The currency “war” myth that won’t die
Over on Rate’s Blog I’ve seen an approving link to an article discussing the “currency wars” that are going on around the world.
As Lars Christensen says here, and as we’ve said on many occassions ourselves given that monetary policy is pegged to an implicit inflation target this isn’t “beggar thy neighbour” policy at all – this is just standard monetary easing.
Now in New Zealand the big complaint is about the exchange rate – many people feel that the New Zealand dollar is “too high”. However, there are two issues here:
- Monetary policy – has NZ monetary policy just been too tight?
- Structural policy – are there structural reasons why our exchange rate has been (potentially) persistently over-valued.
We have discussed this before here.
This isn’t a currency war, let me requote something we’ve said before:
Central banks are not breaking the rules, this isn’t a prisoner’s dilemma – competitive devaluations HELP when demand is suppressed … just look at the Great Depression, and the choice of countries to go off the gold standard!
Yes, there likely are structural issues in the New Zealand economy. But policy makers should be focused on those specifically (why is there insufficient residential building activity, why is the real exchange rate so high) – they cannot be solved by monetary policy or the Reserve Bank. Even when we think a policy issue is clear we need to be careful, as Noah Smith points out:
It’s important to belabor this last point. Economists know some things, maybe a lot of things, but this is absolutely dwarfed by the size of the things we don’t know and don’t understand. If this blog has had one “unifying theme,” it would be the depth of our ignorance. So when economists urge caution in using policy to change large sectors of the economy, this doesn’t necessarily mean “We know that the free market is always perfect and good and that policy can’t help.”
Instead, caution about policy is very similar to doctors’ maxim of “first, do no harm.” As a doctor, you wouldn’t say “I can’t figure out how this organ is helping the body function, so let’s just take it out.”
“We know that the free market is always perfect and good and that policy can’t help.”
I would hope that no economist would ever say that. What they should say is that markets are imperfect but better than the alternative.
It is an obvious point for economists – but not non-economists. If there is one thing I’ve learnt overtime it is that the counterfactual economists have in mind, and the counterfactual that non-economists jump on are often very different … and neither side realises that as we argue past each other!
Good post Matt. One reason I am bullish about global growth in 2014 is the “monetary superpower” impact of the Fed has allowed/forced other CBs to be more proactive.
I would like to see more discussion on here of the real imbalances. IIRC blog predicted the real imbalances in NZ would abate in light of the tax reforms around property etc that followed the stellar work of the SWG and TWG. I think the actual rebalancing has been less that might have been hoped, so perhaps the reforms didn’t go far enough.
I am also interested in the question of whether foreign central bank buying could actually be lowering domestic saving by depressing the cost of imports and overseas holidays. I understand that Chinese economists see the undervalued RMB as a plank of the high Chinese household saving rate.
Hi Blair,
We won’t really know what impact the tax reforms had until we have a bit more data – especially since we have a great big earthquake and financial crisis thrown in right in the middle of it! At this point it is probably pretty important for policy makers to ask if they still believe that the long run RER is to high – and if this is the case then why.
In terms of China, we need to ask why the Chinese RER is “low” to understand what is going on – ultimately we can easily make the arguement that their RER is low because Chinese household savings are so high rather than the other way around!
Remember, there is no significant security net over there, choices are severely limited, and they have had to deal with a sharp change in population demographics through the one child policy – as a result, there has been a lot more saving for retirement. In that sort of environment, private savings relative to investment go up, and the RER (and real interest rates) fall.
With people in China relatively more willing to save, and accepting a lower rate of return, then in a small open economy in NZ we do not need to save as much to fund investment – so we borrow at low interest rates to invest. This is all cool … unless there is some sort of misallocation of investment going on. That is why all these concerns fundamentally come back to thinking about structural problems onshore – rather than trying to explicitly lean against whatever is going on overseas.