Do we need a single global currency?
That question would have seemed quixotic to many analysts of global economics and finance a few years ago. The suggestion that we do, indeed, need a global unit of account—made by a few brave mavericks over the years—would have been, in fact, was, scoffed at and derided as hopelessly unrealistic at best and highly undesirable at worst.
These maverick economists and bankers saw merit in eliminating the destabilizing and destructive volatility in global trade, investment and financial capital movement patterns induced or exacerbated by the excessive volatility of flexible exchange rate regimes—each of which tries to achieve its own national objective without regard to the potentially damaging spillovers caused to others. The greatest of these free thinkers is my own guru, the Nobel economist Robert Mundell. Taking a leaf from former Federal Reserve chairperson Paul Volcker, Mundell has often repeated the mantra: “A global economy needs a global currency.”
During the high water mark of the great moderation, a period of roughly two decades before the great financial crisis, a certain hubris had set in among central bankers and conventional macroeconomists: the notion that the “modern” policy of inflation targeting by independent national or supranational central banks, linked by a series of bilateral flexible exchange rates, would suffice to stabilize the global macroeconomy.
In this benign view, sharp recessions, and, more generally, excessive volatility of output, unemployment and the inflation rate, were a thing of the past. The economics of the conduct of monetary policy was now a science, it was breathlessly averred. In reality, it was a cult, presided over by central bankers as high priests. The army of economists who crunched increasingly complicated mathematical models to guide the priests of the cult were votaries at the altar.
It all came terribly unstuck with the build-up of asset price bubbles that were completely missed by inflation-targeting models fixated on consumer price inflation and by a faith in the ability of financial markets to function efficiently, which proved overly optimistic. As the crisis unspooled, advanced economy central bankers, led by the US Federal Reserve’s Ben Bernanke, unleashed an arsenal of new weapons, known collectively as unconventional monetary policies (UMPs), to bring the global economy back from the brink.
A few prescient voices warned early that such adventurous new policies might, perhaps even would, have seriously undesirable side-effects, in the form of damaging spillovers to emerging market economies, in the form of excessive volatility in capital flows and associated movements in their exchange rates. Such lone voices in the wilderness included the late Ronald McKinnon, a maverick economist in his own right, and India’s own Raghuram Rajan.
From his bully pulpit at the Reserve Bank of India, Rajan has argued that, as advanced economy UMPs were harming emerging economies—as evidenced during the taper talk crisis of 2013, which badly affected India, among others—the right thing for the Fed and others to do would be to take account of these harmful spillovers when they formulated monetary policy. Bernanke, in particular, was dismissive of such arguments, and, famously, has exchanged sharp words with Rajan on a number of occasions since stepping down as Fed chairperson.
To be fair to Bernanke, the US is not going to care about the spillovers of its policy on other economies unless there is a demonstrable spillback on the US itself.
Not only is altruism not part of the Fed chairperson’s job, he or she is explicitly mandated to focus on the US economy, not worry about what is happening in India or elsewhere.
Crucially, despite the best efforts to quantify them—including by this writer and several other economists—such harmful spillbacks have been notoriously difficult to tease out of the data and to assess in terms of their economic significance. Yet, despite this challenge, Bernanke’s successor, Janet Yellen, appeared to suggest in recent remarks that emerging economy spillbacks were a real concern. Critics of the Fed’s policy go further, and argue that, by ignoring them, the Fed made a premature decision to raise rates last December, and is now scrambling to recover.
Mundell has argued repeatedly that the types of crises and mini-crises the global economy has suffered since the collapse of the Bretton Woods system of fixed exchange rates in 1971 are only to be expected, given the absence of any kind of global monetary order since then. Despite the faults it might have had, including the need for sharp and painful adjustments to shocks in the face of slow price adjustment, the Bretton Woods system gave the world a monetary order, within which trade, investment and portfolio allocation decisions could be made without the distorting effect of uncertain, uncoordinated and volatile exchange rates. The quarter-century after the end of World War II, until the collapse of Bretton Woods, was something of a golden period, at least for the advanced economies; it is plausible to argue that the system of fixed exchange rates played its role. In a world even more globalized today, and even more subject to destabilizing volatility, Mundell’s proposal to create a global unit of account surely merits our serious consideration.
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To read Vivek Dehejia’s previous columns, go to www.livemint.com/vivekdehejia