In his speech at the Lowy Institute last week, Australian Treasurer Joe Hockey made a clear case for international policy coordination: 'in a globalised world every policy action taken in isolation has a spillover'. Specifically, this month's G20 meeting of finance ministers and central bank governors in Sydney will have on its agenda the tapering of quantitative easing (QE) by the US Federal Reserve, which is causing concerns for some emerging market economies.
There is vigorous international debate on this question. When America's QE and low interest rates fostered capital flows to emerging economies (pushing up exchange rates to uncompetitive levels), the Brazilian finance minister complained about 'currency wars'. Now that the 'taper' stage of QE is underway, financial markets have responded by reversing these flows. This has been especially painful for emerging economies with political or macro-economic weaknesses (Argentina, Turkey), but the outflows have administered sharp movements in exchange rates, interest rates and equity prices for a much wider range of emerging economies, even those with competent policy settings.
Raghuram Rajan, governor of the Indian central bank, added to the debate when, in the course of a long interview focused mainly on domestic Indian monetary policy, he called for more international coordination of monetary policies such as QE.
In response, the former US Treasury attack-dog Ted Truman came out of retirement to give his usual over-the-top defence. A couple of prominent academic economists joined him in punching out at Rajan's comments, calling this a 'victimhood narrative'. Case proven: Rajan's central point that international monetary cooperation had broken down was well demonstrated.
It's not easy to steer a balanced path through these now heated arguments and counter-arguments. [fold]
The emerging economies certainly made a huge contribution to global growth during the 2008 crisis by continuing to expand strongly, thanks to vigorous fiscal stimulus. China's huge stimulus in 2009 (amounting to close to 10% of GDP, including the boost to credit) kept its growth in double digits in 2010 when the advanced economies were, collectively, in deep recession (Australia owes China special thanks for this). Of course the emerging economies did this in their own interests rather than just to help the world economy, and it's a stretch to hope for a quid pro quo on monetary policy now. Countries will set their policies according to their own interests.
But it's also disingenuous to argue, as (now former) Fed Chairman Ben Bernanke has done, that QE has been unambiguously beneficial for emerging economies because it helps US growth.
There have been (at least) two potential external effects of QE. If in fact QE delivered a quicker US recovery, this helps the whole world. But the excessive and volatile capital flows have been disruptive for many emerging economies, both when the inflows were occurring and when they reversed. The net balance of these two effects is unknowable.
To tell the emerging economies that they should respond by reforming their own policies seems gratuitous, to say the least. Some have indeed made policy mistakes, but the majority have policy in pretty good shape, which is why they have been able to come through this volatile period without severe problems.
If the issue is policy deficiencies, the argument could well shift to America itself. The debate on just how effective QE was in promoting the still feeble US recovery is unresolved. But there can be no doubt that the US recovery has been held back by Congress' recalcitrance on fiscal policy and bloody-mindedness on debt ceilings.
Will the Treasurer, as chairman of the forthcoming meeting, be umpiring a vigorous punch-up on this topic? Rajan will surely be present, and others who share his view might back him up. US representatives have never been shy to defend their position.
This is, however, a debate without the prospect of a useful outcome. Rajan, former Chicago professor and former IMF Chief Economist, is accustomed to being on the unpopular side of an argument. In 2005 at the central bankers' annual jamboree at Jackson Hole, he highlighted deficiencies in international financial markets which three years later turned out to be prescient. He was shouted down in 2005 and he knows he would be again.
Moreover, despite all the talk of the benefits of international cooperation, monetary policy offers few opportunities for such collaboration. There are spillovers, but these very spillovers are one of the principal channels through which monetary policy works: a country easing monetary policy expects to get the advantage of a more competitive exchange rate, at the expense of its trading partners.
The valid criticism of the US is not that it was prepared to experiment with extreme measures such as QE when the disaster of 2008 occurred, but that it allowed itself to get into this parlous position in the first place.
Photo by Peter Morris/Lowy Institute.