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FABSF
WEEKLY LETTER
June 13, 1986
International Policy Coordination
At the recently concluded May 4-6 summit
meeting in Tokyo, the u.s. and six other major
industrial powers agreed to work toward closer
coordination of their economic policies. Such
coordination is seen as a basis for moderating
exchange rate swings and maintaining a healthy
world economy. The focus on improving coordination stems from a heightened awareness by
policymakers that the attainment of national
interests depends on the actions of others, and
that flexible exchange rates do not fully eliminate the effects of the pol icies of foreign countries on their own economies.
At the recent May meeting of G-7 countries, the
G-5 nations plus Canada and Italy agreed to
attempt coordination on a more formal ongoing
basis by periodically assessing one another's
policies and recommending changes to those
whose policies are deemed to be out of line and
damaging to others. To aid in these assessments
and the gauging of economic performance, the
countries will use an array of indicators that
would probably include output growth rates,
inflation rates, interest rates, trade balances, and
possibly, a range of values for each country's
currency.
Many regard the agreement reached at Tokyo as
the natural result of international cooperation
over the past year to bring down both worldwide interest rates and the value of the dollar.
This Letter examines the motivations behind
these policy actions and the prospects for continued international coordination.
Rules versus discretion
Policy coordination among countries may take
different forms. At one extreme are agreements
by individual countries to adhere to particular
policy rules. For example, the Bretton Woods
international monetary system, in effect from
1944 to 1973, represented a rule-based agreement whereby countries sought to fix the value
of their currencies in terms of the dollar. When a
currency departed from its fixed rate, the country behind it was expected automatically to
intervene to bring it into line. The European
Monetary System (EMS) is a more recent example of coordination based on adherence to rules
of exchange rate management by cooperating
countries.
Recent coordination efforts
The May summit agreement was only the most
recent of a series of joint steps undertaken by the
United States and other countries over the last
year. On September 22,1985, the G-5 countries
- the United States, West Germany, Japan,
France, and the United Kingdom - announced
concerted support for a reduction in the foreign
exchange value of the dollar. While the dollar
was already on a downward path, it continued
to fall following the agreement.
In January, the G-5 countries agreed on the
desirability of interest rate declines but stopped
short of coordinated steps to lower interest rates.
It was only in March that the United States, West
Germany, and Japan lowered their discount
rates - the rate that central banks charge on
loans to commercial banks - by half a percentage point. In April, another round of reductions
was undertaken by the Federal Reserve and the
Bank of Japan. The Bundesbank, however, conspicuously chose not to make a similar reduction.
At the other extreme, coordination may take the
form of ad hoc arrangements reached through
formal or informal contacts to deal with particular economic circumstances. The joint effort
announced last September to push down the
value of the dollar and the recent discount rate
cuts may be seen as examples of this type of
coordination.
By their nature, rules limit policy discretion and
encourage individual countries to "bend" or
break the rules when they feel it is in their best
interests to do so. The collapse of the Bretton
Woods international monetary system in 1973
reflected the unwillingness of countries to
FRBSF
accept the restraints on their national economic
policies required by the formal commitment to
maintain fixed exchange rates. For example, in
the period starting in the mid-1960s, when inflation was putting downward pressure on the
dollar, the u.s. chose to let the dollar drop in
value rather than accept the economic stagnancy and greater unemployment that would
otherwise have resulted.
Short-term discretionary arrangements allow
more flexibility than long-term rules in dealing
with specific circumstances. Nevertheless, countries also find it difficult to achieve short-term
policy arrangements because the process of bargaining and negotiating is time-consuming and
the circumstances underlying each round of
negotiations are changeable.
More importantly, the achievement of coordination agreements requires that the countries
involved be able to reconci letheir various interests and views of the world. For example,
some may give higher priority to fighting inflation while others favor lowering unemployment.
Even if policymakers could agree on goals, they
may differ with respect to views about the structure of the economy and the influence of policy
actions on targeted variables. For example, West
German policymakers are generally perceived to
believe that a given fiscal or monetary stimulus
will have a greater influence on the price level,
relative to output andemployment, than policymakers in the u.s.
