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AVOIDINC I.ÍONETARY PROTECTIONISI{:
TTIE ROLE OF POLICY COORDINATION
by
W. Lee Hoskins, Presldent
Owen
F.
and
Humpage, EconomLc Advisor
Federal Resetr¡e Bank of Cleveland
P.O. Box 6387
Cleveland, OH 44101, USA
(2L6) s79-ZLLI
(2L6> s79-20L9
Presented
at
Instltute's Eighth Arrrual Monetary Gonference:
nGlobal Monetary Order: L992 and Beyond"
London, England
February 23, 1990.
Èhe Cato
1
This paper w111 be published in Ëhe Cato Journal, VoI. 10, No. 2 (Fall 1990).
gracefully acknowledge the assistance of the scaff, and the helpful
and conments on early drafts from James Cassing, David Fand, Stevelr
Husted, Arthur Rolnick, and Alan Stockrnan.
I.le
criticlsn
Opinions stated in this paper are our own and do not necessarily reflect those
of the aforementioned individuals, of the Federal Resett¡e Bank of Cleveland,
or of the Board of Governors of the Federal Reserve System.
L_
¡urenenuåMny
AVOIDING UONETARY PROTECTTONIS}I:
THE ROLE OF POLICY COORDTNATION
Economists have long questioned the wisdom of attempting to achíeve
current-account objectives through a monetary manipulation of nominal exchange
rates, and most have come to reject Èhls practice as little
near-uerm palliative.
more Èhan
a
Nevertheless, aiming monetary policies at nominal
exchange-rate targets increasingly seems to be the approach of choice
among
national leaders.
hle
refer to these attempts as monetary protectionism in order to
emphasize their similarities
policies.
to more tradiÈional types of protectionist
As with calls for tarlffs
and quotas, calls for monetary
proEectionism do not stem from a clear, unequivocal demonstration of market
failure, but rather from political
institutions
and íncentives that encourage
those dissatisfied with the market's outcome to seek market intervention.
Proponents of monetary protection seek to supplant the automatic and
nondiscriminatory responses of markets with the discretionary, politically
motivated decisions of bureaucrats. Any ínternational order built on such
a
foundation cannot raise world welfare.
This paper will explore the political
protectionism in order to illustrate
understand lts political
economy
of monetary
its economic shortcomings and to
appeal. As a counterweight to the polírical pull
toward monetary Protectlonism,
\¡re recommend
that nations adopt monetary
constitutions that focus monetary policy on long-term price stability
and that
recognize market-determined exchange..rates. Moreover, r{re contend that
Ínternational policy coordinatlon set withln Èhis framework is both feasible
and credible.
2
}lonetary ProtectLonism
By monetary Protectionism, we refer to attempts co alter real exchange
rates through a manípulatíon of monetary policy, with the hope of ultimately
prornoting a balance-of-payments objective.
In the case of a defÍcit country,
such as the United States in early 1985, monetary protectionists call for an
expansion of money gro!¡Ëh. A monetary expansion, other things being equal,
will produce a nominal depreciation.l
If individuals are unable to adjust
prices immediately, or if they are slow in perceiving the inflationary aspects
of this policy, a real depreciatíon will accompany the nominal depreciation.
As most economists realize, however, the inflation
raÈe \^rill eventually
respond to the monetary expansion, offsetting the nominal depreciation and
returning the real exchange rate to its inicial positlon.
NeverËheless, the
tenuous, shorË-lived relationship between money and the real exchange raÈe is
seductive enough to convlnce politicians
and other "fine-tuners" thaË monetary
policy can serve mercantilist designs.
Our focus on
can do no
this issue stems from a firm betief that central
better than to
efforts to limit Èhis
guaranÈee long-run
guarantee are
price stability and that
banks
any
not likely to raise welfare. This is
the
central lesson from the experience of policymaking during the 1970s, as well
as the message of much of the professional literature based on models with
***********¡k
1
Monetary policy eould play an important role ln correcting a
'
current-account deficit in an ínflationary economy. The correct response, of
course, would be a contractionary policy.
3
forward-looking, optimizing agents. Central banks can juggle a real
exchange
rate and inflation target no better than they can slíde back and forth along
stable Phillips curve.
A central bank that attempts to maintain price stability
a
and a nominal
exchange-rate target has more policy Èargets than policy instruments.
