Guest Contribution: “Oceans Apart? China and Other Systemically Important Economies”

Today we are pleased to present a guest contribution written by Hongyi Chen, Senior Advisor at the Hong Kong Institute for Monetary and Financial Research, and Pierre Siklos, Professor of Economics at Wilfrid Laurier University.

There is a long tradition in economics suggesting that each country’s economic policies should be governed by the motto: “keep your own house in order”. For example, the textbook depiction of a flexible exchange rate is that it acts as an absorber of external shocks thereby allowing each country to independently set monetary policy. Indeed, this can explain why small open economies such as Canada have supported floating exchange rates the longest.  However, even policy makers in Canada have recognized for some time that exchange rate shocks produce distinct effects on goods markets than in financial markets (Dodge 2005).

Of course, the extent to which international linkages are tight or loose may be critical but, under certain assumptions, Obstfeld and Rogoff (2002) demonstrated that the gains from monetary policy coordination are small. More recently, it is the revival of interest in differential monetary policy conditions (e.g., see Howorth et. al. 2019), prompted in large part by the finding that the neutral real interest rate has fallen in large and systematically important economies (e.g., U.S., Eurozone, U.K., and Japan; see Holston, Laubach and Williams 2017), that has led to renewed interest in the policy coordination question. Clarida (2018) argues that, if the decline is truly global and policy rates are partly set according to ones in foreign economies, substantial economic benefits from coordination might accrue. But

Keep reading this article on Econbrowser Blog - James Hamilton & Menzie Chinn.

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