In addition, coordination may be inhibited by
the unwillingness of individual countries to take
the necessary lead even when the same goals
are shared. For example, in a world recession,
countries may prefer to wait for the expansionary policies of others to generate increased
demand for their products rather than stimulate
their own economies. Recovery therefore is
likely to be delayed or aborted, to the loss of all.
Reconciliation of interests
The success of either ru Ie-based agreements or
shorHerm arrangements ultimately depends on
the ,continuing ability of the countries involved
to reconcile their interests and to recognize that
each has something to gain through interna~
tional coordination. The importance of reconciling interests is apparent from a closer
examination of the episodes of international
coordination by the United States, Japan, and
W. Germany over the past year.
What motivated the U.S. last September to seek
a lower dollar was the desire to encourage
exports (by making them more competitive) and
discourage imports (by making them more
expensive), Both Japan and West Germany also
recognized the need to bring down the dollar to
head-off protectionist pressures in the u.s. The
dollar depreciation would reduce u.s. demand
for their products, but the economies of both
countries were showing signs of robust health at
the time. West German growth was picking up
strongly in the second and third quarters of 1985
following a downturn in the first quarter; Japan
experienced reasonable growth in the middle of
1985
Six months later, in March of this year, the u.s.
cut its discount rate because of a desire to stimulate an apparently sluggish economy (growth in
the fourth quarter of 1985 was 0.7 percent). In
addition, U.s. long-term interest rates fell over
1V2 percentage points between late-October
1985 and mid-March 1986 because of expectations of declining inflation and anticipated
reductions in the budget deficit. Since short-term
rates had remained relatively stable over the
same period, the cut in the discount rate
allowed the federal funds rate and other shortterm rates to fall in step. Still another rationale
was a desire to lower worldwide interest rates to
ease the debt burdens of developing countries.
The major reason both West Germany and Japan
followed suit appears to have been a concern
that the dollar was falling too rapidly. Matching.
discount rate cuts would reduce the likelihood
that the cut by the Fed would drive the dollar
down faster. Japan was more than willing to
cooperate (and, in fact, had enacted a unilateral
discount rate cut in January) because the cut
would also stimulate its own then-slowing economy and temporarily halt the effects of a declining dollar on its exports. Because of the fall in
the price of oil and the growing strength of the
yen, the inflationary effects of such a stimulative
action were perceived to be small.
West Germany's motivations were similar. Even
though the expansion of its exports was slowing
because of the strengthen ing of the deutschemark, overall economic growth was moderate.
Domestic demand was being spurred by consumer spending bolstered by income-tax cuts
that went into effect at the beginning of 1986.
Nevertheless, because unemployment remained
historically high at q. level of between 8 and 9
percent, West Germany viewed the stimulative
effects of the small discount rate cut as desirable.
u.s.
Only the
and Japan participated in the second round of discount rate cuts in April, for
much the same reasons as they had in March.
West Germany refused to join in, citing the possible long-term inflationary effects of further
stimulatory actions despite inflation rates of less
than 2 percent in 1985 and 1 percent so far in
1986. Divergent domestic interests thus prevented a complete agreement on policies.
The Tokyo agreement
The Tokyo agreement can be interpreted as an
attempt to create a relatively long-term arrangement to coordinate international economic policies that also recognizes the general
unwillingness to return to a rule-based system
that rigidly limits policymaking discretion.
Before noting the achievements, it is worthwhile
to look first at what was not achieved at the
Tokyo summit. First, the countries did not agree
on a stronger form of coordination, such as
jointly set "target zones" beyond which currency values would not be allowed to fluctuate.
Most countries were unwilling to commit themselves to such a scheme because it would have
required them to take economic steps - such as
changing government spending and taxation
levels, reducing or raising interest rates, or liberalizing access to their markets - solely in
response to pressures on their currencies.
u.s.
