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Policy Imbalances and the Uneven Recovery John B. Taylor Conference on The Uneven Recovery: Emerging Markets versus Developed Economies Oct 14, 2011
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 ExportsY=C+I+G+XY-C-G= I+XS=I+XS-I=XLook at recent history
17
18
19
20
21
22
23
60
62
64
66
68
70
72
1975 1980 1985 1990 1995 2000 2005 2010
Percent Percent
Consumption asa share of GDP(right axis)
Government purchasesas a share of GDP(left axis)
United States C/Y and G/Y
6
8
10
12
14
16
18
20
1975 1980 1985 1990 1995 2000 2005 2010
Percent
US Investment rate
US saving rate[100(1 - C/Y- G/Y)]
-8
-6
-4
-2
0
2
4
8
12
16
20
1975 1980 1985 1990 1995 2000 2005 2010
U.S. net exports as ashare of GDP(Left axis)
U.S. 30-year mortgage rate(right scale)
PercentPercent
Source: Borio and Disyatat (2011)
Capital Flows and the Current Account Consider 2004 (Billions of dollars)Exports of goods and services and income receipts 1531Imports of goods and services and income payments -2118Unilateral current transfers -81Current Account Deficit -668
U.S. Owned Assets Abroad -856Foreign Owned Assets in the United States 1440Statistical discrepancy & other reconciliations 84
http://www.bea.gov/bea/newsrelarchive/2005/trans305.pdf
Source:
Note that these are capital flows
Not capital stocksU.S.GDP was $11734 billion in 2004, soCA was 5.7 percent as a share of GDP
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, thenwhat 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 theincrease in the policy rate in 2/2008 (red line)
0
3
6
9
Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-110
3
6
9
Source: Norges Bank
90% 70% 50% 30%
Factors behind changes in the interest rate path from 1/2008 to 2/2008
-2
-1.5
-1
-0.5
0
0.5
1
1.5
2
08 Q3 09 Q1 09 Q3 10 Q1 10 Q3 11 Q1 11 Q3-2
-1.5
-1
-0.5
0
0.5
1
1.5
2
Higher demand in NorwayHigher inflation in NorwayHigher interest rates abroad and developments in the foreign exchange marketLower growth abroadHigher risk premium in the money market
From 1-10
From Øistein Røisland “Monetary Policy in Norway”
From MPR 1/10
From OECD Survey Norway, 2010
Example from Sebastian Edwards (2005) “The Relationship Between Exchange Rates and Inflation Targeting Revisited”
Empirical evidence that target interest rate in EM central banks responds to exchange rates
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:
Solving for the interest rates results in the following
iyi
iyi****
*
5.5.1
5.5.1
)(5.)(5.111
)(5.)(5.111
***
*
***
yyi
yyi
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
