Policy imbalances and the uneven recovery john b taylor
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Policy Imbalances and the Uneven Recovery John B. Taylor. Conference on The Uneven Recovery: Emerging Markets versus Developed Economies Oct 14, 2011 . Two Global Imbalances. Current account imbalances Monetary imbalances

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Policy Imbalances and the Uneven Recovery John B. Taylor

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Policy imbalances and the uneven recovery john b taylor

Policy Imbalances and the Uneven Recovery John B. Taylor

Conference on The Uneven Recovery:

Emerging Markets versus Developed Economies

Oct 14, 2011


Two global imbalances

Two Global Imbalances

  • Current account imbalances

  • Monetary imbalances

  • Both relevant for emerging markets versus developed economies

  • We hear much about the first

  • But the second may be more important


Current account imbalances

Current Account Imbalances

  • A frequent topic for international coordination

  • A perennial topic for G-20, IMF, OECD (WP3)

  • Sometimes used for calls by USand Europe for exchange rate changes by EME

  • Frequently blamed for the financial crisis

    • Saving glut flows into US, lowers interest rates

    • Alternative to the “too low for two long” view

  • Now “rebalancing” is a major focus of the G-7, G-20, IMF


Link to saving investment gap

Link to Saving-Investment Gap

Saving – Investment =Net Exports

Y=C+I+G+X

Y-C-G= I+X

S=I+X

S-I=X

Look at recent history


Policy imbalances and the uneven recovery john b taylor

United States

C/Y and G/Y


Policy imbalances and the uneven recovery john b taylor

Source: Borio and Disyatat (2011)


Policy imbalances and the uneven recovery john b taylor

Capital Flows and the Current Account

Consider 2004(Billions of dollars)

Exports of goods and services and income receipts 1531

Imports of goods and services and income payments -2118

Unilateral current transfers -81

Current Account Deficit -668

U.S. Owned Assets Abroad -856

Foreign Owned Assets in the United States 1440

Statistical discrepancy & other reconciliations 84

Note that these are

capital flows

Not capital stocks

U.S.GDP was $11734 billion in 2004, so

CA was 5.7 percent as a share of GDP

Source:

http://www.bea.gov/bea/newsrelarchive/2005/trans305.pdf


Policy imbalances and the uneven recovery john b taylor

The connection between current

account and change in official

reserves can be particularly weak

Current account =

Change in official reserves

+ other gross outflows

- other gross inflows


Policy imbalances and the uneven recovery john b taylor

United States


Policy imbalances and the uneven recovery john b taylor

Mainly Europe rather than emerging markets


I f not the current account then what is driving these flows

If not the current account, thenwhat is driving these flows?

  • Monetary policy

  • Exchange rate policy


Clear evidence from a very transparent central bank

Clear Evidence from a Very Transparent Central Bank

  • Norges Bank very explicit and transparent in accounting for how external variables affect interest rate path

  • Useful to consider several episodes in past few years

  • Reveals foreign interest rate as the most significant reason for deviating from basic rule


Policy rate in 1 2008 with fan chart and the increase in the policy rate in 2 2008 red line

90%

70%

50%

30%

Policy rate in 1/2008 (with fan chart) and theincrease in the policy rate in 2/2008 (red line)

Source: Norges Bank


Factors behind changes in the interest rate path from 1 2008 to 2 2008

Higher demand in Norway

Higher inflation in Norway

Higher interest rates abroad and developments in the foreign exchange market

Lower growth abroad

Higher risk premium in the money market

Factors behind changes in the interest rate path from 1/2008 to 2/2008


Policy imbalances and the uneven recovery john b taylor

From 1-10


Policy imbalances and the uneven recovery john b taylor

  • From Øistein Røisland

  • “Monetary Policy in Norway”


Policy imbalances and the uneven recovery john b taylor

From MPR 1/10


Policy imbalances and the uneven recovery john b taylor

From OECD Survey Norway, 2010


Policy imbalances and the uneven recovery john b taylor

Empirical evidence that target interest rate in

EM central banks responds to exchange rates

Example from Sebastian Edwards (2005) “The Relationship

Between Exchange Rates and Inflation Targeting Revisited”


Policy imbalances and the uneven recovery john b taylor

Continued from Sebastian Edwards (2005)


Example from ecb d uring 2000 2006

Example from ECB during 2000-2006

  • Sample 2000.1 - 2006.4.

  • Inflation = 4-quarter rate of change in the harmonized index of consumer prices

  • GDP gap = % deviation of real GDP from trend.

  • Regress deviation of ECB rate from Taylor rule on federal funds rate.

  • Estimated coefficient = .21

    • standard error of .06.

    • Plot of the actual and fitted values from this regression:


Illustrative chart from the oecd march 2008

Illustrative Chart from the OECD, March 2008


The case of the uneven recovery

The Case of the Uneven Recovery

  • Very low policy rate in US

  • Creates pressures on EM central banks to hold rates lower than they would be for domestic price and output stability

    • Also creates pressures to intervene in currency markets and impose capital controls

  • Leads to higher inflation, and perhaps more crises

  • So need to have “monetary rebalancing”

  • But little interest from developing countries


General sources of instability

General Sources of Instability

Consider two country model withiaffecting i* Interest rates are set according to:

Solving for the interest rates results in the following


Conclusion

Conclusion

  • Need to focus more on “monetary rebalancing”

    • Side by side discussion with “current account rebalancing”

  • May be more important than current account rebalancing

  • But how?

    • More global leadership

    • Global inflation target


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