Blog post

The G20 and the coordination of economic policies

Publishing date
05 November 2010

In recent decades economists have been calling for more coordination of the countries’ macroeconomic policies. Some institutions, and especially the IMF, are formally charged with, or are expected to facilitate and promote, this coordination and some issues are analyzed and discussed within the IMF. At particular times countries have been asked to coordinate their fiscal policies, to help pull the world’s economies out of recessions. In the past couple years the G20 has played an increasingly active role in making these calls. At other times the countries have been asked to coordinate other policies. In all cases the objective has been to improve macroeconomic policies, at the global level, and to prevent, or reduce, potential, negative, cross-countries’ spillovers. These spillovers may be caused by the actions of single countries or groups of countries.

The area where coordination remains random and occasional is that of monetary policy. Central banks are expected to be politically independent domestically and, of course, also internationally. This independence has been seen as a major virtue and has been praised by many economists. However when a central bank as important as the Federal Reserve Bank or the European Central Bank acts in the pursuit of what are domestic objectives, it may affects the rest of the world, at times in major and not always positive ways. The actions of these large central banks almost always generate cross- border, or spillover effects that may cause difficulties for other countries.

For example some observers have in the past argued that the monetary policy that the Fed followed in the early 1980s might have contributed to the Latin America’s debt crisis of that decade, because it sharply increased interest rates, in its legitimate attempt to stop the high US inflation that was getting out of control. In more recent years many observers have blamed the Fed’s monetary policy, during the early part of this decade, for causing the sub-prime crisis that led to the “great depression” and that damaged the economies of other countries. In both cases the Fed was, rightly or wrongly, pursuing what it believed were legitimate domestic objectives.
Since last year the Fed has been injecting enormous amounts of liquidity in the global monetary system, liquidity that will penetrate not just into various parts of the US economy but will also spill over into the rest of the world, possibly eliciting some reactions on the part of other countries.
An issue that should be of concern to the G20 is that the Fed did not need to coordinate its policies, such as QE1 and QE2, with any international institution or group. It is doubtful that it even consulted in any meaningful way the IMF. This seems to be a major omission in the global architecture that is supposed to provide a framework for the surveillance and the coordination of macroeconomic policies.

Are there at least theoretical arguments in favor of making major central bank coordinate a little more internationally their actions when those actions have the potential for major cross-border externalities? For example should the Fed be expected to coordinate internationally an action such as that taken on November 3, 2010 (QE2) that will surely have major spill-over effects on other countries? Would such coordination be considered an attack on the Fed’s independence? Should the current IMF surveillance practice be considered sufficient in dealing with these major actions? Should the G20 address this issue even though it may be a hot potato and one too politically sensitive and possibly without a solution?

The Fed QE2 announcement was followed immediately by some fall in the value of the US dollar. This fall may invite other countries to react to protect the value of their currencies. This is clearly a demonstration that the Fed action is an issue of international significance. However, the FOMC latest statement, where international factors are not even mentioned, makes it clear that the Fed was acting strictly in accordance with its mandate. That mandate states that the Fed’s responsibility is that of maintaining domestic price stability and promoting domestic employment. The mandate does not say anything about avoiding the impact of its actions on the rest of the world. This is the real problem and the issue for the G20.It may become a bigger issue in the future.

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