WASHINGTON (MNI) – The following is the third of four sections of
the remarks of Federal Reserve Chairman Ben Bernanke prepared for
Friday’s Sixth European Central Bank Central Banking Conference in
Frankfurt:
The exchange rate adjustment is incomplete, in part, because the
authorities in some emerging market economies have intervened in foreign
exchange markets to prevent or slow the appreciation of their
currencies. The degree of intervention is illustrated for selected
emerging market economies in figure 8. The vertical axis of this graph
shows the percent change in the real effective exchange rate in the 12
months through September. The horizontal axis shows the accumulation of
foreign exchange reserves as a share of GDP over the same period. The
relationship evident in the graph suggests that the economies that have
most heavily intervened in foreign exchange markets have succeeded in
limiting the appreciation of their currencies. The graph also
illustrates that some emerging market economies have intervened at very
high levels and others relatively little. Judging from the changes in
the real effective exchange rate, the emerging market economies that
have largely let market forces determine their exchange rates have seen
their competitiveness reduced relative to those emerging market
economies that have intervened more aggressively.
It is striking that, amid all the concerns about renewed private
capital inflows to the emerging market economies, total capital, on net,
is still flowing from relatively labor-abundant emerging market
economies to capital-abundant advanced economies. In particular, the
current account deficit of the United States implies that it experienced
net capital inflows exceeding 3 percent of GDP in the first half of this
year. A key driver of this “uphill” flow of capital is official reserve
accumulation in the emerging market economies that exceeds private
capital inflows to these economies. The total holdings of foreign
exchange reserves by selected major emerging market economies, shown in
figure 9, have risen sharply since the crisis and now surpass $5
trillion — about six times their level a decade ago. China holds about
half of the total reserves of these selected economies, slightly more
than $2.6 trillion.
It is instructive to contrast this situation with what would happen
in an international system in which exchange rates were allowed to fully
reflect market fundamentals. In the current context, advanced economies
would pursue accommodative monetary policies as needed to foster
recovery and to guard against unwanted disinflation. At the same time,
emerging market economies would tighten their own monetary policies to
the degree needed to prevent overheating and inflation. The resulting
increase in emerging market interest rates relative to those in the
advanced economies would naturally lead to increased capital flows from
advanced to emerging economies and, consequently, to currency
appreciation in emerging market economies. This currency appreciation
would in turn tend to reduce net exports and current account surpluses
in the emerging markets, thus helping cool these rapidly growing
economies while adding to demand in the advanced economies. Moreover,
currency appreciation would help shift a greater proportion of domestic
output toward satisfying domestic needs in emerging markets. The net
result would be more balanced and sustainable global economic growth.
Given these advantages of a system of market-determined exchange
rates, why have officials in many emerging markets leaned against
appreciation of their currencies toward levels more consistent with
market fundamentals? The principal answer is that currency
undervaluation on the part of some countries has been part of a
long-term export-led strategy for growth and development. This strategy,
which allows a country’s producers to operate at a greater scale and to
produce a more diverse set of products than domestic demand alone might
sustain, has been viewed as promoting economic growth and, more broadly,
as making an important contribution to the development of a number of
countries. However, increasingly over time, the strategy of currency
undervaluation has demonstrated important drawbacks, both for the world
system and for the countries using that strategy.
First, as I have described, currency undervaluation inhibits
necessary macroeconomic adjustments and creates challenges for
policymakers in both advanced and emerging market economies. Globally,
both growth and trade are unbalanced, as reflected in the two-speed
recovery and in persistent current account surpluses and deficits.
Neither situation is sustainable. Because a strong expansion in the
emerging market economies will ultimately depend on a recovery in the
more advanced economies, this pattern of two-speed growth might very
well be resolved in favor of slow growth for everyone if the recovery in
the advanced economies falls short. Likewise, large and persistent
imbalances in current accounts represent a growing financial and
economic risk.
Second, the current system leads to uneven burdens of adjustment
among countries, with those countries that allow substantial flexibility
in their exchange rates bearing the greatest burden (for example, in
having to make potentially large and rapid adjustments in the scale of
export-oriented industries) and those that resist appreciation bearing
the least.
Third, countries that maintain undervalued currencies may
themselves face important costs at the national level, including a
reduced ability to use independent monetary policies to stabilize their
economies and the risks associated with excessive or volatile capital
inflows. The latter can be managed to some extent with a variety of
tools, including various forms of capital controls, but such approaches
can be difficult to implement or lead to microeconomic distortions. The
high levels of reserves associated with currency undervaluation may also
imply significant fiscal costs if the liabilities issued to sterilize
reserves bear interest rates that exceed those on the reserve assets
themselves. Perhaps most important, the ultimate purpose of economic
growth is to deliver higher living standards at home; thus, eventually,
the benefits of shifting productive resources to satisfying domestic
needs must outweigh the development benefits of continued reliance on
export-led growth.
Improving the International System
The current international monetary system is not working as well as
it should. Currency undervaluation by surplus countries is inhibiting
needed international adjustment and creating spillover effects that
would not exist if exchange rates better reflected market fundamentals.
In addition, differences in the degree of currency flexibility impose
unequal burdens of adjustment, penalizing countries with relatively
flexible exchange rates. What should be done?
The answers differ depending on whether one is talking about the
long term or the short term. In the longer term, significantly greater
flexibility in exchange rates to reflect market forces would be
desirable and achievable. That flexibility would help facilitate global
rebalancing and reduce the problems of policy spillovers that emerging
market economies are confronting today. The further liberalization of
exchange rate and capital account regimes would be most effective if it
were accompanied by complementary financial and structural policies to
help achieve better global balance in trade and capital flows. For
example, surplus countries could speed adjustment with policies that
boost domestic spending, such as strengthening the social safety net,
improving retail credit markets to encourage domestic consumption, or
other structural reforms. For their part, deficit countries need to do
more over time to narrow the gap between investment and national saving.
In the United States, putting fiscal policy on a sustainable path is a
critical step toward increasing national saving in the longer term.
Higher private saving would also help. And resources will need to shift
into the production of export- and import-competing goods. Some of these
shifts in spending and production are already occurring; for example,
China is taking steps to boost domestic demand and the U.S. personal
saving rate has risen sharply since 2007.
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** Market News International Washington Bureau: 202-371-2121 **
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