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Currency Wars: Perception and Reality

May 2013 Prof. Barry Eichengreen

2 Author

Global Financial Institute

Prof. Barry Eichengreen

George C. Pardee and Helen N. Pardee Professor of Economics and Political Science Department of Economics University of California, Berkeley Email: eichengr@econ.berkeley.edu Web Page: Click here Barry Eichengreen is the George C. Pardee and Helen N. Pardee Professor of Economics and Professor of Political Science at the University of California, Berkeley, where he has taught since 1987. He is a Research Associate of the National Bureau of Economic Research (Cambridge, Massachusetts) and Research Fellow of the Centre for Economic Policy Research (London, England). In 1997-98 he was Senior Policy Advisor at the International Monetary Fund. He is a fellow of the American Academy of Arts and Sciences (class of 1997). Professor Eichengreen is the convener of the Bellagio Group of academics and economic officials and chair of the Academic Advisory Committee of the Peterson Institute of International Economics. He has held Guggenheim and Fulbright Fellowships and has been a Professor Eichengreen was awarded the Economic History Associations Jonathan R.T. Hughes Prize for Excellence in Teaching in 2002 and the University of California at Berkeley Social Science Divisions Distinguished Teaching Award in 2004. He is the recipient of a doctor honoris causa from the American University in Paris, and the 2010 recipient of the Schumpeter Prize from the International Schumpeter Society. He was named one of Foreign Policy Magazine s 100 Leading Global Thinkers in 2011. He is Immediate Past President of the Economic History Association (2010-11 academic year). fellow of the Center for Advanced Study in the Behavioral Sciences (Palo Alto) and the Institute for Advanced Study (Berlin). He is a regular monthly columnist for Project Syndicate.

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Table of contents
1. 2. 3. Introduction............................................................................ 04 History Lessons...................................................................... 06 Reasoning by Analogy........................................................ 08 The Fog of War....................................................................... 11

4. References............................................................................... 12

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Currency Wars: Perception and Reality

Prof. Barry Eichengreen May 2013

Introduction
The problem of currency wars emerged as both a major concern and a source of confusion in early 2013. This once obscure term, first uttered by Brazilian Finance Minister Guido Mantega in response to the initial round of quantitative easing in the United States, came into widespread use following the formation of a new Japanese government under Prime Minister Shinzo Abe in late 2012. Mr. Abe indicated his intention of pursuing more aggressively reflationary monetary and exchange rate policies. This caused the yen to fall by 16% against the dollar and 19% against the euro between the end of September, when it became likely that Mr. Abe would take power, and mid-February 2013, when his appointment of a new Bank of Japan governor was imminent. Both the term and the concerns to which it referred therefore migrated to the front pages of the financial press. A host of additional policymakers some from emerging markets, such as Alexei Ulyukyev, first deputy chairman at the Russian Central Bank, and Bahk Jaewan, South Koreas finance minister, and others from advanced countries, like Bundesbank President Jens Weidmann warned of the adverse consequences of currency manipulation, Mr. Weidmann referring ominously to an undesirable politicisation of exchange rates.
1

toward products produced domestically at the expense of their neighbours a process that is ultimately futile insofar as it provokes retaliation. The only difference is There that in the case of a currency war, it is currency policy rather than trade policy that is being deployed. is, however, the analytical problem that while trade warfare destroys trade, creating a deadweight loss, offsetting devaluations simply return bilateral exchange rates to their initial levels with no enduring relative price effects. It is not clear that the analogy holds water, in other words. Similarly, there is the implication that a currency war can be said to have broken out when one or more countries engages in beggar-thy-neighbour competitive currency depreciation. But it is not clear in this

case whether all policies that result in currency or exchange-rate depreciation are necessarily competitive or beggar-thy-neighbour. in a currency war? Probably the most widely accepted definition of what constitutes a currency war is what countries did in the 1930s. Starting in 1931, one country after another its currency. Since currencies were depreciated Just because a country sees its exchange rate depreciate, is it necessarily engaged

The currency-war problem then became a key

topic at the meetings of the Group of Seven and Group of Twenty this February, where it was the subject of a carefully crafted set of communiques.2 But carefully crafted is not the same as clearly understood. The confusion stems from the fact that there is The no widely accepted definition of a currency war.

