Currency Wars and New Policy Paradigms
By Roubini EconoTeam
We met with a number of central bankers, financial officials and senior IMF personnel during the Fund’s spring meetings in Washington, DC, where new policy paradigms and “currency wars” were key topics of conversation.
Monetary Policy Can’t Do All the Work
As the IMF once again marks down its global growth forecast, the G7 and G20 countries are gradually coming to accept that monetary policy is not enough—expansionary fiscal measures should be combined with monetary stimulus and structural reform to spur growth and inflation.
This shift reflects recognition of the political constraints on structural reforms and the limits of monetary policy as a stimulus measure—not to mention the myriad risks to global growth. For the near term, though, acceptance of fiscal expansion is mostly a matter of word, not deed.
At the recent Shanghai meeting, the G20 gave states the green light to use “all available tools” to jumpstart growth—a message the G20 communiqué at the IMF meetings reinforced. This signals that countries are allowed and/or encouraged to pursue fiscal easing (“tailored to [their] circumstances”).
This new language represents progress, but serious tensions remain on both issues. Germany and the UK remain formally opposed to using fiscal expansion to boost growth. That resistance prevents the G7 from striking an agreement to use fiscal policy in a more active and coordinated way; such a pact was outlined (but not officially recommended) in the IMF’s World Economic Outlook as a potential means of countering the risk of “secular stagnation.”
Germany continues to oppose granting eurozone members any additional flexibility on their deficit targets and Germany’s own fiscal stimulus—spending on refugees and infrastructure—will remain small. The U.S. does not offer much hope for fiscal expansion either, as long as government at the federal level remains divided. Canada will pursue some fiscal stimulus via public investment, but these outlays will be too small to have a global impact. Japan is more likely to turn on the taps in a significant way, easing fiscal policy to compensate for serious downside growth risks.
Currency War Ceasefire Reaffirmed, but Fighting Could Break Out Again
Meanwhile, G20 countries have pledged to “consult closely” on FX, reaffirming their commitment to avoid competitive depreciations. This made room for the recent dollar depreciation versus the euro and Japanese yen as the Fed became very dovish in its messaging.
With respect to currencies, officials in the eurozone and Japan are somewhat at odds with the U.S. The yen and the euro have appreciated, in part, due to strongly dovish messaging from the Fed. The dollar has weakened at a time when the U.S. economy is outpacing the eurozone and Japan in terms of growth, inflation and inflation expectations.
The U.S. is not opposed to Japan easing fiscal policy (via a supplementary budget and a postponement of the upcoming consumption-tax hike) or monetary policy (further moves are likely after April’s inactivity). The U.S has, however, warned against currency intervention, given the risk of a currency war breaking out. One cannot rule out the prospect of Japan engaging in currency-market intervention—which Japanese policy makers have threatened to use—if more quantitative and qualitative easing and a deeper dive into negative policy rates fail to prevent yen strengthening.
The European Central Bank, meanwhile, is less vocal about euro strength and has limited tools to use in response to any further appreciation of the euro; there is little room for additional fiscal easing given German opposition, and the European Central Bank is in no rush to roll out further stimulus.