Ac
times, these two objectives míght be compatible. For example, in the late
1970s, lirniting the rapid dollar depreciation through intervention purchases
of dollars could have been compatible with a conÈracËionary monetary policy to
eliminate inflation.
As often as not, however, these two polícy objectives
will be incompatible, and the cenÈral bank must trade one objective agains¡
the other.2
Under such conditions, markets will view neither price stabíIiËy nor
exchange-rate stabílity
banks will
as a credible policy.
The knowledge that central
deviaÈe from a policy of price stabÍlity
co pursue an exchange-rate
objective wíll raise uncertainty about real returns and will distort the
allocation of resources across sectors and through time. The resources
devoted to protecting wealth from posslble lnflation
productive uses under a policy of price stability.
could be applied to
more
Moreover, atcempts to
maintain nomínal exchange rates will not elimínate exchange-rate uncertainty,
since countries inevltably will resort to periodlc exchange-rate realignments.
Hedging exchange risk w111 remain an important aspect of international
commerce.
Although monetary protectionism seems most prevalent under the present
system of floating exchange rates, one should not conclude that floating
************
2
,Ã" assume here that the world will not adopt a commodity (gold) standard,
nor will all central banks steadfastly pursue price stability.
4
exchange rates Promote its use. Monetary protecÈionism can result any time
that a government lacks a strict monetary constitution and will accept
nonmarket criteria
for exchange rates.
In principle, a gold standard or
a
fixed exchange-rate regime can limit the scope of monetary protectionism,
because if all countries play by the rules of the game, they link money
supplies closely to the flow of internaÈional reserves. In practice, however,
such regimes do not destroy the political
motives for monetary protectionism,
and examples of monetary protection under fixed exchange rates abound. By
allowing some discretion in the choice of exchange-rate pegs, and by
permitting some ínertia in nominal exchange-rate adjustments, fixed
exchange-rate regimes often produce a mechanism that weakens the allocating
efficiency of exchange markets and promotes mercantilist objectives.
EconomLc Arguments
for
Monetary protectlonism
Proponents of exchange-market inËervention contend that the existing
system of floating exchange rates lowers the potenÈial gains from
internaÈional commerce, because it has proven to be excessively volatile
and
because lt has failed to promote adjustmenr-ln the trade accounts. In their
view, a global monetary system built on cooperative efforts
to
manage exchange
among governments
rates would enhance world welfare. Most economists
recognize thaÈ one must base a legitimate case for government intervention
on
microeconornlc evidence of market failure;
and
externalities,
that is, evidence of distortions
which prevent mutually benefícial trades from occurring. Ilhat,
then, are the alleged market failures that underlie the interventionists,
crlticlsm of exchange markets?
Imperfect Information
Prorninent Èhemes in the interventionist
as excessively volatile,
literaËure víew exchange rates
maí.ntain that they overshooÈ their equilibrium
values, and contend that they are subject to speculative runs.
Interventionists view such tendencies as beÍng
synon)rmous
with "market
uncertainty" or "market disorder, " generally implying that they result from
imperfect informatíon.
Exchange markets,
Processors of information.
like other asseE markets, are highly efficient
Forward-looking traders base spot and forward
quotations on all relevant, available information. Upon the receipt of
new,
unanticipated information, traders revise their expectations and their
exchange-rate quotations. The market pays substantial rewards for investments
in knowledge, and provides few institutional
constraints that restrict
particÍpaÈion.
At times, government authorities can possess betÈer information
Ehan
the market; for example, when they contemplate pollcy surprises. But, in
nearly all cases, market participants and government bureaucrats receive
respond to the same information.
and
Bureaucrats do not enJoy prlvileged insight.
Moreover, the market will learn to anticipate the government's reaction to
market developments, so that routine government interventions will not impart
new information.
These observaÈions also suggest that unpredictable changes
in governmenc policies could be a prominent source of much of the observed
exchange
-
rate volatility.
AII of Ëhis does not imply thaÈ exchange rates will remain stable.
