“The topic of this session is lessons learned from the financial crisis,” said Chairman of the Federal Reserve Ben Bernanke at the beginning of a speech he delivered on Monday at the London School of Economics. “For me, perhaps the central insight is that the recent crisis, despite its many exotic features, was in fact a classic financial panic–a systemwide run of ‘hot money’ away from assets whose values suddenly became uncertain.”
While he does not have unanimous support from policymakers, or even other central bankers, Bernanke’s position on the recent economic crisis is well understood. The Fed’s dual mandate and Bernanke’s unconventional policy decisions — chiefly to purchase assets and publicly link policy choices to economic conditions — has been the subject of many speeches he has given over the past few years.
Addressing this pattern, Bernanke used his time in England to “tackle a different and more recent issue that has arisen in the aftermath of the crisis–the issue of whether, in the widespread easing of monetary policies, we are seeing a competitive depreciation of exchange rates.”
Bernanke begins on the eve of the Great Depression and ends on the doorstep of the very real concern being articulated by emerging economies all over the world. Partially due to Bernanke’s influence — and partially due to the effectiveness of his policies — central bankers in struggling developed economies around the globe have pursued accommodating and expansionary monetary policies.
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Historically, this pursuit and the unchecked depreciation of currencies yielded a “beggar-thy-neighbor” global economy, where central banks attempted to spur domestic growth at the expense of international trade partners. However, as Bernanke argues, when expansionary monetary policy is pursued by developed economies in a more competent way than perhaps it was in the 1930s, the system shifts from a destructive negative- or zero-sum game to a positive-sum game.
Bernanke highlights the awkward wholesale abandonment of the gold standard in the 1930s for effectively setting false precedent. “Although it is true that leaving the gold standard and the resulting currency depreciation conferred a temporary competitive advantage in some cases, modern research shows that the primary benefit of leaving gold was that it freed countries to use appropriately expansionary monetary policies,” he said in the speech.
Bernanke continued: “By 1935 or 1936, when essentially all major countries had left the gold standard and exchange rates were market-determined, the net trade effects of the changes in currency values were certainly small. Yet the global economy as a whole was much stronger than it had been in 1931. The reason was that, in shedding the strait jacket of the gold standard, each country became free to use monetary policy in a way that was more commensurate with achieving full employment at home.”
Using monetary policy to pursue full employment is part of the Fed’s dual mandate. Bernanke adds: “Moreover, and critically, countries also benefited from stronger growth in trading partners that purchased their exports. In sharp contrast to the tariff wars, monetary reflation in the 1930s was a positive-sum exercise, whose benefits came mainly from higher domestic demand in all countries, not from trade diversion arising from changes in exchange rates.”
The operative difference in current monetary policy is that its primary function is to boost domestic demand, not to devalue currency. The affect on currency is simply a side affect. This was a central part of the concern that surrounded the rapid devaluation of the yen recently, and what prompted the Group of Seven central bankers and finance ministers to issue a joint statement agreeing to refrain, as Bernanke put it, “from actions focused on achieving competitive advantage by weakening their currencies and reaffirming that fiscal and monetary policies would remain oriented toward meeting domestic objectives using domestic instruments.”
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