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Sunday, February 23, 2014

Why Rich Countries Should Float Their Currencies

This article provides more depth to some comments I made in"MMT and Constraints". I explain why developed countries should allow their currencies to float, which is the policy stance advocated by Modern Monetary Theory (MMT). It is probably a good idea for developing countries to float their currencies as well, but they face inherently difficult policy problems that I do not know enough about to comment on. The implication of advocating a free-floating currency is that I do not see the "external constraint" as being a serious issue, or at least an issue that policy makers can hope to do anything useful about.

In that previous article, I made some quick comments in response to an assertion by Thomas Palley that the "foreign exchange market constraint" is very important for countries other than the United States. Since he did not explain that assertion, I was unable to offer a very detailed criticism. My response was too short, and drew some comments. I expand my explanation here.

I will first explain why I do not think that there is a significant external behavioural constraint on policy makers; but an accounting constraint obviously exists.

I will also note that what I am writing is my opinion, and does not necessarily reflect the views of the economists who developed MMT. I think that poorer countries face some difficulties with free-floating currencies, a view with which they may not agree.

Fiscal Constraint


It is often declared that governments face a constraint on fiscal policy if foreigners buy their bonds. As long as they are issuing bonds issued in a domestic currency, I will just assert here that foreign ownership is a red herring - foreign bond holders have no special status, and so if there is a behavioural constraint on government fiscal policy, that constraint would appear even if 100% of the government debt is owned by domestic investors. That is a big topic, and I would refer to my previous post, "What Is  A Government Bond?" to see my thoughts on the subject.

But as a quick explanation of my distinction between accounting and behavioural constraints, imagine a country where the fiscal authority (Treasury) does not issue bonds, rather it "finances" expenditures by overdrafts at the Central Bank. The Central Bank then issues bonds to drain "excess reserves" in order for the yield curve to remain at a target level. (If the central bank did not pay interest on excess reserves, the interbank rate would be driven to zero if significant excess reserves exist. This would mean that the Central Bank would lose control over the overnight interest rate.) It is clear that there is no possibility of the government defaulting with this institutional arrangement. The government can spend as much as it wants without worrying about "financing" - but it does face the real constraint that very loose fiscal policy is inflationary. Therefore, there is no "financial" constraint on government behaviour, just a real constraint (inflation).

However, government finance obeys the accounting identities that are painstakingly detailed in the article by Palley; changes in the monetary base are related to net bond issuance and the fiscal deficit. The MMT argument is that the term "constraint" is being deliberately misused by economists, blurring the distinction between the technical meaning of the word in mathematics with the common language meaning where it is a limitation on behaviour.

However, I will note that the institutional arrangement I describe above does not hold for real-world economies; there are legal constraints on government finance which make default possible (e.g., the debt limit in the United States). The question is how much those legal constraints matter; I will have to cover that topic at a later point as a result of its complexity.

Financing The Current Account


I argue that the situation for the "external constraint" is similar to my previous example. There is an accounting relationship that says that foreign entities* have to place financial inflows into a country to match the outflows corresponding to its current account deficit (ignoring small external flows like foreign aid transfers). This seems to imply that foreigners have veto power over a country's policies, and I have seen arguments that domestics are forced to borrow in foreign currencies as a result of the accounting.

However, the volume of foreign exchange transactions have been found to be an order of magnitude larger than what is needed to support trade flows. This hyperactivity is partially the result of foreign exchange trading, but it also reflects very large gross cross-border capital market flows. These flows determine the relative value of currencies. The ultimate counterparty to an importer is most likely a foreign investor who wishes to run foreign exchange risk; there is no necessity for domestics to have to borrow in foreign currencies to finance imports.

It is very possible that a fall in the currency will make a current account worse (as imports become more expensive, and quantities do not immediately adjust), a point that was made in the comments to my previous article. But since the valuation of currencies are driven by capital flows, not trade flows, this cannot go on forever. The domestic wage bill of exporters is being deflated versus international peers, and they become more competitive. (Imported input prices rise in local currency terms, but they pay the same world prices faced by competitors.) Since the exporters are more competitive, expected future profits rise, making domestic equities relatively more attractive. This effect will eventually limit the weakness of the currency. And the empirical reality is that the developed market currencies move around a lot, there appears to be a limit how far they can deviate from a purchasing-power parity fair value estimate.

