International Coordination Jeffrey Frankel

Harpel Professor of Capital Formation and Growth Harvard Kennedy School

2015 Asia Economic Policy Conference Policy Challenges in a Diverging Global Economy Federal Reserve Bank of San Francisco November 19-20, 2015

Calls for international macroeconomic policy coordination are back • after a 30-year absence. • Origins in scholarship:

Cooper (1969) and Hamada (1976).

• Heyday of coordination in practice: the decade 1978-1987, – from the Bonn Summit to the Louvre Accord.

Calls for international macroeconomic policy coordination are back

• Coordination then fell out of favor. – Historically, • The Germans, in particular, regretted what they had agreed at the Bonn Summit: reflation turned out to be the wrong objective in the inflation-plagued late 1970s. • Most summit communiques had little effect, – for better or worse.

• Another problem: the structure of the G-7 did not allow a role for EM countries.

– Skeptic scholars: Oudiz & Sachs (1984), Rogoff (1985), Tabellini (1990), Kehoe (1987), Feldstein (1988), Fischer (1988), Frankel (1988), Ghosh & Masson (1988).

The return of international policy coordination • G-20 leaders summits

– 1st summits: DC, Nov. 2008, & London, April 2009, – to deal with GFC.

• Agreements to refrain from competitive depreciation – Ceasefire, G-7 ministers in February 2013 – Side agreement to TPP, November 2015.

• EM calls for FRB to coordinate,

– after “taper tantrum” of 2013 – – RBI Gov. Rajan: “International monetary cooperation has broken down…The U.S. should worry about the effects of its policies on the rest of the world” (1/30/14).

The return of international policy coordination

• This time the issues go by names like – currency wars, – taper tantrums, – and fiscal compacts.

• Some scholars have returned to the subject: – E.g., Blanchard, Ostry & Ghosh (2013), Ostry & Ghosh (2013), Subacchi & Van den Noord (2012), Taylor (2013) and Engel (2014, 2015). – And to the question whether floating exchange rates insulate: Rey (2015)…

Outline • Four possible frameworks for proposals to coordinate fiscal or monetary policy: 1) 2) 3) 4)

the locomotive game (“exporting unemployment”), the discipline game (moral hazard), the competitive depreciation game (“currency war”) and the competitive appreciation game (“exporting inflation”).

• The paper also considers

– claims that monetary coordination has been made necessary by the loss of the short-term interest rate instrument.

• Proposals for the direction of coordination vary widely, – due to different models and – different domestic interests. – These differences weaken the calls for coordination

• which can deflect attention from dealing with important domestic issues.

FISCAL POLICY 1) The locomotive game (as seen, esp., by US):

When cooperation means joint expansion

Historical examples: • G-7 London Summit, 1977; Bonn Summit, 1978 – to promote recovery from 1975 recession.

• G-20 leaders’ summit in London, April 2009 – to deal with GFC.

• G-20 meeting in Brisbane, November 2014 – after a new slowing of global growth. – It agreed to “strengthen policy cooperation,” including to “boost demand and jobs.”

When cooperation means joint expansion Table 1: The locomotive game US pursues contractionary fiscal policy Europe Non-cooperative pursues “beggar-thy-neighbor” contractionary equilibrium: global fiscal policy recession.

US runs trade deficit; complains on behalf of its exporters and importcompeting firms.

Europe pursues expansionary fiscal policy

Cooperative “locomotive” outcome: nobody achieves a trade surplus, but higher spending lifts all boats.

Europe complains, on behalf of its exporters and import-competing firms.

US pursues expansionary fiscal policy

Figure 1: The locomotive game

= US spending

•

•

= German spending

But that’s not how the Germans see it…

2) The discipline game

When cooperation means joint fiscal rectitude In their view, • Fiscal expansion is not expansionary. E.g., AS is vertical. • And one country’s fiscal expansion is a negative externality, not a positive one: – competing for funds in global marketplace • e.g., Chang (1990);

– or gambling on bailout in the event of fiscal crisis • E.g., from IMF • or fellow members of a European Monetary Union – e.g., Glick and Hutchison (1993), Aizenman (1998).

For that matter, it’s not how US congressional Republicans see it either.

Table 2: The discipline game (moral hazard):

When cooperation means joint fiscal rectitude

Germany runs budget surplus Germany runs budget deficit

Other euro member runs budget surplus

Other euro member runs budget deficit

Cooperative agreement on fiscal rules, to eliminate moral hazard.

Germans fear that they will have to bail out the other member.

Other member fears it will have to bail out Germany.

Uncoordinated equilibrium: Everyone runs excessive deficits because of moral hazard from possible bailouts.

Figure 2: The discipline game

= spending of US, or of euro partners

• • = German spending

MONETARY POLICY (3) The competitive depreciation game or “Currency Wars” Historical examples • Competitive devaluations in the 1930s, esp. FDR dropping out of London Monetary Conference of 1933 – – as seen by Europe at the time and historians.

• China currency manipulation, as seen by US politicians. – 2003-13, when PBoC bought dollars – and even 2014-15, when it has been selling dollars.

