Ben S Bernanke: Monetary policy and the global economy
Speech by Mr Ben S Bernanke, Chairman of the Board of Governors of the Federal Reserve
System, at the Department of Economics and STICERD (Suntory and Toyota International
Centres for Economics and Related Disciplines) Public Discussion in association with the
Bank of England, London School of Economics, London, 25 March 2013.
* * *
I'm very pleased to participate in this conference honoring my good friend Mervyn King. As
Mervyn noted in a recent speech in New York, we had adjoining offices at MIT as young
academics and never imagined that 30 years later we still would be colleagues - as central
bankers.1 Now, as then, I value his advice and insight.
The topic of this session is lessons learned from the financial crisis. For me, perhaps the
central insight is that the recent crisis, despite its many exotic features, was in fact a classic
financial panic - a systemwide run of "hot money" away from assets whose values suddenly
became uncertain. In that respect, the crisis was akin to many other financial crises faced by
governments and central banks - including that most venerable of central banks, the Bank of
England - over the centuries. The response to the crisis likewise followed the classic
prescriptions of liquidity provision, liability guarantees, asset evaluation and disposition, and
recapitalization where necessary. Although the crisis had classic features, to a significant
extent it took place in a novel institutional context, making diagnosis and response more
challenging: For example, in the United States, collateralized wholesale funding rather than
conventional bank deposits constituted the hot money, and run pressure was experienced
not only by banks but by diverse other institutions, such as structured investment vehicles. In
addition, the scale and complexity of globalized financial institutions and markets made it
difficult to predict how the crisis might spread or to coordinate the response. One of the few
positive aspects of this episode was the extraordinary degree of international cooperation
achieved among policymakers, including the Bank of England and the Federal Reserve, in
responding to the crisis.
Because I have developed these themes in some detail elsewhere, I thought today I would
tackle a different and more recent issue that has arisen in the aftermath of the crisis - the
issue of whether, in the widespread easing of monetary policies, we are seeing a competitive
depreciation of exchange rates.2 Like other aspects of the crisis, the notion of competitive
depreciation has strong classical antecedents, particularly in relation to the global Great
Depression of the 1930s. So let me start by briefly revisiting the older discussion and its
evolution.
As my audience knows, on the eve of the Great Depression the exchange rates of most
industrial countries were determined by the rules of the international gold standard - or, more
technically, by the gold-exchange standard, as foreign exchange (primarily dollars and
pounds sterling) was used along with gold as a form of international reserves. The gold
standard, which had been suspended during World War I, was painstakingly rebuilt in the
1920s. Unfortunately, the reconstructed gold standard had a number of serious problems.
For one, the exchange rates implied by the gold valuations that countries chose for their
currencies following World War I were in some cases far from the levels consistent with
balanced flows in trade and payments. Notably, as John Maynard Keynes pointed out in his
famous pamphlet, The Economic Consequences of Mr. Churchill, the British pound was
overvalued under the new gold standard, which disadvantaged British exports and
contributed to weak economic conditions in the United Kingdom in the late 1920s.3 One of
Mervyn King's predecessors as governor of the Bank of England, Montagu Norman, who
presided over both Britain's return to the gold standard and its subsequent exit, said of the
illfated choice of parity for the pound: "Only God could tell whether it [the value in gold chosen
for the pound sterling] was or was not the correct figure"; another commentator added, "But
of course the Deity may not be an Economist."4
Another problem, which became clear as the global economy weakened and financial
conditions deteriorated, was that fixed exchange rates under the gold standard were
vulnerable to speculative runs. Although runs, or in some cases policy decisions, effectively
took a number of countries off the gold standard in the early 1930s, the financial world was
shaken to its foundation when the United Kingdom, the unofficial center of the global gold
standard, was forced by a speculative attack to leave gold in September 1931. Over the next
five years, essentially all of the world's industrial nations left the gold standard, either de
facto or de jure. Declines in the value of the departing nation's currency, sometimes very
sharp ones, typically followed.
