Chapter

Part I: Mechanisms for Promoting Global Monetary Stability

Author(s):
Mark Taylor, Peter Isard, Morris Goldstein, and Paul Masson
Published Date:
June 1992
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Author(s)
Morris Goldstein and Peter Isard 
References

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51

Many would argue that disciplined and effective policymaking is much more crucial than effective international coordination, on the grounds that the former would obviate the need for the latter.

53

In the words of the Delors Report (Committee for the Study of Economic and Monetary Union, 1989, para. 5), “the EMS has not fulfilled its full potential…. the lack of sufficient convergence of fiscal policies as reflected in large and persistent budget deficits in certain countries has remained a source of tensions and has put a disproportionate burden on monetary policy.”

54

Part II of this study discusses the issue of market-based fiscal discipline at greater length. Goldstein and Woglom (1992) present empirical evidence that market-based discipline operates within fiscal jurisdictions; in particular, U.S. states that have followed “more prudent” fiscal policies are able to borrow at lower cost. Empirical work has not yet demonstrated whether increases in market borrowing costs have led to corrective adjustments in fiscal imbalances.

56

In general, a necessary condition for such a mechanism to be effective is a credible agreement among the relevant policymakers to relinquish at least one degree of freedom in setting the various tax and expenditure levels. At least one parameter must be left free to adjust over time in response to excessive fiscal imbalances.

59

See Polak (1988) and the comments by Schlesinger (1988), Feldstein (1988), Gyohten (1988), and Hoffmeyer (1988) for a discussion of how and why economic policy objectives and policymaking have changed since the 1970s.

60

The desire to contain fiscal deficits, partly to improve control over broad monetary aggregates, and the objective of lowering income taxes for supply-side or other reasons, also contributed to the demise of fiscal activism in some countries.

61

Tax rates on value added or sales might be the most attractive candidates here, since they apply to flows on a daily basis, as distinct from income tax rates, which are typically applied to annual or quarterly flows.

62

Even so, automatic stabilizers are not totally immune from an inflationary bias. Mechanisms that promptly and automatically counteract any declines in private demand with fiscal stimulus—if sufficiently strong—could invite inflationary price and wage setting by the private sector, and could also weaken incentives to work. Polak (1988, p. 14) places this inflationary bias first on his list of reasons that fiscal activism proved unsatisfactory during the 1960s and 1970s.

63

For example, the breakdown of traditional money demand relationships that had underpinned monetary control during the late 1970s and early 1980s has complicated decision making.

64

Such emphasis can be found consistently in recent years in the World Economic Outlook and related IMF publications. See, for example, Feldman and others (1989), p. 1.

65

Feldman and others (1989) summarize the main themes in the literature on the political economy of structural reform.

66

Fischer (1988), Frenkel, Goldstein, and Masson (1990a), Kenen (1990), and Cooper (1990) provide overviews of the literature. With regard to semantics, it has become common to follow Artis and Ostry (1986), Horne and Masson (1988), and Bryant (1989), among others, in distinguishing between “cooperation” and “coordination.” Cooperation refers to the broad spectrum of collaborative interactions, including those related to the sharing and critical evaluation of information on current economic developments, forecasts, perceptions about economic structure, estimates of econometric parameters, policy intentions, and so forth. Coordination refers in a narrower sense to the process of conducting the policies of individual countries in ways designed to be mutually beneficial to all countries.

68

Frankel and Rockett (1988); but see also Ghosh and Masson (1991), who consider the case with both model uncertainty and learning by policymakers. The agreement reached at the 1978 Bonn Summit is sometimes cited as an example of counterproductive policy coordination, but as Solomon (1991) and others have noted, the global instability that followed this agreement should be blamed primarily on the tripling of the price of oil in the aftermath of the Iranian revolution, which could not have been foreseen by the parties to the Bonn agreement.

70

See Kenen (1990). Broadly speaking, the difference between the two connotations of policy coordination—policy optimization and regime preservation—appears to be a matter of degree. Policy optimization connotes a process in which countries rely continuously on formal analysis with macro-econometric models to identify “cooperative solutions” for setting their policy instruments. Regime preservation connotes a process in which countries focus more selectively and less formally on policy issues for which there is broad agreement that failure to coordinate poses a threat to global stability.

72

The Plaza Agreement involved only the Group of Five, but the process was expanded to the Group of Seven at the Tokyo Economic Summit in May 1986. See Crockett (1989), Funabashi (1989), Dobson (1991), and Solomon (1991) for historical discussions and evaluations.

73

Guth (1988), p. 215.

74

Ibid.

77

The proposals have included supplemental and special consultations with member countries, follow-ups to consultations, a broadening of the focus of surveillance, the use of quantitative indicators, recourse to greater publicity of IMF assessments, and a strengthened linkage between technical assistance and surveillance.

78

Polak (1988), p. 22. Gyohten (1988), p. 39, emphasizes that “the relationship between domestic demand growth and the external balance has been one of the major interests of the finance ministers and the governors of the central banks in recent discussions of the Group of Five and Group of Seven.”

79

A second limitation of the decentralized approach is that it needs to be supplemented with judgment to distinguish between good and bad external imbalances. Frenkel, Goldstein, and Masson (1990b) emphasize the importance of making such distinctions.

80

It has also addressed a number of regional issues in recent years and will continue to do so.

81

The Williamson and Miller (1987) blueprint or the Boughton (1989) reverse assignment guidelines. See Frenkel, Goldstein, and Masson (1989 and 1990a) for comparative analysis of formal rules based on counterfactual simulations.

82

Padoa-Schioppa (1988), pp. 24–25. See also Dobson (1991), p. 142.

83

See Frenkel and Goldstein (1988).

84

Other global indicators (such as the price of a basket of primary commodities) could also be helpful in gauging the appropriate overall stance of policies in the Group of Seven countries.

85

Group of Ten, Deputies (1985), para. 45. The proposal by the Deputies focused on procedures that could effectively follow up the Article IV consultations between the Fund and those “countries whose policies and performance are of greatest concern for the world economy….” In principle, the follow-up procedures could also be linked to other diagnoses conducted within the policy coordination framework.

87

The practice of commenting in official communiqués on the appropriateness or inappropriateness of prevailing exchange rate levels should consistently be sharply curtailed.

88

The key issues surrounding the advisability and practicality of adopting target zones for key exchange rates were discussed by the Executive Board in 1986. See Frenkel and Goldstein (1986) for a revised version of the background paper.

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