Mark Carney points out the currency war myth
In this piece on Bloomberg, Mark Carney (the govenor of the Bank of Canada, and soon to be governor of the Bank of England) points out that the criticism of the BOJ for the drop in the Yen isn’t fair:
Speaking on the same Davos panel, Bank of Canada Governor Mark Carney commended Japan’s focus on beating deflation. Carney, who will move to the Bank of England in July, said Amari had been “very clear and the Bank of Japan (8301) is clear in terms of the policy focused on a domestic inflation target.”
As long what is going on is consistent with an underlying inflation/NGDP target this is just normal monetary easing, not “beggar they neighbour intervention”. I noticed that a lot of people keep throwing out this currency war myth, even in NZ, but as we have discussed in a number of posts listed here it is simply a myth.
Truly, if people are concerned about the “plunging Yen” they need to ask why – is it because they have left monetary conditions too tight in their own countries? If so, that is really just their own fault. If domestic monetary conditions aren’t too tight we actually have to ask what the issue is – and if there is an issue it will be to do with direct market failure or government policy, it will have nothing to do with rule/expectations based monetary targeting.
Sidenote for New Zealand: If you are really worried about our “competitiveness” instead of going on about the currency – ask why New Zealanders are so willing, and able, to borrow from overseas. It is the fundamental drivers of that phenomenon that are inherently related to any lack of competitiveness – the nominal currency is a symptom, a by-product, of the fact that New Zealand consistently invests more than it saves … and tends to not make a sufficient social rate of return on that investment. To “solve” any perceived problem, we need to actually ask why in this context, rather than arbitrarily attacking things.
I’ve been really impressed with that Key has NOT gone populist on this one. It would be really easy for him.
Now he’s talked a bit of rubbish about how the bank couldn’t cause a big depreciation (asymmetry: hard to maintain an overvalued rate; easy to push a rate down if you have printing presses), but he’s been good on the benefits of a higher dollar and that it’s best left alone.
Indeed.
On the flipside I’m disappointed that New Zealand macroeconomists haven’t been able, or willing, to convincingly explain to people why inflation targeting and the actions of the Reserve Bank are not the core of any “issue” here 🙁
Will have to find an NZ Macro person to start blogging.
Or if we had an academic macroeconomist who would write and comment on NZ macro issues publically. Some sort of “macro chair” of a university. That would be nice.
Yes, that would be nice, Matt.
I’m aiming to jointly major in
macroeconomics but that’s still a three years or so away for a degree I
started in 1996! – stuff happens – so I can only give you a layman’s
opinion, although I did pass Economics 101 in 1970 and I’m now
refreshing that after (almost) a working lifetime in manufacturing,
including being blindsided by Rogernomics and losing all my substantial
export customers, literally, in one case, overnight, as a result of the
eventual exchange rate appreciation. And I voted for the buggers!
But
I’ve been following your posts on the currency issue for a while now,
and I do have some problems with your conclusions, on two grounds,
especially.
The first is that you seem to be calling QE, as in
Japan, normal monetary easing, yet the term most widely used is
“unconventional” monetary policy. Unconventional, by definition, surely,
cannot be “normal”. I’m interested in how you draw your distinction
between the two.
In addition, insofar as QE increases the volume
of currency in circulation, the standard supply and demand graph tells
us 101 students that an increase in supply leads to a decrease in the
price. Therefore, if we do have an overvalued exchange rate, surely the
fix is in our own hands.
In terms of a currency war, well, China
has been explicit in its aim of strictly controlling the value of its
currency, as has been Switzerland in its QE actions. And now Japan.
Germany has benefited mightily by being grouped with countries who exert
downward pressure on the euro – was it engaged in an undercover
currency war?
The second ground for concern with your analysis is
that RBNZ papers use a flow chart that is explicit that the expected
effect of a rise in the OCR is a rise in the value of our dollar. I fail
to see how you can justify your point that inflation targeting via the
sole weapon of the OCR is symptom, not a cause, when the bank has many
other tools at its disposal, and could have more if it requested them.
But successive RB governors are also explicit in their refusal to
utilise any.
My own opinion is that, at this stage of my working life, I understand that simplicity makes one’s job much easier 😉
A
final point is this: we, the average punters, live our lives in a
market economy exactly as the theory presupposes, that is, we follow the
price signals. If we spend rather than save and take in overseas money
to compensate that’s because, individually, we are acting rationally.
And
I do get tired of being told what a naughty boy I am for following the
price signals. As Krugman says, often, economics is not a morality
play.
I look forward to your thoughts.
Heya,
Thanks for the clear question, hopefully I can answer 🙂
“The first is that you seem to be calling QE, as in Japan, normal monetary easing, yet the term most widely used is
“unconventional”
monetary policy. Unconventional, by definition, surely, cannot be
“normal”. I’m interested in how you draw your distinction between the
two.”
