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Internatlonal
Panacea
Pol I cy
or
Coordlnailon:
Pandora,s Box?
l.{. Lee Hosklns, Presldent
The Federal Reserve Bank of Cleveland
Pllllod Lecture
Kent State Unlverslty
November
16,
1988
Pollcy makers and economlsts today embrace the argument thet lncreased
oPenness arnofi8 the world's econonles
Justlfles--lf noc necesslÈates--a closer
coordlnatLon of natlons' economic porfcies. Ttrefr autonaÈfc, almost
unthinkfng, accePtance of thls ldea reflects the undenfable fact that
growing trade and caplcal flows now tightly l1nk the worldrs markets
and an
of words like ncooperatfonn and ncoordlnationn wlth
luages of harnony, Peace and prosperlty. only a fool would quesclon the
need
for cooperation and pollcy coordfnaclon, contend proponenÈs of international
unwavering associaËlon
cooperatlon. Are we noÈ, after all, in the sa-me boaE, affected by each
ocher's pollcies? f{e nusc pull cogether lf we hope co progress.
The matter
ls not qulte so sinple. rn a rush to
enuneraÈe Ehe posslble
beneffcs of cooperation, we have neglecced co recognlze sone of che potentfal
costs. For those of us who belleve that free markets guerantee Ëhe highest
posslble stand¿rd of llving, the words ncooperatlon" and ncoordlnatlonn
rfng
like
for colluslon against nerket outcones and sound a threaË
proven source of lastlng prosperlty.
euphemisus
My concerns steD nost
Ëo a
recently fron actenpts aE, and continued calls for,
close global coordfnatfon of mecroecononfc pollcles, but ny fears have roots
ln other lnterrretlonal developments, lncludlng policies dealfng .wlth the
lnternaclonal debt situatlon. To be sure, certaln types of cooperaÈfon are
2
beneficial--fndeed essenÈlal--Èo the smooth functfonfng of narkets,
governnenÈs, through cooperaÈlon, often attempc
to
buÈ
supplanÈ narkegs and to
avold narket dlscfpllne. As such, we should keep a jrary eye on proposars
for
global cooperation.
conpetitlve narkets are unlque soclal nachfnes thac produce an efflclenc
allocacfon of chE world's resources and the hfghest possfble scandard
of
llvfng' The prlce nechanlsm relays lnfor¡atfon to arl conponerits of the
markeÈ, whlle the proflÈ nechanfsm forces
prices and costs to thefr nlnfnrrn.
Ttrrough Èhese mechanisrns, conpetiÈfve narkeËs
foster a speclal
E¡pe of
cooperatlon. Partlclpants readlly understand the obJecttves of thfs
cooperation, and narkets malntafn dfsclplfne qulckly and without
dlscrinlnatlon. Ttrls cooperaÈlon nfthln narkets rewards frmoveÈfons and
economlc
efficiencfes and
re¡noves
realfze that
global scale of narkets only setr¡es Èo enhance
waste. rt confers net beneflts on pertfcfpanÈs ln
excess of what they could othenrfse secure. Economlsts have recognfzed
these
qualltles of open, conpetlÈf.ve markets slnce the Ëfne of Adan snlth, and
Èhe
Èhese
quallties.
Markets requfre an lnstlÈuÈlonal franework
fricclons
thaÈ w111 result as partfcfpanÈs
lnscltutlonar sÈructure fncludes raws Èhat
to reduce the inevicable
lnteract. rn
narkeË econonles, the
guarenÈe€ property
rights,
fncludlng contracts, and laws thaÈ procect ocher rtghts of indlvfduals.
Moreover, a medlum of exchange with reasonably predfctable purchaslng
polrer
can er¡hance the snooth functlonlng
of the market mechanlsm.
Tt¡ese
3
lnsticuclons reduce crensacËfon costs and allow markets
Èo achieve econonfes
of scale.
