Don’t worry about currency wars

January 22, 2013
speech yesterday in which he warned of "increased politicisation of exchange rates" and a potential "devaluation competition" between currency zones.

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Bundesbank president Jens Weidmann gave a speech yesterday in which he warned of “increased politicisation of exchange rates” and a potential “devaluation competition” between currency zones. The speech was timely: it came as the Bank of Japan doubled its inflation target to 2%, adding fuel to the strong trend of the past six months, where the euro has been appreciating while the yen has been getting significantly weaker.


It’s easy to see what Weidmann is worried about here: according to UniCredit economist Marco Valli, a 10% rise in the euro’s value will reduce eurozone GDP growth by 0.8%. On top of that, Weidmann is certainly right that the Bank of Japan has become increasingly politicized, and it’s less independent than it used to be.

But it’s worth having a bit of perspective, here. Firstly the euro is still much more competitive, against the yen, than it was before the crisis. Here’s the five-year chart, which shows that if there’s any competitive devaluing going on, then Europe did it first.


And of course neither currency zone is really engaged in any kind of currency war at all — what we’re seeing here is just the natural consequence of growth expectations and the interest rates that result from them.

Interestingly, Weidmann kicked off his speech — well before the “independence of central banks in danger” section — by quoting economist Michael Woodford with approval: “Not only do expectations about policy matter, but (…) very little else matters.” And really all we’re seeing in Japan is the first real effort from the central bank to wrestle with the implications of that fact, and to try to force the Japanese population into a stance where it genuinely expects inflation rather than deflation. (Deflation, of course, is something of a self-fulfilling prophecy: if you expect prices to fall, then you’ll hold on to your money rather than spend it, which causes prices to fall.)

What’s more, the fact is that Japan is more likely to fail than to succeed: like most Japanese policy actions for the past couple of decades, this one looks like it’s too little, too late. When it comes to 2% inflation, the reasonable stance of the Japanese population is “I’ll believe it when I see it” — which in turn means that they’re not going to do either, any time soon.

I’m sure that the Japanese government is happy about the weakening yen. But these are not the opening salvos in some new currency war: instead, the yen should be getting cheaper, just because the Japanese central bank should be doing everything in its power to increase inflation expectations and nominal GDP growth. This move is what you’d expect if the yen moved in line with the kind of monetary policy that makes sense.

And as for central bank independence — well, that battle was lost during the financial crisis, I’m afraid. When it comes to globally coordinated policy actions, central banks should not be independent, and in general the more independent they are, the less effective they have been. Nominal independence is a good thing: we don’t want the finance minister announcing interest rate moves, as used to happen in the UK until about 15 years ago. Central bankers are like judges: they should be technocrats, rather than politicians.

But the fact is that the last genuinely independent central banker was Alan Greenspan, who blew two enormous bubbles and was in many ways the prime cause of the global financial crisis — mostly by being far too laissez-faire, and keeping interest rates far too low for far too long. Central bank independence gave him the kind of credibility that he’d never have had if the president had been setting the exact same monetary policy, more’s the pity.

For the time being, then, let’s not worry too much about central bank independence or about currency wars. Global interest rates are very low and are going to stay very low for the foreseeable future, and that’s pretty much all the monetary policy that the world has. Currencies will fluctuate, of course. But don’t blame central bankers for that.


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