Tag Archives: Federal Reserve

Been There, Done That

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President Barack Obama has nominated Stanley Fischer to the Board of Governors of the Federal Reserve Board, where he will succeed Janet Yellen as Vice-Chair of the Board. Fischer’s accomplishments are well-known. But he also brings an interesting set of credentials to the Board at a time when it has been criticized for ignoring the impact of its policies on other countries.

Fischer received his doctoral degree from MIT, and returned there after a stint on the faculty at the University of Chicago. During the 1970s and 1980s he taught or advised such future luminaries as Ben Bernanke, Greg Mankiw and Mario Draghi. He served as Vice President and Chief Economist of the World Bank from 1988 to 1990. He was the First Deputy Managing Director of the IMF from 1994 through 2001, a period when financial crises recurred on a regular basis in the emerging market countries.

Fischer’s experience with those crises gives him a perspective that macroeconomists who work only on the U.S. economy do not possess. Paul Krugman has written about how the financial instability of the post-Bretton Woods era has affected the views of those who follow these events. In 2009, for example, when our profession was castigated for not foreseeing the global financial crisis, Krugman wrote: “

…the common claim that economists ignored the financial side and the risks of crisis seems not quite fair – at least from where I sit. In international macro, one of my two home fields, we’ve worried about and tried to analyze crises a lot. Especially after the Asian crisis of 1997-98, financial crises were very much on everyone’s mind.

Similarly, in 2011 Krugman wrote:

Indeed, my sense is that international macroeconomists – people who followed the ERM crises of the early 1990s, the Latin American debt crisis, the Asian crisis of the late 90s, and so on – were caught much less flat-footed.

The IMF, of course, was widely criticized at the time for its crisis-management policies and its advocacy of deregulating capital flows.  In retrospect, Fischer’s arguments in favor of capital account liberalization appear overly zealous, and he has drawn criticisms for those positions. The IMF has recently adopted a more nuanced position on the use of capital controls as a macro prudential tool.

And yet—in 2000, after the resignation of the IMF’s Managing Director Michel Camdessus, Fischer, who was born in Rhodesia (now Zambia), was nominated to be Camdessus’ replacement by a group of African nations. (Miles Kahler presents the story in his Leadership Selection in the Major Multilaterals.) This was a challenge to the European governments that had always claimed the prerogative of naming the Managing Directors of the IMF since it commenced operations in 1945. But the nomination was also an indication of the respect that Fischer enjoyed amongst the African and other developing countries. In the end, it was impossible to change the IMF’s traditional governing procedures, and Horst Köhler of Germany became the new Managing Director.

After Fischer left the IMF, he went to work at Citigroup. In 2005 he was appointed Governor of the Bank of Israel, and served there until last year. Under his leadership the Bank received praise for its policies. Fischer was widely admired and received an “A” for his stewardship from the magazine Global Finance. Those pouring through his recent speeches and writings for indications of what he might do as a Federal Reserve Governor believe that he endorses the Fed’s accommodative stance, but may have a nuanced approach on the benefits and costs of forward guidance.

Stanley Fischer, therefore, brings several attributes to the Federal Reserve. First, he has an unquestioned command of macroeconomics, and in particular, monetary policy. Second, he has a wealth of experience in dealing with financial calamities. And third, he earned the trust and respect of policymakers in developing nations while he served at the IMF. Those qualities will be much appreciated as foreign officials and financial markets deal with the Federal Reserve’s policy pivot.

Affairs, Domestic and Foreign

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Raghuram Rajan, ex- faculty member of the Booth School of Business at the University of Chicago, ex-head of the research department of the IMF, and currently Governor of the Reserve Bank of India (its central bank), set off a storm of comment when he warned of a breakdown in the global coordination of monetary policy. Frustrated by the decline in the foreign exchange value of the rupee that followed the cutback in asset purchases by the Federal Reserve, Rajan claimed that the Federal Reserve was ignoring the impact of its policies on the rest of the world.  Does he have a valid cause for concern?

Quite a few folks have weighed in on this matter: see here, here, here, here, here and here. Rodrik and Subramanian make several interesting points. First, the Federal Reserve was criticized when it lowered rates, so complaints that it is now raising them are a bit hypocritical (but see here). Second, blaming the Fed for not being a team player as the emerging markets were when they lowered their rates in 2008-09 is not a valid comparison. The emerging markets lowered their rates then because it was in their interest to do so, not out of any sense of international solidarity. Third, their governments allowed short-term capital inflows to enter their economies; did they not realize that the day could come when these flows would reverse? Finally, their policymakers allowed the inflows to contribute to credit bubbles that resulted in inflation and current account deficits, which are significant drivers of the volatility.

