Last week’s press briefing comments by ECB President Mario Draghi to the effect that “The exchange rate is not a policy target but it is important for growth and price stability,” had put markets on their guard that the central bank was taking note of recent currency movements, and especially those vis-à-vis the Japanese yen.
As ever, Europe failed to speak with one voice. French President Francoise Hollande, putting himself at the head of the Euro periphery, stated that it was natural for a currency union to have an exchange rate policy in order to avoid the impact of violent and often excessive fluctuations in value. No sooner was this said than a spokesman for the German government emerged to deny that there was any question of the Euro being overvalued. This week the government view has been backed up by the head of Germany’s Bundesbank, Jens Weidemann who also stated there was no question of the currency being overvalued, and warned against the inflationary consequences of any devaluation.
Obviously, one can deduce from all this nay saying that a pretty serious debate is going on somewhere in the background, but that at this point Germany is more sensitive to possible suggestions that it is engaging in currency manipulation than it is to any pleas for help from exporters trying to hold their ground in the key Asian markets.
Quite different is the situation in Japan, where Prime Minister Shinzo Abe is unabashedly trying to talk his currency down. Evidently he is not convinced that export prices don’t matter. But Abe isn’t simply forcing down the yen to improve export competitiveness, much as Japan needs this. He is also following the advice of Swedish economist Lars Svensson, who over a number of years now has been advocating currency weakening as the key tool in his “foolproof way” to beat deflation. As defined by Svensson the infallible technique consists of a price-level target path, currency depreciation and commitment to a currency peg and a zero interest rate until the price-level target path has been reached.
Here we won’t dwell on just why the technique needs to be “foolproof” – we trust there is not some sort of subtle comment here on the collective capacities of central bankers – or even on whether or not it is going to work in the case of Japan. We would simply observe that his framework is the key intellectual prop behind the argument that at this point Japan is different, and hence a blind eye can and will be turned to what is going on there. Whether Japan will ultimately succeed in generating “benign” inflation or will end up sowing the seeds of its own ruin, only time will tell.
Backing for this idea can be found in this week’s G7 statement where the group simply reaffirmed that its “fiscal and monetary policies have been and will remain oriented towards meeting our respective domestic objectives using domestic instruments, and that we will not target exchange rates.” Since Japan is targeting an inflation rate and not a given value for its currency Japan’s Finance Minister Taro Aso was able to claim victory – he asserted the statement acknowledged his country wasn’t targeting exchange rates with its monetary policy – and the yen unceremoniously resumed its downward path.
This approach will work so long as Japan continues to be seen as a special case. But Europe’s growth problem is scarcely better. With domestic demand severely weakened all along the periphery, it is hard for the PIG countries to make progress however hard they strive to do so. The aggregate demand numbers just don’t add up, and the whole bloc needs to export more externally.
Portugal is a good example. Exports were up 5.8% in 2012, but to no avail since the economy still contracted by around 3%. Significantly this export growth wasn’t evenly distributed. Exports to countries outside the EU shot up by 19.8% while those to EU countries rose a bare 1%. This means the relative value of the Euro is going to matter, and that the bottom line is we should expect the debate about exchange rate policy to be revisited, and most likely in the not too distant future.
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