(Update: Another, probably more important factor is the fact that the investors in developed countries have considerable foreign currency assets as a result of diversification. Since the investors have local currency liabilities (actuarial as well as financial), a rapid fall in the currency is an opportunity to repatriate those foreign assets. This asset repatriation will also limit the downside to the currency. I did not use the term "rich" in the the title by accident; having large financial asset balance sheets aids these countries weather out volatility.)

Although currency volatility is disruptive, companies can use currency hedges to limit the impact of short-term volatility. In a country like Canada, where currency volatility is expected, business managers have learned the hard way that external currency economic exposures need to be controlled. (For example, the next year's expected foreign currency revenue may be hedged, giving time to react to forex moves.) Conversely, what we we saw in Asia in 1997 was that businesses had come to rely on central banks stabilising the currency, and they engaged in speculative cross-currency exposures (such as borrowing in U.S. dollars because "interest rates were lower"). To paraphrase Minsky, instability is stabilising.

In any event, I argue that a bid for a developed market currency always exists at some price, because of the potential demand for local currency financial assets. It would require the currency to essentially cease to exist in order for there to be no demand for the currency. This could result from the government repudiating its debt, or regime change (war, revolution). Additionally, it could result from a mass default by the domestic banking system. The latter possibility is very real, and it explains why that it is necessary for regulators to prevent domestic banks from building up foreign currency exposures (as seen in Iceland). This implies that there is a constraint on regulation - banks must be regulated in a fashion that is coherent with a free float in the currency. Many countries have failed to regulate their banks properly (e.g., foreign currency mortgages are commonplace in many countries), but their incompetence does not mean that it is impossible to run a banking system properly.

Under the assumption that there is always a bid for the currency, it will always be possible to finance a current account deficit. The only question is the price at which the financing occurs.

(Since "emerging markets" lack the deep financial markets to absorb these capital flows, they face an inherently difficult problem. I do not have any advice for countries in that position, other than they appear to face a choice: either attempt to develop behind capital controls and manage their currency, or let the currency float and be extremely vigilant about currency mismatches.)

What About Inflation?


One expected response is: OK, there will always be a price for the currency, but currency weakness could be highly inflationary. This high inflation will be unacceptable to authorities, and they will be forced to react in response.

I would agree, but only to a very limited extent. A weaker currency is presumably stimulative for an economy, and the mainstream response is that interest rates would have to be adjusted in response. That said, the effect is fairly weak, and it is only one effect amongst many that central banks react to. The sensitivity of the price level to the currency is low; a drop of 20% in the currency may only raise the price level by about 1%. (The U.K. appears to be more sensitive than other countries, but the recent experience was clouded by the decision to raise consumption taxes, which had a large mechanical upward effect on the price level. Nick Edmonds raised the example of the U.K. in the comments to my previous article; but given the issue of the VAT hike, I skipped over that case in the original text.) Given that the effect is so weak, it is very difficult to get a good sensitivity estimate, since there are other variables changing at the same time.

The Bank of Canada used to use the "Monetary Conditions Index", a rule of thumb in which a 10% depreciation the currency was equivalent to cutting rates by 1%. However, they abandoned that concept by the late 1990's once it was clear it did not offer any useful information.
Chart: U.S. Headline And Core Inflation


The sensitivity of the price level to the level of the currency appears to be smaller than the sensitivity to energy prices. As the chart above shows; there are relatively large deviations from CPI headline from the ex-food and energy ("core") measure.**  And the reaction of sensible central banks to rising energy prices is to do nothing. (The ECB would disagree, as they hiked rates in 2008. I am in the camp that was a policy error.) An energy price spike represents a one-time upward shock to the price level;  under current circumstances where indexation in the economy is limited, this does not lead to persistent inflation. (In the 1970's, wages tended to be indexed to CPI, and so anything that raised the price level tended to lead to "second round" effects. Luckily for policymakers, that tendency  has generally faded, although the U.K. appears to retain relatively more inflation persistence.)

I argue the situation for currency moves is similar to the case for energy. It takes a very large move to generate a measurable impact on CPI inflation. But once that move is finished, the expectation should not be that it will repeat, rather the currency will reverse or at least stabilise (on asset relative valuation grounds). It makes little sense for the central bank to react to such a one-off move.

The situation would be different if the currency was steadily losing value due to higher domestic inflation than developed market trading partners. In this case, the reasonable expectation would be that the fall in the currency will continue. This is not the case for any developed market for the past 20 years; inflation rates are all near 2% (except for Japan, which has achieved price level stability). However, the currency is not the problem, the problem is inflationary domestic policy settings; the currency is just one channel for inflationary pressures.