Moreover, the Federal Reserve is constrained by law to promote maximum employment, stable prices, and moderate long-term interest rates in the U.S., not the global community But couldn’t turmoil in the emerging markets threaten U.S. conditions? Robin Harding at the Financial Times thinks this is an unlikely scenario. He points to two channels of transmission between the U.S. and the countries that have shown the most turbulence: exports and financial markets. The emerging market nations that have witnessed the most volatility account for very small proportions of U.S. exports. (China, on the other hand, does claim 7.5% of our exports, but so far has not suffered any signs of distress (but see here).) In addition, financial flows might be affected, but to date these have resulted in lower interest rates in the U.S. due to a flight to safety. Previous shocks from the emerging markets pushed U.S. stock prices down, but these effects were short-lived. Therefore, Harding claims, “…it would have to become much more of a crisis…” to endanger the U.S. economy.

The problem with this assessment is that it assumes that we know the extent of our financial vulnerability to a decline in the fortunes of these economies. But one lesson of the 2007-09 global financial crisis is that there may be much we do not know about our financial structure. U.S.-based institutions can be vulnerable to shocks in ways that we do not recognize. Subprime mortgages were not themselves that significant a share of the liabilities of U.S. banks and shadow banks, but they were the foundation of a range of derivatives, etc., that took down the financial markets when these mortgages became toxic.

The threat of more declines in foreign asset prices does not mean that the Federal Reserve should retreat from its current policies. A situation with some interesting similarities took place in the early 1980s. U.S. banks, awash with recycled oil revenues, had lent extensively to countries in Latin America and elsewhere in the 1970s.  A debt crisis ensued after Paul Volcker and the Federal Reserve raised interest rates (see Chapter 4). Volcker recently reflected on these events in an interview with Martin Feldstein in the fall 2013 issue of the Journal of Economic Perspectives:

“What were you going to do? Were you going to conduct an easy-money policy and go back on all the policy you’d undertaken to try to save Mexico, which wouldn’t have saved Mexico anyway? We did save Mexico, but by other means.”

U.S. policymakers have always claimed (with some justification) that a healthy U.S. economy is the best remedy for a troubled world economy, and monetary officials will no doubt proceed as they think best. But we should take a look around before we proceed. The February ice underneath our feet may be a bit thinner than we realize.

Birds of a Feather

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Policy coordination on the international level is one of those ends that governments profess to aspire to achieve but only realize when there is a crisis that requires a global response.  There are many reasons why this happens, or rather, does not. But in one area—monetary policy—central bankers have in the past acted in concert, and their activities provide lessons for the conditions needed to bring about coordination in other policy spheres.

Jonathan D. Ostry and Atish R. Ghosh suggest several reasons for the lack of coordination.  First, policymakers may only focus on one goal at a time, and ignore intertemporal tradeoffs. Second, governments may not agree on the size of spillovers from national policies. Finally, those countries that do not participate in policy consultations do not have a chance to influence the policy decisions. Consequently, the policies that are adopted are not optimal from a global perspective.

All this was supposed to change when the G20 became the “premier forum for international economic co-operation.” The government leaders agreed to a Mutual Assessment Process, through which they would identify objectives for the global economy, the specific steps needed to attain them, and then monitor each other’s progress. How has that worked? Most observers agree: not so well. Different reasons are advanced for the lack of progress (see here and here and here), but the diversity of the members’ economic situations works against their ability to agree on what the common problems are and a joint response.

There is one area, however, where there has been evidence of communication and even coordination: monetary policy. What accounts for the difference?  The linkages of global financial institutions and markets complicate the formulation of domestic policies. Steve Kamin has examined the literature on financial globalization and monetary policy, and summarized the main findings. First, the short-term rates that policymakers use as targets are influenced by foreign conditions. Second, the long-term rates that affect spending are also affected by foreign factors. The “savings glut” of the last decade, for example, has been blamed for bringing down U.S. interest rates and fuelling the housing bubble. Third, the financial crises that monetary policymakers face have foreign dimensions. Capital flows exacerbate volatility in financial markets, and disrupt the operations of banks (see here). Therefore, central bankers can not ignore the foreign dimensions of their policies.