Indeed, nominal and real exchange rates have been substantially more volatile
6
since L973, uPon the demlse of BreÈton Woods. At quesÈion is the extent to
which one should view volacirity
as necessarily reflecEing market
imperfections, which would require government intervention.
contrary, as
\¡¡e
Quite the
discuss in the next section, movements in nominal exchange
rates can be part of efflcient
adjustment in the terms of trade.
lack convincing evidence that exchange-raÈe volatilíty
Moreover,
r¡¡e
is greater than that
observed in other asseË prices, or that exchange-rate volatility
has reduced
internaËlonal trade or worldwlde investment (see Balley [1988]).
The interventionlsts'
characterization of exchange-rate overshooting
and of speculative runs presumes that they know the equílibrfum exchange-rate
path. Theoretícally, a sustainable equllibrium exchange-rate path is
consistenu with our concept of general equilibrium.
Unfortunately, economists
simply lack sufficient knowledge to specify accuraÈely such an equilibrium
path for a dynamic economy. Interventionists,
therefore, designate
equilibrium values in terms of a limited set of "fundamentals," which they
hope will
track the general-equilibrium path accurately enough that a polÍcy
of forcing market rates to this path will increase economic rvelfare.
I.Ie
are highly skeptical of such efforts.
Volumes of econometric work
have attempËed to specify the relationship among sets of these fundamentals
and exchange rates, wlth mostly unsatisfactory econometric results.3
Most
often, analysts speclfy the equilibrium exchange-rate path in terms of
purchasing-power parity.
The problems assoclated with deriving purchasing-
Power parity estimates of exchange rates are well known. Accuracy assumes
that one chooses an equilibrium base períod and chat all subsequent shocks are
************
The seminal study on
this issue is
Meese and Rogoff (1983).
7
monetary in nature.
Because norunonetary shocks can
alter the equilibrium real
exchange rate over time, the original purchasing-power parity estimate can
dríft away from the correct equilibrium exchange rate.
Another
common
alternative ls to define exchange-markeË equilibrium in
terms of a ttsusÈainable" current-account balance: one equal to "normal"
capital flows. This approach relies on an estimation of a stable relatíonship
beÈween exchange
rates and the current account after the statistician
has
removed the effects of business cycles, Èrade dlstorÈ1ons, and other anomalies
and temporary influences.
Beyond the obvious technical problems, a strong economic racionale for
such a stable relationship between exchange rates and the current account does
not exist.
As stockman (August 1988, p. 535) notes: ". .any patÈern of
correlations between the current account and the exchange race can be obtained
from theory, depending on the source of the disturbance and
some
characteristics of the modeI."4
In truth, governments have no better infornation about what
constitutes the equilibrium exchange-rate path than do markets. Under
Ëhese
circumstances, attempts to force the exchange rate to a designaËed equtlibrium
are unlikely to enhance economic rvelfare.
Sticky Prices and
l{ages
Bullding on the idea that exchange rates should respond to trade
flows, a second interventionist theme justifies
active manipulation of
exchange rates because prlces (notably wages) are sticky (see Krugman t19891).
************
Stockman (October l-988) provides examples.
8
In this vlew, exchange-rate manipulation is seen as a means of fosÈering
internatíona1 adjustmenÈ when prices, most notably
country, are sticky.
r^¡ages
in the deficit
A real depreclation is partícularly necessar1r, because
strong propensities to spend in home markets weaken income-adjustment
policies.
I,IiÈh stieky prlces, a nominal depreciation alters the terms of
trade, offerlng a necessary Íncentive to switch the pattern of expenditures.
The key here is an "active manipulatíon" of nominal exchange rates.
Floating rates can indeed promote effictency and aid in international
adjustment, especially when prices are stsícky. For example, an íncrease in
foreign
demand
for U.S. goods produces a dollar appreciation, which
that demand. Otherwise, with
home
dampens
prices assumed sticky, we would require
a
non-price mechanism to accorunodate the excess demand (see SËockrnan IOctober
1988, August 19881). Such exchange-rate adjustments promote mutually
beneficial trades and thereby enhance welfare.
The activist
view, however, rejects floatlng rates because they can
permit large, persistent current-account deficits.
assumes
Instead, this approach
that current-account deficits are disequilibrium responses to policy
errors, which market lmperfections aggravate. It characterizes the U.S.
current-accounË deflclt
as abnormal from a historic perspective, and
unsustainable 1n vlew of some subjective calculations of our abllity
as
to
finance chis debt. According to this view, exchange markets apparently fail
to consider these debt dynamics.
