«Elke Muchlinski1 Explicit or implicit Monetary Coordination – Considering Historical And Future Aspects© Key words: currencies, central banks, ...»
Explicit or implicit monetary coordination? Dr. Elke Muchlinski 2002 17 world. The questions still open in present debates can be identified as follows: Does the euro's assessment through the market represent an avarage performance of Euroland as a whole or some countries of Euroland? In other words: Does the euro represent a new currency union or merely the old d-mark anchored standard in Europe with new clothes?
The replacement of the d-mark by the euro has great implications for the new configuration, because the real challenge for the euro is to become a medium of exchange, store of value, and unit of account, and also being compelled to represent these functions from the outset. To be more precise, this real challenge must be addressed by both the ECB and public financial agencies.
A reasonable consideration as well is that the euro takes its place in a world of persistent payment imbalances among the United States, Europe, and Japan (Salvadore 1998a, BIS 2000, 1998, IMF 1999). Some authors state that the U.S.dollar's prospective rule will basically depend on the United States' external economic position.13 The BIS outlines problems according to the U.S.dollar which are conceivable for two reasons.
First, a loss of confidence in the market regarding the U.S.deficit could lead to pressure on the U.S.dollar. A consequence of the lower degree of confidence could be a greater likelihood of a system change back to a tight money policy. A second problem could emerge from the United States' tendency to retreat into protectionism of the United States (1998, chap. VI, IX). At this point, no substantial divergence is to be found in the current Annual Report of the BIS (2000).Therefore, the amount of the euro's decline will be quite dependent on whether it will be accepted as an international currency or not.
Bergsten (1997a, b), Mundell (1995, 528; 1996, 140), Salvadore (1995, 515).
Explicit or implicit monetary coordination? Dr. Elke Muchlinski 2002 18 Unlike Great Britain and the United States, Japan has never been east into the role of World Banker.14 Nevertheless research by the Bank of International Settlements (BIS) underscores that the yen has defended its third place as an international currency with 24 percent of all transactions worldwide; it is involved in two of the ten most widely traded currency pairs (BIS 1996, p. 24; see also BIS 1999, chap. VI). In terms of the prospective role of the yen, Bergsten concludes that "the euro's rise will convert an international monetary system that has been dominated by the U.S.dollar since World War II into a bipolar system" (1997, 92). Similarly, Issing (1998, 24f,) and Fratianni et al (1998) focus on the prospective bipolar system. Frankel referred with some criticism to the "popular hypothesis", "that the world is breaking up into three blocs, one pegged to the dollar, one to the euro, and one to the yen" (1999, 17; see also Frankel and Wei 1995).
Comparing the old and new configuration I would like to emphasize that historically the United States pursued a different U.S.dollar strategy than they did in the 1970s and 1980s. Regarding the euro, one can hardly assume that the ECB will adopt the strategy of the Bundesbank. Furthermore, one must bear in mind some changes in macroeconomic theory since the emergence of the old configuration of tripolarity in the 1980s: Macroeconomic theory today does not unconditionally accept the assumptions of the NCM and the premise of the neutrality of money.
To summarize the main points of this section, then, the replacement of the d-mark by the euro will presumably not lead to a replacement of the U.S.dollar. The success of McKinnon/Ohno (1997), Tavlas/Ozeki (1992, 21).
Explicit or implicit monetary coordination? Dr. Elke Muchlinski 2002 19 the euro in becoming an international money depends heavily on the policy of the ECB which shall act as a market participant and not a speculator of the market.15 Because money is non-neutral, and monetary policy lead to its non-neutrality, basic assumptions of the NCM theory are passé.
Considering the framework of exchange rate relations is a further component of the theoretical outline to precisely depict the configuration of tripolarity. First of all, I would like to consider certain terminology concerning exchange rate regimes. The term exchange rate regime is based on a "mechanism design" on international coordination that goes back to the old-fashioned view of macropolicy dominated economic discussions since the tradeoff of the Phillips curve (Johnson 1969, 399). Applied to those items dealing with international macropolicies, it seemed plausible to solve aspects of economic interdependencies by focusing on definitions of instruments and goals. The mechanism design is basically found in the literature dealing with the policy optimizing approach.16 The notion regime includes the application of rigid rules governing the monetary and financial relations between countries (Cooper 1975). It also encompasses the term system which can also be applied to monetary coordination. An exchange rate system adheres less to certain rules and conventions than a does regime. By contrast, an exchange rate arrangement characterize an adhoc acceptance of urgently needed bargaining on exchange rates. Besides this attempt to differentiate the notion regime, sysExplicit or implicit monetary coordination? Dr. Elke Muchlinski 2002 21 tem, and arrangement, most authors use regime not in the rigid meaning introduced at the beginning of this paragraph.
The approach to monetary coordination I introduce in the paper should be distinguished from monetary integration which in a narrow sense pursues as its main goal unification by a common currency issued by a single central bank. Monetary integration refers to a certain status quo or goal (Hamada/Porteous 1992). Both a single currency and fixed exchange rates are central features of monetary integration because a country steps aside for the autonomy of monetary policy.
Monetary coordination refers both to a flexible exchange rate system and fixed system, i.e., basically to different degrees of flexibility or rigidity. Theorefore monetary coordination goes beyond a dualism of free floating versus rigid fixed exchange rate system. By contrast, Hamada defined such an approach which goes beyond such dualism as an "eclectic regime" (1998, 422). I do not follow his view. By definition or taken as a textbook version, the dual distinction refers to the question, if a central bank does or does not intervene in the foreign exchange market. Regarding the debates among the scientific community on the real functions and feasibility of fixed versus flexible exchange rates, one can hardly find a common-sense view. This dualism only makes sense as a hermeneutic approach.