The actions of monetary policymakers during the global crisis are instructive. In October 2008, the Federal Reserve, the European Central Bank, and several other central banks simultaneously announced that they were reducing their primary lending rates. The Federal Reserve established swap lines with fourteen other central banks, including those of Brazil, Mexico, Singapore, and South Korea.  The central banks used the dollars they borrowed from the Federal Reserve to lend to their own banks that needed to finance their dollar-denominated acquisitions. The Federal Reserve also lent to foreign owned financial institutions operating in the U.S.

While the extent of their cooperation in 2008-09 was unprecedented, it was not the first time that the heads of central banks operated in concert. There are several features of monetary policy that allow such collaboration. First, monetary policy is often delegated by governments to central bankers, who may have some degree of political independence and longer terms of office than most domestic politicians. This gives the central bankers more confidence when they deal with their counterparts at other central banks. Second, central banking has been viewed as a more technical policy area than fiscal policy and requires professional expertise. In addition, the benign economic conditions associated with the “Great Moderation” gave central bankers credibility with the public that manifested itself in the apotheosis of Alan Greenspan. Third, central bankers meet periodically at the Bank for International Settlements, and have a sense of how their counterparts view their economies and how they might respond to a shock. A prestigious group of economists have proposed that a group of central bankers of systemically significant banks meets under the auspices of the Committee on the Global Financial System of the BIS to discuss the implications of their policies for global financial stability.

All this can change, and already has to some extent. Monetary policy has become politicized in the U.S. and the Eurozone, and even Alan Greenspan’s halo has been tarnished. Policymakers from emerging markets were caught off-guard by the rise in U.S. interest rates last spring and argued for more monetary policy coordination.

Are there lessons for international coordination on other fronts? The conditions for formulating fiscal policy are very different. Fiscal policies are enacted by legislatures and executives, who are subject to domestic public opinion in democracies.  There is little consensus in the public arena on whether fiscal policy is effective, which can lead to stalemates. Finally, there is no common meeting place for fiscal policymakers except at the G20 summits, where there is less discussion and more posturing in front of the press.

The G20 governments enacted fiscal stimulus policies at the time of the crisis. Since then, the U.S. has been unable to fashion a coherent policy plan, much less coordinate one with foreign governments. The Europeans are mired in their debt crisis, and the G20 meetings have stalled. It is difficult to see how these countries could act together even in the event of another global crisis. Like St. Augustine’s wish for chastity, governments may want to coordinate their policies—but not quite yet.

Another Divergence

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The decline in inflation rates in advanced economies to historically low rates has been widely reported.  But inflation is increasing in some of the largest emerging markets. This divergence poses dilemmas for policymakers in those countries.

The annual difference between the GDP-weighted average inflation rates of high income countries and developing nations has fluctuated between 3-4% between 2010 and 2012 (see data here). More recently, the gap has jumped to 4.8%. Among the countries where prices are rising more rapidly are Brazil (5.8% in the most recent month), Egypt (10.5%), India (10.1%), Indonesia (8.3%), Russia (6.2%), and South Africa (5.5%).  Moreover, all except Russia are recording current account deficits.

The increase in prices is drawing attention. In Brazil and Indonesia, rising prices are fueling popular discontent with the governments. The Russian central bank has admitted that it will miss its inflation target for the year. Arvind Subramanian finds inflation in India worrisome, in part because it is unprecendently high.

What fuels the rises? In many emerging markets, the governments have sought to offset reduced demand by their trade partners in the advanced economies by stimulating domestic demand. The result has been increases in domestic credit and household debt, and in these countries escalating prices.

Some central bankers have responded by raising their target interest rates. In India, the new target rate is 7.75%. Brazil’s central bank has raised its target rate to 10%, and Indonesian monetary policymakers have hiked their rate to 7.5%. South Africa’s central bank has kept its rate unchanged, but signaled that this may change.

These increases could leave the central bankers in a quandary. After blaming the Federal Reserve for capital flows to their countries, it would be awkward if the same policymakers were now seen as responsible for creating the conditions that could attract capital. Moreover, higher rates might choke off the domestic spending that it is seen as essential. But allowing inflation to continue unchecked could result in harsher measures later. Of course, higher growth in the advanced economies could alleviate many of these problems. Convergence can work in more than one direction.

The 2013 Globie!

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Once a year I choose a book that deals with some aspect of globalization in an interesting and illuminating way, and award it the “prize” for the Globalization Book of the Year (also known as the “Globie”). Previous winners are listed below. This year (for only the second time), I have two titles to recommend.

