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_FR3:
CLEVELAND
HOSKI}¡S
.
.
ADDRESSES .
#8.
INTERNATIONAL POLICY CæRDINATION:
CAN I^IE AFFORD IT?
l{. Lee Hoski ns, Presl dent
The Federal Reserve Bank of Cleveland
tmltnes[;nK
0F lGisA¡8
Ctrf
'rsf
ìESEARCH LIBRARY
of Buslness Economlsts
Denver, Colorado
Denver Assoclatlon
December
9,
1988
Internatlonal Pollcy Coordination:
Policy makers and economists today
openness among the
coordínat.ion
world's
of nations'
Can lJe
embrace
Afford
the argunent
IÈ?
ÈhaÈ lncreased
Justifles--if not necessltates--a closer
polÍcies. Ihelr automatic, alnosÈ
economles
economic
unthlnkíng, acceptance of this idea reflects the undenlable fact
growing Èrade and
capltal florss
unwaverlng association
ímages
for
of
of words like
harmony, peace and
cooperatl-on and
now
Èightly llnk the world's markeÈs and an
ncooperaÈion" and ncoordinatlon" with
prosperity. Only a fool would question the
pollcy coordinatlon,
contend proponents
need
of lnternational
cooperatlon. Are we not, after all, ln the
same
other's policles? lle must pull together if
we hope Èo progress.__
The rnatter
Èhat
boat, affected by
each
ls noc quite so sinple. In a rush to enunerate the posslble
benefits of cooperacion, we have neglecÈed to recognize
some
of the potential
costs. For those of us who believe that free narkeÈs guerantee the hlghest
possible standard of llvlng, Èhe words ñcooperatlonn and "coordinatlonn rlng
like
euphemisms
proven source
for colluslon agalnst market ouÈcomes and sound a threat
Èo a
of lastlng prosperity.
My concerns stem most
recently fron attempts at, and conÈinued calls for,
close global coordlnation of macroeconornlc policies, buÈ ny fears have roots
in other international developments, including polfcles deallng with
the
lnternational debt situation. To be sure, certain types of cooperation are
2
beneficlal--indeed essential--to the smooth functioning of markets, but
governments, through cooPeration, often attempt
to supplant markets and to
avoid market dÍscipllne. As such, we should keep a vrary eye on proposals for
global cooperatlon.
The Functlon
of
MarkeÈs and The Role
of
Government
Conpetitlve narkets are unLque social nachines that produce an effícient
allocaclon of the world's resources and the highest possible standard of
llvlng. The prlce mechanl-sm relays lnfornatlon Èo all conponents of the
market, whlle the proflt mechanl-sm forces prlces and costs to their minimun.
Through these nechanlsms, competltlve markets
economic
cooperatlon. Particlpants readily
foster a speclal tlpe of
undersÈand the obJectlves
of this
cooperation, and markeÈs maintain disclpllne qufckly and wlthout
discrimlnation. This cooperation wlthln narkets rewards innovations and
efflclencLes and renoves neste. It confers neÈ beneflts on partlclpants in
excess of what they could otherwlse secure. Economlsts have recognized these
qualitles of open, conpetÍtlve markets sl.nce Èhe tlne of Adarn Smith, and
realize thaÈ the global scale of narkets only serves to
enhance these
quallcles.
l'farkets requlre an lnstitutional framework to reduce the lnevltable
frictions that
w111
result as partlclpants lnteract. In narket
lnstltuÈlonal structure includes laws that
gueranÈee property
economles,
rights,
including contracts, and laws that protect other rights of indlviduals.
Moreover, a medÍum
of
exchange
with reasonably predictable purchaslng power
can enhance the smooth functionlng of the market mechanism.
These
Èhe
3
institutlons reduce transaction costs and allow markeÈs to achieve
of scale.
The markeÈ machfnery, however, does
economies
not always work perfectly.
Sometimes
narkets do not fully lnternallze the benefits, costs, or risks associated with
private actíviÈies to the responsible partfes, or a nfree rider" problen
exists. Frequently,
economlc shocks,
starting fn
one market, can
disrupt
a
wide range of economic activity as they ripple throughout the economy.
Sornetlmes Èhe
nature of goods or the characterlstlcs of production confer
nonopoly Powers on
lndlviduals. At
oÈher tLmes, we make adJustnents
nerket, sacrlflcing efftclency, to correct for inherent lnequltles
to
the
among
fndlvlduals.
