Beggar thy neighbor interest rate policy

Ronald McKinnon of Stanford University writes in this paper that US has not learnt from its past mistakes.

In Great Depression, it was one of the first countries (after UK) to abandon gold standard leading to a trigger of exchange rate devaluations or beggar thy neighbour exchange rate policies. In this crisis, by keeping rates at zero it is leading to beggar thy neighbour interest rate policies. These low rates lead to capital flows in other economies threatening their growth potential. This has also led to rise in prices of commodities leading to inflation in emerging economies which are more dependent on them. The issue of carry trades also crops up. Overall, the main idea is US policies have a much bigger role to play in international economics than it realises.

He also adds that Fed policies have not led to bank lending as at zero% interest rates there isn’t any incentive to lend. It also puts savings and pensions of people in jeopardy.

A nice paper giving a different perspective.

Mckinnon also talks about Keynes proposal to limit carry trades and speculative flows:

In this halcyon (“high” Bretton Woods) period, however, financial capital could not move  freely. Indeed, one of the principal architects of BW was John Maynard Keynes. He was  obsessed with the damage that “hot” money flows in anticipation of exchange rate changes, and  what we now call “carry trades”, responding to interest differentials—had done in the interwar  period.  The Keynes Plan of 1944 for an International Clearing Union envisioned that all  crosscurrency payments for imports and exports would be cleared multilaterally through central  banks. Open foreign exchange markets made by commercial banks, which inevitably must bet on  which way exchange rates and interest rates might move, would no longer exist. With hot money  flows suppressed, Keynes wanted each national government to have national macroeconomic  autonomy in monetary and fiscal policy without being constrained by the foreign exchanges. 
In 1945, however, it was the White Plan, named after the American Harry Dexter White,  that mainly prevailed. Private foreign exchange markets were re-opened with the dollar used as  the clearing currency in interbank trading between any two countries outside the communist  bloc. However, Keynes’s influence was still strongly felt in the IMF articles of Agreement.  All  member countries remained, and remain today, free to impose capital controls on international
payments. Their currency convertibility obligation under Article VIII only covers payments for  current account transactions: importing and exporting as well as payments of interest and  dividends must be kept free of exchange controls. In 1945, almost all IMF members opted to  retain, or impose, capital controls in some form.  Only the United States chose not to do so.  Foreigners were left free to transact in the New York financial markets, for example, by buying  or selling U.S. Treasury bonds. Indeed for the dollar based system of international payments to
work, the U.S. itself could not impose capital controls.    

Well, knowing history is so important. If Keynes had prevailed, it would have been a very different world for currency markets.


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