Benoît Coeuré: Policy coordination in a multipolar world
Remarks by Benoît Coeuré, Member of the Executive Board of the ECB, at the 5th annual
Cusco conference organised by the Central Reserve Bank of Peru and the Reinventing
Bretton Woods Committee: "70 years after Bretton Woods: Managing the interconnectedness
of the world economy", Cusco, 22 July 2014
* * *
I would like to thank Michele Ca' Zorzi and G. Georgiadis for contributing to these remarks. I remain solely
responsible for the opinions expressed herein.
Dear Governor Velarde, dear Marc Uzan, ladies and gentlemen,
I would like to thank the organisers for giving me the opportunity to share some thoughts with
you on the changes in the international monetary system (IMS) and the role of monetary
policy coordination.
History casts a long shadow over the IMS. Over the past three decades, however, the global
economy has changed in decisive ways. Three aspects are particularly striking. First,
financial factors have become an increasingly relevant source of cross-country interlinkages,
with some evidence of cross-country de-linkages since the global financial crisis. Second,
emerging economies have raised their clout, as reflected by the impact of their business
cycles on global growth and the growing use of their currencies: the global economy has
become multipolar. And third, monetary policy in advanced economies has - more recently -
entered new territory by resorting to unconventional measures.
I would like to outline these shifts in the global economic landscape, and then elaborate on
the implications for the IMS and monetary policy coordination.
Three structural shifts in the global economy
Globalisation, home bias and regionalisation
Clearly, the defining feature of the last three decades has been the dramatic strengthening of
globalisation in both trade and finance. Cross-border trade in goods and services as well as
investment has soared, driven by trade-liberalising policies, the lifting of capital controls as
well as innovations in transport and information technologies.
The global financial crisis has led to a halt in this trend, perhaps only temporarily. But there is
also the possibility of a step backwards, i.e. a re-emergence of financial home bias and a
stronger drive towards regionalisation. Early evidence of this is the resurgence of the
so-called "Feldstein-Horioka puzzle", that is, a sharp rise in the correlation between savings
and investments.1 European banks have retreated from dollar-denominated lending.2 Banks
from emerging economies also have a stronger regional orientation, in particular in
SouthEast Asia, Central America and the Commonwealth of Independent States.3 Regulators have
been tempted to ring-fence their domestic financial systems. Restrictions on intra-European
cross-border liquidity flows or the US rules for foreign banking organisations may be seen as
examples.
Such a "de-globalisation" scenario, if confirmed, could become self-validating and have
profound effects on the degree of international risk-sharing, spillovers and the global
allocation of savings, and therefore on global long-term growth.
Shifting economic centre of gravity
Since the early 2000s the world has also witnessed impressive growth rates in emerging
economies, which have exceeded those in the advanced world. In particular the BRICS
(Brazil, Russia, India, China and South Africa) have more than doubled their share of global
GDP from less than 10% in 2000 to 21% in 2013; similarly, other low and middle-income
economies have seen their share increase from 7% in 2000 to 12% in 2013. The rise of
emerging economies is also illustrated by the eastward shift of the world's economic centre
of gravity, which is occurring at a faster speed than ever before in human history. And the
shift towards a multipolar world is in turn reflected in changes to global institutions and fora,
as evidenced by the switch in relative importance between the G7 and the G20, and the
ongoing governance reforms at the IMF.
In line with the shift in economic centre of gravity, the currency constellation in the IMS may
also be gradually changing. In particular in light of the remarkable growth of China's
economy and recent policy measures adopted by its authorities, the international use of the
renminbi has gained momentum.4 And China's plans to liberalise its capital account as well
as to increase exchange rate flexibility and develop domestic financial markets will enhance
the role of the renminbi as an international reserve currency. Some analysts believe that,
over time, it can reach international currency status, alongside the US dollar and the euro.5
We would then enter an era of a tri-polar IMS.
Unconventional monetary policy
Before the global financial crisis the widespread adoption of explicit price stability objectives
had been conducive to prolonged low inflation outcomes alongside economic growth. Major
central banks were content to invoke the Tinbergen principle, aiming to achieve their primary
objective of price stability through a single monetary policy instrument: short-term interest
rates. The global financial crisis changed this setting abruptly. Pursuing central bank
mandates in a zero lower-bound environment has meant that monetary policy needed to
broaden the set of policy instruments at its disposal, including forward guidance and asset
purchases by central banks. As a result of the latter, the balance sheets of all major central
banks have increased significantly.