Recent work questions thís approach by suggesüing that large
current-account deficits can be an equillbrium attempt to smooth consumption
over time in the face of shocks that temporarily reduce current output, or in
Ëhe face of demographic factors that encourage current eonsumption relative to
9
future consurnpÈÍon (see Koenig t19891). As Hill (1989) suggesrs, models rhar
do not consider recent demographic patterns can produce misleading conclusions
about the nature of the current-account deficit.
Historic patterns, then,
might noË provide a basls against which to compare recent trends. Moreover,
this recent work seens to question the validity
of highly subjective
calculations of our abilíty to finance that debt.
Ile previously addressed a more important criticism of this I'activist"
view: Monetary-induced changes ín nominal exchange raËes will alter real
only temporarily, to the extent that prices are slow to adjust.
raÈes
In the long
term, monetary policy cannot alter the terms of trade.
Exchange-RaÈe Indetermínacy
I.Iallace (L979) offers a justification for exchange-rate management
based on the argument
that equilibrium
exchange
rates for fíat currencies are
indeterminate; that ls, many equilibrium exchange rates are possible.
Governments can break Èhe indeterminacy
either by fixing
exchange
rates,
by
íntroducing legal restrictions on currency holdings, or by credibly
threaÈening future exchange-market interventÍon.
Thls theoretical model
seems
to sug€est that all volatility is
superfluous and unrelated to any economic fundamentals. As already noEed,
exchange-rate
volattlity that is related to
and demands--can Promote the adJustment
fundamentals--changíng supplies
process.
The model
also
assumes
that
fiat currencies are perfect substitutes, but individuals typically hold
Portfolios of interest-earning assets, not currencles. Evidence suggests that
these assets are p.¡! perfect substitutes (see Hodrick [1987] ).
risk will render
exchange
rates determínant.
The associared
10
Even lf one accepEs the indeterminacy argument, it does noE justify
the maintenance of fíxed exchange rates through intervention in fiat
currencies. Legal restri-ctions, such as a simple rule that governments
collect all taxes and other pa)rments in their own currencies, would suffice to
solve the alleged problem.
Policy Spillovers
A recent justification
for monetary protectionism stems not from
market imperfections, but from alleged inefflciencies
macroeconomic
in government
policymaking. Because a few, very large countries (Èhe Group of
Five) domlnate international macroeconomic policy, the actions of any one
have
significant spillover effecËs on all other nations. Only through policy
coordination can governments internaLize these spillover effects, and achieve
polícy choices that are Pareto superior to autarkic policy setting.
Many
of
the recent calls for monetary policy to focus on fixing exchange rates or
on
establishing target zones stem from policy coordination arguments.
The elegant gleam of the theoretical argument for policy coordination
becomes tarnished when exposed
to empirical tests.
Generally, studies do not
offer support for international mechanlsms, such as fixed exchange rates or
target zones, that requlre a continual coordination of macroeconomic
policies.5
Empirical sÈudies of coordination find only small gains,
suggestíng that policy spillovers are not critical
of the largest industrial countries today.
************
Humpage (1990) surveys
this llterature.
to the economic well-being
11
A maJor argument against policy coordlnatlon
sufficient
knowledge about the nature
to agree on a sPecífic
is that
of international
model and on corrective
we lack
economic interactions
policíes. Nearly all
differ in their policy multÍpliers. Ilhen these multipliers
refer to domestic pollcy objectives, the dÍfferences are mainly ín degree; but
econometric models
multípliers refer to inÈernational policy effects, the differences
are often in direction. This uncertainty about the true economic model raises
when the
questions about the ability of policy coordlnatíon to enhance welfare.
In large Part, the lack of
success
in addressing current-account
imbalances among Llest Germany, Japan, and the United States
has arisen because each country views the cause
of the
in recent years,
problem
differently
and, therefore, each has a separate prescriptfon for redressing Ít.
problem stemming from U.S.
qtest
fiscal policies.
of international policy coordination is
that it can challenge the more traditfonal ordering of policy preferences,
Another questlonable aspect
whÍch
is an importanÈ aspect of national sovereignty.
example,
trfest Germany,
traditionally has favored relatively low Ínflation
and
for
a
current-account surplus, and is unltkely to accept a high rate of inflation in
order to eliminate its current-account surplus. Countries will pursue
lnternational policy coordfnation only
will
abandon
when
it is mutually advanÈageous;
they
pollcy coordinatlon if it conflicts with highly valued,
traditional domestic goals.