The need
to provlde the
aforementloned
instltutfonal framework, and at
tl'nes to adJust the narket nachfnery, provldes a role for governments ln
narket economLes. International cooperation can enhance Èhls role ln a
closely lntegrated, global narket.
Government trnterr¡ention, whether slngular'
or cooPeratlve' can gulde an econo¡ny towards its ultlmate obJectlve of
naintainlng the hlghest standard of llving when lt enhances Èhe funcÈioning of
private markets and when lt dampens the transmlsslon of severe, dlsruptive
economLc shocks.
Unllke the market, however, the nachlnery of government includes
no
for naxinizlng output and rnfnlmlzlng cosÈs. Rather than
pronote efficiency and lmprove this funportant soclal engine, governments often
autonatLc nechanlsns
slow and lnpede the narket's proper functlon. l.Ie have come to recognize
wlth governmental interventlon ln markets at the natlonal level, but
we often seem unwilting to accept that government lnterventlon at the
problems
4
international level can impede the functloning of global markets, Just
eas lly.
as
Government Versus MarkeÈ ObJecÈlves
Students
maxLmize
of
governnent dlsmlss the vlew
that elected offlclals seek to
the ncommon good." Pollc¡rnakers, ln their
own
self-lnterests,
pronote the deslres of thelr constlÈuencles, and these often conflict with
market outcomes. The world economy today is tled 1n a web of tariffs,
taxes,
subsldles, and regulatlon that, more often than noÈ, lack purpose other than
to secure rents for certaLn, lnfluentlal
Ihls
tendency
in terms of thelr
of elected
own
government
segments
of society.
offlclals to deflne "the
cornmon goodn
self-lnterest and the lnterests of thelr constltuencles
should ceuse us to questlon all government policles. Do these pollcles
strengthen the instltutlonal franework that enhances the market,s perfornance?
Do they provlde adJustments
to the narket that help secure a hlgh, sustainable
standard of llving? Or, alÈernatlvely, do these policies serve to supplant
well-functionlng narkets with administrative and regulatory nechanlsns theÈ
inÈerfere wlth narket dlscipllne and narket perfornance eÈ the expense of real
econonLc growth?
Interdependence and the Beneflts
The current percelved need
fron Global Coordlnatlon
for global poltcy coordinaÈion stens
from
evidence that markets for goods, servf.ces and capltal are now more open, or
globally integrated, than in the past.1
Advances
communicatlons have increased Èhe degree
of internatlonal
fn transporÈation and in
openness by making
5
production and distribution on a global scale more feasible.2 Th"
liberallzation of ùrade and capital
movements has
permitted producers
and
investors to take fuller advantage of these advances. Indeed, trade flows
have increased
capltal flows
relatlve to
GNP
ln nearly all naJor developed countries,
can be a large proportion
and
of natlonal savings and lnvest¡nent.3
Greeter openness has enhanced econornlc lnterdependence among natLons.
Changes
ln
economlc
variables ln one country have a more immedlate, stronger
lnfluence on economic variables ín another. A tendency Èo underestimate the
growing Lmportance
of lnterdependent narkets has caused surprises ln recent
years. Inflows of foreign capltal, for example, lessened the expected lnpact
of large budget deficlts on real lnÈerest rates in the Unlted
A concern most often cited by advocates
that global
States.
of coordlnated macro-policies ls
lnterdependence has lncreased the
rlsks of
nsystemic
fallure.n
Thls tern eludes preclse deflnlÈ1on, buÈ lt tnplies a conplete collapse of the
financlal systeú, currency markets and só forth,
ernanatlng
fron the actlons of
only one country or events in a single narket. In an integrated world
economy,
individual countries nighÈ not be able to insulate thenselves against
such contaglon and
their
Observers often
enormous cosÈs.
polnt Èo tldo recent events as evldence of the
rlsks of systenlc fallure ln the world today.
One
ls
crlsls, whlch gained wide recognitlon ln late L982.
Èhe
lncreased
lnternational debt
Ttre debt
cris|s
threatened not only large banks, but also many middle-sized reglonal banks and
snall banks through their lendlng
Èhrough
their
arrangements
wlth debtor countries and
dornestlc and internatlonal correspondent banking relationships.