The narkeÈ machinery, however, does
markets do noÈ
fully lnternallze
not always work perfecÈry.
sometlmes
beneflts, coscs, or risks assocfat˿ wrth
prlvate acÈlvftfes Ëo the responsfble partfes, or a nfree rÍder'problen
exfsts. FrequenÈly, econonic shocks, startfng ln one narket, can dfsrupt
Ehe
a
wlde range of econonf.c actfvlcy as they rfpple throughout the econotry.
sonetlnes the nature of goods or the characterisEics of production
confer
nonopoly pohters on lndfvlduals. Ac other tfnes, we make adJustnenÈs
to Èhe
markeÈ,
sacrlflcfng efflcLency, to correct for inherent lnequlËles
anong
fndivtduals.
1t¡e need
to provlde che aforenentloned lnstftutfonal framework, and aÈ
Elnes Ëo adJust the narkec nachfnery, provldes a role for governments
in
narkeË economLes. rnternaÈfonal cooperatlon can enhance Èhfs
role in a
closely tntegraÈed, global narket. Governnent lnte¡lrention, whether sfngular
or cooPeraEive' catl guide an econony towards fts ultfmate obJectlve of
¡oaintafnlng the highest standard of lfving when lE enhances the funcgionfng
of
prfvace narkets and when 1t darnpens the transtrlsslon of severe, dfsruptfve
economic shocks.
unllke the narket, however, the
machinery
of govern¡ent fncludes
no
automatic nechanfsns for naxfnfzfng oucput and ninfnrztng costs. Rather
than
Promote efficfency and lmprove thls fmportanc socfal englne, governments often
slow and lnpede Ehe narket's proper functlon. t{e have cotre to recognlze
problens wlth governnentel Lnteri\renclon in markets at the netfonel
level,
we
often seen unwÍllfng co accept that governnenc fnten'enËfon ac Èhe
buË
4
lnÈernaclonal rever can fmpede the functronfng of gtobal
narkets, Just
easfly.
as
students of government dfsnlss the vfew thaÈ elecÈed
officfals seek to
naximfze the rcomnon good.n Polfcymakers, ln Èhelr
oern
self-interests,
of thetr constituencles, and Èhese often confricÈ
narkec outcones. Ttre ¡rorld economy today ls tled ln a web
of tariffs,
Promoce che deslres
wfÈh
taxes,
subsldfes, and regulatlon thaÈ' nore often than not, rack
purpose other than
Ëo secure rents for certaln, fnfluentfal segnenÈs
of soclety.
thls tendency of elected governt¡ent offfcrals Èo deffne nthe conrnon
goodtr
ln terms of thelr
self'lnÈeresÈ and the fnteresÈs of chelr constftuencfes
should cause us co questton all governnent polfcfes.
Do these porfcles
own
strengthen Èhe fnstitutlonal fra¡¡ework chaË enhances
Èhe narket,s perfornance?
Do chey provlde adJustnents to che markeË thaÈ help
secure a hlgh, sustafnable
of lfvlng? 0r, alternatively, do these porfcres sene to
well'functlonlng narkets r¡1th adnlnlstracfve and regulatory
sËandard
supplanÈ
nechanis¡¡s that
lnterfere with narket dfsclpllne
and narket perfornance aÈ
the expense of real
economfc growth?
The current percefved need
evfdence thagnarkets
for global policy coordlnatlon
for goods, ser'Íces
stems fron
capltal are non nore open, or
globally lntegrated, than.ln the pest.1 Ad*r.rr"es fn transportatlon
and in
coumunlcatlons have lncreased the degree
and
of incernaÈfonar openness by
naklng
5
productlon and dfstributlon on a grobar scare more feaslble.2
Tt"
lfberallzaÈlon of crade and capfcar movenents has pernicted producers
and
lnvesËors Ëo take fuller advantage of these advances. rndeed,
trade flows
have lncreased relacive to GNP ln nearly all maJor developed
countrfes,.and
capltal flows
can be
a large proportlon of natlonal savfngs and fnvestnent.3
Greater oPenness has enhanced econonfc lnterdependence among
natfons.
changes
ln
varlables ln one country have a more lnnedrate, stronger
fnfluence on econotic varlabres 1n another. A tendency to underestfnate
the
economlc
growlng lnportance
of
lnËerdependent markets has caused surprfses
ln receût
years' rnflows of foreign caplcal, for exrnple, lessened the
expected lnpact
of large budget deffcics on real lnteresÈ rates in the unlted sËates.