In view of the substantial weight countries attach to domestic policy
targeËs, and given the apparent model uncertainty, policy coordination will
lack the discipline and the spontaneity that it requires for credíbilicy,
much
L2
less for success. An approach lacking credibility
creates uncertainty
Ëhe reasons for government actions and could increase the volatility
abouË
of asset
prices, especially exchange rates.
The Polftical
I^Ie
Economy
of Ìfonetary Protectlonlsm
have attempted to illustrate
that the economic arguments offered in
favor of monetary protectionísm are weak; that such monetary manipulations
do
not have a Permanent effect on Èhe terms of trade, and that they risk causing
inflation.
political
To understand Ëheir proliferation,
institutions
one must investigate the
that give rise to monetary protectionism.
In contrast to the lnÈerventionist literature,
which presupposes an
all-v¡ise government acting in Èhe public's best interest, a rich, growing
literature
on political
economy characterízes
elected officials
as seeklng to
enhance their owrt power, prestige, and wealth by maximÍ-zi.:ng their ability
to
gain votes. Politicians and bureaucrats attemp! to extend the scope of their
political
influence by responding to the
demands
of the most politicalty
active (voting) constltuencies, This literature has offered important
insights lnto tradítional protectionisrn (see Quibria [1989]). Ilhat follows
are some thoughts on sirnilar elements relating to monetary protectionism.
Buying Time and Deferring Criticism
By 1985,
account was
dollar
exchange rates r¡rere
at their zenith; the U.S. current
deteriorating rapidly, and evidence suggested that the United
States was becomlng a debtor country
for the first time since
l^Iorld l.tar
I.
13
U.S. manufacturers, facing increasingly stiff
Congress for trade legislatlon.
competition worldwide, besieged
Most fmporcanÈ, analysts increasingly linked
the deterioratíon in the external accounts wíth fiscal policies of the
administration and Congress. The opportuniuy cost of government lnaction,
measured in terms of votes lost, seemed to rise sharply in the early 1980s.
The administration teal-ized that the U.S. current-account deficit
reflected imbalances becween savings and investment in the United States,
in lfest Germany and Japan. Governments, however, cannot easily redress
and
such
structural relationships through fiscal pollcies because of strong vested
interests Ín maintalning various tax and expendlture patterns.
The
unwilllngness of the Uníted States to take strong measures to cut the
federal budget deflcit cypifies the problem. A corresponding relucËance
Eo
expand fiscal policy for balance-of-payments purposes exisÈed in I.Iest Germany
and Japan in the early 1980s.
Lacking an
ability to address these structural
problems
directly
quickly, polic¡rmakers might resort to exchange-market intervention.
and
I"Ihen
coordinated through the Group of Seven, such interventíon offers a highly
visible signal that
governments are addressing
constituencies. If
accompanled
the requirements of their
by credible pronouncements of changes in
future monetary and fiscal policies, inËervenÈion might serve to diffuse
crlticism of adnlnistration policies, to blunt protectionlst
buy time
for
more fundamental
demands, and to
policy adjustments.
Targetin& Benefits. Diffusing Costs
llhile goods prices are slow to adjust, a nominal currency depreciation
is equivalent to a temporary, across
-
the -board
tax on imports and a subsidy to
t+
exporÈs. I.Iith Èhe terms of trade temporarily altered, certain groups in the
traded-goods sectors can realize benefíts from monetary protectionism similar
to those afforded by commercial policies. Ultimately,
monetary Protectionism disslpate
reduced
credibility of
monetary
any
benefits
with a higher inflation rate
polícy.
The
and
inflation costs of
from
with
a
monetary
protectloní.sm, however, are dispersed across a wider spectrum of individuals
and over
a longer time horizon than the beneflts. A constÍtuency that
receives net benefits from monetary protectlonism (export and import-
firms) can exist.
competing
Such
a constituency is likely to be polÍtícally
more cohesive than any constituency
policy that
for price stabilÍty.
Consequently,
seems myopic from an economic perspecÈive can be
a
politically
fars Íghted.