pegged to gold rather than to one another, countries depreciated by abandoning their pre-existing gold parities and allowing the domestic currency price of gold to rise. This consequently had the effect of also raising the domestic currency price of foreign currencies still pegged to gold at prevailing parities.3 As the story is conventionally told, this enhanced the competitiveness of countries depreciating their currencies but worsened that of the remaining gold-standard

term is not found in the leading textbooks of economics. There is the implication that a currency war is to be understood by analogy with the concept of a trade war, in which countries use trade policy to shift spending
1 2

 uoted in Randow and Schneeweiss (2013). Q See Group of Seven (2013) and Group of Twenty (2013). 3 The gold parity referred to the weight of gold of specified purity in the national monetary unit as specified by law or statute of a country said to be on the gold standard.

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countries.

This saddled the latter with overly strong

this was not well understood at the time. the conventional story. In part, contemporary misunderstanding

As a result,

exchange rates, creating pressure for them to respond tit for tat, as they ultimately did. After five years of competitive devaluations, exchange rates had returned to levels very close to those prevailing in early 1931. No

the point is not understood today by those advancing

arose

from

country succeeded in engineering a sustained improvement in competitiveness or, it is argued, achieved faster economic growth. other adverse But there were a variety of ranging from heightconsequences

the fact that interwar governments did a poor job of communicating their intentions. In part it arose from the fact that they did a poor job of implementing their policies; they could have done much more to accentuate the positive-sum aspects. And in part it arose from the fact that policymakers continued to view their current situation through the lens of past problems, failing to acknowledge that circumstances and therefore the appropriate policies had changed. The same factors are again present today, once more distorting the debate over currency policies. Policymakers have done a poor job communicating their intentions. They could have done more to accentuate positive-sum aspects of their actions. And, along with market participants, they have had a tendency to view policies through the distorting lens of past problems rather than current circumstances. Understanding these shortcomings of the present debate and correcting the resulting misapprehensions would go a long way toward solving the currency war problem.

ened exchange rate uncertainty that disrupted trade and production to the imposition of trade barriers and exchange controls by countries with overvalued currencies and weakened balances of payments.
4

It is not an

exaggeration to say that popular accounts blame the currency wars of the 1930s for aggravating the political tensions that made it more difficult for countries to collaborate in averting the military and diplomatic conflicts that led ultimately to World War II.5 In fact, this conventional narrative is oversimplified and misleading in important respects. This in turn means that todays debate over currency wars, because it is heavily informed by that narrative, is itself oversimplified and misleading. The modern literature emphasises that the policy changes associated with currency depreciation in the 1930s were not actually zero sum. To the contrary, those policy changes left all countries better off relative to the status quo ante, in which policy did not change and exchange rates did not move. But

These negative side effects were highlighted by Ragnar Nurkse (1944) in his influential contemporary account, which helped to clear the way for the Bretton Woods System of pegged-but-adjustable exchange rates. A recent, somewhat revisionist treatment is Eichengreen and Irwin (2010). 5 See for example Kennedy (1999).
4

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1. History Lessons
The background to the currency and exchange rate problems of the 1930s was, of course, the depression and deflation that started in 1929. In turn, that depression and deflation must be understood in the context of the gold standard, the monetary regime providing the structure for global monetary and financial affairs.6 The 1920s monetary regime was a gold-exchange standard rather than a pure gold standard. and governments operated under Central banks obligatIt might be thought that these policies of austerity, pursued in the face of depression and deflation, could not be sustained indefinitely. depreciate its currency. Indeed, they could not. Britain was the first major country to abandon them and It had a Labour government that could not agree on budgetary economies and high unemployment that rendered the central bank reluctant to raise interest rates further in order to stem capital flight.11 It suspended gold convertibility in September 1931, and the pound quickly fell from $4.86 to a low of $3.40, from which it recovered modestly before stabilising. Some two dozen other economies, principally The next shoe expansionmembers of the Commonwealth and Empire and British trading partners, quickly followed suit. Takahashi implemented an to drop was Japan, whose finance minister Korkiyo aggressively ary monetary policy that pushed down the yen startThe gold-exchange standard had been put back in place in the 1920s after roughly a decade of suspension, during which a number of current and former belligerents had suffered high inflation.
9

cut interest rates to encourage borrowing and spending. rency. Injecting liquidity in order to support a distressed Running budget deficits rekindled fears, inherGovernments were banking system threatened to fatally weaken the curited from the 1920s, that central banks would be pressured to monetise public debts. therefore forced to cut public spending and raise taxes in order to preserve confidence in their exchange rate commitments.

