I am travelling to the US and UK to discuss my ideas on monetary policy with some of the best economic minds in the world, including former World Bank chief economist Joseph Stiglitz, Harvard academic Jeffrey Frankel and IMF chief economist Olivier Blanchard.
Jeffrey Frankel says:
• He prefers nominal GDP over CPI for inflation measurement
• Inflation targeting hasn’t stopped asset bubbles
• Asian economies show exchange rate focus doesn’t come at expense of inflation
Jeffrey Frankel is a Professor at the John F Kennedy School of Government at Harvard, holding the chair in capital formation. He is a prolific writer and has published widely on the subject of monetary policy and exchange rates over a number of decades.
Professor Frankel reminded us that times change, saying the world had at different times given primacy to targeting exchange rates, then money supply and then inflation. Each one of these has led to shocks in the past. He could have added to that list, even earlier, the gold-standard.
He has previously written that:
• no single currency regime is best for all countries
• no single currency regime is a panacea
• even for one country, no single currency regime is necessarily best for all times
As he has written, life always involves trade-offs. Countries have to balance the advantages of more exchange rate stability against the advantages of other flexibility. He notes that: “‘Fixed versus floating’ currency debate is an oversimplified dichotomy. There is, in fact, a continuum of flexibility”. Options include.
• a currency union
• a currency board
• a truly fixed exchange rate
• adjustable peg
• crawling peg
• basket peg
• target zone or band
• managed float
• free float
Prof Frankel is interested in New Zealand but he was understandably reluctant to advise what he thought would be the best settings for New Zealand in the absence of in-depth knowledge of our exact circumstances. He did note his preference for grounding inflation measurement in nominal GDP rather than the CPI, and that he favours product price targeting for some commodity exporters.
He said that the GFC showed that central banks pursuing inflation targeting had commonly failed to properly take into account asset price bubbles, but said the answer to that probably lay in prudential policies (such as those I have mentioned in earlier blogs) rather than interest rates. I said that was my view too, noting that the carry trade was a large part of the problem in New Zealand.
Prof Frankel said that Asian countries have shown that it is possible to successfully influence exchange rates for lengthy periods while not giving up on monetary independence. “Central banks can maintain the exchange rate lower for longer – 10 years plus, or at least longer than some of my colleagues would suggest – without giving up their credibility on inflation”.
On the principle of the supposedly impossible trinity (ie that a country must give up on one of three goals – exchange rate stability, monetary independence, or financial-market integration; it cannot have all three at once), Prof Frankel has said that as financial markets are becoming more integrated internationally, the choice has narrowed towards giving up exchange rate stability or monetary independence. “But this is not the same thing as saying that one cannot give up on both, that one cannot have half-stability and half-independence.”
That is, exchange rates can be influenced for longer periods than have been traditionally acknowledged by most economists, without losing the battle to control inflation. This has of course advantaged the exporters from countries that have achieved this, and contributed to current account surpluses.
I would note this is exactly the opposite experience to what has occurred in New Zealand.
Along with his extensive knowledge in this area another research interest of his is how to achieve politically acceptable national greenhouse gas emission targets in order to attain global CO2 concentrations of 460ppm. This man is a force for the good.