The title of Dr Bernanke’s post is: What did you do in the currency war, Daddy? 🙂
He says we need to look at both aspects of central bank easing:
The lessons of the Depression should inform today’s discussions of currency wars. An important failing of some currency war accusations is that they focus on one channel of monetary policy transmission—the effect on the exchange rate—while ignoring others. An easing of monetary policy does work in part by depreciating the currency, which, all else equal, tends to increase the easing country’s exports and reduce its imports. But all else is not equal, since an easing of monetary policy, by lowering interest rates at home, also stimulates domestic demand, employment, and incomes. Higher incomes in turn lead to more imports, as consumers and firms buy foreign as well as domestic products. For example, a weaker dollar might make foreign-made autos more expensive for Americans, which, on its own, tends to reduce U.S. auto imports. But if easier Fed policy leads to more jobs and higher incomes in the U.S., then Americans will spend more on autos in general, including imported cars. In short, monetary policy shifts affect net exports through both an exchange-rate channel and an income/demand channel, and these two channels work in opposite directions.
Because monetary policy has countervailing exchange-rate and income effects on foreign exports, the net effect of a monetary easing on foreign trade should be relatively modest. Indeed, in the case of the United States at least, the evidence is that the two effects largely offset. For example, according to recent Fed estimates (see Steve Kamin’s remarks at the Peterson Institute in November), a Fed easing that lowers ten-year Treasury yields by 0.25 percentage points increases U.S. net exports by 0.15 percent of GDP through the exchange-rate effect, but also lowers U.S. net exports by almost exactly the same amount through the income effect.
Of course, in general, there is no guarantee that the two effects of monetary policy on trade will exactly offset. Fortunately, additional protection against the threat of currency wars is enjoyed by countries that maintain flexible exchange rates. As Milton Friedman taught us long ago in his seminal 1953 essay, “The Case for Flexible Exchange Rates,” if exchange rates are free to adjust, countries can ensure that the overall amount of stimulus being felt by their own economy is appropriate, independent of what other countries are doing. Not all countries allow their exchange rates to be market-determined, but that is a policy choice they make. Fiscal policy (in either the easing country or its trading partners) provides an additional potential tool for offsetting the effects of changes in currency values on output and trade.
Well, I think the key issue is all these capital flows which were high during Depression and even before this crisis. All the emerging market policymakers want more and more of these flows during good times and encourage capital account openness. They may issue occassional warnings against rising flows but that is just that a mere warning. And then when cycle reverses and the flows start to shift bases, all kinds of complaints start over Fed policy and so on. Earlier central bank policy was hardly seen as an exogenous factor to these flows but has now become the main element.
They should have thought more clearly on both the gains and losses of joining the so called financial globalisation game..