Another seemingly attractive aspect of monetary protectionism ts that
Congress and
the administration can justify it ln terms of broader
macroeconomic considerations, such as exchange-rate "misalignmentt' or
current-account "lmbalance," rather Èhan lndusÈry-specific considerations,
such as automobile and
aspects
of
steel employment. Consequently, the rent-seeking
monetary protectionism are less obvious than those
of
commercial
policies
In the early 1980s, most import-cornpeting firms sought direct
restraints,
because Congress can
tailor
commercial
policies to fit specific
products or countrles. Direct restraints, however, seemed increasingly
difficult for legislators
enact. As the frequently-heard plea "I'm for
free trade as long as 1t's fair" suggests, even those who seek resÈraints
recognLze
Ëo
that as a general poI1cy, protectionísm is costly
Perhaps more importanc, however, Congress faces
and
inefficient.
a growing antiprotectionist
5
lobby (see Destler and odell [1987]). Multinational firms and domesric
exporters fear that U.S. trade sanctions could trigger foreign retaliation.
Domestic importers of consumer goods and firms that use traded goods as
component
parts face higher coscs because of ímport restraints.
Congress is constrained ln the use of traditlonal
In addition,
import restraints because
such policies often violaÈe existing treaties or tend to compromise other
types of foreign-pollcy iniciatives.
Wary of the pitfalls
Congressmen sought
of traditional commercial policies,
to satisfy constituencies and avoid foreign reÈaliation
through a manipulation of nominal exchange rates.
biIls,
some
By the end of 1985,
many
inÈroduced and supported on both sides of the aisle, contalned specific
endorsements of exchange-rate policy.
One
item, submitted by senators
Brad1ey, Moynihan, and Baucus, called for the creaËion of a "strategic Capital
Reserve," akln Èo the Exchange Stabilization Fund, which the Treasury would
use to purchase foreign currencies when Èhe current-account defÍcit exceeded
target value and when the dollar deviated from a leve1 compatible wiËh a
currenc-account balance. The b111 also instructed the Federal Reserve System
not to sterllize
the monetary effects of intervention from the Strategic
Capital Reserve.6 The demands for protectionism seemed to lessen after
Èhe
Uniced States and the oüher large industriaLlzed countries began to inEervene
and after the dollar began to depreciate.
************
Destler and Henning (1989), pp. 108-112, diseuss this legÍslarion.
a
16
Government Collusion
Countries interested in establlshing exchange-rate targets have a
strong incentive to collude in their efforts with forelgn goverrunents (see
Vaubel t1986]).
In the case where countries attempt to alter nomínal
exchange
rates, such collusion provides tacit foreign approval of these policies
and
limits the chances Èhat a foreign government will take steps to neutralize the
exchange policies of another. Sometlmes such collusion involves having cartel
members
cartel
delay policy negotiations or exchange-rate adjustments when individual
members
face criÈical elections.
Bretton lloods and the European
Monetary System (EMS) are examples of faírly
successful collusion.
competltíve currency devaluations of the 1930s show what can happen
The
when
governments attempt to fix a price, but the cartel breaks down.
Coordinated efforÈs to fix exchange raÈes can allow individual
countries to influence the policies of others and to defer
some
of the
adjustment burdens of maintaining the peg. Such mechanisms are found in the
EMS
and fígure í.n some proposals for target zones and for fixed exchange
rates. Many suPport the European Central Bank proposal for just this reason.
The alternative is to sacriflce monetary sovereignty to maintain a fixed
exchange rate and to follow the monetary policy of a dominant country.
Rogoff (1985) presents another important reason that governments might
collude to manipulate nomlnal exchange rates.
a higher tolerance for lnflation
In hfs model, governments
have
than the publlc and attempt to exploit any
short-term stíckiness in prlces for a higher rate of output and employment.
Under floating exchange rates, a rapi-d depreciatlon fn the nominal exchange
rate in resPonse Èo such inflationary policy signals the market's displeasure
and consÈralns goverûnents. Through collusion to fix the exchange rate,
L7
however, governments can blunt the exchange-rate reacEion to their policíes
and reduce the políuicar costs of pursuing inflationary
policies.
Generalizing from Rogoff's argument, coordination to limit exchange-rate
fluctuations is politically
attractive because it eliminates an important,
immediate barometer of the market's opinÍon of goverrunent polieies.