The uncoordinated abandonment of the gold standard in the early 1930s gave rise to the
idea of "beggar-thy-neighbor" policies. According to this analysis, as put forth by important
contemporary economists like Joan Robinson, exchange rate depreciations helped the
economy whose currency had weakened by making the country more competitive
internationally.5 Indeed, the decline in the value of the pound after 1931 was associated with
a relatively early recovery from the Depression by the United Kingdom, in part because of
some rebound in exports. However, according to this view, the gains to the depreciating
country were equaled or exceeded by the losses to its trading partners, which became less
internationally competitive - hence, "beggar thy neighbor." Over time, so-called competitive
depreciations became associated in the minds of historians with the tariff wars that followed
the passage of the Smoot-Hawley tariff in the United States. Both types of policies were
decried - and in some textbooks, still are - as having prolonged the Depression by disrupting
trade patterns while leading to an ultimately fruitless and destructive battle over shrinking
international markets.
Economists still agree that Smoot-Hawley and the ensuing tariff wars were highly
counterproductive and contributed to the depth and length of the global Depression.
However, modern research on the Depression, beginning with the seminal 1985 paper by
Barry Eichengreen and Jeffrey Sachs, has changed our view of the effects of the
abandonment of the gold standard.6 Although it is true that leaving the gold standard and the
resulting currency depreciation conferred a temporary competitive advantage in some cases,
modern research shows that the primary benefit of leaving gold was that it freed countries to
use appropriately expansionary monetary policies. By 1935 or 1936, when essentially all
major countries had left the gold standard and exchange rates were market-determined, the
net trade effects of the changes in currency values were certainly small. Yet the global
economy as a whole was much stronger than it had been in 1931. The reason was that, in
shedding the strait jacket of the gold standard, each country became free to use monetary
policy in a way that was more commensurate with achieving full employment at home.
Moreover, and critically, countries also benefited from stronger growth in trading partners that
purchased their exports. In sharp contrast to the tariff wars, monetary reflation in the 1930s
was a positive-sum exercise, whose benefits came mainly from higher domestic demand in
all countries, not from trade diversion arising from changes in exchange rates.
The lessons for the present are clear. Today most advanced industrial economies remain, to
varying extents, in the grip of slow recoveries from the Great Recession. With inflation
generally contained, central banks in these countries are providing accommodative monetary
policies to support growth. Do these policies constitute competitive devaluations? To the
contrary, because monetary policy is accommodative in the great majority of advanced
industrial economies, one would not expect large and persistent changes in the configuration
of exchange rates among these countries. The benefits of monetary accommodation in the
advanced economies are not created in any significant way by changes in exchange rates;
they come instead from the support for domestic aggregate demand in each country or
region. Moreover, because stronger growth in each economy confers beneficial spillovers to
trading partners, these policies are not "beggar-thy-neighbor" but rather are positive-sum,
"enrich-thy-neighbor" actions.
Again, the distinction between monetary policies aimed at domestic objectives and
tradediverting exchange rate devaluations or other protectionist measures is critical. The former
can be mutually beneficial, the latter are not. Indeed, it was this view that prompted the
Group of Seven central bankers and finance ministers to issue a statement in February
agreeing to refrain from actions focused on achieving competitive advantage by weakening
their currencies and reaffirming that fiscal and monetary policies would remain oriented
toward meeting domestic objectives using domestic instruments.7
Among the advanced economies, the mutual benefits of monetary easing are clear. The case
of emerging market economies is more complicated. To a first approximation, industrial
countries are most concerned that domestic aggregate demand be set at the level that best
fosters price stability and a return to full employment at home. In contrast, many emerging
market economies may be concerned not only with the level of domestic demand (as needed
to achieve objectives for employment and inflation) but with other considerations as well.
First, because in recent decades many of these countries have pursued an export-led
strategy for industrialization, they may be leery of expansionary policies in the advanced
economies that, all else being equal, tend to cause the currencies of emerging market
economies to appreciate, restraining their exports. Second, because many emerging market
economies have financial sectors that are small or less developed by global standards but
open to foreign investors, they may perceive themselves to be vulnerable to asset bubbles
and financial imbalances caused by heavy and volatile capital inflows, including those arising
from low interest rates in the advanced economies.