As a result, I do not see imported inflation posing a particular problem for policy making. Even if the central bank reacts to every wiggle in inflation, fiscal policy can safely ignore the currency.

This may be less true from some countries, such as Iceland, that have considerable dependence upon consumer imports. In such a case, the external constraint is a real economic constraint that has to be taken seriously. But even then, the question arises - what can policymakers do about it?

"There Is No Alternative"


My final point is that there is almost no sensible policy space involving currencies. We did not arrive at a free-floating currency system as the result of a fad in economic thought; we are here as the result of the collapse of the Bretton Woods system. Yes, the Europeans are attempting to keep yet another failed currency peg system together, because that is what European policy elites do. Most other countries realise that attempting to peg the currency is doomed. (Even the continental Europeans allow the euro to float versus the yen, dollar and sterling).

The British government was repeatedly humiliated during the Bretton Woods era in its attempts to keep the pound at overvalued levels. And this was a period when the capital account was closed, government intervention in the economy was at its peak, and the culture of amoral bypassing of regulations with derivatives did not yet exist. They were defeated by "leads and lags" - international traders lengthening and shortening the terms of accounts receivable and payable. This mechanism to defeat currency pegs will always exist, and it would be supplemented by capital market players using derivatives. As soon as the ink dries on a law limiting currency trading, investment banks would hire away the technocrats who helped draft the law. Unless the financial sector in all of the concerned countries are completely crushed under the heel of government interference, attempting to peg currencies would be doomed.

(As the Japanese and the Swiss have shown, it is possible to limit the upside in a currency, as a government has an unlimited ability to issue money to buy foreign currency. That only provides control in one direction, and it also presumes that the other country whose currency is being purchased does not object. As a result, this type of intervention will only happen in rather special situations.)

Policymakers could attempt to "coordinate" policy to guide currencies, "guiding" markets without attempting to peg their levels.*** This currency guidance was attempted during the 1980s and 1990s, but the studies that I have seen showed that these policies were not particularly effective. (The last coordinated currency intervention was the effort to raise the value of the euro shortly after it was introduced.****) All that policymakers can do is help nudge the currency back towards "fair value" once it was clear that the trend of moving away from fair value has broken. And the question remains: who is going to agree on the direction of intervention? The Europeans appear to be the only masochists who value a strong currency; not many other policymakers would be willing to intervene to strengthen their currencies in the current environment of low inflation and chronic overcapacity.

And attempts at "guiding" the currency is a dangerous policy. As we saw in Asia during the 1997 crisis, business leaders are willing to run massive currency bets if they think "the central bank has their back". Currency volatility should be welcomed, as it helps keeps imbalances under control.

In conclusion, for most rich developed economies, I do not see very large costs associated with floating the currency. Currency levels can move a lot, but those end up being self-limiting, one-time shocks. And realistically speaking, there is no chance of implementing policies to control the level of the currency. However, the situation for some smaller countries and for poorer "emerging markets" appears to be more difficult, but once again, they have limited ability to do anything about the currency without closing the capital account.

Footnotes

*Which may include pools of foreign capital that are owned by domestic investors, which is an extremely important point when discussing Japan.
** I am skating over two objections to this example. Firstly, there is the issue that oil prices are a world price and so currency weakness increases oil prices, but what we see in practice is that energy prices are much more volatile than developed market currencies. Secondly, the U.S. has relatively low taxes on gasoline, so the energy component of the CPI is more volatile than other countries.
***Somewhat similar to their stance towards long-dated bond yields; central banks comment on bond yields if they do not like where they are, but they are not currently attempting to set them.
**** The currency swap arrangements the Fed entered into during the financial crisis were not done to address the levels of foreign currencies; rather they were there to deal with the funding mismatches of foreign banks. These banks originally piled into U.S. dollar assets, using funding from the U.S. money markets. As money market players drew away from those banks, the banks were in danger of losing the funding for those assets. The banks were able to get funds from their local central banks, but this funding would be in the local currency, not U.S. dollars. The banks could not use that funding, as they are not allowed to run the currency mismatch. They thus turned to use currency swaps with the Fed, in which the Fed swaps U.S. dollar funding in exchange for the foreign currency.