statutes

ing them to back their monetary liabilities with gold and convertible foreign exchange.7 Other than this provision for holding reserves in the form of foreign exchange, the regime had many of the features of a textbook gold standard. unrestricted. International financial flows were With the capital account of the balance

of payments open, domestic interest rates could not deviate significantly from those in the rest of the world. If domestic policymakers sought to depress rates further, capital would migrate to foreign financial markets where they were higher, causing the central bank to lose gold and foreign exchange reserves, and threatening the maintenance of gold convertibility. standard open-economy trilemma.8 This is the With exchange

rates pegged and capital markets open, central banks had limited monetary policy room for manoeuvre.

ing in December. full day in office.

President Franklin Delano Roosevelt He made that embargo permanent

embargoed gold exports on March 5th, 1933, his first in April and actively pushed up the dollar price of gold (pushed down the dollar exchange rate) from October. A number of U.S. trade partners, principally in Latin America, followed the dollar down. In January 1934, when the dollar was again stabilised against gold, the sterling/dollar exchange rate was back to roughly the level prevailing before September 1931. These efforts by Britain, the U.S., and Japan to depreciate sterling, the dollar, and the yen made life more

That experience in turn 48

shaped their expectations of risks and outcomes in the event that gold convertibility was again 32 suspended. As it happened, deflation rather than inflation turned out to be the immediate danger.10 freedom of action. When it developed after 1929, central banks and governments had little As long as they remained on the They could not unilaterally gold standard, they could not unilaterally take steps to stem the fall in prices.

As I argued in Eichengreen (1992), on which the remainder of this section draws. Typically at ratios of 33 to 40 per cent. 8 See Obstfeld, Shambaugh and Taylor (205). 9 The hyperinflations in Germany, Austria, Hungary, and Poland being extreme cases in point. 10 Describing the origins of the global deflation would take us too far afield; in this, see Bernanke (1995) and Eichengreen (2004). 11 That Labour government was succeeded by a National government which agreed on budgetary economies in August, but by this time it was too late.
6 7

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difficult for countries still on the gold standard.

(That

Takahashi

supplemented

his

reflationary

monetary

these are the same three countries currently under attack for being engaged in currency war is presumably a coincidence.) Having lost international competitiveness, these so-called gold-bloc countries saw their balances of payments accounts weaken and gold flow out of their central banks. Forced to raise interest rates to defend the reserve position rather than cutting them to support the economy, their depressions deepened. The result was not an equilibrium in either the economic or political sense. Economically, the condition of domestic financial institutions continued to worsen. Politically, opposition welled up against policies of austerity. The remaining members of the gold bloc proCzechoslovakia and Italy gressively fell by the wayside.

policy with an increase in public spending and instructions that the Bank of Japan purchase the resulting increase in the public debt. In the U.S., FDR used his bombshell message to the World Economic Conference of June-July 1933 to signal that he was unwilling to restore the gold standard. He was not prepared to privilege exchange rate stability (what he referred to in that message as the old fetishes of international bankers). The bombshell message may have made international cooperation on trade policy, security policy, and other matters more difficult, but it was a strong signal of a durable change in the monetary regime. These new policies had other important effects apart from their impact on exchange rates. Lower interest rates encouraged interest-rate sensitive forms of spending, in the U.K. for example, where the literature refers to the housing boom of the 1930s.12 equal, stimulated investment spending. squeeze on profits. They put By halting upward pressure on asset prices which, other things deflation, they stemmed the rise in debt burdens and By creating expectations of higher By givfuture prices, they encouraged households to shift consumption from the future to the present. ing central banks more freedom of action, they allowed them to intervene as lenders of last resort to limit bank distress.13 And insofar as the policies had these stabilising effects on the initiating country, they encouraged residents to spend more on foreign as well as domestic goods. Currency devaluation by an individual country may have had negative spillovers on its neighbours via the exchange rate channel, but it had positive spillovers via these interest rate, asset price, and expectations channels. Even if the negative exchange rate spillovers dominated when a single policy was taken in isolation, once the entire round of exchange rate changes was complete those negative spillovers were gone and only the positive interest rate, asset price, and expectation effects remained. These conclusions are, of course, inconsistent with the presumption that monetary policy was impotent in the 1930s because interest rates were at the zero lower

