IMF (2011a) examined international capital flows over the last 30 years and found that net capital flows to emerging markets have been strongly correlated with changes in global financing conditions, rising sharply during periods with relatively low global interest rates. Based on these and similar observations some observers have conclude that the effects on capital flows to other countries should be taken into account in, for instance, Federal Reserve policy decisions. For example, Eichengreen, Rajan, and Prasad (2011) find that the political authorities in large economies “should let considerations of these external effects play an explicit role in the monetary policy framework. Central banks in these countries should pay more attention to their collective policy stance and its global implications.”5 I do not agree with that conclusion. The Federal Reserve’s mandate concerns U.S. inflation and employment, and the Federal Reserve is not responsible for inflation, real developments, and monetary policy in other countries except as they feed back into the United States. That responsibility should rest with the policy authorities in those countries. Countries that choose to stabilise their dollar exchange rate or even peg to the dollar will tend to import U.S. expansionary monetary policy into to their own country. This monetary policy may in many cases be too expansionary for the countries concerned, creating an overheated economy with risks for bubbles and other negative consequences. A flexible exchange rate would give the countries the option of conducting an independent monetary policy appropriate for the country in question.

Specifically, we call for the creation of an International Monetary Policy Committee composed of representatives of major central banks that will report regularly to world leaders on the aggregate consequences of individual central bank policies.”  6  Ferrero, Gertler, and Svensson (2009) provide a suitable model for such thought experiments, a New Keynesian DSGE model of a world with two large countries and tradable and nontradable goods. BIS central bankers’ speeches  7  foreign economy. Everything else equal, this has two consequences for the domestic economy. First, due to increased foreign activity, foreign demand for domestic exports increases somewhat. Second, the interest-rate differential between the domestic and foreign interest rates increases. This will trigger an incipient capital inflow into the domestic economy and appreciation of the domestic currency. Suppose the appreciation is so large as to trigger depreciation expectations that balance the increased interest-rate differential. This will again stabilise the capital flow at zero. Everything else equal, the appreciation of the currency is a real appreciation, which is contractionary for the tradable-goods sector. Assume that this contractionary effect dominates over the initial increase in export demand, so the net effect on the tradable-goods sector is contractionary. Demand for, and the output of, nontradable goods may expand somewhat from the appreciation, but assume that the contraction of the tradable-goods sector dominates so the net effect on domestic output is a contraction. The appreciation also leads to lower inflation, through lower prices on imported goods.