A concertr nost often clted by advocates of coordfnaËed macro-pollcles
1s
global lnterdependence has fncreased Èhe rlsks of nsystenic failure.n
Thfs Èern eludes precfse deffnltion, but ft lnplles a compleÈe
corrapse of
financlal systeE, currency markets and so forth, enanaÈfng fron the
chac
the
actfons of
only one country or events 1n a sfngle narket. rn an integraced
rrorld
econo¡ny' indivfdual counÈrfes nlght not be able to
lnsulaÈe chenselves against
such contagfon and
thefr
enormous coscs.
obserr¡ers often polnÈ
to two recent
evencs as evidence
of che increased
rlsks of systenlc faflure ln the world roday. one is the lnternacfonal
crisfs, whlch gafned wÍde recognltlon ln late LIBZ. Ttre debt crlsfs
debt
threatened not only large banks, but also nany nlddle-sfzed
reglonal banks
snall banks through Èhelr lendlng arrangemencs with debtor countrles
and
and
through Ëhelr donestlc and fnternatlonal correspondent banking
reracfonshfps.
rtre repercussfons of wldespread defaults could have had serlous
g1obal
6
furplfcatfons. The stock narkeE collapse of october 19, l9g7 offers
a second,
more'recenc example of the risks of sysËenfc fafrure. Ttris colrapse
spread
rapfdly Èhrough stock markeÈs around the world, posing e threat Èo grobal
econoufc growth and
stablltty.
Although unscathed
fron these recent
experiences, we remafn rnrlnerable to slnllar types of events.
rn llsting
Ëhe argunenÈs
for closer lnternatfonal pollcy coordlnaÈfon, r
also should note thac chis globar lnterdependence, whfch conpllcates
economÍc
lnteracclons and Lncreases che rlsks of systenfc failure, often ser¡/es
to
dlsciplfne polfcyuakers. NaËlons ÈhaÈ have adopted inflaËionary porlcies
seen the narket's dlsapproval qulckly reflected fn capftal
flows,
exchange'race Dovemencs and,
wlth
sone
delay, trade pacterns. sfnflarly,
have
Èhe
fncreased ease wlth whfch nanufacËuring and ffnancfal ffr-ns can
nove about
globe places a check on regulaÈlon and ÈaxaÈion. sfnply sÈated,
greeter
Èhe
lncernatlonal lnterdependence lncreases the opportunlties for investors
and
craders co ProËect thelr wealth from Ehe nlsgulded polfcles of fndlvlduel
countrfes.
ProponenÈs
of global policy coordinatlon argue EhaE because of
lncreased economlc fntegraÈlon, the chances of achievlng substanËfal
beneflts
through nutual cooPeraÈlon are greater now than aË any other tfne.
rn
nany
resPects, they are correct. The potentfal beneflcs fron Èhe nutuel
reductlon
of crade restrafnts and from Ëhe further lfberallzacion of caplcal novenenËs
undoubÈedly grow as markets
expand. r applaud such narkeÈ-enhanclng
internetlonal cooperatfon as GATT and the u.s.-canadlan Free Trade Agreenent.