devalued in 1934, Belgium in 1935, Poland, France, the Netherlands, and Switzerland in 1936, returning their exchange rates to roughly the same levels against the dollar and sterling that prevailed before 1931. These competitive devaluations gave rise to a good deal of damaging exchange rate and financial volatility, but at the end of the day, it is said, they changed nothing. Such is the conventional narrative. The modern litera-

ture on exchange rate policy in the 1930s, beginning with Eichengreen and Sachs (1985), disputes this view that the exchange rate policies of the 1930s were without positive effect. While currency depreciation did switch demand toward domestic goods and away from their foreign substitutes, this was not its exclusive or even its principal impact. Rather, abandoning the commitment to peg the exchange rate allowed countries to replace the deflationary measures of the preceding period with reflationary monetary policies. Going off the gold standard was a credible way of signaling this commitment to prioritise price stability over exchange rate stability. Thus, six months after abandoning the gold standard, the Bank of England began cutting interest rates; by July 1932 these had reached the historically low level of 2%, inaugurating a new era of cheap money. standard with an explicit price level target.
12 13

The

Swedish government and Riksbank replaced the gold In Japan,

See Middleton (2010) for references. The cross-country evidence can be found in Grossman (1994).

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bound.14

Cross-country comparisons, calibration exer15

depreciation tended to dominate the positive spillovers transmitted through now lower interest rates and inflationary expectations. And the failure of policymakers to more clearly explain their intentions which were not to beggar their neighbours but to stabilize their own prices, economies, and financial systems caused their motives to be widely misunderstood. Thus, to the extent that there was a currency problem in the 1930s, it stemmed not from the decision of countries abandoning the gold standard to reflate, but from the failure of the countries of the gold bloc to do likewise. That failure was rooted, as noted above, in earlier experience with high inflation in France, Belgium, Poland, and the Central European countries that now clung to the gold standard with the help of exchange control.16 Policymakers and their constituents continued to perceive current economic and financial circumstances through the lens of past problems, with profoundly negative consequences. The problem in the 1930s, then, was not too much currency warfare, but too little.

cises, and national case studies, all using data from the 1930s, have combined to overturn this presumption. These studies highlight that interest rates were still significantly above zero prior to the change in policy regime; the change therefore gave central banks further room to cut. They remind us that even when nominal interest rates are near zero, central banks can still affect the real interest rates on which allocation decisions depend through the expectations channel by using forward guidance and asset purchases to create expectations of inflation rather than deflation. FDRs gold purchases and Takahashis government bond purchases can be thought of as analogous to quantitative easing, while the Bank of Englands commitment to keep interest rates low and the Riksbanks commitment to target the price level can be thought of as forward guidance. Modern studies thus conclude that countries abandoning the gold standard and allowing their currencies to depreciate recovered most quickly from the 1930s depression. ous. Recovery was, however, less than vigorCountries abandoning the gold standard and In Britain, for

depreciating their currencies were reluctant to implement aggressively reflationary policies. example, the Bank of England, concerned that the sterling exchange rate could collapse in the absence of its golden anchor, took three full quarters to convince itself that cheap money was safe and to cut interest rates to 2%. Even then it remained reluctant to cut them further. FDR, although depreciating the dollar by 50%, put the U.S. back on the gold standard at the now higher gold price in January 1934, contrary to the advice of John Maynard Keynes and others. In the subsequent Central banks period, the Treasury repeatedly sterilised gold inflows, limiting the growth of money and credit. and governments could not free themselves of the specter of the 1920s inflations and thus were reluctant to make full use of their newfound monetary room for manoeuvre. As a result, the beggar-thy-neighbour effect of currency
14