Second, the
could not obtain agreement,
particularly from West Germany and Japan, on
an arrangement whereby countries automatically would be obliged to adjust their policies
in response to "objective indicators" for measuring economic performance. Such an arrangement would have called for both West Germany
and Japan to stimulate their own economies fur-
ther by increasing their fiscal spending and, in
so doing, assume the "Iocomotive" role of sustaining growth in the world economy as
economic growth slowed.
u.s.
Both West Germany and Japan have staunchly
opposed such policies. While West Germany
cut income taxes in January and has scheduled a
second set of cuts for 1988, one of its overriding
policy objectives remains to reduce the relative
size of its public sector. Because of the size of its
central governmentdeficit (near 5 percent of
GNP in 1985), the substantial increase in central
government debt over the past ten years, and a
prospective large increase in social security payments, Japan,also continues to emphasize reductions in the level of its central government
spending.
Instead of policy rules, the Tokyo agreement
calls for the recommendation, rather than the
requirement, of appropriate policies to countries
that diverge from desired international economic
goals. Individual goals are to be set each year at
ministerial meetings of the member nations, with
the International Monetary Fund to monitor how
well each country lives up to them. Proponents
of the plan hope that the pressure of international attention will force individual countries to
comply with the jointly set goals. Nevertheless,
the ultimate success of the plan still depends on
a continuing coincidence of interests.
Certainly, the prospects for coordination have
been enhanced by the fact that all the major
economies are now growing. The sustained drop
in oil prices has improved the inflation outlook
both in the
and abroad. In addition, the
anticipated decline in
federal budget deficits together with the recent discount rate cuts
represent a convergent trend among national
economic policies.
u.s.
U.s.
Given all these developments, the conditions
may be conducive to arrangements and concessions that are to every country's best interests.
Thus, the Tokyo agreement should be seen as a
positive step by the large industrial countries to
reduce the instability in world economies that
arises from conflicting national policies.
Reuven Glick
Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San
Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor (Gregory Tong) or to the author .... Free copies of Federal Reserve publications
can be obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco
94120. Phone (415) 974-2246.
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BANKING DATA-TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)
Selected Assets and Liabilities
large Commercial Banks
Loans, Leases and Investments1 2
Loans and Leases 1 6
Commercial and Industrial
Real estate
Loans to Individuals
Leases
U.S. Treasury and Agency Securities 2
Other Secu rities 2
Total Deposits
Demand Deposits
Demand Deposits Adjusted 3
Other Transaction Balances4
Total Non-Transaction Balances 6
Money Market Deposit
Accounts-Total
Time Deposits in Amounts of
$100,000 or more
Other Liabilities for Borrowed MoneyS
Two Week Averages
of Daily Figures
Change from 5/22/85
Dollar
Percentl
Amount
Outstanding
Change
from
5/21/86
202,276
183,412
52,386
66,968
38,922
5,627
11,028
7,836
200,491
48,297
33,792
15,737
136,457
5/14/86
190
185
489
244
48
8
12
7
-1,318
-
~1,646
-
-
46,440
36,234
23,854
-
-
650
20
347
10,197
9,943
149
3,881
4,843
266
564
817
7,644
4,464
6,269
2,621
560
5.3
5.7
- 0.2
6.1
14.2
4.9
- 4.8
11.6
3.9
10.1
-15.6
19.9
0.4
3,063
7.0
440
-
-
135
405
Penod ended
Penod ended
5/19/86
5/5/86
2,162
552
Reserve Position, All Reporting Banks
Excess Reserves (+ )/Deficiency (-)
Borrowings
Net free reserves (+ )/Net borrowed{ -)
28
41
13
15
39
55
1 Includes loss reserves, unearned income, excludes interbank loans
2 Excludes trading account securities
3 Excludes U.s. government and depository institution deposits and cash items
4 ATS, NOW, Super NOW and savings accounts with telephone transfers
S Includes borrowing via FRB, TT&L notes, Fed Funds, RPs and other sources
6 Includes items not shown separately
7
Annualized percent change
-
5.6
2.3
@FedFRASER