A Reawakening of International Monetary Policy Research

International Monetary Stability: Past Present and Future was the topic of this year’s monetary policy conference held last week at Stanford’s Hoover Institution. With highly volatile exchange rates, the spread of unusual monetary policies, and disappointing growth and stability, it was a hot topic for the researchers, the market participants, the media, and the four FOMC members who attended. In contrast to the frequent focus on exchange rate interventions and capital flow management at many other international meetings recently, this conference focused more on the need for a classic rules-based reform of the international monetary system.  In this respect, especially when combined with two previous monetary conferences (with books here and here), it constituted a reawakening of monetary research.  A book on the conference proceedings is planned, but in the meantime here is a quick summary.

Sebastian Edwards led off with his work on international monetary policy independence showing that despite flexible exchange rates (and despite arguments to the contrary by central bankers) there is significant policy spillover or contagion from the Fed to central bank decisions in Latin American countries. David Papell, in discussing the paper, considered whether this was due to recent departures from optimal policy rules in the US, concentrating on the concluding lines of Edwards paper that “to the extent that the advanced country central bank (i.e. the Fed) pursues a destabilizing policy, this will be imported by the smaller nations, creating a more volatile macroeconomic environment at home.”

David Beckworth and Chris Crowe came next with a novel paper that demonstrated some of the destabilizing impacts of such policy spillovers especially when the United States is “banker to the world” with a large portfolio of longer term assets financed by short term liabilities.  They considered ways in which more rules-based policy could alleviate these international instabilities. In his comments, Chris Erceg raised some empirical issues and noted that the results implied a positive effect of U.S. policy deviations (shocks to policy rules) on real GDP abroad.

V.V. Chari and Pat Kehoe then examined rules-based policy in the context of a fixed exchange rate system or a currency union. They showed that currency unions bring about more rules-based and less discretionary monetary policy, but noted that such unions have disadvantages in dealing with incentives to bailout the debt of member countries. In his discussion, Harald Uhlig explained in detail the nature of the assumptions and noted that some of the price-stability effects of monetary union observed in the countries of Europe are also observed in the United States.

Pierre-Olivier Gourinchas then presented a model which he has developed along with Ricardo Caballero and Emmanuel Farhi. He showed that the existence of the zero lower bound on the central bank interest rate combined with a shortage of safe assets in the global economy gave rise to the current account imbalances and currency wars that we see in the data.  In his comments on the paper, John Cochrane questioned the relevance of the zero lower bound, and he argued real factors such as the marginal product of capital provide a better explanation of what is going on in the world today. While praising the paper for laying out a model that could be discussed substantively, he also questioned the existence of aggregate demand deficiency so many years after the financial crisis.

The fifth research paper of the conference was an historical analysis by Michael Bordo and Catherine Schenk which focused on the importance of rules. They covered a range of different international monetary systems from the gold standard, to the early Bretton Woods, to the 1980s and 1990s, looking at particular episodes of formal policy coordination. Their over-riding finding is that systems that are more rules-based and do not require active coordination of policy actions work better than more discretionary systems.  Their discussant, Allan Meltzer, delved into some of the reasons underlying their findings based on his studies of the history of the Federal Reserve.

Following these research papers, a panel of three economists with experience with international economic policy coordination at the US Treasury—Richard Clarida, George Shultz and I—discussed Rules-Based International Monetary Reform. Clarida explained how his own research led to the conclusion that a nearly optimal rules-based international system could be generated by optimal rules in each country. He also emphasized, however, that certain inherently global developments—such as a change in the equilibrium real interest rate—required an analysis of trends in other countries. George Shultz described how international reforms that first brought about flexible exchange rates were implemented in practice during his own experience as Treasury Secretary.  I reviewed my proposal for a rules-based international monetary system in which each country announces and commits to its own policy rule.

In many ways the highlight of the conference was the final panel on international monetary policy and reform in practice with four current members of the Federal Open Market Committee: Jim Bullard of St. Louis, Rob Kaplan of Dallas, Dennis Lockhart of Atlanta, and John Williams of San Francisco. Though there was some disagreement, there seemed to be a lot of consensus that the equilibrium real interest rate (r* was the term most commonly used) had declined.  This did not have much bearing on their current interest rate decisions, but it meant that gradual normalization would be to a lower rate than earlier anticipated.  In addition, Jim Bullard presented an analysis in which deviations from optimal rules-based policy could cause instabilities in other countries, a possibility raised by Sebastian Edwards at the start of the conference.

Following each of these presentations there was a lively and robust exchange with the other conference participants—too much to summarize here—which will be brought out in due course in the forthcoming conference volume. While there is no way to summarize a main finding of the conference, George Shultz commented that he heard a wide consensus for a rules-based monetary policy and international system, about which no one disagreed, though differences of opinion about which rule is best were heard throughout the day.

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