I agree these challenges are significant. However, a few points should be made. Regarding
the effects of monetary easing on exchange rates and exports, I would note that
tradeweighted real exchange rates of emerging market economies, with some exceptions, have
not changed much from their values shortly before the intensification of the financial crisis in
late 2008. Moreover, even if the expansionary policies of the advanced economies were to
lead to significant currency appreciation in emerging markets, the resulting drag on their
competitiveness would have to be balanced against the positive effects of stronger
advanced-economy demand. Which of these two effects would be greater is an empirical
matter. Simulations of the Federal Reserve Board's econometric models of the global
economy suggest that the effects are roughly offsetting, so that accommodative monetary
policies in the advanced economies do not appear, on net, to have adverse consequences
for output and exports in the emerging market economies.8 A return to solid growth among
the advanced economies is ultimately in the interest of advanced and emerging market
economies alike.
Regarding capital flows: It is true that interest rate differentials associated with differences in
national monetary policies can promote cross-border capital flows as investors seek higher
returns. But my reading of recent research makes me skeptical that these policy differences
are the dominant force behind capital flows to emerging market economies; differences in
growth prospects across countries and swings in investor risk sentiment seem to have
played a larger role.9 Moreover, the fact that some emerging market economies have policies
that depress the values of their currencies may create an expectation of future appreciation
that in and of itself induces speculative inflows.
Of course, heavy capital inflows and their volatility pose challenges to emerging market
policymakers, whatever their source. Policymakers do have some tools to address these
concerns. In recent years, emerging market nations have implemented macroprudential
measures aimed at strengthening their financial systems and reducing overheating in specific
sectors, such as property markets. Policymakers have also experimented with various forms
of capital controls. Such controls raise concerns about effectiveness, cost of implementation,
and possible microeconomic distortions. Nevertheless, the International Monetary Fund has
suggested that, in carefully circumscribed circumstances, capital controls may be a useful
tool.10
In sum, the advanced industrial economies are currently pursuing appropriately expansionary
policies to help support recovery and price stability in their own countries. As the modern
literature on the Great Depression demonstrates, these policies confer net benefits on the
world economy as a whole and should not be confused with zero- or negative-sum policies of
trade diversion. In fact, the simultaneous use by several countries of accommodative policy
can be mutually reinforcing to the benefit of all.
Let me end these remarks as I began, by paying tribute to Mervyn King. He has been a
leader in the central banking community during an extraordinarily difficult period. I wish him
the very best in the next stage of his career.
8
Other work also supports the finding of no adverse spillovers. For example, one that finds strong positive
spillovers is Bennett T. McCallum (2003), "Japanese Monetary Policy, 1991-2001 (PDF)," Federal Reserve
Bank of Richmond, Economic Quarterly, vol. 89 (Winter), pp. 1-31.
9
For example, Fratzscher, Lo Duca, and Straub find that factors other than U.S. monetary policy have been
substantially more important as drivers of capital flows to emerging market economies; see Marcel Fratzscher,
Marco Lo Duca, and Roland Straub (2012), "A Global Monetary Tsunami? On the Spillovers of US
Quantitative Easing (PDF)," Centre for Economic Policy and Research, Discussion Paper Number 9195
(London: CEPR, October). See also Atish R. Ghosh, Jun Kim, Mahvash S. Qureshi, and Juan Zalduendo
(2012), "Surges (PDF)," IMF Working Paper WP/12/22 (Washington: International Monetary Fund, January);
and International Monetary Fund; Strategy, Policy, and Review Department (2011), "Recent Experiences in
Managing Capital Inflow - Cross-Cutting Themes and Possible Policy Framework (PDF)," paper (Washington:
IMF, February).
10
Importantly, such circumstances exclude the use of capital controls to avoid other necessary macroeconomic
policy adjustments, such as greater exchange rate flexibility. See, for example, International Monetary Fund
(2012), "The Liberalization and Management of Capital Flows: An Institutional View," (Washington:
International Monetary Fund).