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Monetary easing targets growth not currency war
By Alaistair Chan |
February 21, 2013, Thursday
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Print Edition
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CONCERNS appear to be growing about the potential for a so-called global currency war. Officials in Brazil, China, France, Germany, the Philippines and Thailand have warned about the destabilizing effects when many countries attempt to devalue their currencies simultaneously, and economic textbooks for decades have portrayed such a scenario in terms such as "zero-sum" and "beggar-thy-neighbor."
Yet simultaneous policy easing among big economies would actually be a good thing given the current state of the global economy, and mitigating any adverse effects is well within national policymakers' abilities.
Japan ignited the recent bout of currency war angst when Shinzo Abe was elected prime minister after he campaigned heavily on stripping away the Bank of Japan's independence and pressuring it to do more to lift the country out of deflation. Global opposition to Abe's plan culminated in a G-7 statement supporting policies that boosted domestic demand without explicitly targeting exchange rates. This was followed by similar statements at a G-20 meeting.
Yet if any country has a clear case for monetary easing, it is Japan. Economist Milton Friedman once noted that the best measure of monetary policy is not interest rates but their economic effect. Using Friedman's benchmark, even the Bank of Japan's 0.05 percent call rate has not created a particularly accommodative monetary policy.
Japan has been in deflation for more than three years. Excluding food and energy, consumer prices have fallen in annual terms every month since January 2009. Since 2008, the yen has been on an appreciating path; at its strongest point in mid-2012, it was close to 40 percent higher on a trade-weighted basis than it was in 2000. Fourth quarter GDP data show that Japan's recession remains entrenched, as output fell for a third consecutive quarter Abe's election had a clear and positive effect on market expectations. The yen has fallen 14 percent on a trade-weighted basis since the election was called in August.
Markets now expect Japan to escape its deflationary trap. Rather than competitive devaluation, monetary easing should be seen in the context of raising inflation expectations and lowering real borrowing costs.
Further easing
Although further quantitative easing in Japan may be likened to "pushing on a string," research by central banks such as the US Federal Reserve shows there is a measurable positive effect from unconventional easing policies at the zero bound. It should be noted that contrary to popular perception, Japan's economy is domestically driven. Exports make up 15 percent of GDP, only a bit more than the 13.4 percent ratio in the US.
Potential downsides of a currency war include increased protectionism if other countries perceive unfair competition in global trade and asset bubbles if countries ease monetary policy aggressively in order to lower their currency values.
Yet a leap from currency war to trade war became less likely with the creation of the World Trade Organization in 2001, which created a forum for addressing trade disputes.
In any case, the potential for misaligned currencies to start a trade war seems overstated. Widespread acknowledgment of the Chinese yuan's undervaluation did not lead to trade retaliation during the previous decade. Quotas and tariffs on Chinese goods such as textiles arose instead from unrelated trade violations.
Yet simultaneous policy easing among big economies would actually be a good thing given the current state of the global economy, and mitigating any adverse effects is well within national policymakers' abilities.
Japan ignited the recent bout of currency war angst when Shinzo Abe was elected prime minister after he campaigned heavily on stripping away the Bank of Japan's independence and pressuring it to do more to lift the country out of deflation. Global opposition to Abe's plan culminated in a G-7 statement supporting policies that boosted domestic demand without explicitly targeting exchange rates. This was followed by similar statements at a G-20 meeting.
Yet if any country has a clear case for monetary easing, it is Japan. Economist Milton Friedman once noted that the best measure of monetary policy is not interest rates but their economic effect. Using Friedman's benchmark, even the Bank of Japan's 0.05 percent call rate has not created a particularly accommodative monetary policy.
Japan has been in deflation for more than three years. Excluding food and energy, consumer prices have fallen in annual terms every month since January 2009. Since 2008, the yen has been on an appreciating path; at its strongest point in mid-2012, it was close to 40 percent higher on a trade-weighted basis than it was in 2000. Fourth quarter GDP data show that Japan's recession remains entrenched, as output fell for a third consecutive quarter Abe's election had a clear and positive effect on market expectations. The yen has fallen 14 percent on a trade-weighted basis since the election was called in August.
Markets now expect Japan to escape its deflationary trap. Rather than competitive devaluation, monetary easing should be seen in the context of raising inflation expectations and lowering real borrowing costs.
Further easing
Although further quantitative easing in Japan may be likened to "pushing on a string," research by central banks such as the US Federal Reserve shows there is a measurable positive effect from unconventional easing policies at the zero bound. It should be noted that contrary to popular perception, Japan's economy is domestically driven. Exports make up 15 percent of GDP, only a bit more than the 13.4 percent ratio in the US.
Potential downsides of a currency war include increased protectionism if other countries perceive unfair competition in global trade and asset bubbles if countries ease monetary policy aggressively in order to lower their currency values.
Yet a leap from currency war to trade war became less likely with the creation of the World Trade Organization in 2001, which created a forum for addressing trade disputes.
In any case, the potential for misaligned currencies to start a trade war seems overstated. Widespread acknowledgment of the Chinese yuan's undervaluation did not lead to trade retaliation during the previous decade. Quotas and tariffs on Chinese goods such as textiles arose instead from unrelated trade violations.
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