The repercussions
of
widespread defaults could have had serlous global
6
implicatlons.
The stock market collapse
more-recent example
of October 19,
1987
offers a second,
of the risks of systemic failure. This collapse
spread
rapidly through stock markets around the world, posÍng a threat to global
economic growth and
stablllty.
Although unscathed from these recent
experlences, rüe remain vulnerable to simllar types of events.
In llstlng the
arguments
for closer l-nternatlonal polfcy coordlnatlon, I
also should note that thls global lnterdependence, whlch compllcates
economic
interacÈlons and increases the risks of systemlc failure, ofÈen serves to
discipllne policymakers. Natlons
thaÈ have adopted
inflatlonary policles
have
seen the market's disapproval quickly reflected 1n capltal flows,
exchange-rate movernents and, wf.th some delay, trade
patterns. Slnilarly,
the
increased ease wlËh which manufacturlng and flnancial firns can move about the
globe places a check on regulatlon and taxatlon. sinply stated, greater
internatlonal
lnEerdependence Lncreases
the opportunltles for lnvestors
and
traders to protect thelr wealth fron the nlsgulded pollcies of tndlvldual
countrles.
ProponenÈs
of global policy coordlnatlon argue
Èhat because of
increased economic integration, the chances of achievlng substantial beneffcs
through nutual cooperatlon are greater now than at any other tlme. In nany
resPecÈs, they are
of
Èrade
correct.
The
potentlal beneflts from the mutual reduction
restralnts and fron the further liberallzatlon of caplËal
undoubtedly grow as markets expand.
novements
r applaud such rnarket-enhanclng
lnternaÈ1onal cooperatlon as GATT and the U.S.-Canadian Free Trade Agreement.
The removal
of artlficÍal restraÍnts on markets can increase the standard of
living worldwide. Moreover, one cannot deny the value of shared ínformatlon,
7
common PurPose
'
crisis'
economic
Èhrough markeÈs
and coordinated
In today's
efforts durlng those rare perfods of clear
economic environment, such shocks can
ripple
quickly and forcefully.
In contrast to these efforts,
many
of
Èhe recent proposals
for global
pollcy cooperatlon call for a detatled harmonizatlon--a nfLne tunlng'on
grand scale--of monetary, flscal and reguletory pollcles ¡nong the naJor
developed
countries.
Recent meetings
of the Group of
example, have focused on developlng a set
of
Seven
a
countries, for
mobJectlve indlcatorsn--lncludfng
lnflatlon, current-account balances, exchange rates, and ¡noney
growth--thet could trtgger polley changes ln participant coun¡ries. others
unemplolnnent,
have recomrnended tax+et.-zone arrangements
whlch PresuPPose a wlllingness
closely.4
Some
advocates
to
or fixed-exchange-rate
reglmes,
coordLnate baslc macroeconoml.c polictes
of coordlnatlon have sought solutfons for
lnternatlonal-debt situatlons that lnvolve greatly
expanded
the
roles for
governments and quasl - govern¡nental internaÈf.onal organizatfons
.
of globally lntegrated narkets creates both the
potential for nations to beneflc fron cooperation and the great
The evolving lmporcance
enornous
danger
that
entail substantlal costs by subverting
markets for politlcal ends. Conslder, for exanple, recenË allegatlons that
the G7 countries are relylng on a loose system of nreference zones' for
such cooperatl-on could
rates and on a set of lndlcators of economlc performance to gufde
their declslons about the compatibtllty of macroeconomic policies and abou¿
exchange
the appropriateness of adJustments. one can flnd little
concrete evidence
I
that these reference
zones and lndicators actually have influenced
macroeconomic declslons
noÈ be
entirely fafr.
ln the separate
G7
countrles. Thts
Judgement
The G7 has never announced a conplete
nlght
set of
"indicatorsn along with their relative welghts ln pollcy dfscussions, nor have
they revealed their reference zones for exchange races. Furchermore, we do
not know what policy would otherwise have been.
To date, most
exchange
of the cooperaÈ1ve efforts
rates; the lndustriallzed countrf.es
have atternpted
have
to stabflize
not focused thelr attack
the fundanental problens underlying thelr current-eccount lnbalances.
on
Under
the gulse of cooperatLon and exchange-rate stabllizatLon, the United States
and Èhe other uraJor lndustrlalized counÈrles have flnanced a growfng share of
the U.S. current-account deflcit through official reserve flows. IJtrile
sone
mtght conËend that this slowed the adJustrent process to a manageable pace,
one could ergue Just as
forcefully that thls offtclal financing has avoided
the adJustments that the exchange narket ultfuoately will denand--speciflcal-ly,
an lncrease in U.S. prlvate savings and a substantial reductlon tn the U.S.
deficlt.
