The IMF/World Bank meetings were held in Bali last week. In addition to the many good beaches there were many good panels including one I was on with Mark Carney and Agustin Carstens. It was organized by the Group of Thirty, led by Jacob Frenkel and Tharman Shanmugaratnam, and focused on “Sustaining an Open and Stable Global Order,” a broad topic, within which I focused on the global monetary and financial system in the following way:
A long-held view of mine—based on solid economic theory and much empirical evidence—is that a global monetary and financial system conducive to a stable global order has three attributes: (1) open capital markets, (2) flexible exchange rates between countries or blocs and (3) a predictable and transparent, or rules-based, monetary policy.
To be sure this is a goal, and we are not there yet, though I think we have very recently started moving in that direction. One of the three attributes—open capital markets—was just recommended as a long-term goal in a Report by the G20 Eminent Persons Group (EPG) on Global Financial Governance on which I served. The idea of open capital markets carries through intellectually and practically to goods markets. The current emphasis on “capital flow management measures” or restrictions on capital flows easily carries over to restrictions on goods flow which we all want to reduce and avoid.
When policy moves closer to those three attributes, as in the 1980s and 1990s for the advanced countries and more recently for emerging market countries, the economy does well, growing in a stable manner. When policy deviates from those three, as U.S. monetary policy did going into the tragic global financial crisis, the economy does poorly. And continued deviations in many of the past 12 years have led to poorer performance, competitive devaluations of exchange rates, and complaints of currency manipulation. These claims diminish when there is greater transparency about monetary policy.
How do we get from here to there? We need an international policy framework in which each central bank follows its own rules-based monetary policy, and in doing so contributes to a global rules-based system. In my view the framework should embody those same three attributes as a goal. There is no need for one central bank to tell another central bank what to do except to be transparent about its strategy or rule. The IMF, the FSB, and the BIS could all be involved in monitoring the rules-based policy, which should be a key part of their new integrated “coherent global risk map” role also recommended by the EPG.
The most practical way forward is for one or more central banks to “just do it,” to start to move in a rules-based direction. It appears that the Fed has begun to normalize in this way. This can be seen in the past year and a half in actions, appointments, publications, and speeches. Actions include the transparent well-telegraphed move to normalize the policy interest rate and reduce the size of the balance sheet. Appointments at the FOMC include more people who have thought of policy in terms of rules, including Randy Quarles and Rich Clarida as vice chairs, and the move from San Francisco to New York by John Williams. Publications include the quantum shift in the semiannual Monetary Policy Report which now has whole sections on policy rules and how the Fed uses them. Speeches include Janet Yellen’s January 2017 speeches describing the Fed’s strategy for the policy instruments (“When the economy is weak…we encourage spending and investing by pushing short-term interest rates lower….when the economy is threatening to push inflation too high down the road, we increase interest rates…”), comparing Fed strategy with the Taylor rule and other rules, and explaining the differences. Also in February of last year, Stanley Fischer gave a talk with a similar message, comparing actual policy with monetary rules and explaining how rules-based analyses feed into FOMC discussions to arrive at policy decisions. In February of this year, Jay Powell, in his first testimony as Fed Chair, talked about making monetary policy with policy rules, saying that “In evaluating the stance of monetary policy, the FOMC routinely consults monetary policy rules that connect prescriptions for the policy rate with variables associated with our mandated objectives. Personally, I find these rule prescriptions helpful. Careful judgments are required about the measurement of the variables used, as well as about the implications of the many issues these rules do not take into account.”
This emphasis on rules and strategy did not go unnoticed by those who follow policy: As Larry Kudlow put it before he moved to the White House: “I’ve never seen that in any testimony before….and I think that’s progress.” More recently, President Donald Trump said: “We’re normalizing money, and that’s good,” though he added that “I think we don’t have to go as fast.”
Other central banks need to follow in a global normalization. It will not be easy, so it is important to be predictable and gradual. We are beginning to see such changes at the ECB, and the BOJ may be next, with small open economies, many represented at these meetings, moving when they can.
There are risks, of course, but an international policy framework will help if it is based on those three attributes: Rules-based monetary policy at each central bank, flexible exchange rates between countries or blocs, and open capital markets. Those are the keys to a sustaining a more open and stable global financial order.