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February 11, 2013 7:05 pm
As finance ministers and central bankers make their way to this week’s Group of 20 leading nations meeting in Moscow, some of them may find it impossible to resist the temptation to grab headlines by lamenting a new round of “currency wars”. They should resist, for there is no such thing as a currency war.
This is because central banks are simply doing what they are meant to do and what they have always done. They set monetary policy consistent with their domestic mandates. All that has changed since the crisis is that central banks have had to resort to unconventional measures in an effort to revive wounded economies.
In the US, for example, the unemployment rate is 2 percentage points above its postwar average. In the UK, output remains 3 per cent below its level at the end of 2007.
In both of these countries, the remits given to the central banks make their responsibility clear: to take action to provide economic stimulus. The US Federal Reserve, for example, has responsibility to “promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates”. In the UK, the Bank of England’s main objective is to maintain price stability. But subject to that, it is required to “support the economic policy of Her Majesty’s government, including its objectives for growth and employment”.
Japan’s problems are different in nature, and longer in the making. Japanese inflation has been negative, on average, for well over a decade. It is an environment that would not be tolerated in any other developed economy. The recently signalled desire for inflation of 2 per cent is hardly a leap towards monetary unorthodoxy, let alone an act of war.
The natural response to the problems facing developed economies would be cuts in short-term interest rates. But they cannot be cut much further. A next step might be to commit to low short-term interest rates for a specific period, as the Fed has done. But expectations of future policy rates are incredibly low: rate rises are not priced into markets until at least 2015 in the US and the UK. And still demand remains weak.
That is the prism through which one should view the balance sheet expansions of central banks. Has anything actually changed that suggests that central banks are suddenly seeking ways to subvert the usual mechanisms? Are they trying to manipulate their currencies to keep them undervalued in some way? Well, it seems hard to argue that the US or the UK are seeking to keep their exchange rates unfairly depressed to boost exports. Both countries are running current account deficits equivalent to about 3 per cent of their respective gross domestic product. And that is despite subdued domestic demand, and so unusually low demand for imports.
Again, the case of Japan is rather different. It continues to run a current account surplus. A depreciation of the yen may boost that surplus further in the short run. Nonetheless, that could, and arguably should, be part of the mechanism through which Japan is able to make the transition towards a higher inflation rate.
As with all monetary policy, we should not be surprised if the actions of central bankers affect nominal exchange rates. As long as policy tries to meet reasonable remits, this should be accepted as part of a natural adjustment mechanism.
One can sympathise with emerging economies with floating exchange rates, which may feel they are bearing too much of the burden of adjustment. But surely the answer is not for developed economy central banks to turn away from their remits. Rather, it is for emerging economies to focus their own monetary policy on sensible domestic remits, with their exchange rates free to be determined in the market.
There is one small and particularly open economy where sustained currency movements were not merely the consequence of conventional or unconventional monetary policy measures but where the central bank opted to influence the exchange rate directly. In September 2011, when I was chairman of the Swiss National Bank, it announced that it would no longer tolerate an exchange rate below 1.20 Swiss francs to the euro – and to enforce that minimum rate it would be prepared to buy foreign currency in unlimited quantities.
But even in this case, the central bank acted entirely within its mandate. Latent deflationary risks had to be addressed at a time when policy rates had reached their lower bound and legal and market obstacles made other monetary policy measures such as asset purchases impossible. Price developments since then seem to have validated the SNB’s policy actions. The minimum rate notwithstanding, inflation was negative throughout 2012.
The monetary policy battles that have been fought and continue to be fought in so many economies are domestic ones. They are fights against weak demand, high unemployment and deflationary pressures. A greater danger to the world economy would in fact arise if central banks did not engage in these internal battles. These monetary battles are justified and fully embedded in legal mandates. They are not currency wars.
The writer is vice-chairman of BlackRock and former chairman of the Swiss National Bank
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