• US QE2, 2010-11 – as seen by Brazilian leaders. • Japan’s QQE (Abenomics), 2012-13 – as seen by US. • ECB QE, 2014-15.

“Currency wars” • Brazilian complaints: – Finance Minister Guido Mantega, 2010: “We’re in the midst of an international currency war, a general weakening of currency. This threatens us because it takes away our competitiveness” (9/27/2010). – President Dilma Rousseff continued the currency war accusation, criticizing QE by the US and other advanced countries as a “monetary tsunami” that had detrimental effects via the exchange rate (April 2012).

Table 3a: The competitive depreciation game (currency wars): When cooperation means keeping interest rates high

Other country tightens monetary policy Other country expands monetary policy

US pursues contractionary monetary policy Superior cooperative equilibrium: all agree to refrain from currency warfare. Dollar appreciates. US complains, on behalf of its exporters.

US pursues expansionary monetary policy Dollar depreciates. Trading partners complain, on behalf of their exporters . “Currency war” noncooperative outcome: said to be bad for all, because none achieves depreciation & trade stimulus.

Examples of cooperative agreements to prevent competitive depreciation • Rules to avoid currency wars by requiring floating. – IMF’s 1977 Surveillance Decision & Article IV (3.1), 1978: each member shall “avoid manipulating exchange rates…to prevent effective balance of payments adjustment…“

– “G-7 ceasefire in the currency war,” February 2013 “We, the G7 Ministers and Governors, reaffirm our longstanding commitment to market determined exchange rates… [O]ur fiscal and monetary policies have been and will remain oriented towards meeting our respective domestic objectives using domestic instruments.”

– Side-agreement to TPP, November 2015. – Proposals to go further, to put currency manipulation rules into trade agreements, backed up by trade sanctions. • e.g., Bergsten (2013, 2015a) and Gagnon (2012, 2013).

Doubts about the currency wars paradigm: • Revisionist view of 1930s competitive devaluations – Eichengreen-Sachs (1985, 1986); Eichengreen (2015). – When all devalued against gold, money became easier, which is just what was needed.

• Monetary easing ≠ currency manipulation. – It isn’t even clear whether effect on TB >0 or a strong dollar. • One view was that it represented competitive appreciation: • US policy mix exported CPI inflation to other countries. • Sachs (1985).

• In any case, the $ provoked complaints among trading partners and in 1985 led to one of the most renowned coordination agreements: – the Plaza Accord, • in which G5 ministers agreed to bring the dollar down. • 30th anniversary this year.

– Cooperation meant fx intervention to depreciation the $ • whereas today it seems to mean refraining from intervention.

Table 4: The competitive appreciation game (exporting inflation)

When cooperation means keeping interest rates low US raises interest rates Other country Non-cooperative raises interest equilibrium: rates High interest rates everywhere. The world is stuck in recession. Other country Dollar appreciates, keeps interest lowering US CPI inflation rates low at the expense of other countries

US keeps interestrates low Dollar depreciates, raising US CPI inflation

Cooperative equilibrium: Low interest rates everywhere. Exchange rates unchanged, but growth is sustained.

To summarize, differences in perceptions and domestic politics are as big as the difference between cooperation and non-cooperation. • Who was right about the 1933 London Monetary Conference? – FDR or the Europeans? • Who was right about the 1977-78 locomotive proposal? – The US or Germany? • Which is the negative externality in the eurozone: – fiscal austerity or fiscal irresponsibility? • Which has a negative spillover on EMEs: – when the US eases money (2010) or tightens (2015)?

Disagreement as to the nature of the spillover effect and the direction desirable proposals wreaks havoc with the whole idea of coordination. • 1st , if countries disagree on the model, the officials might not even be able to carry on a coherent discussion of the potential gains from coordination and how to achieve them. – Think of the negotiations between the new Greek government in January 2015 and its euro partners. – The precedent of cooperation in other areas suggests that a common model may be a pre-requisite: Cooper (2001).

• 2nd , even if negotiators come up with a coordinated package of policIes that each believes will leave them better off – which technically they can, though they don’t understand why the other side wants to make the deal – it could make things worse. – Frankel & Rockett (1998).

Concluding thoughts • Regular meetings of officials (within reason!) are useful. – Consultation, to minimize surprises. – Perhaps they can narrow differences in perceptions. – But each country has an incentive to claim to believe in whatever model suits its interest in the bargaining process • Ostry & Ghosh (2015).

– Officials may come increasingly to believe the models that suit their claims • – “cognitive dissonance.”

• Calls for international coordination are sometimes less useful, – when they blame foreigners to distract attention from domestic constraints and disagreements.

Examples where calls for coordination distract: • In 2010, Brazil’s budget deficit was too large and the economy overheated. – Domestic 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 obscured the problem.

• In 2015, US wages continue to stagnate. – Politicians’ efforts to ban currency manipulation in trade agreements are scapegoating Asians rather than dealing with the problem.

International Coordination Jeffrey Frankel 2015 Asia Economic Policy Conference Federal Reserve Bank of San Francisco November 19-20, 2015