Some Lessons from Recent Global Macro Events

I’ve just attended a conference sponsored by the Reinventing Bretton Woods Committee, entitled “The International Monetary System: Old and New Debates”, which took place against the backdrop of France’s chairmanship of the G-20.

Numerous topics were discussed, including the deficiencies of the international monetary system, externalities of international financial capital flows, multiple reserve currency regimes, and balance of payments adjustment. I was on the panel dealing with the last topic, and included Claudio Borio (BIS), Kathryn Dominguez (U. Mich.), Pier Carlo Padoan (OECD). I made the following comments: 

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Some lessons from recent global macro events

(Or, things I would not have thought two years ago)

  • Even surplus countries can be faced with unpleasant choices (the Trilemma strikes!)
  • Exchange rate adjustment can occur without nominal exchange rate changes
  • Exchange rates matter for trade flows
  • Difficulties in monetary/exchange rate coordination do not rule out positive outcomes.

Surplus countries eventually adjust. Certain emerging market economies have managed to run substantial and persistent current account surpluses, sometimes with the assistance of capital controls. But we see now that there are limits to the freedom afforded by these measures. Increasing monetary easing in the US combined with a desire to restrain inflation in China has presented China with a serious dilemma: allow faster nominal appreciation or allow more rapid inflation and hence real appreciation. The Trilemma strikes! (aka the “Impossible Trinity”, the fact that countries cannot simultaneously pursue monetary autonomy, fixed exchange rates, and full capital mobility) [1]


Figure 1: drawn from Figure 4 in Aizenman, Chinn, Ito (2008).


Figure 2: Log real (CPI deflated) bilateral USD/CNY (blue), and log real trade weighted value of CNY (red), rescaled to 2005M07=0. Source: St. Louis Fed FREDII, CEIC, ADB ARIC, BIS, and author’s calculations.The fact that inflation is sufficiently high relative to other countries’ rates so as to appreciate the CNY in real terms reinforces the point that there are limits to sterilization, even in China. [FT]


Figure 3: Year-on-year CPI inflation (blue), and WPI inflation (red). Source: IMF, International Financial Statistics.Elasticity pessimism. The variation in trade flows and real rates, especially China’s, has allowed us to get a better idea of the responsiveness of trade flows to price changes. This is particularly true where Shaghil Ahmed, as well as I, find it easy to obtain relative high price elasticities (compare [2] to [3]). Hence, there is more scope for adjustment by this path than I thought before.

There is a rejoinder that unless saving and investment determinants change, there will be no change in current account imbalances. But if the exchange rate changes are sufficiently large, they will affect those saving and investment determinants. So, it’s not an either or proposition. Rather, the elasticities, the saving-investment (or macro balances) approach and the monetary approach are all different ways of looking at the same phenomenon. [4]

A final lesson, completely unsurprising, is that coordination is very hard to achieve. But that doesn’t mean mutually beneficial sets of actions can’t occur. I think that QE2 will help convince other countries to either loosen their monetary policy (in developed countries), or ease their link to the dollar (in emerging market economies).[5] I think both of these are salutary developments.

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On the issue of diplomatic versus economic success, this paragraph from the latest issue of China Economic Quarterly [not online] seems relevant:

On the current account balance, China helped organize the rejection, at the G-20 summit in Seoul in November, of a proposal by US Treasury Secretary Tim Geithner that the major economies commit to specific limits on current account balances. China’s refusal to sign anything concrete was mainly political: embarrassing the United States and undermining its ability to impose a latter-day Plaza Accord are important goals for a China that wishes to maintain maximum policy autonomy. But Beijing realizes that ever-expanding trade surpluses are politically unsustainable and will likely prompt a wave of protectionism. At the IMF’s annual meeting in October, deputy PBC governor Yi Gang indicated that China will aim to get its current account surplus below 4% of GDP within the next three to five years. The surplus this year is likely to be 5.5% of GDP, about half the 2007 peak of 10.6%; the more narrowly defined trade surplus will be about 3.8% of GDP, well down from the 2007 peak of 8.7%.

This meeting was discussed in this post.

Originally published at Econbrowser and reproduced here with permission.