Rules, Reputation and Macroeconomic Policy Coordination
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It addresses the advantages and disadvantages of simple policy rules, how to formulate policy in the face of uncertainty, the possible benefits from international policy coordination and the role that credibility plays in determining the effectiveness of government intervention. These issues are brought together to produce a unique, unified approach to the subject. The book will be of interest to students and teachers of macroeconomics, and professional economists concerned with the design of policy using macroeconomic models.
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Language: English. Brand new Book. In this book David Currie and Paul Levine address a broad range of issues concerning the design and conduct of macroeconomic policy in open economies. Adopting neo-Keynesian models for which monetary and fiscal policy have short-term real effects, they analyse active stabilisation policies in both a single- and multi-country context.
Questions addressed include: the merits of simple policy rules, policy design in the face of uncertainty and international policy coordination. A central feature of the book is the treatment of credibility and the effect of a policy-maker's reputation for sticking to announced policies.
Modern Theoretical Developments
These considerations are integrated with coordination issues to produce a unique synthesis. The volume develops optimal control methods and dynamic game theory to handle relationships between governments and a conscious rational private sector and produces a unified, coherent approach to the subject. This book will be of interest to students and teachers of open economy macroeconomics and to professional economists interested in using macroeconomic models to design policy.
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Front Matter : Macroeconomic Policies in an Interdependent World:
Established seller since Seller Inventory LQ So, in this case, the effect of an increase in the interest rate differential on exchange rate appreciation occurs with some time lag due to the attractiveness of large shortterm capital inflows. This tendency will only be interrupted by sudden stops. In other words, this suggests that, in practise, not only the exchange rates in open emerging economies are far from being characterised by low volatility, but also the flexibility of their exchange markets does not provide them soft adjustments of the BoP.
This situation means that, in practise, the supposed independence between both the exchange rate behaviour and monetary policies, as suggested by the Mundell-Fleming model, is a mere fiction. Actually, in these cases, central bankers have to deal with the dilemmas imposed by such a straitjacket. If they choose to keep the exchange rates freely floating, the domestic currency will tendencially appreciate and accumulate a large level of overvaluation.
In order to avoid this latter trend, monetary authorities are compelled to purchase large amounts of international reserves. The issue is that, when there is a lack of adequate sterilization of the monetary impacts of the previous policy, the overaccumulation of international reserves provided by large external savings might generates bubbles in asset prices and credit.
Consequently, policy-makers face a trade-off between purchasing international reserves to avoid a large real overvaluation of domestic currency and, since they have to sterilize the monetary impacts of that policy, absorbing this extra burden on gross public debt. This means that, in practise, monetary policy goes beyond the announced goal of keeping the inflation controlled, especially in countries like Brazil, which manage the monetary policy in an inflation targeting framework.
This Section must now give an answer for part of its title: are policy-makers really unable to overcome economic policy constraints imposed by the "trilemma? Based on the arrangements of macroeconomic policies in most Asian countries, we could anticipate a "no. So, at least in in middle-term, policy-makers are able to overcome the constraints imposed by the impossible trinity", in other words, rather than a dirty floating exchange rate regime like most Lain American countries including Brazil , the Asian countries have, in practical terms, an administered floating exchange rate regime.
India, for stance, has a large and growing exchange market that operates under a floating exchange regime. The strategy followed by Brazil from to and some Latin-American countries could be named "the peripherical growth model" for, by combining a high short-term interest rates differential and a real exchange rate overvaluation trend, they have submitted their economies to low rates of labour productivity growth, stop and go growth behaviour and a trajectory of fallingbehind in the long-term 6. Economic development is a complex phenomenon which depends on economic factors, especially the augmenting of the capital stock and technological progress, but that is also influenced by other non-economic causes, such as historical, geographical, sociological, political and even cultural ones.
Rodrik and Berg and Miao went further and showed empirical evidence that not only does overvaluation damage growth, but also that undervaluation benefits growth.