Extendins Influence
As 1n the United States, exchange-rate pollcy often falls under the
purview of Treasuries and Finance Ministries, but its success requires the
particÍpation of central banks. As is well knorvn, sterilized exchange-rate
intervention has no lastlng effects on exchange rates (see
Humpage t1986]).
For their part, central banks often are willing participants, viewing
exchange-rate management as a legitimate aim of monetary policy.
Exchange-rate movements can impart useful information for policymaklng and,
already noted, exchange-rate targets can sometlmes be consistent with
as
a
monetary policy of price stability.
As often as not, however, exchange-raËe polícies conflict with price
stabilÍty.
For example, U.S. intervenÈ1on sales of dollars Ëhis pasË year
seemed lnconsisÈent
conflict,
with a goal of prlce stability.
Ilhen these objectives
the Federal Reserve System faces a dilemma betr¡¡een its mandate of
pollcy independence and its accountability to the broad national policy goals
set by the Congress and adminlstration.
The System does not wish to appear
unresponsive to the objectives of government before Congress and the
administration or in the eyes of the publ1c. Participation also enables
a
central bank to lnfluence policy formulations that 1t is powerless to prevent.
Nevertheless, as Herbert Stein recently noted, "Despite alI the formal
18
Provisions for Íts lndependence, the Fed seems constantly to feel that if iÈ
uses its independence too freely it will 1ose it. "
7
In countries with independent central banks, intervention policies
mighc enable fiscal agents to extend thelr lnfluence beyond the exchange
market to domestic moneEary policy.
Elected officials
often seek easier
monetary pollcy than central banks, hoping to lower interest rates and to
stimulate real growth and employment. In choosing a nominal exchange-rate
target, engaging in intervention, and encouraging the central bank not to
sterilÍze
the inÈerventÍons, fÍscal agents have a mechanism for such an
influence.
Thls channel of lnfluence would not always be open. AÈ times,
however, such as when the central-bank policy commíttee is not in unanimous
agreement, such an influence, marginal though it may be, could prove decisive
in charting future monetary policy.
A Global Monetary Order. L992 and
I^Ie
have attempted
Beyond
to instill a healthy skepticism for
exchange-market
manÍpulatlon, arguing that monetary protectlonism is not grounded in widely
supported economíc evidence
unlikely to
of market fallure and, therefore, that it is
enhance economic
welfare. Instead,
monetary proEectionism stems,
as a near-term palllative, from the political interactions between
policymakers and consÈltuencies with vested interests
outcomes. Any
international monetary order wllling to accept
crlterÍa for exchange rates
************
I'How
to
Ín particular
and
failing
co blnd goverrunents
l,Iorsen the Fed's Problem," I^Iall Streec Journal
market.
nonmarket
with
monetary
, October 19,
1989.
L9
constitutions is ripe for monetary protectionism. To counter the political
íncentíves toward monetary protectionism,
vre
urge nations to adopt monetary
constitutions, along lines similar to the Neal Resolution in the United
States, which focus monetary pollcy on achieving long-term price stability.
This would do more for eliminatíng exchange-market uncertainty and for
fostering the efficient worldwide use of real resources than any program
Eo
manipulate nominal exchange raÈes.
Our comments are not meant as a blanket condemnation of international
policy cooPeraEion.
I,rIe
strongly support cooperation that emphasizes monetary
constitutions, focusing on price stabilíty,
market-deÈermined exchange rates.
seems
and that recognize
Only cooperation based on these conditions
both feasible and credÍbIe, because it recognizes the preeminence of
national policy objectives and monetary sovereignty.
Contrary to what some might infer, this approach does noË preclude
European monetary uniflcation,
but it suggests a different approach than
currently seems to be favored (see Hoskins [1989]). European governments are
not likely to relinquish national monetary sovereignty upon adoption of
a
single market Ln L992. Indeed, this concern is at the heart of the British
reluctance to join the EMS. Consequently, ._greater exchange-rate flexibÍlity
than the El'lS currently provides seems necessary to ensure that exchange rates
do not interfere with the efficient
flow of goods, labor, and capital
following Ëhe removal of restrictlons.