The first is The Alchemists: Three Central Bankers and a World on Fire by Neil Irwin of the Washington Post. Irwin describes the responses of Ben Bernanke of the Federal Reserve, Mervyn King of the Bank of England and Jean-Claude Trichet of the European Central Bank to the financial and economic crisis that began in 2007. The account of how each man reacted to the crisis is quite riveting. Bernanke emerges as the policymaker who most quickly understood the magnitude and consequences of the implosion in the financial markets. The narrative also provides an overview of central banks and monetary policy.

Angus Deaton of Princeton University deals with very different aspects of globalization in The Great Escape: Health, Wealth, and the Origins of Inequality. In the first part he offers an account of the medical and other advancements that have contributed to prolonging our lives, and how uneven that progress has been across nations. The second part of the book deals with inequality, first within the U.S. and then the rest of the world. The last section presents his view that foreign aid has failed to assist nations that have not shared in the improvements in the human condition. Deaton, a well-respected development economist, combines historical with economic analysis to explain the reasons why so many of us live longer and in better circumstances, and why so many others have not yet made that transition.

Globalization Books of the Year

Year

Author

Title

2005

 Pietra Rivoli The Travels of a T-Shirt in the Global Economy: An Economist Examines the Markets, Power, and Politics of World Trade

2006

 Jeffry A. Frieden Global Capitalism: Its Fall and Rise in the Twentieth Century

2007

 Kwame A. Appiah Cosmopolitanism: Ethics in a World of Strangers

2008

 Farid Zakaria The Post-American World

2009

 Alan Beattie False Economy: A Surprising Economic History of the World

2010

 Stephen D. King Losing Control: The Emerging Threats to Western Prosperity 

2011

 Gideon Rachman 

Dani Rodrik

 Zero-Sum Future: American Power in Age of Anxiety  

The Globalization Paradox: Democracy and the Future of the World Economy

2012

 Daron Acemoglu and James A. Robinson Why Nations Fail: The Origins of Power, Prosperity, and Poverty

Hobglobins and Hypocrites

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“A foolish consistency is the hobglobin of little minds…”

Ralph Waldo Emerson

Before this week’s announcement by Federal Reserve Chairman Ben Bernanke that the Fed would continue its asset purchases under Quantitative Easing 3, finance ministers and other leaders in emerging market nations had been voicing their concerns over the prospect of U.S. policymakers winding down their operations (see here). They feared that higher interest rates in the U.S. would bring back the capital that had flowed out in search of higher returns, which would leave the emerging market officials in the uncomfortable position of raising their own interest rates or watching their currencies depreciate. The calls for the Federal Reserve to exercise caution peaked at the G20 leaders summit in St. Petersburg, where the final communiqué called for “Further changes to monetary policy settings…to be carefully calibrated and clearly communicated.”

It would be easy to dismiss the foreign reaction on the grounds that there was a large measure of hypocrisy in these exhortations to the Federal Reserve to move slowly.  Many of these officials had previously castigated the Federal Reserve for the currency appreciations that accompanied the earlier capital inflows. Surely, it can be claimed, they should welcome a reversal in Federal Reserve policy.

But the calls for caution demonstrate that a country’s economic welfare incorporates many diverse interests that exercise influence at different times. The worries voiced earlier about currency appreciation were based on the fears of exporters that they would be adversely affected by the resulting increases in prices in foreign markets. Their grievances were heard sympathetically by domestic policy officials who have been dealing with an unsteady recovery from the Great Recession of 2008-09. The decline in import prices was of little import, as inflation has not been a concern. Human nature dictates that we resent adverse changes and take for granted those that benefit us. Moreover, Mancur Olson pointed out that when the benefits are diffuse and the “pain” concentrated, it is not surprising that the voices of those who feel threatened are predominant.

Capital outflows and currency depreciations, on the other hand, will affect other interest groups. Those who have liabilities denominated in dollars fear a rising burden in repaying their debts. Domestic firms dependent on imports worry about their higher costs. Regulators of domestic financial markets are anxious about financial volatility and declines in asset prices. Finance ministry and central bank officials fret about the financing of current account deficits. It would be surprising if their calls for protective actions were offset by a wave of messages from exporters jubilant at regaining market share.

When U.S. interest rates do rise, those outside the U.S. who are adversely affected will register their complaints. Their government representatives will respond by criticizing the Federal Reserve for ignoring the global impact of their policies. It may be inconsistent, but not hypocritical, for them to serve whichever domestic interests have the largest megaphones.