The bad news is familiar. The financial crisis continues to grind on. Fiscal policy in many countries remains firmly in the hands of austerity obsessives and supply side retreads. The IMF continues to press its traditional recovery-through-strangulation formula in Southern Europe. Indeed, in recent weeks the Fund has intensified pressure on Greece’s government to go further in the direction of destroying its social fabric through new spending cuts (on public sector salaries) and tax hikes. This has understandably driven Greeks to the streets and caused another stalemate between the government and the Troika. The same kinds of social tensions are spilling over daily in Spain and Portugal as the unemployed and impoverished mobilize to protest new austerity measures that the government is invoking to stave off the need to turn to the Troika.
And so, yes, the backdrop is dismal. Against all of this some central bankers and finance ministers are taking steps to respond in some measure to the challenges they confront. In many national contexts, central banks have been forced to carry the weight of fostering recovery in their moribund economies. We know that in mid-September US Federal Reserve chair, Ben Bernanke, inaugurated a third round of quantitative easing (“QE3”) while also making a commitment to hold short-term interest rates down until mid-2015. It’s a step in the right direction, though clearly it cannot provide the full assist that the US needs absent complementary measures on the fiscal side and the restoration of growth in Europe. But renowned Financial Times columnist Martin Wolf was quite correct to praise the move as an ethical and necessary one in light of US labor market conditions and the Fed’s dual (statutory) mandate to foster “maximum employment and price stability.”
The Fed’s latest policy measures are of a piece with those of other central banks that are seeking to respond to a diverse array of challenges by using heterogeneous tools of expansionary monetary policy. The European Central Bank and the Bank of England deployed expansionary monetary policies this summer aimed at responding to growth slowdowns. The central banks of Brazil, China, Colombia, the Czech Republic, Israel, South Korea, the Philippines, South Africa, Denmark, and Switzerland, and most recently Japan have all deployed expansionary monetary policy to respond to weaker growth and export performance. Up until a few months ago, central banks in a subset of these same countries were also responding to the fallout from the currency appreciation that was induced by conditions in the US and the Eurozone, conditions that led to unsustainable inflows of foreign investment and carry trade activity. The Bank of Japan announced a new round of monetary easing on the heels of the Fed’s announcement. Many analysts rightly speculated that this action was offensive in nature as Japanese officials sought to head off further hollowing out of its export sector in the wake of a QE3-induced flood of capital to the country. And, in a familiar pattern, Brazil’s Finance Minister, Guido Mantega, has rattled sabers again (quite appropriately, I must add) about action that his government would be forced to take to protect against the domestic effects of US and Eurozone monetary policy.
Will this free-for-all in monetary policy end? At present there are few clear signs that policymakers are willing to coordinate monetary policies or even to acknowledge the cross-border spillovers of their monetary policy decisions in the present environment. That said, minor outbreaks of sanity are emerging in this chaotic and distressing environment. For instance, recent research released by IMF staff takes note of the costs of failing to coordinate monetary policy and consider cross-border spillovers. The research explicitly acknowledges Keynes—in particular, reminding readers of his argument for managing capital flows in both source (e.g., the US) and recipient countries. Moreover, moving beyond the issue of monetary policy it is heartening to see the IMF (of all institutions) call attention to the likelihood that the Basel III rules for global banks may actually privilege larger over smaller banks and may therefore aggravate the too-big-to fail problem. And on the “even a broken clock” front, it is encouraging that German Chancellor Merkel has taken on high-frequency trading in her country, a move that US regulators and politicians have been unable to contemplate owing to their capture by Wall Street.
So where and how might all of this end? That is, of course, the question of the day. Either finance ministers and other economic policymakers will recognize the wisdom in establishing a new regime of international monetary cooperation—one that allows for coordinated reflation without the risk of damaging international spillovers—or the risks of counterproductive currency manipulations, in which some countries are able to offshore the burdens of monetary adjustments onto others, will deepen.