By Pierpaolo Benigno, Federica Romei
http://www.nber.org/papers/w17944
How do monetary policy and the exchange rate affect the adjustment? What happens in a monetary union in which some countries are forced to deleverage? What if mistaken policies are followed?
Deleveraging is a costly process: it forces debtor countries to cut spending sharply and depresses demand. A healthy correction would involve an increase in spending in the rest of the world. But international relative prices are not immune to the adjustment, and the exchange rate can in fact accompany the process and attenuate its costs.2 If the fall in demand is sharper for domestic goods, the excess supply of these goods globally lowers their prices relative to foreign prices and expands overall demand for them, thus easing the depressive impact of deleveraging. These changes in relative prices can be achieved by depreciation of the deleveraging country’s currency, but if exchange rates are fixed, as in a monetary union, some deflation there should achieve adjustment but at the cost of a longer contraction. In the longer run, a country that has paid down part of its debt is richer than at first, since there is less debt to serve, so the demand for domestic goods is relatively higher. The exchange rate swings from short-term depreciation to appreciation in the long run.
Other relative price movements are also critical to a smooth adjustment. These are intertemporal relative prices such as real interest rates. The debt of some agents corresponds to assets of others, either domestic or foreign. In the course of the adjustment, to reduce their asset holdings creditors should increase consumption, which could be favored by a fall in the real interest rate. Given that the real exchange rate depreciates in the short run and appreciates in the long run, the real interest rate of the deleveraging country falls by more.
In shorts, a smooth adjustment to a deleveraging shock in some part of the world economy requires short-run depreciation and long run appreciation of the deleverager’s real exchange rate and a sharper short-term fall in its real interest rate than in the rest of the world. Constraints or policies that impede these mechanisms can only prolong the contraction. For instance, the zero-lower-bound constraint on the nominal interest rate can keep the real rate from falling when prices are sticky, causing a longer contraction. And, fixed-exchange-rate or controlled-rate policy regimes can also lead to a more protracted stagnation. A monetary union falls into the latter category, since sluggish adjustment in relative prices makes deleveraging in some countries inherently costly. Other policies, such as keeping nominal interest rates too high or exiting too early from the zero lower bound, can be even more damaging.
Conclusion
We have examined the international implications of debt deleveraging in one country within the world economy or a monetary union. Deleveraging reduces aggregate demand and may lead to recession, as economic agents save to repay the debt. There are interesting international spillovers through trade and the exchange rate. A smooth adjustment requires movements in two relative prices; namely the exchange rate and the real interest rate. The exchange rate, which is an international relative price, should move in such a way as to rebalance resources across countries. The deleveraging country’s currency will depreciate in the short run and appreciate in the long-run. This depends critically on home bias in consumers’ preferences. Since in the short run agents who are paying down their debt have less resources for consumption, the price of home goods should fall relative to the foreign, and a fall in the exchange rate will assist this adjustment. Once the debt has been repaid, however, agents have more resources to spend and in particular on domestic goods. The other important relative price in the adjustment, the real interest rate, will come down and fall more sharply in the deleveraging country.
In this study, we have concentrated on the role of monetary policy and alternative exchange-rate regimes in mitigating or amplifying the costs of debt deleveraging. The zero lower bound on nominal interest rates is a significant constraint in our analysis, because the natural rate of interest falls substantially. Floating exchange rates help ease the recession, whereas under fixed exchange rates international relative prices move sluggishly.
Deleveraging is a costly process: it forces debtor countries to cut spending sharply and depresses demand. A healthy correction would involve an increase in spending in the rest of the world. But international relative prices are not immune to the adjustment, and the exchange rate can in fact accompany the process and attenuate its costs.2 If the fall in demand is sharper for domestic goods, the excess supply of these goods globally lowers their prices relative to foreign prices and expands overall demand for them, thus easing the depressive impact of deleveraging. These changes in relative prices can be achieved by depreciation of the deleveraging country’s currency, but if exchange rates are fixed, as in a monetary union, some deflation there should achieve adjustment but at the cost of a longer contraction. In the longer run, a country that has paid down part of its debt is richer than at first, since there is less debt to serve, so the demand for domestic goods is relatively higher. The exchange rate swings from short-term depreciation to appreciation in the long run.
Other relative price movements are also critical to a smooth adjustment. These are intertemporal relative prices such as real interest rates. The debt of some agents corresponds to assets of others, either domestic or foreign. In the course of the adjustment, to reduce their asset holdings creditors should increase consumption, which could be favored by a fall in the real interest rate. Given that the real exchange rate depreciates in the short run and appreciates in the long run, the real interest rate of the deleveraging country falls by more.