The removal of artlffclar restralnÈs on narkets can Lncrease
the stendard of
llvlng worldnlde. Moreover, one cennot deny the value of shared inforaation,
7
conmon PurPose, end coordlnated
econonlc
crlsls.
rn today,s
efforts durlng those rare periods of clear
economlc envÍronment, such shocks can
rfpple
through narkets qulckly and forcefully.
rn contrasÈ Èo these efforts,
many
of the recenc proposars for grobal
polfcy cooperaulon call for a detailed harmonfzaËipn--a'fine
tunfngn on a
grand scale--of monetary, flscal and regulaÈory poltcfes ¡no'g
the
naJor
developed
countrfes.
neetlngs of chE Group of seven countrfes, for
example, have focused on developlng a sec of nobJectfve
fndfcators'--fncludlng
RecenE
unenplo¡ment,
lnflatlon' current-eccount balances, exchange rates, and
Doney
gronth"EhaÈ could trigger pollcy changes ln parÈicfpant
counÈrles. others
have reconnended cergec'zone arrangemencs
whfch PresuPPose a wllllngness
closely'4
sone advocates
to
or ffxed-exchange-rate regfues,
coordfnaÈe basic nacroeconomfc polfcfes
of coordlnatlon have sought solutfons for
the
lnternaËlonal-debc siÈuatfons chat fnvolve greatly expanded
roles for
governDents and quasl-gover¡rmenÈal fnternaËtonal
0rganlzatl0ns.
The evolvfng lnportance
enormous poËencial
of globally fntegrated
narkeËs creaËes boch the
for natfons to benefft from coopereËfon and the
greaÈ
danger chac such cooperaÈlon could enÈa1l subsÈanËial
cosÈs by subvertlng
narkets for pol1tlcal ends. conslder, for example, recenÈ
allegatfons
uhe G7 countrles are relying on a loose systen of nreference
zonesn
Èhat
for
exchange raËes and on
a sec of fndlcators of economfc perforrnance to gufde
thelr decisfons about the compatfbllfcy of macroecononfc pollcles
and about
the approprlaceness of adJustnents. one can flnd little
concrete
evfdence
I
chac these reference zones and lndlcators actuarry
have influenced
mecroecononic decisfons fn che separece G7 countries.
Ttrls
Judgement ntghc
noÈ be enÈlrely
fafr.
The G7 has never announced a complete
set of
"lndicaÈorsn along wlth chefr relatfve weights in policy dlscusslons,
nor have
Èhey revealed thelr reference zones for exchange
rates. FurËhermore,
we do
noc know what pollcy would otherwfse have been.
To daÈe, most
exchange
ratesi
Èhe fundamencal
of
che cooperatfve
efforts
have aÈteDpted Èo
stabfllze
lndustrfallzed countrfes have noË focused chelr attack on
problens underlylng thelr current-eccounc inbalances.
under
Ëhe
the guise of cooperetlon and exchange-raEe stabirfzatfon, the
unfÈed states
and the other naJor lndustriaLLzed, councries have ffnanced
a growfng
share of
the u's' current-account deflclc Èhrough officfal reser¡¡e
flows. Iltrile
nfght contend that thls slowed the adJustnenc process to a
sone
nanageable pace,
one could ergue Just as
che adJustDents
forcefully
that the exchange
offlcfal flnanclng has avofded
narkeÈ ultfmately wfll denand--specfffcally,
ËhaÈ Ëhis
an fncrease fn U.s. prlvaËe savfngs and a substantlal reduction
rn ine u.s.
budgec deffclt. r doubc that the rubric of cooperaclon
has led counËrÍes to
adopt narkedly better polfcies, or that lt has reduced
exchange-narkeË
uncerËalnty. Faflfng Ëhls, ft has fmposed substanÈfar costs.
sfnllar arguments aPPly to the developlng-councry-debt situatfon.
sure' qulck acËfons by the unlÈed states ln provldfng brtdge
To be
loans helped
co
avoid outrfght defaults Ln some fnstances, and the cooperatfve
efforts of
governnents and of the rnÈernatlonal l,lonetary Fund
helped to inftiate
adJustuent PrograDs
egreenencs from
ln
many
banks.
debtor countrles and to secure reschedurfng
These
actlons reduced the risks of systenlc failure.