The free flow of resources will
foster a convergence of policy
preferences within Europe as governments compete for these resources by
providÍng stable econornlc and political
environments. Governments that fail
to provide such an envirorunent will lose resources, as markets "vote"
on
20
pollcies.
The
resulting convergence of monetary and fiscal policies will
lead to greater exchange-rate stability.
In time,
when
the governmental
competition for resources attains a convergence of macroeconomic policy,
issues of natlonal policy sovereignty, in effect, will be muted. OnIy then
will a monetary union with a common currency be feasible,
monetary union augment the
To
within the
fix
exchange raËes
prÍor to a convergence of policy
Moreover, judging from the experience
would seem to guarantee speculators
preferences
to ensure that interest rates
wíll bear more of the adjustment burden as resources
to
will
efficiency gains of a single market.
Economic Community seems
adjustment and
and only then
move across currencíes.
of Bretton lloods, fixed
of perlodlc
encourage goverrunenÈs
to
and prices
exchange rates
and obvlous exchange-ta:ue
impede
capital through the reíntroductlon of restraints.
the flow of goods
The dynamlcs of
achieving monetary union are as important as the goal.
and
2T
References
Bailey, Martin J. and George S. Tavlas. "Trade and Investment under Floating
Rates: The u.s. Experience," cato Journar, Vor. g, No. 2, (Fall lgsg)
pp. 42L-42.
Destler, r.M. and c. Randall Henning. Dollar politics: Exchange Rate
Policymaking in the United States (tlashington,D.C.: Institute For
International Economícs), 1989.
DesÈIer, I.M. and John S. Odel1. Anti-protecÈlonÍsm: Chansinø Forces ín IInírcrt
StaÈes Trade Politics (i{ashlngton, D.C.: Institute For International
Econornics) , 1987
.
Hill,
John K. "Demographics and the Trade Balance," Federal Reserve Bank of
Dallas. Economic Review (September 19B9), pp.1-11.
Hodrick, Robert J. The Empirical Evidence on the Efficiency of Forward
Futures Foreign Exchange Markets (London: Harwood Academic
Publishers), L987
andt
.
Hoskins, IJ. Lee. "A Market-Based view of European Monetary union,"
, April 1,
1989.
F. "A Hltchhiker's Guide to International Macroeconomic policy
Coordination, " Federal Reserve Bank of Cleveland. Economic Review, (forthcoming) Quarter 1, l-990.
Humpage, Owen
. "Exchange-Market Intervention: The Channels of Influence, "
Federal Reserve Bank of Cleveland. Economic Review, Quarter 3, 1986,
pp. 2-L3.
Koenig, Evan F. "Recent Trade and Exchange Rate MovemenÈs: Possible
Explanations, " Federal Reserve Bank of Dallas . Economí c- Rer¡í eur
(September 1989), pp. 1-3-28.
Krugman,
Paul. Exchange-Rate Instability (Carnbridge, Mass.: MIT press),
1989.
Meese, Richard and Kenneth Rogoff. "Empirical Exchange Rate Models of the
Seventies: Do They Fit Out of Sample?" Journal of International
Economics, Vol. 14, No. f/2 (January 1983), pp. 3-24.
Quibria, M.G. "Neoclassícal Poritical Economy: An Application To Trade
Policies," Journal of Economic Surveys, Vol. 3, No. 2, (1989),
I07 -36.
pp.
Rogoff, Kenneth. "Can International Monetary Policy Cooperation Be
Counterproductive? " Journal of International Economics., Vol. 18,
1985), pp. L99-2L7.
(May
22
Stockman, Alan C. "Exchange Rates, the Current Account, and Monetary policy,"
processed draft written for the American Enterprlse Institute
Monetary Pollcy ProJect, October 1988.
. "on the Roles of rnternatlonal Flnanclal Markets and rheir
for Economlc Po1icy," Journal of Money. Credit and Banking,
Vol. 2, No.3, Parx 2 (Augusr 1988), pp. 531-549.
Relevance
Vaubel, Roland. "A Public Choíce Approach to Internatfonal Organî-za1ion,"
Public Chofce, vol. 51, No.1 (1986), pp. 39-57,
Wallace, Nell. "Iftry Markets in Forelgn Exchange Are Different from Other
Markets, " Federal Reserve Bank of Minneapolis. Ouarterly Revfew (Fall
L979), pp. L-7.
@FedFRASER