Essays on International Finance Volume 1: October 2013 International Cooperation and Central Banks Harold James Essays on International Finance Volume 1: October 2013 International Cooperation and Central Banks Harold James International Cooperation and Central Banks Copyright © 2013 by The Centre for International Governance Innovation Editorial Board CIGI Masthead Domenico Lombardi Carol Bonnett The opinions expressed in this publication are those of the author and do Editorial Board Chair Managing Editor, Publications not necessarily reflect the views of The Centre for International Governance Director of the Global Economy Jennifer Goyder Innovation or its Operating Board of Directors or International Board of Program, CIGI Publications Editor Governors. James Boughton Sonya Zikic CIGI Senior Fellow Publications Editor Barry Eichengreen Vivian Moser George C. Pardee and Helen N. Pardee Assistant Publications Editor Professor of Economics and Professor Steve Cross This work is licensed under a Creative Commons Attribution — Non- of Political Science at the University of Media Designer commercial — No Derivatives License. To view this license, visit California, Berkeley (www.creativecommons.org/licenses/by-nc-nd/3.0/). For re-use or distribution, Eric Helleiner Executive please include this copyright notice. Professor of Political Science at the University of Waterloo Rohinton Medhora President Harold James CIGI Senior Fellow David Dewitt Vice President of Programs Fred Kuntz Vice President of Public Affairs Mark Menard Vice President of Finance Communications Declan Kelly Communications Specialist [email protected] tel: 1 519 885 2444 x 7356 57 Erb Street West Waterloo, Ontario N2L 6C2 Canada tel +1 519 885 2444 fax +1 519 885 5450 www.cigionline.org Contents Foreword vii Introduction 1 Pre-1914 Central Banking 2 Modern Central Bank Cooperation Part One 5 The Bretton Woods Vision 9 Regional Monetary Integration 10 Financial Stability 16 The Great Recession and the Euro Crisis 18 Conclusion 22 Acronyms 24 Bibliography 25 About the Author 30 About CIGI 31 International Cooperation and Central Banks Foreword The CIGI Essays on International Finance aim to promote and In the setting of a highly globalized world economy, there is a disseminate new scholarly and policy views about international temptation to view public policy as the outcome of technocratic monetary and financial issues from internationally recognized decision making. It is important to note, however, that while academics and experts. The essays are intended to foster technical expertise and sound analysis may inform policy, they multidisciplinary approaches by focussing on the interactions do not supply or demand it. The supply and demand sides of between international finance, global economic governance policy making are essentially determined by a number of and public policy. interacting social, political and economic factors: the state of ideas, interests and institutions; the distribution of information, International finance cannot be properly understood without financial resources and expertise; and major focussing events, reference to the global governance arrangements that shape such as crises. the regulatory environment in which financial actors operate. The rules and playing field of the global financial system — As an area of study, international finance has no natural the organizations, regimes, principles, norms, regulations disciplinary home. Indeed, it is a social, political, historical, and decision-making procedures that govern everything from economic and even geographical phenomenon. Thus, there are banking practices and accounting standards to monetary distinct advantages to taking a multidisciplinary approach. By relations and official cross-border lending — have a profound harnessing the comparative strengths of different disciplines impact on how that system operates. Even though international — including the different conceptual tools, theoretical insights finance is commonly conceived of as a largely unregulated and methodological techniques on offer — such an approach domain, it is generally held together by a commitment to provides richer, more diverse analytical troves from which to a particular set of policy priorities on the part of key global draw. Furthermore, breaking down disciplinary divides can governance actors. In other words, a lack of regulation does not help to establish common ground between different, sometimes imply a lack of governance. competing, perspectives. The intent of the CIGI Essays on International Finance is to encourage productive dialogue The principles and practices that have underpinned particular and the building of common ground by providing a research- global governance arrangements — such as the earlier classical based, policy-relevant venue for high-level, cross-disciplinary gold standard, the subsequent Bretton Woods order and the contributions to the field of international finance and global current regime — reflect historically and socially contingent financial governance. commitments to particular policy priorities. As power, interests and ideas evolve, the priorities that guide global governance do Domenico Lombardi so as well. Changes in governance structures, in turn, result in Director of the Global Economy Program, CIGI changes to the functioning of financial markets. Understanding the social, political and historical forces that determine how global finance is governed is, thus, crucial to understanding why financial markets function as they do, and how global financial governance can be improved to become more effective. vii International Cooperation and Central Banks Introduction Why do central banks attempt to cooperate with other central interaction gives rise to the greatest policy debate: is the overall banks? Why should those political systems (in practice, these long-term goal so important that it justifies the adoption of are democratic states in the advanced modern industrial world), what otherwise would be a non-optimal policy? to which the central banks are ultimately accountable, accept a cooperative strategy of the central banks? What overall gain do In general, tackling a major crisis that originates with “global they expect to achieve as a result? The answers clearly depend imbalances” and has transmission mechanisms that are cross- on the definition of the fundamental tasks of central banks national seems prima facie to demand a more substantial and and, thus, on how cooperation might be envisaged as a tool institutionalized cooperation. But in the aftermath of the recent in accomplishing those goals. The purposes and functions of financial crisis, visions of what central banks can and should central banks, however, have changed dramatically over the do have changed profoundly. In particular, the demand that course of time. they should play a much more vigorous and pre-emptive role in financial supervision has made them more nationally focussed Institutional interaction occurs at varying levels of intensity. and less prone to cooperate. The following types of engagement may be distinguished: collaboration — for instance, in regular meetings in Explaining the paradox of an increased demand for cooperation international fora such as the Bank for International Settlements alongside the heightened reluctance to let central banks (BIS), the International Monetary Fund (IMF), the Organisation cooperate requires an examination of the fundamental tasks of for Economic Co-operation and Development (OECD) Working central banks. To start with a simplified chronology of the long- Party Three or the Group of Ten (G10) — where the primary term development of central banks: they (or their prototypes) objective of the interaction is to exchange information and views began historically with government debt management, and to obtain a broader awareness of the international environment found that exchange rate stability was key to successful and and its implications for the domestic economy, to acquire a more credible debt management; then they moved into financial accurate realization of domestic policy objectives; discursive stability issues; and, finally, they became concerned with cooperation, in which policy objectives can be discussed and monetary and price stability. There was some overlap between elaborated with regard to conceptually difficult issues (such as each of these phases, in particular the financial stability function, the definition of appropriate monetary policy or best practice with which had declined in prominence over the past 20 years, but regard to financial regulation); instrumental cooperation, has, since 2008, become widely regarded as a major objective in which actions (such as exchange rate interventions) can be of twenty-first-century central banks. There are also, however, made more credible and effective because they involve more obvious tensions; from the nineteenth century on, a rich stream than one central bank and, thus, reflect an agreed international of literature (William Stanley Jevons, Alfred Marshall, Francis policy orientation; and coordination — a more extreme form Ysidro Edgeworth, Irving Fisher, Karl Helfferich) has suggested of instrumental cooperation — in which central banks may be that the metallic standard, which provided exchange rate required to do something that they would not do under normal stability, was not the ideal mechanism for maintaining price circumstances (again, in the case of exchange rate intervention stability.