2. Reasoning by Analogy
Many of these points have analogues in the current debate. First, there is the view, implicit in the critiques of emerging market policymakers, that the unconventional monetary policies of advanced-country central banks are ineffectual. Monetary policy, they allege, has lost its potency now that interest rates are at the zero lower bound, just as it allegedly lost its potency in the 1930s. left. While there is less than full consensus on the efficacy of unconventional monetary policies at the zero lower bound, a growing body of literature studying different episodes suggests that such policies are not entirely without effect. Oda and Ueda (2005) and Ugai (2006) Only the negative side-effects, it follows, are

A presumption that is popularly cited as explaining Keyness discovery of the importance of using activist fiscal policy in a liquidity trap. 15 See, respectively, Bernanke and James (1991), Eggertsson (2008), and Romer (1992) for examples. 16 In the cases of Switzerland and the Netherlands, an additional motive was the desire not to jeopardise the position of Zurich and Amsterdam as international financial centres and the power of the banking lobby.

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analyse the impact of the Bank of Japans experience with quantitative easing between 2001 and 2006 and conclude in favor of small but noticeable impacts on medium- and long-term interest rates. Gagnon, Raskin, Remarche, and Sack (2011) report evidence, derived using a variety of methodological approaches, of positive effects of quantitative easing in the United States. Krishnamurthy and Vissing-Jorgensen (2010) look at low frequency variations in the supply of long-term Treasury bonds like those that would follow from quantitative easing and identify effects on interest rates on other relatively safe assets. Krishnamurthy and VissingJorgensen (2011), disaggregating further, find evidence of a signaling channel, an expected inflation channel, and a demand-for-long-term-safe-assets channel transmitting effects of both the first and second rounds of quantitative easing by the Federal Reserve. Looking back at Operation Twist in the 1960s, Swanson (2011) finds a small but significant impact on long-term interest rates operating through the portfolio rebalancing channel. Joyce, Lasaosa, Stevens, and Tong (2010) similarly find evidence of the operation of the portfolio rebalancing channel in the response of gilt prices to large-scale asset purchases by the Bank of England starting in March 2009. In a companion paper, Kapetanios, Mumtaz, Stevens, and Theodoridis (2010) conclude that those Bank of England purchases had an effect on the level of real GDP of around 1 % and raised the annual rate of CPI inflation by about 1 percentage points at its peak. Different studies consider different episodes and arrive at different point estimates, but as a group they are inconsistent with the view that unconventional monetary policies are without effect. This casts doubt on the assertion by some

the extent that central banks fail to complement open mouth operations pushing down the real exchange rate with open market operations and other asset purchases pushing down real interest rates, their neighbours will have correspondingly more reason to complain about the spillover effects on output and employment in other countries. But the exchange rate channel can also be important for signaling the policy authorities commitment to do what it takes to hit their inflation target. Svensson (2003) refers to the combination of a price-level target path, a zero interest rate commitment and, importantly, currency depreciation and a commitment to maintaining a level for the exchange rate as the foolproof way of ending deflation. Insofar as ending the deflation and avoiding the extended period of economic stagnation to which it can give rise is good not just for the initiating country but also its trade and financial partners, positive spillovers on other countries from depreciation of its exchange rate may still dominate. The studies referred to earlier in this section suggest that unconventional monetary policies also operate IMF through the portfolio rebalancing channel that leads to changes in the term structure of interest rates. (2011) finds that portfolio-rebalancing-related interestrate effects dominated the other negative cross-border spillover effects of QE1 and QE2 in other words, that the spillover impact on foreign output was positive on balance, the complaints of emerging market policymakers notwithstanding. Third, there are complaints about other negative side effects of unconventional monetary policies. The worry is that quantitative easing is encouraging renewed financial excesses in advanced countries and emerging markets alike. Risks are being allowed to build up.

