and nancial partners, posi-
tive spillovers on other countries rom depreciation o
its exchange rate may still dominate.
The studies reerred to earlier in this section suggest
that unconventional monetary policies also operate
through the portolio rebalancing channel that leads
to changes in the term structure o interest rates. IMF
(2011) nds that portolio-rebalancing-related interest-
rate eects dominated the other negative cross-border
spillover eects o QE1 and QE2 in other words, that
the spillover impact on oreign output was positive on
balance, the complaints o emerging market policymak-
ers notwithstanding.
Third, there are complaints about other negative side
eects o unconventional monetary policies. The worry
is that quantitative easing is encouraging renewed
nancial excesses in advanced countries and emerg-
ing markets alike. Risks are being allowed to build up.
Equity markets in the United States are becoming richly
valued as investors acing near-zero interest rates on
sae assets stretch or yield by purchasing riskier instru-
ments. The natural process o deleveraging by the
household and nancial sectors needed to produce a
saer and more stable economy is being rustrated, the
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10 Currency Wars: Perception and Reality
implication ollows.
This view has an analogue in the liquidationist
response to the Great Depression.17 U.S. policymak-
ers inside and outside the Fed worried that monetary
accommodation would cause the development o an
even larger Wall Street boom and bubble, leading sub-
sequently to an even larger crash. Herbert Hoovers
Treasury Secretary Andrew Mellon amously argued
that restraint was necessary to teach speculators
a lesson and purge the rottenness out o the sys-
tem.18 Similar views were advanced by Austrian and
other Continental European economists rom Hayek to
Schumpeter.
The modern literature on the Great Depression and on
nancial crises generally acknowledges that activism
has risks but suggests that inaction in the ace o cri-
sis also has a downside. And to the extent that pol-
icy activism in response to crisis encourages nancial
excesses, these are best addressed by tightening super-vision and regulation o nancial markets, not by pre-
mature abandonment o supportive monetary policies.
Some recent studies have questioned this separation
principle they have questioned whether there exists
an adequate array o monetary and regulatory instru-
ments, so that monetary policy can be assigned to infa-
tion and growth while regulation is assigned to nancial
stability.19 Maybe not, but i not the call should be or
policymakers to develop a wider array o instruments,
not or central banks and governments to abandon the
pursuit o all other valid goals in the interest o nancial
stability.
The same goes or the complaint that unconventional
monetary policies in the advanced countries are eed-
ing nancial excesses in emerging markets. The worry
itsel is not without oundation: As Chen, Filardo, He
and Zhu (2011) show, quantitative easing in the United
States has had a strong impact on credit growth,
asset prices, and capital infows in emerging markets.
But the rst-best response or policymakers in those
countries is not to jawbone the Federal Reserve and
Bank o Japan to abandon quantitative easing, which
would make or slower global and even possibly slower
emerging-market growth, but to tighten their own
supervision and regulation o nancial markets. And to
the extent that conventional regulatory instruments are
not up to the task, emerging market policy makers can
resort to capital infow taxes and controls as a second
line o deence against nancial excesses resulting rom
oreign policies.20
Similarly, to the extent that low interest rates in the
advanced countries encourage capital infows into
emerging markets that an infation, result in currency
overvaluation, and create worries o overheating, the
rst-best response is not or ocials there to pressure
advanced country central banks to abandon their low
interest rate policies but to adjust their own policies
appropriately. The rst-best response is or emerging
markets to tighten scal policy. Tightening scal policy
puts downward pressure on domestic spending. It putsdownward pressure on asset valuations. It means less
infation, other things equal. It means lower interest
rates and, thereore, smaller capital infows and less
pressure or real exchange rate appreciation. By reduc-
ing sovereign debt burden, it puts the economy in a
stronger position going orward.
The objection here is that political constraints make
it dicult to adjust scal policy, which is even more
politicised than monetary policy. Maybe so, but then
the call should be to make it easier to implement opti-
mal adjustments o scal policy in emerging markets
by strengthening automatic stabilisers or delegating
aspects o scal policy to an independent scal council,
not to insist that advanced country central banks aban-
don the pursuit o price stability and recovery.