What does monetary coordination within a configuration of tripolarity of exchange rates imply regarding these differentiations? It implies a certain perception of divergent domestic and international interests, and to developing a strategy for balancing For a further description, see Bryant (1995) and Kenen (1995).
Explicit or implicit monetary coordination? Dr. Elke Muchlinski 2002 22 these interests. To be sure, different types of coordination are conceivable: According to the idea of monetary coordination outlined in this paper, monetary authorities for three main currencies – the configuration of tripolarity – are committed to coordinating exchange rates within a certain zone or to smooth exchange rate movements. This approach leaves behind the idea of a domestic economy as being constrained by economic interdependencies. I would propose to define this view as a challenge to shaping monetary coordination. The requirement for shaping monetary coordination represents a shift of paradigm or shift of theoretical understanding; it could be interpreted as a preliminary step toward certain forms of international bargaining in economics. The tripolar configuration refers to the functions of money and particularly to the non-neutrality of money. Moreover, it direchts attention to the special relationship of the three dominant currencies (addressed in the following paragraph).
Against the historical background of a period of disillusion with both free floating and fixed exchange rates, economic theories and debates contain a huge variety of theoretical concepts that deal with the phenomenon of instability in the international monetary system.17 The paradigmatical view of the RE and the hypothesis of the neutrality of money became foundations of theories on exchange rate movements and balance of payments. This theoretical explanation of exchange rates is embedded in the theoretical view of a perfect foreign exchange market which does not differentiate between different currencies, interpreting all currencies equally. Persistent market disequiFor a comprehensive review of the literature of exchange rate theories, see Taylor (1995). There is no place here to reconstruct the monetarist approach to exchange rate theories.
Explicit or implicit monetary coordination? Dr. Elke Muchlinski 2002 23 libria in the 1980s were evidenced by higher exchange rate volatility. All of this cast certain doubt on the metaphor that the market knows best. Kenen stated: "If goods prices were perfectly flexible, there would be little cause to worry about exchange rate arrangements" (1994, 122; emphasized by EM). Regarding the U.S.dollar's ups and downs in the 1980s Kenen concluded: "If the inhabitants of the market had been endowed with the marvelous attributes displayed by those who populate many economists' models, they would have known that the U.S. budget and trade deficits could not last indefinitely and that the U.S.dollar would have to return eventually to something near its 1980 level" (1994, 124). This type of thinking is hardly acceptable because the formation of expectations is not due to a uniform model but to different models and perceived situations, i.e., to the contemporary world. According to the configuration of tripolarity, markets have created various currencies having functions as international currency, compared to the gold standard and Bretton Woods era.
Monetary coordination – Some new and some not so new considerations Debates on international coordination of macropolicy, particularly monetary coordination, began during the time upheavals in exchange rates theories and events occured.18 These unsolved problems in the theories of foreign exchange markets have A large number of articles have already discussed the advantages and disadvantages of coordination. These include, f.i., Branson et. al (1990), Bryant (1995), Currie (1993), Currie/Levine (1993), Canzeroni/Henderson (1991),Canzeroni/Grilli (1996),Cooper, R. W. (1999), Fischer (1988), Frankel/Rockett (1986), Frenkel/Goldstein/Masson (1991, 1988), Goldstein/Masson/Taylor (1992), Goldstein Explicit or implicit monetary coordination? Dr. Elke Muchlinski 2002 24 significant impacts on macropolicies and the process of income generation. Of course, the idea of coordination is older than that.19 The term monetary coordination can be described by a reference to Bryant who precised the meaning of coordination in a broader sense of the meaning: "International coordination, in my view, is best defined as coordination that goes further than mutual recognition in focusing on the crossborder spillovers and arbitrage pressures that erode the differences among national economics and policies" (1995, 398) In addition, monetary coordination can at best apply in reference to central banks and monetary authorities of the countries focusing on exchange rate stability. Monetary coordination therefore shall avoid a fallacy of composition. It does not imply atruism.21 The suggestions for improvements in monetary coordination shall be divided into two main groups. To be more precise, this classification is a conceivable way regarding the suggestions and implications. It does not imply initiatives given by the IMF and the Word Bank, nor those dealing with capital controls.22 (1994), Ghos/Masson (1991), Hamada/Kawai (1997), Kantzenbach (1990), Kenen (1994).
Contributions on the history of international interdependence leads back Cooper (1968), Johnson (1954), Meade (1951), Niehans (1968), and Scitovsky (1941).
A fashionable assertation during the 1980s which was not only lectured by adherents of the "market view" reads as follows: There is no need for international policy coordination, if every country keep its own economy in shape. Blinder (1999) presented an entirely different view of this view which was dominated in the literature.
Hamada/Kawai (1997, 93f.) refer to an example of a fallacy of composition given by Keynes (1936). Keynes explained that an individual's rationality does not necessarily imply a rationality of the whole because the latter is not simply an addition of its parts.
See the Bretton Woods Commission Report (1994), Feldstein (1998), Masson/Mussa (1997). For debates on capital controls, i.e., the Tobin Tax, see, Aretis/Sawyer (1997), Edwards (1999), Garber/Taylor (1995), Smith (1997), and UNCTAD (1994).
Explicit or implicit monetary coordination? Dr. Elke Muchlinski 2002 25 Group one contains different forms of target zones. The significant framework of monetary coordination was established by Williamson and Miller (1987).23 Both the definition of central parity and target zone, i.e., the band-widening, provoke many questions regarding the feasibility and adequacy of such arrangements. The Exchange Rate Mechanism I (ERM I) is one famous example for investigating the concept of target zones. The ERM II, which was implemented in January 1999, is going to be another example (Muchlinski 1998).