observers based in emerging markets that such policies should simply be abandoned. Second, there is the view that unconventional monetary policies operate only by pushing down currencies, with beggar-thy-neighbour tries. goods. consequences for other counTo be sure, the exchange rate channel can be Insofar as this channel dominates, the effect

Equity markets in the United States are becoming richly valued as investors facing near-zero interest rates on safe assets stretch for yield by purchasing riskier instruments. The natural process of deleveraging by the household and financial sectors needed to produce a safer and more stable economy is being frustrated, the

important for switching expenditure toward domestic will be to beggar thy neighbour. Just as in the 1930s, to

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implication follows. This view has an analogue in the liquidationist U.S. policymak-

countries is not to jawbone the Federal Reserve and Bank of Japan to abandon quantitative easing, which would make for slower global and even possibly slower emerging-market growth, but to tighten their own supervision and regulation of financial markets. And to the extent that conventional regulatory instruments are not up to the task, emerging market policy makers can resort to capital inflow taxes and controls as foreign policies.20 Similarly, to the extent that low interest rates in the advanced countries encourage capital inflows into emerging markets that fan inflation, result in currency overvaluation, and create worries of overheating, the first-best response is not for officials there to pressure advanced country central banks to abandon their low interest rate policies but to adjust their own policies appropriately. The first-best response is for emerging Tightening fiscal policy It puts It means less markets to tighten fiscal policy. a second line of defence against financial excesses resulting from

response to the Great Depression.17

ers inside and outside the Fed worried that monetary accommodation would cause the development of an even larger Wall Street boom and bubble, leading subsequently to an even larger crash. Treasury that tem.18 Secretary was Andrew Mellon to restraint necessary Herbert Hoovers famously teach argued speculators

a lesson and purge the rottenness out of the sysSimilar views were advanced by Austrian and other Continental European economists from Hayek to Schumpeter. The modern literature on the Great Depression and on financial crises generally acknowledges that activism has risks but suggests that inaction in the face of crisis also has a downside. And to the extent that policy activism in response to crisis encourages financial excesses, these are best addressed by tightening supervision and regulation of financial markets, not by premature abandonment of supportive monetary policies. Some recent studies have questioned this separation principle they have questioned whether there exists an adequate array of monetary and regulatory instruments, so that monetary policy can be assigned to inflation and growth while regulation is assigned to financial stability.19 Maybe not, but if not the call should be for The objection here is that political constraints make it difficult to adjust fiscal policy, which is even more politicised than monetary policy. Maybe so, but then the call should be to make it easier to implement optimal adjustments of fiscal policy in emerging markets by strengthening automatic stabilisers or delegating The same goes for the complaint that unconventional monetary policies in the advanced countries are feeding financial excesses in emerging markets. The worry itself is not without foundation: As Chen, Filardo, He and Zhu (2011) show, quantitative easing in the United States has had a strong impact on credit growth, asset prices, and capital inflows in emerging markets. But the first-best response for policymakers in those
17 18

puts downward pressure on domestic spending. downward pressure on asset valuations. inflation, other things equal.

It means lower interest By reduc-

rates and, therefore, smaller capital inflows and less pressure for real exchange rate appreciation. stronger position going forward. ing sovereign debt burden, it puts the economy in a

policymakers to develop a wider array of instruments, not for central banks and governments to abandon the pursuit of all other valid goals in the interest of financial stability.

aspects of fiscal policy to an independent fiscal council, not to insist that advanced country central banks abandon the pursuit of price stability and recovery. The European Central Bank, spokesmen for which have complained about how the policies of other central banks have produced an uncomfortably strong euro exchange rate, is in a different position. In contrast to

See DeLong (1990). As quoted in Hoover (1952). 19 See Committee on International Economic Policy and Reform (2011). 20 This is the justification of capital inflow restrictions as a second-best form of financial regulation first developed, if I am correct, in Eichengreen and Mussa (1998).

