Tuesday, November 10, 2015

Taylor Truman Medal Speech

John Taylor's speech  on receiving the Truman medal for economic policy is noteworthy. John thinks about the institutions that govern monetary and financial policy. We spend too much time on the will-she-raise-rates-or-won't-she sort of decisions that we forget how important this institutional structure is to good, predictable and (as John might put it) rule-based policy.

John reflects on the institutions of postwar policy:
Seventy years ago Harry Truman signed the Bretton Woods Agreements Act of 1945. It officially created two new economic institutions: the International Monetary Fund and the World Bank. A year later he signed the Employment Act of 1946. It created two more new institutions: the President’s Council of Economic Advisers (CEA) and the Congress’s Joint Economic Committee (JEC). And in 1947 came the General Agreement on Tariffs and Trade (GATT) and the Truman Doctrine, and in 1948 the Marshall Plan.

Prewar problems:
... One serious economic evil leading up to World War II arose from competitive devaluations and currency wars...
A second economic evil stemmed from extensive “exchange controls,” in which importers of goods were forced to make payments to a government monopoly in foreign exchange. The government would determine what types of goods could be imported and how much to pay exporters. Exchange controls also involved multiple exchange rates, government licenses to export and import, and even officially conducted barter trade. They deviated from the principles of economic freedom, and caused all sorts of distortions and injustices...
Bretton Woods:
Each country—each party to the agreement—would commit to two basic monetary rules... First, they would swear off competitive devaluations by agreeing that any exchange rate change over 10% from certain values, or pegs, would have to be approved by a newly-created IMF. ... It was called an adjustable peg system.
Second, countries agreed to remove their exchange controls, with a transition period because many had extensive controls in place. The countries, however, did not agree to remove capital controls, which include restrictions on making loans, buying or selling bonds, and equity investments.
John's judgement:
In important respects the blueprint succeeded. Exchange controls were removed, though it took more than a decade, and the currency wars ended, though the adjustable peg system itself fell apart in the 1970s and gave way to a flexible exchange rate system. The 1970s were difficult because monetary policy lost its rules-based footing and both inflation and unemployment rose. 
But in the 1980s and 1990s policy became more focused and rules-based and economic performance improved greatly. Though not part of the blueprint, virtually all the developed countries that signed the original agreement—and others like Germany and Japan—also abandoned capital controls. By the late 1990s, many emerging market countries were adopting rules-based monetary policies, usually in the form of inflation targeting, and entered into a period of stability. Some emerging market countries, such as Brazil, began to remove capital controls, and the IMF recommended adding their removal to the articles of agreement.
I'm a bit skeptical of this judgement. (And I think I've persuaded John, so we'll see what happens in later writings.) Bretton Woods featured pegged exchange rates, something of a gold standard to the dollar, and capital controls to lessen exchange rate pressures. All three blew up by 1970. The basic structure of Bretton Woods failed.

The restoration of order in the 1980s featured important reforms to monetary and fiscal policies internationally, and the Bretton Woods institutions (IMF, CEA, etc.) may have had something to do with it. But Bretton Woods was gone.

Bretton Woods did, however, help to keep the chaos of the 1930s from returning. John's point may be that bad rules are better than no rules.

On to the present:
Unfortunately this benign situation has not held, and today the challenges facing the international monetary system eerily resemble those at the time of the creation...
Consider currency movements. Quantitative easing (QE) started in earnest in 2009 in the United States. It was followed by a period where the dollar was low relative yen. It was followed by QE in Japan in 2013 which depreciated the yen, as was the expressed intent of Japan governor Haruhiko Kuroda. That was followed by QE in the Eurozone in 2014 which depreciated the euro, as was the expressed intent of ECB president Mario Draghi. The dollar- yen-euro story from 2009 to 2014 looks a lot like the pound-dollar-lira story from 1931 to 1936, even though U.S policy makers today consider the exchange rate effect to be by-products of their actions, not the direct intent. So QE begets QE, which begets QE, and so on.
There is a big challenge understanding just how QE affects currencies. Notice John says "followed by." But if you regard QE as signals of future interest rates, it is easier to understand. Exchange rates are a sort of present value of future interest differentials.  Continuing
Interest rate decisions at central banks around the world also resemble currency wars. Whether you ask them or watch them, you can tell that central bankers are following each other. Extra low U.S. interest rates were followed by extra low interest rates in many other countries, in an effort to prevent sharp currency appreciations. Those low interest rates appear to have resulted in a boom-bust pattern in emerging market countries evident in the recent commodity cycle...
Capital also flows in response to interest rate differentials—even if attenuated by policy reactions. .. A host of government interventions and restrictions on housing markets have been used to prevent the low interest rates from causing bubbles. Macro-prudential regulations, which have legitimate purposes, are also being used to counter the effects of the low interest rates.
There’s also been a revival of capital controls. Even the IMF has endorsed capital controls, calling them “capital flow management” or CFM for short.
John's conclusion
In my view we need a new strategy to deal with these problems.
So as in the 1940s we should forge an agreement where each country commits to certain rules... 
. A second reform would set up rules for eventually removing capital controls. Currently, 36 countries now have open capital accounts, but 48 are classified as “gate” countries and 16 as “wall” countries with varying degrees of capital controls.
John rethinks the role of the 40s institutions.
.. recreating the ‘40s founded institutions for today’s global economy must go beyond the IMF. The World Bank was originally created to supplement private capital flows for reconstruction and development. But today capital flows and savings to finance investment are abundant—some even see a glut.
He goes on to rethink the roles of CEA, JEC, GATT, WTO, and so forth.

