Monday, November 15, 2010

Econbrowser On The G20 Meeting

Menzie Chinn explains, in theoretical terms, about QE2, currency wars and capital controls:

Losing the Battle, Winning the War?

…I have also been thinking about the anger with which the policymakers and economists in the rest-of-the-world (as well as certain US politicians [5]) have greeted QE2 with. In some ways, the fact that they are angry speaks volumes about the effectiveness or ineffectiveness of QE2. (In other words, to criticize QE2 as having no effect, and then to be angry that it is being undertaken, are internally inconsistent views.)

My view is that anger at the US position is currently being driven by an understanding that QE2 has been surprisingly effective at depreciating the dollar, and that the rest-of-the-world has limited scope in countering that depreciation. In a game theoretic context, we usually think of competitive devaluation as a form of the prisoner’s dilemma, where the devalue option dominates the no-devalue option, and both parties end up with a devalued currency, but no net improvement because countries cannot all devalue against each other…

…However, because of the radically different post-recession economic conditions facing the US and China, the payoff matrix has changed. The US gains by allowing the currency to depreciate against the rest-of-the-world, but the Chinese (and to a lesser extent the other BRICs) have competing goals of maintaining rapid growth, high exports, and stable inflation. This point has become apparent as inflation has surged in China. [6] The conflicting goals Chinese policymakers face can be illustrated by reference to the Mundell-Fleming model. (See this post for detail)…

If you want to suss out the policy options that are facing the major economies right now, you could do worse than to read this.

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