(c) Brian Romanchuk 2014

16 comments:

  1. "I do not see the "external constraint" as being a serious issue, or at least an issue that policy makers can hope to do anything useful about."

    Sorry man. The adage that balance of payments is self-adjusting is a bias more ancient than the quantity theory of money.

    "This would mean that the Central Bank would lose control over the overnight interest rate.) It is clear that there is no possibility of the government defaulting with this institutional arrangement. The government can spend as much as it wants without worrying about "financing" - but it does face the real constraint that very loose fiscal policy is inflationary. Therefore, there is no "financial" constraint on government behaviour, just a real constraint (inflation)."

    Like Turkey didn't hike interest rates a month back due to troubles in the fx markets?


    "The ultimate counterparty to an importer is most likely a foreign investor who wishes to run foreign exchange risk; there is no necessity for domestics to have to borrow in foreign currencies to finance imports."

    So you mean nations whose governments have debt in foreign currency are being silly?

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    1. "Sorry man. The adage that balance of payments is self-adjusting is a bias more ancient than the quantity theory of money."

      My point is that the price of a "developed" currency stays within a very wide range around some notion of fair value. The mean reversion is driven by portfolio effects, not trade. There is no reason to expect that the current account deficit will close. Rather, the point is that it will always be "finance-able", as there is a price for the local currency.

      "Like Turkey didn't hike interest rates a month back due to troubles in the fx markets?"

      I'm sorry to say this, but Turkey does not qualify as being "rich" on my definition, as far as I can tell. In every bond index system that I am aware of, Turkey would be qualified as an "Emerging Market". I did not cover Emerging Markets, and so I do not have any feel for the data or the issues.

      Does Turkey have very large (when scaled versus GDP) institutional money running assets against actuarial liabilities? If not, they lack an extremely important potential demand for the domestic currency.

      Additionally, the inflation rate in Turkey is relatively high. They are presumably concerned about passthrough inflation. This is not a burning issue for the small set of countries that I consider to be "rich".

      "So you mean nations whose governments have debt in foreign currency are being silly?"

      Silly or suicidal, or both.

      None of the "rich" nations I refer to borrow in foreign currency (to any major extent; yes there are a few Canadian and UK foreign issues floating around). Therefore, for these countries, foreign currency borrowing is obviously not "necessary".

      Emerging market countries do it a lot, and argue that they "have" to do it. Similarly, the continental Europeans argue that they "have" to always peg their currencies against something. I have little sympathy for the European position; my view is that their elites are unwilling to learn from past history. For the Emerging Markets, I do not know whether their desire to borrow in foreign currency represents similar institutional inertia, or an actual constraint on behaviour.

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    2. "I'm sorry to say this, but Turkey does not qualify as being "rich" on my definition, as far as I can tell."

      You are right but in a very roundabout way. The above statement I quote is an admission to the fact that poor nations cannot put up fiscal policy to fight the balance of payments constraint but this is contradictory to the MMT you defend.

      Success in international trade is one big factor in determining the success of nations. But it costs failure for others. But if you read across MMTosphere, international competitiveness is hardly anything worth mentioning there.

      "If not, they lack an extremely important potential demand for the domestic currency."

      Well, yeah which means that Turkey is limited by its ability to finance current account deficits and do painful adjustments to domestic demand to keep its balance of payments under check.

      The thing reading your posts is the quite contradictory arguments you present. On the one hand, you seem to suggest a market mechanism to correct balance of payments adjustments and on the other hand, you argue that fx turnover is huge compared to trade in goods and services. But here lies your contradiction. Since the latter is true, there is no way of adjustment via prices (exchange rate) and it is income which adjusts.

      "Silly or suicidal, or both.

      None of the "rich" nations I refer to borrow in foreign currency"

      Usually in the MMT blogs, this is presented as if this is under the direct control of the central government and so do you. But the story is different. The current account is determined by non-price competitiveness and income and which in turn determines the net indebtedness to foreigners via cumulative current account deficits. To maintain stabillity of the exchange rate - via international portfolio preferences, the State goes into debt in foreign currency for the part which international investors do not wish to hold in domestic currency. This happens for poorer nations.

      You are right in dividing rich and the poor but don't seem to realize that it is success in trade which makes this divide. So this thing is more important than the monetary system.

      To summarize you are admitting to a constraint on fiscal policy for poor nations but then don't realize that the rich ones have become rich because of international trade. But this is a dynamic process and it is for the rich nations to continue to be successful in the current rules of the game, which means such things are highly important.