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emerging markets, spokesmen for which have similarly complained that their exchange rates are uncomfortably strong, the Eurozone does not currently suffer from excessive inflation, frothy asset markets, or risk of economic overheating to the contrary. Eurozone inflation fell to 2% in January in line with the ECBs target, while core inflation at 1.2% is running below that. The fourth quarter of 2012 saw Eurozone GDP shrink by 0.6%. The standard policy prescription for a central bank engaged in flexible inflation targeting and worried by an overly strong exchange rate would be to join the currency wars. In the event, the ECB is not a conventional It has a mandate to inflation-targeting central bank. sue other goals.

but that it would only take additional steps to foster expectations of higher prices, lower real interest rates, and more spending 12 or more months in the future, that statement further heightened fears abroad that the new strategy was exchange-rate-centered and beggar thy neighbour. It may be that the essence of Japans new monetary policy strategy is the higher inflation target of 2% and that the Bank of Japan will make a concerted effort to achieve it, creating expectations of a higher future price level and encouraging additional spending by Japanese consumers something that would be more likely to have positive spillovers for other countries. fears of currency war. If so, this fact needs to be conveyed more clearly to avoid fanning

hold inflation at or below its target of 2% but not to purThe European public, whose approval lends the ECBs policies political legitimacy, continues to worry about inflation, which was yesterdays problem but is less obviously todays or even tomorrows. The analogy with the deflationary 1930s when central banks were haunted by the spectre of inflation in an earlier decade, in turn feeding their reluctance to take more aggressive monetary action is direct. How the ECB squares this circle will have implications not just for the global currency wars, but for the future of the Eurozone itself. A final analogy with the 1930s is the failure of policy makers in countries following unconventional monetary policies to adequately communicate their goals and strategies. In late December, Japans incoming prime minister made a series of comments about the desirability of resisting a strong yen that were interpreted in terms of the desirability of a weaker yen exchange rate. By focusing on the exchange rate rather than on measures to push up the price level, reduce interest rates, and encourage spending, those comments fanned fears that the strategy was intentionally beggar thy neighbour. In its first policy statement for 2013, the Bank of Japan then signaled its responsiveness to the new governments desires, but announced that it would consider further ramping up its programme of asset purchases only in 2014. By creating expectations that it might acquiesce to a weaker yen exchange rate

3. The Fog of War

Currency war is now a standard trope in journalistic accounts of monetary policy. But what exactly Not constitutes currency warfare remains unclear.

every economic policy that is associated with a weaker exchange rate is undesirable, and not every domestic policy associated with a weaker exchange rate necessarily redounds to the disfavor of other countries. Officials warning of currency wars would do better to distinguish positive from negative effects of the foreign monetary policies of which they complain. do well to consider the alternatives. They would Would emerging

markets really be better off if advanced countries at risk of deflation and recession abandoned their unconventional policies? Policymakers in emerging markets could spend less time complaining about advanced country policies and more time identifying and implementing an appropriate policy response. Policymakers Only in advanced countries, for their part, need to do a better job of communicating the intent of their policies. then are we likely to see our way through the fog of war.

