Macroeconomic policies: new issues of interdependence

This paper discusses three novel macroeconomic policy challenges: the macroeconomic implications of China’s emergence; the implications of intensifying financial integration; and the interaction of Asia’s foreign exchange regime with monetary policy in the OECD area.

First, China may now be regarded as a price maker on some international commodity and energy markets. Its global impact nowadays stretches importantly not just into goods and commodity markets, but equally into world financial markets. The acquisition by the Chinese official sector of large amounts of foreign assets has raised the country’s global cyclical, financial and macroeconomic importance. Hence, China should not just be perceived as a producer of low-priced goods, but likewise of "cheap savings". China as a swing exporter/importer could destabilise commodity markets, with important repercussions for developing countries. Variations in China’s output gap will have important repercussions on key global interest and exchange rates.

Second, the wave of financial globalisation since the mid 1980s makes nationally oriented macroeconomic analysis increasingly meaningless and policies ineffective. Moreover, the prospective rise in institutional savings, fed by demographic trends and switches from PAYG to funded pension systems, together with the need to achieve decent capital returns despite the headwinds of shrinking labour forces in the OECD area, can be expected to intensify the macroeconomic effects of business cycles in both OECD and non-OECD areas. Faced with low returns, pension-fund strategy committees and individual investors have been increasingly turning to hedge funds, searching for uncorrelated asset classes with a focus on absolute (rather than benchmark-oriented) returns. These new actors may require policy attention as they have probably introduced amplifiers to global credit cycles, with potentially harmful effects to both capital-importing countries and investment returns in capital-exporting countries.

Third, Asia’s high-reserve policy and limited exchange rate flexibility have relevant implications and certain repercussions for main OECD countries. Asia is unlikely to drop the dollar peg - explicit or implicit - as long as China does not. Sizable current account surpluses have translated into a sustained increase in US Treasury bill purchases on the part of East Asian central banks. The pairwise interaction between the Asian producer and the American consumer, with Asia delivering "cheap" goods (keeping US consumer price inflation down) and "cheap savings" (keeping US interest rates down), has permitted an accommodative US monetary stance, with the euro as the "residual" degree of freedom in the global monetary system. In turn, exchange rate pegs have clearly been causing problems in Asia, not only through trade friction, but also by exacerbating the country’s accelerating liquidity growth/overheating economic growth problems.