Also, Williamson suggests that "the very best policy in terms of maximizing growth appears to be a small undervaluation" p. Coherently with the above mentioned empirical literature on the relationship between the real exchange rate and economic development Rodrik, ; Williamson, ; Berg and Miao, , this "optimal" rate must incorporate a small undervaluation 7. In our paper, we developed a theoretical and empirical model that allowed us not only to show the main determinants of the long-term trend of real exchange rate in Brazil and its persistent trend of overvaluation in the period February February , but also to estimate the long-term "optimal" real exchange rate that should have been set in motion in April for putting the Brazilian economy in a sustainable growth trajectory.
Among all explanatory variables incorporated into our econometric model, the GDP per-capita , the terms of trade and the short-term interest rates differential not only were significant, but also showed the largest coefficients, respectively, for explaining the long-term trend of RER in Brazil during the estimated period. This agenda should include a targeting for reaching the long-term "optimal" real exchange rate. The issue is whether or not it is possible to find an organised exit for such adjustments when the level of overvaluation has reached a significant magnitude as has happened in the case of Brazil.
Nowadays, there is some consensus that the main causes of the Asian crisis in were linked to the rapid process of external financial openness, which was responsible for large net capital inflows, high level of domestic currency overvaluation and bubbles in the asset prices see Krugman, ; and Stiglitz, As Aizenman et al. The main purpose of these administrated floating exchange rate regimes is to prevent Asian domestic currencies from the overvaluation trend.
In addition, in practise, by coordinating monetary and exchange rate policies, Asian policy-makers implicitly target a small level of real undervaluation of their currencies, aiming at preserving the level of competitiveness of their economies and avoiding balance of payments crises.
In short, Aizenman et al. By comparing with Brazil, we could not draw the same previous conclusion. After the introduction of the floating exchange rate regime in , Brazil suffered from the violent aftermaths that followed the three episodes of strong depreciation of its currency in , and and, even so, policy-makers did not take care to avoid new tendencies of real exchange rate overvaluation.
The main reason is linked to the lack of coordination between both lato sensu long-term economic policies and strictu sensu monetary, fiscal and exchange rate policies. This means that, taking into account that as the ad hoc correct measures of capital control were ineffective to deter the trend of overvaluation, sooner or later this large misalignment of the Brazilian real might be violently adjusted by market forces in the short coming years, independently of whether or not the scenario in the world economy will be charaterised by a new strong downturn As shown by the empirical evidence, since one of the longterm structural explanations for the overvaluation trend of the Brazilian real has been the favourable terms of trade, due the high export concentration in primary products, food and other industrialized commodities, industrial and technological policies of those kind are fundamental to avoid early deindustrialization as well as to induce structural change and economic development.
This is the reason why the maximization of the performance of the industrial and technological policies depends on a fine and continuous coordination with other economic institutions, especially those dealing with the monetary, fiscal and exchange rate policy Another suggestion related to the long-term policies is that Brazil should mirror India's strategy in the past few years of aggressively inducing the internationalisation of their national enterprises see Nassif, In other words, the strategy of boosting the internationalisation of the Brazilian enterprises could both work as industrial and exchange rate policies.
There is no room in this paper to detail the specificities of the management of the policy rates the primary short-term interest rate Selic , but it is enough to remember once again that the Brazilian Monetary Committee of Brazil's Central Bank, differently from most central banks in the world, kept unchanged the Selic at Once Brazilian monetary authorities were worried about the augmenting of inflation expectations in a context of an effective drop in world prices, this decision had to be evaluated as a serious macroeconomic policy mistake.
In addition, as Lopes pointed out, although Brazil' s Central Bank has lately reduced the Selic rate from Federal Reserve Bank went around in the same direction, this decision was very timid and inferior to the reduction of the U. In other words, notwithstanding the context of the global economic crises, the short-term interest rates differential has increased in Brazil. This exaggerated evaluation has been reconsidered by recent empirical evidence. Luporini 2 , for instance, presents sound econometric evidence that "from through the analysis indicates that domestically, the nominal interest rate has been the major source of macroeconomic instability while the exchange rate market has been the main channel through which international shocks have affected the Brazilian economy" It is needed to recognise that, since mid, the new Monetary Committee of Brazil's Central Bank, under governor Alexandre Tombini, has essayed to implicitly change the conduction of monetary policy in Brazil.