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    3. I cannot answer for the rest of the MMT blogosphere; some of my thinking might be considered "out of paradigm" (e.g., should bonds be abolished?).

      I am only really familiar with the "developed countries" (as was defined by bond indices). Although I enjoy arguing about topics I know little about in real life (bluffing can get you a long way), doing so on the internet is a recipe for looking silly. I understand your complaint about "emerging" countries and MMT; I simply do not know how people like Wray, Mosler and Mitchell would respond.

      As for becoming rich, Canada did so over the past 100-150 years or so on the back of highly restrictive trade and capital controls. Canada was part of the Commonwealth Free Trade area (whatever they called it), but had strong restrictions on trade with the U.S. When you consider that Canadian cities are strung out on a line very close to the American border, this implied very strong intervention into commerce. After WWII, those trade barriers were progressively dismantled, as Canada grew relatively richer. The Australian/Kiwi experience was somewhat similar, as far as I can tell.

      With that background, I am not going to say that Free Trade and neglect of the external sector is the way to develop your economy. It seems to me that you need internationally competitive industries - which are components of your stock index - in order to be able to float and be able to ignore the external sector completely. You are focussing on the real trade industry side, I follow Minsky's "Wall Street View of the economy", and I am looking at the financial balance sheets. It seems to me that the views do not really contradict each other, at least when applied to the "rich" countries.

      On the other hand, China has turned into an important trading nation without issuing "hard currency" debt. I am unsure about the "necessity" for issuing foreign-denominated debt - does it have to be done, or is it a quick fix for local elites who want to import Scotch, Swiss watches and German luxury autos? I will admit that I am a fairly cynical person, and I have a tendency to doubt the stories spun by officials.

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  2. Brian: very nice piece; I think your instincts are right. Pay no attention to what the Troll claims MMT says. He's been trolling for years now, always on the same topic, always making false claims, always trying to confuse the conversation rather than add to it. In any case, I just posted a response on the topic, based on your piece and the one by Neil Wilson, over at GLF.

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    1. Oh puhleez. Nice shift in position. Always knew you will and make it look as if you didn't hold extreme views. Will continue to remind you of your paper on Mexico - which during the crisis went for IMF - in total contrast to the Panglossian view you presented in your paper.

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    2. Ah Troll Ramanan: well we know you cannot read for comprehension; nor, apparently, write a coherent sentence. Or spell.

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  3. " inflation rates are all near 2% (except for Japan, which has achieved price level stability). However, the currency is not the problem, the problem is inflationary domestic policy settings;"

    What domestic policy settings?

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  4. The domestic policy settings would be fiscal policy (taxes too low relative to spending) and/or monetary policy. I would also include an extensive use of indexation in the economy, which will tend to make inflation persistent.

    My comment about the developed countries was an aside that inflation was currently not an issue for those countries. I realise now that sentence should have been moved to the end of the paragraph, or stuck in parentheses, as that made the paragraph confusing.

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  5. Great Post Brian

    I'd like to add a thought that has not been mentioned thus far in the discussion. Everyone has referenced the term "rich nations" in some guise but nobody has brought up the wage level as a natural corollary.

    For example:
    In a perfectly free trade environment, the cost of any good should roughly be:
    labor costs + plant, equipment, financial services costs etc. aka capital costs + transport costs

    What does it matter if labor and transport cost ratios are inverted?

    If the Chinese can afford to ship socks half way across the globe to my local walmart (and still be priced competitively with socks made 90 miles away in Milwaukee) because of their relatively cheap labor costs, why should that matter more than the size of the deficit?

    In other words, why is it better to suppress our wages in order to placate the trade balance gods, than to just run bigger deficits?

    Unless we are willing to impose tariffs to artificially inflate import prices, as long as we have higher wages, as far as I can tell, we will be a net importer.

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    1. You can have higher wages and still be a net exporter, as long as you are more productive in what you are exporting. Canada currently has an advantage on that front - with oil prices high, people working in the oil patch are highly productive (in dollar terms). But places like Germany and Japan have been able to be export powerhouses despite high wages.

      But largely speaking, I am in agreement with the MMT principle that imports are a benefit, and exports are a cost, and so as long as other countries want to net export to you, you might as well take advantage of that. There is the problem of job losses (in industries that are losing ground to exports), as well as some strategic questions (was it a good idea to stop producing rare earth metals?).