9
Many have argued, however,
that this rcooperatÍonr
becween debcor and.
creditor governnents also has helped nany banks to avold the re-prfcfng
of
thefr assets' but has done llttle to eese developfng counÈries, debc
burdens
or to foster a lastfng
ln debcor countries. substantiating Ëhis
debts trade far below their book values ln
adJustmenc
appraisal, developing counÈry
secondary narkets, as does the stock
of hfghly
exposed banks
ln equlty
markeEs. Tt¡ese pollcies have noÈ signiflcanÈly reduced uncertafntles
assoclated rvlch the long-Èerm prospects for uninterrupted debt
sen¡fce and
probably have lncreased che overall, real resource coscs of
adJustment.
rn addttlon to the potentlally large real-resource cor¡cs, whfch r have
chus far ectrlbuced to che Èendency of governnents to supprant
narkeÈs,
fnternaclonal coordfnaÈ1on could create addltfonal costs by generaÈing
narket
uncertalnËy. PrlvaËe narket parÈicipants base declsfons, ln part,
on
expecËed actlons
of governnents.
Pertlclpencs ectenPt to hedge
Êhe
polfcies ere uncertafn, narket
by ratslng prices or by avoldlng actfons Èhac
tlhen fuÈure
nlght leave theu vtrlnerable to pollcy
"hrrrg!". RecenÈ proposals for decailed
fnternatlonal pollcy coordlnatlon could accually lncrease uncertainties,
ff
they create doubt about che wllllngness and ability of governnenÈs
to
lmplenent then.
Natlons wllltngly cooperaÈe when all beneflt. Mutual gains nosÈ likely
result when cooperatlon ls narrow ln scope, when Èhe nr¡mber of parcfcipants
is
snall'
the resultlng pollcles pronote the s¡nooth functfonfng of
markets' Bllateral crade egreenents are an exanple. IJhen cooperatLon
fs
a¡¡d when
more
10
comPlex, however, as
ln the
case
of ¡nacro-pollcy coordlnatlon,
success often
requfres thaÈ councrfes take actlons contrary to sone of thelr lndlvfdual
fnËerests. conpliance then entafls burdens, whfch councrles hlstorfcally
actenpted Eo avoid or co shfft.
have
consider our experiences wlÈh macroecono¡nlc
polfcy coordlnatfon slnce 1985. rn llght of che sparse progress
thac the
uniced staËes has nade towards lowerlng its budget deflcfts, our part
of the
bargaln, one could argue thac the dollar's depreclatfon has shifted more
of
the adJustDenc burden onto our cradlng percners--an outcone thac lras
noc
conpletely the result of fnternatlonal coordinaÈfon and cooperaÈion.
Because
fnternatlonal polfcy coordinaÈ1on--unl1ke markets--often lacks a credlble
systeE for enforcetrenc and burden-sharlng, 1È can create uncerÈalnËfes
about
the extenc of conpllances.
lf
wllllng co coordfnaÈe broed polfcy obJectfves, trâny
obsenrers doubt thaÈ they can. Ttre sharp differences erDong econoulsts
about
the crue stete of che econony, about che near-term dtrecÈfon of the economy,
Even
naÈfons are
and abouc the interrelatlonships anong pollcy levers and econonlc
varlables
are alnost legendary. If economfsts cannot agree on how the econony works,
can we exPecc governnenËs co agree on and fmplenent coordinated,
effeccfve
macroecononfc pollcies? One also nfght r¡onder aboug Èhe ouücone
if the r¡orld
cooperated, but adopted the wrong model of how the world works. Ttrfs,
of
course, ls a problen at the naclonel level, buc lnternational coopera¡lon
could greatly f.ncrease the cosÈs of an
"rror.5
of the proposals for detatled fnternetlonal coordinaÈion renfnd ne of
polfclmakers' "flne cuningn efforts of rhe 1960s and 1970s, when
they
Many
11
atËempced
to echleve
sinurtaneousry. The Èhrust of pollcies
shffted frequently, and those polfcfes generarly missed on
all accounts.