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4. References
Bernanke, Ben (1995), The Macroeconomics of the Great Depression: A Comparative Approach, Journal of Money, Credit and Banking 27, pp.1-28. Eichengreen, Barry and Jeffrey Sachs (1985), Bernanke, Ben and Harold James (1991), The Gold Standard, Deflation and Financial Crisis in the Great Depression, in R. Glenn Hubbard (ed.), Financial Markets and Financial Crises, Chicago: University of Chicago Press, pp.33-68. Chen, Qianying, Andrew Filardo, Dong He, and Feng Zhu (2011), International Spillovers of Central Bank Balance Sheet Policies, BIS Paper no.66, pp.230-274. Committee on International Economic Policy and Reform (2011), Rethinking Central Banking, Washington, D.C.: Brookings Institution. DeLong, J. Bradford (1990), Liquidation Cycles: Old-Fashioned Real Business Cycle Theory and the Great Depression, NBER Working Paper no.3546 (December). Eggertsson, Gauti (2008), Great Expectations and the End of the Depression, American Economic Review 98, pp.1476-1516. Eichengreen, Barry (1992), Golden Fetters: The Gold Standard and the Great Depression, 1919-1939, New York: Oxford University Press. Eichengreen, Barry (2004), Understanding the Great Depression, Canadian Journal of Economics 37, pp.1-27. Eichengreen, Barry and Douglas Irwin (2010), The Slide to Protectionism in the Great Depression: Who Succumbed and Why? Journal of Economic History 70, pp.871-897. Eichengreen, Barry and Michael Mussa, with Giovanni DellArricia, Enrica Detagiache, Gian Maria MilesiFerretti, and Andrew Tweedie (1998), Capital Account Liberalization: Theoretical and Practical Aspects, Kennedy, David (1999), Freedom from Fear: The American People in Depression and War, 1929-1945, New Kapetanios, George, Haroon Mumtaz, Ibrahim Stevens, and Konstantinos Tehodoridis (2012), Assessing the Economy-wide Effects of Quantitative Easing, Economic Journal 122, pp.F316-F347. Joyce, Michael, Ana Lasaosa, Ibrahim Stevens, and Matthew Tong (2010), The Financial Market Impact of Quantitative Easing, Bank of England Working Paper no.393 (August). International Monetary Fund (2011), United States: Spillover Report 2011 Article IV Consultation, Washington, D.C.: IMF (22 July). Hoover, Herbert (1982), The Memoirs of Herbert Hoover: The Great Depression, New York: Macmillan Group of Twenty (2013), Communique of Meeting of Finance Ministers and Central Bank Governors, Moscow, 15-16 February 2013, http://en.g20russia.ru/ documents/. Group of Seven (2013), Statement by G7 Finance Ministers and Central Bank Governors (12 February), http://www.g8.utoronto.ca/finance/index.htm . Grossman, Richard (1994), The Shoe that Didnt Drop: Explaining Banking Stability During the Great Depression, Journal of Economic History 54, pp.654-682. Gagnon, Joseph, Mathew Raskin, Julie Remache, and Brian Sack (2011), The Financial Market Effects of the Federal Reserves Large-Scale Asset Purchases, International Journal of Central Banking 7, pp. 3-43. Exchange Rates and Economic Recovery in the 1930s, Journal of Economy History 49, pp.924-946. IMF Occasional Paper no.172, Washington, D.C.: IMF (August).

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York: Oxford University Press. Krishnamurthy, Arvind and Annette Vissing-Jorgensen (2011), The Effects of Quantitative Easing on Interest Rates: Channels and Implications for Policy, NBER Working Paper no.17555 (October). Krishnamurthy, Arvind and Annette Vissing-Jorgensen (2010), The Aggregate Demand for Treasury Debt, unpublished manuscript, Northwestern University. Middleton, Roger (2010), British Monetary and Fiscal Policy in the 1930s, Oxford Review of Economic Policy 26, pp.414-441. Nurkse, Ragnar (1944), International Currency Experience, Geneva: League of Nations. Obstfeld, Maurice, Jay Schambaugh, and Alan Taylor (2005), The Trilemma in History: Tradeoffs Among Exchange Rates, Monetary Policies and Capital Mobility, Review of Economics and Statistics 87, pp.423-438. Oda, Nobuyuki and Kazuo Ueda (2005), The Effects of the Bank of Japans Zero Interest Rate Commitment and Quantitative Monetary Easing on the Yield Curve: A Macro-Finance Approach, Bank of Japan Working Paper no. 05-E-6, Monetary Affairs Department, Bank of Japan (April). Randow, Jana and Zoe Schneeweiss (2013), Weidmann Says Exchange Rates Should be Determined by Markets, Bloomberg Business Week (15 February), http://www.businessweek.com/news/2013-02-15/weidmann-says-exchange-rates-should-be-determined-bymarkets. Romer, Christina (1992), What Ended the Great Depression? Journal of Economic History 52, pp.757-784. Ugai, Hiroshi (2006), Effects of the Quantitative Easing Policy: A Survey of Empirical Analyses, Working

Paper no.06-E-10, Monetary Affairs Department, Bank of Japan (October). Svensson, Lars (2003), Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others, Journal of Economic Perspectives 17, pp.145-166. Swanson, Eric T. (2011), Lets Twist Again: A HighFrequency Event-Study Analysis of Operation Twist and Its Implications for QE2, Brookings Papers on Economic Activity, Spring, pp. 151-88.

14 Disclaimer

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