Download Simple Rules for Open Economies John B. Taylor Stanford University

Policy Imbalances and the
Uneven Recovery
John B. Taylor
Conference on
The Uneven Recovery:
Emerging Markets versus Developed Economies
Oct 14, 2011
Two Global Imbalances
(1) Current account imbalances
(2) Monetary imbalances
• Both relevant for emerging markets
versus developed economies
• We hear much about the first
• But the second may be more important
Current Account Imbalances
• A frequent topic for international coordination
• A perennial topic for G-20, IMF, OECD (WP3)
• Sometimes used for calls by US and Europe for
exchange rate changes by EME
• Frequently blamed for the financial crisis
– Saving glut flows into US, lowers interest rates
– Alternative to the “too low for two long” view
• Now “rebalancing” is a major focus of the G-7,
G-20, IMF
Link to Saving-Investment Gap
Saving – Investment =Net Exports
Y=C+I+G+X
Y-C-G= I+X
S=I+X
S-I=X
Look at recent history
United States
C/Y and G/Y
Percent
Percent
72
70
68
Consumption as
a share of GDP
(right axis)
66
64
23
62
22
60
21
20
19
Government purchases
as a share of GDP
(left axis)
18
17
1975
1980
1985
1990
1995
2000
2005
2010
Percent
20
US Investment rate
18
16
14
12
US saving rate
[100(1 - C/Y- G/Y)]
10
8
6
1975
1980
1985
1990
1995
2000
2005
2010
Percent
20
Percent
16
U.S. 30-year mortgage rate
(right scale)
12
2
8
0
4
-2
U.S. net exports as a
share of GDP
(Left axis)
-4
-6
-8
1975
1980
1985
1990
1995
2000
2005
2010
Source: Borio and Disyatat (2011)
Capital Flows and the Current Account
Consider 2004 (Billions of dollars)
Exports of goods and services and income receipts
Imports of goods and services and income payments
Unilateral current transfers
Current Account Deficit
U.S. Owned Assets Abroad
Foreign Owned Assets in the United States
Statistical discrepancy & other reconciliations
Note that these are
capital flows
Not capital stocks
1531
-2118
-81
-668
-856
1440
84
U.S.GDP was $11734 billion in 2004, so
CA was 5.7 percent as a share of GDP
Source:
http://www.bea.gov/bea/newsrelarchive/2005/trans305.pdf
The connection between current
account and change in official
reserves can be particularly weak
Current account =
Change in official reserves
+ other gross outflows
- other gross inflows
United States
Mainly Europe rather than emerging markets
If not the current account, then
what is driving these flows?
•Monetary policy
•Exchange rate policy
Clear Evidence from a Very
Transparent Central Bank
•
Norges Bank very explicit and transparent
in accounting for how external variables affect
interest rate path
•
Useful to consider several episodes in past
few years
•Reveals foreign interest rate as the most
significant reason for deviating from basic rule
Policy rate in 1/2008 (with fan chart) and the
increase in the policy rate in 2/2008 (red line)
9
9
90%
70%
50%
30%
6
6
3
3
Source: Norges Bank
0
Mar-06
0
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
Factors behind changes in the interest rate path from
1/2008 to 2/2008
2
2
1.5
1.5
1
1
0.5
0.5
0
-0.5
-1
-1.5
0
Higher demand in Norway
Higher inflation in Norway
Higher interest rates abroad and
developments in the foreign exchange
market
Lower growth abroad
Higher risk premium in the money market
-2
-0.5
-1
-1.5
-2
08 Q3 09 Q1 09 Q3 10 Q1 10 Q3 11 Q1 11 Q3
From 1-10
From Øistein Røisland
“Monetary Policy in Norway”
From MPR 1/10
From OECD Survey Norway, 2010
Empirical evidence that target interest rate in
EM central banks responds to exchange rates
Example from Sebastian Edwards (2005) “The Relationship
Between Exchange Rates and Inflation Targeting Revisited”
Continued from Sebastian Edwards (2005)
Example from ECB during 2000-2006
• Sample 2000.1 - 2006.4.
• Inflation = 4-quarter rate of change in the
harmonized index of consumer prices
• GDP gap = % deviation of real GDP from trend.
• Regress deviation of ECB rate from Taylor rule on
federal funds rate.
• Estimated coefficient = .21
– standard error of .06.
– Plot of the actual and fitted values from this
regression:
Illustrative Chart from the OECD, March 2008
The Case of the Uneven Recovery
• Very low policy rate in US
• Creates pressures on EM central banks to hold
rates lower than they would be for domestic price
and output stability
– Also creates pressures to intervene in currency
markets and impose capital controls
• Leads to higher inflation, and perhaps more crises
• So need to have “monetary rebalancing”
• But little interest from developing countries
General Sources of Instability
Consider two country model with i affecting i*
Interest rates are set according to:
*
i  1.5  .5 y  i
i*  1.5 *  .5 y*   *i
Solving for the interest rates results in the following
i
1
1.5(   )  .5( y  y )
*
*
1   *
1
*
*
*
i 
1.5(   )  .5( y  y )
*
1  


Conclusion
• Need to focus more on “monetary
rebalancing”
– Side by side discussion with “current account
rebalancing”
• May be more important than current account
rebalancing
• But how?
– More global leadership
– Global inflation target