In shorts, a smooth adjustment to a deleveraging shock in some part of the world economy requires short-run depreciation and long run appreciation of the deleverager’s real exchange rate and a sharper short-term fall in its real interest rate than in the rest of the world. Constraints or policies that impede these mechanisms can only prolong the contraction. For instance, the zero-lower-bound constraint on the nominal interest rate can keep the real rate from falling when prices are sticky, causing a longer contraction. And, fixed-exchange-rate or controlled-rate policy regimes can also lead to a more protracted stagnation. A monetary union falls into the latter category, since sluggish adjustment in relative prices makes deleveraging in some countries inherently costly. Other policies, such as keeping nominal interest rates too high or exiting too early from the zero lower bound, can be even more damaging.
Conclusion
We have examined the international implications of debt deleveraging in one country within the world economy or a monetary union. Deleveraging reduces aggregate demand and may lead to recession, as economic agents save to repay the debt. There are interesting international spillovers through trade and the exchange rate. A smooth adjustment requires movements in two relative prices; namely the exchange rate and the real interest rate. The exchange rate, which is an international relative price, should move in such a way as to rebalance resources across countries. The deleveraging country’s currency will depreciate in the short run and appreciate in the long-run. This depends critically on home bias in consumers’ preferences. Since in the short run agents who are paying down their debt have less resources for consumption, the price of home goods should fall relative to the foreign, and a fall in the exchange rate will assist this adjustment. Once the debt has been repaid, however, agents have more resources to spend and in particular on domestic goods. The other important relative price in the adjustment, the real interest rate, will come down and fall more sharply in the deleveraging country.
In this study, we have concentrated on the role of monetary policy and alternative exchange-rate regimes in mitigating or amplifying the costs of debt deleveraging. The zero lower bound on nominal interest rates is a significant constraint in our analysis, because the natural rate of interest falls substantially. Floating exchange rates help ease the recession, whereas under fixed exchange rates international relative prices move sluggishly.
We have also shown that alternative times of exit from the zero lower bound can have a major impact on real economy, as can mistaken policies of keeping interest rates too high for too long.
We have analyzed a very simple two-country open-economy model; the consequent limitations are essentially the price paid for the simplifications used. First of all, the debt constraint in this model is exogenous and deleveraging is interpreted as a progressive lowering of this limit. It would clearly be interesting to have more endogeneity along these dimensions, but this limitation is shared with other recent works in the field. Second, in the real world debt deleveraging affects a variety of agents in the economy: households, banks, firms and governments. Distinguishing them in the model would enhance realism and possibly enable us to differentiate the effects of deleveraging on the economy according on which agents are paying down their debt. It is likely that, however, the qualitative results implied by our simple framework would hold also in a more complex context.
Finally, the asset market structure has been kept very simple — only one asset traded internationally. This is a significant limitation, since the portfolio position of a country is much more complex and diversified involving assets and liabilities, in different currencies and instruments ranging from equity to debt. This is an interesting avenue for future research.
The paper focuses on the positive implications of deleveraging under alternative monetary policies. An open issue, which we plan to address in future work, is the optimal design of monetary policy given the objective of maximizing welfare in the world economy.
We have analyzed a very simple two-country open-economy model; the consequent limitations are essentially the price paid for the simplifications used. First of all, the debt constraint in this model is exogenous and deleveraging is interpreted as a progressive lowering of this limit. It would clearly be interesting to have more endogeneity along these dimensions, but this limitation is shared with other recent works in the field. Second, in the real world debt deleveraging affects a variety of agents in the economy: households, banks, firms and governments. Distinguishing them in the model would enhance realism and possibly enable us to differentiate the effects of deleveraging on the economy according on which agents are paying down their debt. It is likely that, however, the qualitative results implied by our simple framework would hold also in a more complex context.
Finally, the asset market structure has been kept very simple — only one asset traded internationally. This is a significant limitation, since the portfolio position of a country is much more complex and diversified involving assets and liabilities, in different currencies and instruments ranging from equity to debt. This is an interesting avenue for future research.
The paper focuses on the positive implications of deleveraging under alternative monetary policies. An open issue, which we plan to address in future work, is the optimal design of monetary policy given the objective of maximizing welfare in the world economy.
No comments:
Post a Comment
Agrega tu comentario u opinión. Add your comment.
Si deseas puedes usar perfil anónimo o identificarte.