Good question. It is indeed both unconventional, and normal – as I’m using the terms in different contexts.
It is unconventional because it doesn’t involve moving the cash rate, so we have far less experience regarding what the impact on the Japanese domestic economy will be – as a result, there is a lot more uncertainty.
It is normal in so far as QE aims to replicate the impact of a cut in the cash rate, and they are doing this in order to reach their inflation target! This is just the same as normal monetary policy, as long as they are doing it with an inflation target in mind (here is another way to think about an inflation target http://www.tvhe.co.nz/2012/11/29/a-different-view-of-an-inflationprice-level-target-no-monetization-commitment/)
When the Swiss made a “target” for the exchange rate they were saying the following “we have deflation, and interest rates at zero, we are going to print money to buy a specific asset … our own currency … to ease monetary conditions and increase current demand to meet our inflation target”. This is the thing, when the cash rate hits zero, central banks “buy assets including currency” to achieve their inflation mandate – as it increases liquidity and gives asset holders a return.
Would New Zealand want to do this? It seems not IMO. For one, our cash rate is still positive – and for another, a lot of the holders of currency are not New Zealander’s, so I’d we’d could well just be giving people overseas free money/resources.
“In addition, insofar as QE increases the volume of currency in
circulation, the standard supply and demand graph tells us 101 students that an increase in supply leads to a decrease in the price.”
Monetary easing aims to increase demand, which should increase the currency in circulation. Of course, when it comes to competitiveness and the real exchange rate, matters are not nearly as clear! And the evidence doesn’t show much of an impact from RBNZ policy:
http://www.tvhe.co.nz/2012/09/24/what-has-been-driving-the-real-exchange-rate/
“I fail to see how you can justify your point that inflation targeting via the sole weapon of the OCR is a symptom, not a cause, when the bank has many other tools at its disposal, and could have more if it requested them”
The RBNZ isn’t in charge of “running the economy”, it is in charge of ensuring that inflation remains close to its target – and to take advantage of the “stickiness” of inflation to try and limit the damage to NZ when something goes wrong. It does this by influencing the “price” related to inflation – the interest rate (which influences the incentives to borrow and save now, and thereby demand” directly).
The “other instruments” the bank uses are for “other roles”. They DO have risk adjusted credit ratios – or essentially a reserve requirement – for banks. They are introducing further prudential policies, and have been for a decade. Unlike a political party, they don’t go around telling everyone how they are saving the world – they just focus on putting in policy that is appropriate to ensure we have a stable, efficient, and credible financial sector.
Now NZ may well have some “structural issues” – but the bank didn’t make these, and doesn’t have the democratic right to deal with them. What do I mean here? Well, one of the structural issues is working for families – one of the cost of working for families is a lower return for manufacturing firms.
Why? Well it transfers resources in such a way that it increases spending and reduces the incentive to invest and save (outside of potentially housing). By doing this it pushes up the real exchange rate, reducing the return to exporters.
The government likes to pretend that these sort of policies don’t have an impact on the real exchange rate – but they do. Even before WFF we had a similar (albeit less extreme) issue, and at the time factors such as competition policy were identified. This “issue” existed before we targeted inflation, and has been exacerbated by incoherent policy settings.
This sounds bad, until we realise that even with policy failure NZ has done pretty well compared to other countries – and the economy isn’t as perilous as the media makes it sound, although there are industries that are struggling!
“A final point is this: we, the average punters, live our lives in a
market economy exactly as the theory presupposes, that is, we follow the price signals. If we spend rather than save and take in overseas money to compensate that’s because, individually, we are acting rationally.”
Exactly. Don’t get me wrong, people should be just allowed to live their lives – preaching at an individual about the way they live their life would be a supreme type of arrogance by me 🙂
All I’m asking policy makers and interested individuals to think about here is “why”. Why are these price signals the way they are? Why is debt at a level that is so high? Given answers to these questions, we can ask about policy.
And the kicker here is saying “print more money” or “get the nominal exchange rate down” isn’t an answer! These are the “real” variables that drive imbalances. I suspect that the public doesn’t know/isn’t convinced of this – and that is where economists have to try to be clearer.
Three other quick points for in general – there is no silver bullet to make us all rich, NZ is a lot wealthier than it realises, technology change is making NZ less competitive in manufacturing – we need to remember that the industries that NZ is favourable for change through time.
Thanks Matt, very informative and lots to think about!
But I’m not so gloomy about manufacturing! It’s a good time to upgrade machinery and technology, and overseas contracts are still capable being won at the higher end of the market. And IP rights are a very good thing!
Now I need to stop cruising these really informative blogs you guys inhabit and get stuck into real work – studying for exams 🙂
The high exchange rate makes capital cheap – as does the growing capital intensity of capital production overseas!
Good luck for your exams