One of the major challenges in the years ahead will be the differentiated normalisation of
unconventional monetary policies in advanced economies. Many have argued that in this
process central banks in advanced economies should be mindful of the spillovers to the rest
of the world.6 There have even been calls for a fundamental strengthening of international
monetary policy coordination. I would like to take this opportunity to elaborate on my views
on this discussion.
The debate on international monetary policy coordination
There are different proposals on how the IMS should change. In particular, there have been
several calls to establish a more formal framework of monetary policy coordination, or some
kind of revised Bretton Woods system. Overall, I will argue that the forces which are at play
today in the IMS, as described above, call for a strengthening of some of its features rather
than an overhaul.
Theory
First, while the literature suggests that international monetary policy coordination may be
instrumental in achieving a globally optimal solution, it generally concludes that the gains
from coordination are small relative to an environment in which national policy-makers
pursue optimal domestic policies.7
Second, it is not clear that the benefits from coordination increase monotonically with
economic and financial integration.8 On the one hand, financial integration intensifies the
impact of foreign shocks on the domestic economy. On the other hand, it also improves
diversification and insurance opportunities, hence mitigating the impact of foreign shocks. It
is difficult to know ex ante which of these effects will dominate both in "normal" and "crisis"
times. My suggestion would be that while the diversification effect dominates in "normal"
times, in "crisis" times the effects from large adverse spillovers prevail. I will come back to
this issue later.
Practical obstacles
There are also several practical challenges that make more explicit and binding forms of
monetary policy coordination difficult. The first stems from political economy. Central banks
operate under different mandates, time horizons, objectives and accountability
arrangements. They are ultimately backed by their domestic fiscal authority and report to
their domestic parliament (the euro area is no exception to this rule, even if sovereignty is
shared locally). As a consequence, they cannot act as lenders of last resort other than in a
discretionary way beyond the boundaries of their political constituencies.
In addition, economic cycles do not always coincide across countries, which creates tensions
between what is needed for domestic purposes and what is optimal from an international
perspective (the demise of the Louvre Accord is a classic example).
Finally, given that uncertainty is pervasive in economic policy-making, developing a common
assessment of global risks and spillovers will always be difficult. This considerably
complicates consensus-building concerning the design and enforcement of policies that
countries should implement.
Take, for example, the pre-crisis debate on the risks stemming from global imbalances. The
current account deficit in the United States was seen by some as problematic, as they
believed it would eventually trigger a balance of payments crisis or a sudden and strong
depreciation of the US dollar with global ramifications. Others instead argued that the current
account deficit was not of concern given the international status of the US dollar; the positive
valuation effects and the positive net foreign income balance were seen as evidence that the
current account deficit in the US was sustainable. As a matter of fact, we did not experience
a US balance of payments crisis, even though we did experience a spectacular global
financial crisis.9 What was the connection between global imbalances and the global financial
crisis? What were the drivers of those global imbalances? The debate has still not been
settled. Similarly, I would claim that the main obstacle today to international monetary policy
coordination is the lack of consensus on (and maybe even of understanding of) the degree of
slack in the labour and product markets of the major economies.
Reaching a consensus on the nature of spillovers is not straightforward either. Most models
of international monetary policy coordination assume that policy-makers are able to identify
the types of shock and how they are transmitted to the domestic and global economy. But
this is often not the case in practice.
For instance, there have been marked differences in the views on the global impact of
Federal Reserve announcements. On the one hand, some have argued that the Fed's
monetary policy is driving a global financial cycle.10 On the other hand, others have argued
that the key driving forces of capital flows are global risk and uncertainty, with a much looser
connection to US monetary policy.11 Another example of diverging views concerns the
question of whether emerging economies have the tools to neutralise the spillovers
originating from other parts of the global economy.
As a result of our poor understanding of the types of shock and their transmission,
establishing which policy responses are the best for each country seems to be rather difficult.
Internalising the effects of one's monetary policy on other jurisdictions would be even more
challenging. Suppose the Fed had a mandate to internalise the global impact of its decisions,
which it does not have, would the financial stability impact of cheap dollar funding in
emerging market economies have called for a later, or for an earlier, normalisation of US
monetary policy? Ultimately, there is necessarily a high degree of subjective judgement
involved. As I already suggested, crisis times such as 2008-2009 are the exception, since
the spillovers are at the same time less ambiguous and more visible.
The scope of coordination
This does not imply that regular dialogues between central banks as well as exchanges of
views during meetings at the IMF, the BIS, the G20 and at regional level, are not useful. In
fact, I believe that it is quite the contrary. Global institutions and fora play an essential role for
three reasons.
