It Is the Aggregate Demand, Stupid
Karl Smith: Apostle to teh Ignoramuses

Monetary Easing Achieved Through "Competitive Devaluation" Is Better than No Monetary Easing

Mark Thoma three hundred miles north along The Five informs me that Barry Eichengreen five feet north through the office wall has written yet another good column:

Barry Eichengreen: Competitive devalution to the rescue: In the 1930s, it is true, with one country after another depreciating its currency, no one ended up gaining competitiveness relative to anyone else. And no country succeeded in exporting its way out of the depression, since there was no one to sell additional exports to. But this was not what mattered. What mattered was that one country after another moved to loosen monetary policy because it no longer had to worry about defending the exchange rate. And this monetary stimulus, felt worldwide, was probably the single most important factor initiating and sustaining economic recovery.

It is true that the process was disorderly and disruptive. Better would have been for the countries concerned to co-ordinate their moves to a more stimulative monetary policy without sending exchange rates on a roller-coaster ride. But, not for the first time, they failed to agree. Those in the most precarious positions had no choice but to pursue the new policy unilaterally.

In any case, monetary easing achieved through a process of "competitive devaluation" was better than no monetary easing. Those countries that shifted in this direction first were also first to recover. But in the end – the end coming after an excruciating five years – they had all moved in the requisite direction, and they all began to recover.

This, in a nutshell, is our situation again today. Sterling's weakness reflects, in part, the exceptional severity of the British slump. But it also reflects the fact that the Bank of England has moved further and faster in the direction of quantitative easing than any other central bank. With the Old Lady buying up British Treasury bonds hand over fist as a way of bringing interest rates down, it is no surprise that sterling should fall. It is no surprise, that is, given the failure of the ECB and the Fed to move as quickly to quantitative easing. And, in the event, this aggressive quantitative easing is precisely the medicine needed by a British economy on life support.

Now the Swiss National Bank has followed suit, announcing a shift to quantitative easing in response to mounting fears of deflation. It implemented that policy last week by buying foreign exchange and corporate bonds, rather than government debt as in Britain, but the net result was the same. It was a sharp fall in the exchange rate, by 3%, on the first day of the new regime.

So sterling and the franc are falling because their central banks are administering precisely the treatment that their economies require. Will other central banks, seeing their own currencies strengthen, conclude that the threat of deflation has grown more immediate and also now move quickly to quantitative easing? If so, exchange rates against sterling and the franc will revert to more normal levels. And, with quantitative easing all around, the world will receive the additional dose of monetary stimulus that it desperately needs.

Better of course would be for the major countries to agree to co-ordinate their monetary policy actions. Then exchange rates will not move by large amounts in one direction today and the opposite direction tomorrow. There will not be further disruptions to the global trading system. There will not be international recriminations over beggar-thy-neighbour policy. The G20 countries could even make such co-ordination part of their agreement at the 2 April summit in London. Or not.