rnany targeÈs
The
markeEs' nlsÈrusc
Ëhac compllcaced
of pollc¡rnakers was reflected fn an inflatfonary psychology
and extended the flght agalnsc lnflatfon. rf or"
,,o, ,"k"
domesÈÍc obJecEives subJecc
to lnternatlonal targets
and evencs, econonfc
agents once agafn courd lose confidence 1n the willfngness
and che
pollcynakers Ëo pursue importanÈ domestfc goals.
abilfty of
Conclusfon
r don'c
ltenÈ ny
polnt to be nlsconstrued. obvlously
essentfal rore ln a narket econony. Ttrat narkets
gover¡rments
play
an
Ëodey exËend across natlonal
boundarles does noÈ
alter thfs role; indeed, global narkeËs enhance lt.
shourd explore opportunfties for lnEernacfonar cooperaÈfon
thaË erùrance
perfortance of narkets and reduce Èhe rlsks of systenic
failure, but we
consÍder both Èhe beneflts and cosÈs of such pollcies.
Recently many have advocated a grea¿ly expanded role
pollcy coordinaÈfon.
I.¡,e
the
nust
for internatfonal
Ttrey argue thaÈ as markecs becone fncreasfngly
lntegraced, the potenËlal beneflts frou such coordinatlon
become enornous. r
cautÍon that such polfcles often seek to supplant markets
and Ëo avold narket
df scfplfne. such polrcres, therefore, run
the rf sk of carrying with Èhen
enor'ous costs fn terus of real econonlc growth and
efflclency.
of the currenc Èhrust towards global cooperetton is concerned
wfth
macroecononlc pollcy coordinatlon. Glven the polftical
and economlc reallties
of the world today, r belleve that a Eove toward detailed coordfnaÈfon
Much
of
macroeconoufc
pollcles would not lmprove,
buÈ could very
well Jeopardfze
our
L2
standards
of llvfng.
rnstead' r would urge countrfes co edopÈ, Èo announce,
and to steadfastly mafntafn long-tern nonlnal ÈargeÈs
for pollcy, conslstent
wfth zero lnflaclon and rong-term real grolrth potenÈlar.
Tt¡is
would not
stablllze
exchange
rates, buE It would remove nuch of
fuÈure pollcy whlch contributes
Ehe
uncertarnty
to exchange-rate volatllicy.
aþouc
Exchange rates
would adJusc making the plans
of lndlvlduar natlons conpatfbre, and flexlble
exchange rates would provfde a buffer to external pollcy
errors and shocks.
such broad, lndfvidually lnstlcuÈed targecs would be
credfble, predfcÈable
and'-nost lnportantly--would nalntaln Èhe lntegrlty of prfvate
narkets.
13
1
A perceived need for pollcy coordlnatfon fs nof
new. For a
dfscussfon of cencrar-bank .oåp"r"tton in rhe 1920s,
see
SÈephen V.O. Clarke,
g+ l Bank Cooperarfon Lg24-3L. New york: Federal Resenre
Bank of New york
L967.
2
For a dfscussfon of factors
increasing world lntegratlon, see Rfchard
Cooper, nEconomlc Interdependence and Coordinatfon
of Econonf.c Polfcies,'
I{. Jones and peter B. Kenen, eds.,
Vol. 2. Ansrerdan:NorÈh-Holland publishlig
in
Ronald
1985:1195-L234.
f trade and capfÈar flows, see Norman s. Freleke,
ce beEween Nations: Reason for porrcy õooratnation?'
. Federal Reserve Bank of Bosron. (uäyl"luiet;-;i:iå
ate Systen, n policl Anal.r¡ses þ
on,D.C. : InsÈltute for fnternãîfonal
cary and Exchange Rates polfcfes for
posal,n Journal g¡[ Economfc
:
q
-
83-103.
see Jeffrey A. Frankel and Katherfne Rockett. nrncernaEfonal
Macroeconor¡fc Polfcy coordfnatlon-Í{tren_Po11cynit"."
Model,n I&, Amerlcan Economic Revfew, (June igggl: Do Not Agree on the True
31g -340,
New
@FedFRASER