First, they achieve a better understanding and a common assessment of the global spillovers
from domestic policy actions and the potential policy trade-offs. The discussion on capital
flow management measures is a good example.12 The IMF should continue to lend its
analytical and impartial voice to this effort.
Second, even if the scope for coordination is limited in good times, they make coordination
possible in bad times. Consider, for example, the establishment of a system of bilateral swap
agreements among major advanced economy central banks, or the recent decision to
establish such an agreement between the ECB and the People's Bank of China.
Third, they prompt work at bodies such as the Basel Committee for Banking Supervision, the
International Organization of Securities Commission or the Committee on Payments and
Settlement Systems, to establish the standards and infrastructures and create a level playing
field, which are necessary for global markets to function in a smooth and safe way. In so
doing, they foster risk-sharing through decentralised markets, avoiding the need to
coordinate in the first place. Against the background of the possible "deglobalisation" forces
that I mentioned earlier, and given the ongoing transition to a more multipolar currency
system, this work may become even more crucial.
To summarise, I am not convinced that the existing approach to monetary policy coordination
should be fundamentally overhauled at the current juncture. Due to knowledge and
legitimacy gaps, we should not believe that there can be a "global planner" which sets the
rules or prescribes the monetary, prudential, fiscal and structural policies that each country
shall pursue. However, countries can and should maintain the foundations for coordination to
make global markets a safer place and allow for joint action in times of crises.
The evolution of the IMS
The IMS during the Bretton Woods era was strictly rules-based with fixed exchange rates
and a gold standard. While appropriate in a world with capital controls and relatively modest
trade flows, it proved to be too inflexible in the presence of large idiosyncratic shocks and
growing internationalisation. The end of the Bretton Woods era gave rise to an IMS that is
mostly based on principles, which are discussed in fora such as the G7, G20 or the OECD
and BIS. In particular, one principle holds that multilateral financial safety nets should be
available to countries facing large financial market disruptions caused by major external
shocks.
Like any insurance-providing scheme, the IMS is incentives-based. The incentives for any
economy to access the IMF's credit lines, bilateral swap agreements or regional balance of
payment support facilities depend on the conditionality embedded in each of these
mechanisms, as well as on the degree of self-insurance acquired by this economy, e.g.
through foreign exchange reserves. The problem here is that conditionality is not always
explicit, nor is it consistent across instruments, providing a fuzzy set of incentives - and
therefore a bias towards self-insurance. This may create arbitrage opportunities across
facilities (in other words, a "race to the bottom" of conditionality, encouraging moral hazard)
and, ultimately, a bias towards self-insurance, a sub-optimal way to deliver global stability.
There is scope for improving the consistency of these facilities both horizontally across
institutions and vertically between the global and regional level.
A different set of incentives stems from the surveillance carried out by the IMF and other
institutions and fora. This has taken place since the demise of the Bretton Woods system at
the bilateral level in the context of the IMF's Article IV consultations and it has expanded
recently at the multilateral level with the IMF's Spillover and External Sector Reports as well
as the G20 Mutual Assessment Process, not to mention regional exercises.
The resulting recommendations are however not binding and therefore constitute only a light
form of multilateralism. Clearly, countries may be reluctant to submit to closer scrutiny,
fearing that the recommended policies may not be in their national interest. Thus, better
awareness and maintaining a spirit of multilateralism will be a crucial element in
strengthening the effectiveness of surveillance and contributing to global stability. This
requires institutions that are both legitimate and effective. In particular, lack of progress in
global governance reform (reflecting the shift towards a multipolar world) would fuel a lack of
trust in the IMS. It would encourage the ring-fencing of national systems and the
re-nationalisation of savings, harming growth and jobs in all economies.
Conclusion
Let me conclude. The belief that the comfortable pre-crisis world could return is long gone.
And I also believe that we should not aspire to turn the clock back. The global economy has
changed fundamentally, and there is clearly a greater understanding of the role of
crossborder linkages. The current IMS leaves countries with more domestic policy options to
counter adverse idiosyncratic shocks than the inflexible system of the Bretton Woods era.
At the same time, in a highly interlinked global economy consensus-building concerning the
transmission of spillovers is crucial for dealing with shocks that affect substantial parts of the
global economy. Moreover, the IMS should also provide incentives to foster appropriate
preventive action that renders economies more resilient to shocks, and provide the
necessary standards and infrastructures to make global markets work better as well as make
coordination possible when warranted. This is already a robust policy agenda.