At least three new aspects can be noticed: first, a better coordination between monetary authorities and other economic ministries, especially the Ministry of Finance; second, the use of other mechanisms of monetary control e. It is early, however, to predict whether or not the decisions of the Brazilian Monetary Committee in the coming years will be taken more independently of the pressures of financial markets and will follow the Romer observation that "central banks in inflation-targeting countries, like other central banks, do not just try to control inflation; they also try to mitigate output fluctuations, avoid large swings in interest rates and exchange rates, and keep the financial system stable".
At least, the first aspect deserves an additional comment. It is misleading to interpret the coordination between monetary, fiscal and exchange rates policies as a way of reducing the de facto operational independence of Brazil's Central Bank. In practice, central banks coordinate those policies, even when they are de jure independent. For instance, the U. Treasury with the implementation of the so-called quantitative easing QE through which the FED has unconventionally purchased U.
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Treasury Notes of medium and longterm maturity aiming at pushing down the Notes' yields as well as US interest rates across debt markets that are closely tied to U. Treasury rates The Wall Street Journal , In other words, through such coordination, the FED is trying desperately to induce the recover of the U. Another important suggestion for the improvement of the inflation targeting regime in Brazil is that, given the extreme difficulty in conciliating the reduction of the still high nominal interest rates in Brazil to bring the actual inflation to the centre of the targeting in a calendar year, the inflation target could be managed through an augmenting "year" of 18 months see, among others, Oreiro et al.
Far from a misleading interpretation of accepting a little more inflation in benefit of a more real GDP growth, by giving monetary authorities more room to reduce the Selic basic interest rates, this change could help to adjust the misalignment in the real exchange rate in Brazil. Based on the accountable interrelationships between excess of investment over total domestic savings and current account deficits, these latter are explained by the shortage of domestic savings.
In other words, for this group, the trend of real overvaluation of the domestic currency is the consequence, not the cause of growing current account deficits see, for instance, Pastore and Pinotti, ; the second one, assumes that, although there is an unquestionable accountable ex-post relationship between the excess of investment over total domestic savings and current account deficits, these latter are basically explained by the real overvaluation of domestic currency.
For this group, a currency overvalued, not only contributes to low rates of labour productivity, but also tends to augment the domestic wages when expressed in dollar terms. This tends, in turn, to sharply increase the domestic consumption and considering everything equal, to reduce total domestic savings through import booms see, for instance, Bresser-Pereira and Gala, ; and Bresser-Pereira, For being shared with the second position, I support the view that the fiscal responsibility through a tight control of superfluous current government expenditures can be an important allied mechanism for both giving Brazil's Central Bank more room to reduce short-term interest rates and liberalising resources to augment the public investment in Brazil.
In addition, as the shortterm policy rates in Brazil the Selic rate are both used for controlling aggregate demand in the inflation targeting regime and for yielding the short-term Brazilian Treasury Bonds the LFTs , a procyclical fiscal policy can become ineffective in the long-term for Brazil's Central Bank is obliged to increase the Selic rate everytime policy-makers face a internal or external shock The main constraint is linked to both the still high short-term interest rates and the short duration of the total gross public debt.
One could argue that, even so, Brazil has, paradoxically, accumulated a large amount of international reserves. This is the reason why Lopes named this strategy as "a speculative accumulation of international reserves".
follow In this respect, despite recognising the high opportunity costs associated with the accumulation of reserves in Brazil, I support the view that, since this strategy helps to contain the trend of overvaluation, Brazil's Central Bank should continue to pursue it. Even though capital controls are not a panacea, even conservative voices have upheld that some sort of protection against speculative short-term capital inflows should be established by emerging economies to avoid exchange rate overvaluation.
The main issue is that these governmental measures including the mix of the above suggested macroeconomic policies should have been implemented in mid, when the real exchange rate began to show a sustained trend of appreciation and not in ad hoc small doses as has occurred from early on.