Last but not least, international economic policy and foreign policy are intertwined. The Bretton Woods generation understood that.
...we see the same international cross-border encroachment on freedom, including economic freedom. In my view the United States should commit to promoting economic freedom as part of its foreign policy strategy. It should also strongly support economic leaders who are committed to economic freedom in their own countries. This is the lesson learned from the transitions from government control to market economies two decades ago, especially in Poland. The U.S. government strongly supported Polish economic reforms—the removal of price controls, of barriers to new businesses, and of subsidies of old state enterprises, along with a restoration of the rule of law and property rights. Today international support packages tend to do just the opposite: encourage more government subsidies and controls.
It is amazing just how much of the international financial and monetary architecture resides in institutions set up in the 1940s. Good rules need good institutions. But institutions need rethinking on occasion.


  1. It seems his view of the nineties is a bit sanguine for emerging markets. For example how much of the bailout to the tequila crises was based on rules and international institutions, or was driven by US interests. I also think he is overselling a bit by connecting current central bankers to the currency wars of the 30s. You yourself have presented plenty of scepticism on how much control they actually have.

  2. John Taylor is a deep thinker and a nice guy.

    But I think rather rules than on instruments, we need rules on goals or targets.

    Central banks should target nominal GDP growth, using instruments to get to the target.

    If not NGDP targets, then an IT band, say of 2.5% to 3.5%, will probably result in the same, generally positive outcomes. I suspect the Fed 2% IT, which seems to have morphed into a ceiling, is suffocating real U.S. economic growth. Remember, inflation as measured is somewhat arbitrary, and the US has prospered mightily in times of moderate inflation (as measured).

    I get a little leery whenever a sometime Washingtonian expresses the need for US involvement in other countries, including their economic policies. Like we know better.

    Lastly, Taylor needs to think about local housing policies, barely mentioned in his presentation, What inflation we have in the US is linked to ubiquitous property zoning, including single-family detached housing zoning. I do not see what the Fed can do about that. The Fed can suffocate the economy to reach zero inflation, or live with moderate inflation.

    As it is, the residents of Newport Beach CA (and just about every other city) want to criminalize new housing construction; restrict retail space through zoning; outlaw push-cart vending (which would provide competition for limited retail space); but have robust growth, and no inflation.

    Got that?

    I think robust economic growth but no inflation is a null set in the U.S.

  3. The best reading on this is Maddison (1988) who was stunning in his prophesies about what the dangers would be of Bretton Woods capital market liberalisation and abandonment of monetary arrangements (not altogether related but he also forecast a permanent productivity slowdown from the late 1970s). Speculation started with the weakening of capital controls in the late Bretton Woods Period. Global financial instability worsened, particularly from about 1987. It continued with the IMF's increasingly neo-liberal ideology, and resurfaced in Japan (Japan's capital market liberalisation got in earnest in the late 1970s) and the Asian Financial Crisis. Monetary policy and financial deregulation during the 1970s, and Great Moderation - 1980s, 1990s and 2000s cannot be judged by any standard a success- its ultimate culmination was the Lehman shock oh, but of course we did not have a worldwide bubble or I guess a crash either). Monetary policy was not addressing, but a big part of the cause of, housing and other asset price bubbles.

    Worldwide shocks and crashes are obviously linked to international capital movements - especially of the short term speculative kind. The Bretton Woods period was unique in its benigness.

    But some good news. At last someone is putting rational expectations theory away and doing some real world history.


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