What’s In and Out in Global Money

• Author: Jeffrey A. Frankel
• Position: Professor at Harvard University
• Pages: 13-17

Page 13

Things are hot, then they are not, in the world of international money

OUT

• The G-7

• The corners hypothesis

• “Currency manipulation”

• Inflation targeting

• Exorbitant privilege of the dollar

IN

• The G-20

• Intermediate exchange rate regimes

• Reserves

• Fighting asset bubbles

• Multiple international reserve assets

IN international monetary economics our exam questions remain the same. Only the answers change, from decade to decade. I nominate five concepts, which were virtually conventional wisdom a short time ago, for my list of what is now “out.” I also nominate five concepts, which might have been described as “out” a few years ago, for my list of what is now “in.”

1

Out: The G-7

In: The G-20

Out: The G-7 (Group of Seven) world leaders first met in France in 1975, to ratify the de facto move to floating rates, following the demise of the Bretton Woods world. G-7 finance ministers cooperated to bring down a stratospheric dollar in 1985 and then again to halt the dollar’s depreciation in 1987, in the Plaza and Louvre agreements, respectively. The G-7—Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States—was the most important steering group of the world monetary system. But the membership became increasingly anachronistic. Russia’s addition in 1997, making it the G-8, was much too little, and too late. The exclusion of China and other major developing or emerging market countries rendered the group out of date. What can finance ministers accomplish by discussing a currency that is not represented at the table?

In: The G-20 adds 12 major economies and the European Union to the G-7—Argentina, Australia, Brazil, China, India, Indonesia, Mexico, Russia, Saudi Arabia, South Africa, South Korea, and Turkey. The G-20’s London meeting in April 2009 had some substantive successes and some failures. Regardless, the meeting was a turning point in that the G-20, more than the G-8, is making substantive decisions—finally giving major emerging countries representation.

2

Out: The corners hypothesis

In: Intermediate exchange rate regimes

Out: The corners hypothesis postulated that countries are— or should be—moving to one or another corner in their choice of exchange rate regimes: either full flexibility or rigid institutional commitments to fixed exchange rates in the form of currency board, dollarization, or monetary union. According to the hypothesis, anything in between the two extremes was no longer feasible.

The corners hypothesis arose (Eichengreen, 1994) in the context of the European exchange rate mechanism (ERM)Page 14 crisis of 1992–93. The ERM had permitted the exchange rates of European currencies to fluctuate within a narrow band. But, under pressure, Italy, the United Kingdom, and others had to devalue or drop out—and only because the band was widened could France stay in. The crisis suggested to many that there was no middle ground between floating and fixing (a judgment seemingly borne out when the leap from wide bands to full monetary union proved successful in 1998–99). After the east Asia crises of 1997–98, the hypothesis was applied to emerging markets too. In efforts to reform the financial architecture to minimize the frequency and severity of future crises, the “fix or float” proposition rapidly became the conventional wisdom (Obstfeld and Rogoff, 1995; Summers, 1999; Meltzer, 2000).

Trouble was, the proposition was never properly demonstrated, either theoretically or empirically. The collapse in 2001 of Argentina’s convertibility plan, which had rigidly linked the peso to the dollar, marked the beginning of the end. Today, it is clear that most countries continue to occupy the vast expanse between floating and rigid institutional pegs, and it is uncommon to hear that intermediate regimes are a bad choice generically.

In: Intermediate exchange rate regimes. If the corners hypothesis is “out,” then intermediate regimes are “in.” Intermediate regimes include target zones (bands), crawls, basket pegs, adjustable pegs, and various combinations of them. The IMF classifies more than half of its members as following regimes somewhere in between free float and hard peg. Economists’ attempts to classify the regimes that countries actually follow (such as Frankel and Wei, 2008), sometimes in contrast to what they claim to follow, generally find an even higher proportion with intermediate regimes.

3

Out: “Currency manipulation”

In: Reserves

Out: Currency manipulation. In 2007, the IMF was supposedly given responsibility for surveillance over members’ exchange rates, which the United States believed meant telling China that the value of its currency was lower than it should be. The phrase “unfair currency manipulation” has had official status in U.S. law for 20 years and in the IMF Articles of Agreement for longer, despite its protectionist ring. In practice, the supposed injunction on surplus countries to revalue upward has almost never been enforced—in contrast to the pressure on deficit countries to devalue. Some would...