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    2. There certainly are other considerations. Countries rich in natural resources can be net exporters and have higher wages. The US in the 1950's, with the only intact industrial base in the first world had higher wages and was a net exporter.

      All things equal, yes, a country with wages low enough to offset higher transportation costs will have a price advantage for their production, but won't necessarily be able to export enough to purchase all the imports it wants, and may still end up with a trade deficit.

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  6. Brian:

    Of course there are exceptions to every rule. My example of socks would be different than natural gas or computer code. I was speaking more as a general rule of thumb than some hard and fast natural law.

    After all, what do the neo-liberals mean when they say that Greece or the US needs to be more "competitive" in order to export more in the aggregate? They are mostly talking about wages (yes, I know regulatory and taxes are a part of "competitiveness").

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    1. It is a good bet that neo-liberals are talking about wages being too high when discussing competitiveness. The concept that demanded profit margins are too high would not register.

      Increasing capital investment should help, but the reality is that it does not make business sense to ramp up investment in an industry that is facing overcapacity, which is a chronic condition of most sectors in manufacturing.

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  7. Firstly, good article and I should say that in general, I would agree with you. I'd certainly agree that developed countries should have floating exchange rates. Furthermore, in most cases, I think the right response to reduced activity involves more expansionary fiscal policy and allowing the currency to depreciate if necessary.

    A few points.

    Aside from any impact on expectations, higher interest rates can really only have a downward impact on prices in one of two ways. One is through the direct effect on prices as a result of any exchange rate impact; the other is by affecting aggregate demand. There are lots of potential channels for the second, but they all come down to demand. So, if the central bank is using interest rates to counter potential inflation effects of a depreciation, it needs to more than offset the effect of any fiscal expansion. In practice, however, I don't think this matters because the main impact of raising rates is to prevent the depreciation, rather than negate the effects of it.

    An exchange rate depreciation shifts the share of income between wages, profits and the external sector with wage earners being the loser. Although there may be limited short term effect, the medium term effect depends on the power of labour to maintain its share. This may well differ between countries, but in the UK it seems to take severe levels of underemployment, such as we have recently, to make the wage reduction stick.

    In general, I think it is possible for countries to use fiscal expansion to raise output, whilst using high interest rates to maintain the value of the currency. It is worth noting though that there are theoretical limits to this. The higher the ratio of external debt to GDP, the higher the return foreign investors require. Once the interest rate exceeds the growth rate, and if trade deficits persist, then the debt ratio can become unstable. I should say that I think, in practice, most countries are operating within the zone where this is not an issue. However, for countries like the UK that may be partly because it's easy for people to believe that the government would impose more austerity rather than see the debt ratio explode.

    I don't wish to give the impression that I think external issues completely bind policy. In fact, I think there is quite a lot of room for manoeuvre and, as I would certainly say that any policy measures the UK should be taking at the moment would have fiscal expansion at their core. However, I would not go so far as to say that "fiscal policy can safely ignore the currency". Even if it's not pressing, I think a comprehensive policy proposal needs to include potential measures to deal with exchange rate. It may be that there are lot of options, like capital controls or import controls, but these are not the sort of measures that can be applied as an afterthought.

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    1. It may be that I would be forced to change my view if countries actually made some very large expansions to fiscal policy. Since nobody is contemplating such large expansions (most of the discretionary stimulus efforts during the crisis were small relative to the hole blown in aggregate demand; the big deficits that people were mad about was the result of the automatic stabilisers), I have been able to get away with my "bah fiscal!" stance without sweating it.

      And given the lack of radical moves on fiscal policy, I do not worry about fiscal ratios - if people wanted to hold debt at a debt/GDP ratio of X, it seems reasonable to expect that they would be willing to hold it at (X+delta), where delta is not "too large". However, a discretionary stimulus of 10% of GDP (for example), would raise some eyebrows.

      And as I have sort-of implied, the external sector is one channel in which policy changes show up. My "bah, external sector" view is implicitly embedding that channel inside the overall reaction of the economy to changes in the policy stance. I would still argue, however, that domestic channels are likely to be dominant versus the external channel. As a result, I am not sure how domestic policy makers can take "external considerations" into account. At least with (domestic) inflation, you have a handle on what the constraint on policy is. For example, trying to target the exchange rate with fiscal policy would be suicidal, given the importance of (equity) capital flows in the determination of exchange rates.

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