I doubt Ëhat the rubric of cooperatlon has led countrles to
adopt narkedly betÈer pollcles, or that it has reduced exchange-narket
budget
uncertalnty. Falllng this, lt has lnposed
subsÈantLal costs.
Sirnllar arguments apply Èo the developlng-country-debt sltuatlon. To be
sure, qufck actLons by the Unlted StaÈes ln providtng brtdge loans helped to
avoid outright defaults 1n some lnstances, and the cooperatfve efforts of
goverrlments and
of the Internatlonal
adjustrnenÈ Prograns
Monetary Fund helped
in nany debÈor countries
and
to lnltlate
to secure reschedullng
agreenents from banks. These actl-ons reduced the
risks of systemlc fallure.
9
Many have argued, however,
creditor
that Èhls "cooperatlonn
goverrìments also has helped many banks
their essets, but has
done
ltttle to
between debtor and
to avoid the re-pricing of
ease developlng counÈrles, debt burdens
or to foster a lasting adJustnent ln debcor countrles. SubsÈanÈIating this
appraisal, developing country debts trade far below thelr book values Ln
secondary markets, as does the stock
narkets.
These
of highly
exposed banks
in
equiÈy
pollcles have not slgnlflcantly reduced uncertafntles
associated wlth the long'term prospects for unlnterrupted debt servlce and
probably have Lncreased the overall, real resource costs of adJustment.
Coordinatfon and Èhe Costs of Uncertalnty
In addltion to the potentially large real-resource costs, whlch I have
thus far attrlbuÈed to the tendency of governnents Èo supplant markets,
lnternational coordination could create additlonal costs by generatlng narket
uncertalnÈy. PrlvaÈe market patticlpants base declsions,- in part, on the
expected actions
participants
of governnents.
to
l.ltren
future policies are uncercain,
market
raislng prices or by avoidlng actions that
night leave thern vulnerable to pollcy changes. Recent proposals for deÈailed
atÈempt
hedge by
internatlonal pollcy coordinatlon could actually increase uncertaLntl.es, tf
they create doubt about the wllltngness and ablllty of governments Èo
implement
Èhem.
Nations wlllingly cooperate when all beneflt. Hutual gains nosÈ likely
result
when cooperatlon
snall,
and when the resulting
ls narrow 1n scope,
markets. Bilateral trade
when the nunber
pollcles promote the
of partlcipants is
smooth functioning
of
agreements are an example. Ilhen cooperation
is
more
10
conplex, however, as in the case of macro-policy coordination, success often
requlres that countries Èake acÈions contrary to
some
of Èheir indivldual
interests. Conpliance then entails burdens, whlch countries hfstorlcally have
attenPted Èo avoid or to shlft. conslder our experLences wlth nacroeconomic
policy coordfnatlon since 1985. In llght of the sparse progress that the
Unlted States has nade towards lowerlng fts budget deficits, our part of the
bargaln, one could argue that the dollar's depreclatlon has shlfted more of
Èhe adJusÈment burden onto
our tradlng parÈners--an outcone that was noË
conpletely the result of lnternatlonal coordinatlon and cooperation.
Because
internaclonal policy coordlnatf.on--unllke markets--often lacks a credible
system
for
enforcement and burden-sharlng,
1t can create uncertaLnÈies
about
the extent of conpllances.