The European Central Bank, spokesmen or which have
complained about how the policies o other central
banks have produced an uncomortably strong euro
exchange rate, is in a dierent position. In contrast to
17 See DeLong (1990).18 As quoted in Hoover (1952).19 See Committee on International Economic Policy and Reorm (2011).20This is the justication o capital infow restrictions as a second-best orm o nancial regulation rst developed, i I
am correct, in Eichengreen and Mussa (1998).
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11 Currency Wars: Perception and Reality
emerging markets, spokesmen or which have similarly
complained that their exchange rates are uncomort-
ably strong, the Eurozone does not currently suer rom
excessive infation, rothy asset markets, or risk o eco-
nomic overheating to the contrary. Eurozone infation
ell to 2% in January in line with the ECBs target, while
core infation at 1.2% is running below that. The ourth
quarter o 2012 saw Eurozone GDP shrink by 0.6%.
The standard policy prescription or a central bank
engaged in fexible infation targeting and worried by
an overly strong exchange rate would be to join the cur-
rency wars. In the event, the ECB is not a conventional
infation-targeting central bank. It has a mandate to
hold infation at or below its target o 2% but not to pur-
sue other goals. The European public, whose approval
lends the ECBs policies political legitimacy, continues
to worry about infation, which was yesterdays prob-
lem but is less obviously todays or even tomorrows.
The analogy with the defationary 1930s when central
banks were haunted by the spectre o infation in anearlier decade, in turn eeding their reluctance to take
more aggressive monetary action is direct. How the
ECB squares this circle will have implications not just
or the global currency wars, but or the uture o the
Eurozone itsel.
A nal analogy with the 1930s is the ailure o policy
makers in countries ollowing unconventional monetary
policies to adequately communicate their goals and
strategies. In late December, Japans incoming prime
minister made a series o comments about the desir-
ability o resisting a strong yen that were interpreted
in terms o the desirability o a weaker yen exchange
rate. By ocusing on the exchange rate rather than
on measures to push up the price level, reduce inter-
est rates, and encourage spending, those comments
anned ears that the strategy was intentionally beggar
thy neighbour. In its rst policy statement or 2013,
the Bank o Japan then signaled its responsiveness to
the new governments desires, but announced that it
would consider urther ramping up its programme o
asset purchases only in 2014. By creating expectations
that it might acquiesce to a weaker yen exchange rate
but that it would only take additional steps to oster
expectations o higher prices, lower real interest rates,
and more spending 12 or more months in the uture,
that statement urther heightened ears abroad that the
new strategy was exchange-rate-centered and beggar
thy neighbour.
It may be that the essence o Japans new monetary
policy strategy is the higher infation target o 2% and
that the Bank o Japan will make a concerted eort to
achieve it, creating expectations o a higher uture price
level and encouraging additional spending by Japanese
consumers something that would be more likely to
have positive spillovers or other countries. I so, this
act needs to be conveyed more clearly to avoid anning
ears o currency war.
Currency war is now a standard trope in journalis-
tic accounts o monetary policy. But what exactly
constitutes currency warare remains unclear. Not
every economic policy that is associated with a weaker
exchange rate is undesirable, and not every domestic
policy associated with a weaker exchange rate nec-
essarily redounds to the disavor o other countries.
Ocials warning o currency wars would do better to
distinguish positive rom negative eects o the oreign
monetary policies o which they complain. They would
do well to consider the alternatives. Would emerging
markets really be better o i advanced countries at
risk o defation and recession abandoned their uncon-
ventional policies? Policymakers in emerging markets
could spend less time complaining about advanced
country policies and more time identiying and imple-
menting an appropriate policy response. Policymakers
in advanced countries, or their part, need to do a better
job o communicating the intent o their policies. Only
then are we likely to see our way through the og o war.
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4. Reerences
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