Evaluating Causes, Cures and Global Imbalances
5. Nature of the adjustment mechanisms THE NEW POLICY ENVIRONMENT With the onset of ﬂoating exchange rates in 1973, the current account position replaced the overall balance of payments as an indicator of the need for adjustment in a country’s macroeconomic policies. One point we make in this chapter is that in the new environment of ﬁnancially integrated markets the distinction between internal balance and external balance made in the theory of economic policy may no longer be relevant: the latter balance, however deﬁned, can no longer usefully or indeed reliably be targeted by traditional instruments such as monetary and ﬁscal policy. Policy-makers may also ﬁnd themselves in the unfamiliar position of having the capital account drive the current account, rather than the reverse causation implied in old Keynesian models, and this can lead to policy confusion as we have seen with the debates about the causes of the US current account deﬁcit and who bears the onus for its correction. A lack of utility in current account targeting is implicit in the intertemporal theory of the balance of payments, as expressed for example by Sachs (1981) and by Frenkel and Razin (1987). The process of global ﬁnancial integration makes the essential assumptions of that theory more nearly realistic. From a policy viewpoint, the basic trouble is that the current account imbalances are being measured, and concerns about them assessed, at the wrong level. This conclusion is the message that emerges from Alan Greenspan’s analysis of the implications...
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