1f natLons are wlll1ng to coordinate broad pollcy obJecÈives, many
observers doubt that they can. The sharp dlfferences Frnong economlsts abouÈ
Even
the true state of the economy, about the near-term dlrectlon of the economy,
and about the fnterrelatlonships among pollcy levers and econonic varlables
are almost legendary. If econonists cannot agree on how the econony works,
cen lre exPect governments
to agree on and lnplenent coordf.nated, effectlve
macroecononlc pollcles? One also nlght wonder about Èhe outcone if the world
cooperated, but adopted the wrong nodel
of
how the world
works. Ttrls, of
course, is a problen at the natlonal level, but 1nÈernaÈlonal cooperatLon
could greatly increase Èhe costs of an
"rror.5
of the proposals for detalled lnternational coordfnation renfnd
policymakers' nflne tunfng'r efforts of the 1960s and 1970s, when they
Many
me
of
11
attempted
to achieve
many
targets simultaneously. The thrust of policíes
shifted frequently, and those policles generally nissed on all accounts. The
markets' mlstrust of policymakers was reflected ln an inflationary psychology
chat cornplfcated and extended the fight agalnst lnflaÈion. If we now make
domestic obJectfves subject
to international targets
and events, economLc
agents once again could lose confldence 1n the wflllngness and the abiliÈy of
to pursue frnportant domestic goals.
policymakers
Concluslon
I don't want ny point to be ml.sconstrued. Obvtously governments play an
essentlal role in a market economy. ThaÈ markets today extend across natlonal
boundaries does not alÈer
thts role; indeed, global markets enhance iÈ.
f{e
should explore opportunltles for lnternational cooperation thaÈ erihance the
perfornance of markeÈs and reduce the rlsks of systenlc failure, but we must
consider both the benefits and costs of such pollcles.
Recently many have advocated a greatly expanded role for international
policy coordination.
They argue
that as markets become increaslngly
lntegrated, the potential beneflts fron such coordlnatlon
become
enormous. I
caution that such pollcles often seek co supplant narkets and to avÒld narket
disclpllne.
enornous
Much
pollcles, therefore, run the risk of carrylng with
costs in terns of real econonLc grovrth and efficlency.
Such
of the current thrust towards global
macroecononic
policy coordlnation.
Gf.ven
cooperaELon
ls
then
concerned wlth
the polltlcal and economlc realitfes
of the world today, I believe that a move toward detalled coordinatlon of
macroeconomic policies would not lmprove, but could very well
Jeopardize our
T2
standards of llvlng.
Instead, I would urge countries to adopt, to
announce,
to steadfasÈIy malntaln long-tern nomlnal Èargets for pol1cy, conslstent
wiÈh zero fnflatíon and long-term real growth potentlal. Thls would not
and
stabllfze
exchange
rates, but ft would
remove nuch
of
Èhe
uncertainty about
future pollcy whlch contrlbutes to exchange-rate volatlllty.
Exchange raËes
of lndivldual natlons compatlble, and flexfble
rates would provide a buffer to external pollcy errors and shocks.
would adJust naklng the plans
exchange
Such
broad, lndlvldually fnstltuÈed targets would be credlble, predlctable
and--most lnportantly--would nalntain the lnÈegrity
of prfvace narkets.
13
1
A perceived need for policy coordinatfon is not new. For a
discussion of central-bank cooperation ln the 1920s, see Stephen V,O. Clarke,
Central Bank Cooperation 7924-3L. New york: Federal Reserve Bank of New york
L967
.
2
,ot a dlscussion of facÈors lncreasing world inËegration, see Rlchard N.
Cooper, 'Economlc Interdependence and Coordlnatlon of Ecoñornlc policles,,, in
Ronald I{. Jones and Peter B. Kenen, eds., Handbook of InÈernatlonal Economlcs,
vol. 2. Ansrerdam:Norrh-Holland publishlng co. , 1995: llgs-rz¡¿.
2
of trade and capltal flows, see Norman S. Ffeleke,
"Economic Interdependence between Nations: Reason for policy Coordlnation?,,
England Economic Review. Federal Reserve Bank of Boston. (Mäy/June); Zt-iS
On Èhe growth
4 John l{irllamson, nrhe
Exchange RaÈe system,n pollcy Analyses ln
Internatlonal Economlcs, No. 5. l.Iashlngton,D.b.: InstfÈute- for tnternatlonal
Economlcs, 1985. Ronald HcKinnon, nMoneÈary and Exchange Rates policies for
rnternatlonal Flnanclal stabiltty: A proposâl, n Journal-g[ Economfc
Perspectives, Vol.2, No.l, (I{inter 19Sg): g3-103.
5 ,". Jeffrey A. Frankel
,,Internatlonal
and Katherine Rockett.
Macroecononlc Po1icy CoordinaÈlon l{tren Polic¡makers Do Not Agree on the True
Model,', Ib, Anerlcan Econonic Review, (June igAA): 3lg-340.
Nev¡
@FedFRASER