NCPA - National Center for Policy Analysis

Currency Wars and Global Macroeconomic Policy

February 28, 2013

The world's largest economies are struggling to maintain their annual gross domestic product growth. The most common solutions involve quantitative easing, which amounts to printing money, and austerity measures, which reduce deficits by reducing spending. Despite the intent of these policies, they fail to produce their desired incomes when used improperly, says John Makin, a resident scholar at the American Enterprise Institute.

  • The combination of austerity measures and fiscal pumping results in currency weakness, which exports deflationary pressures.
  • These deflationary pressures threaten a currency war since every country cannot have a weaker currency.
  • During the most recent G20 summit, accusations spread about an ongoing global currency war.

Amid the global recession, most developed countries have sought to reduce deficits through fiscal consolidation, though the austerity measures reduce demand and slow growth.

  • Easier money increases the supply of dollars in the global financial market while tighter fiscal policy reduces demand for foreign currency in global financial markets.
  • The combination of easier money and tight fiscal (EMTF) policy is a recipe for a weaker dollar.
  • The European Union and United States have all continued to increase their EMTF efforts despite the likelihood of increasing currency competition.

Japan has opted for easier money and easier fiscal (EMEF) policy supported by central bank bond purchases, which creates problems for the other G7 countries and undercuts their EMTF efforts.

  • Global money printing can only be successful if tighter fiscal policy proceeds at the right pace. If it proceeds too rapidly, it reduces the likelihood that easy-money policy can offset tighter fiscal policy's negative impact on aggregate demand.
  • Easy-money policy will create more inflation if fiscal policy does not occur gradually. Easy-money policy does nothing to boost aggregate supply, and once full employment is reached, it just creates more demand for goods, which creates inflation.

The only way to mitigate slower growth caused by fiscal tightening is to have central banks aggressively pursue easier money. Central bankers must find the appropriate balance between both policies if the world is to continue recovering from the global recession. While Japan's EMEF policy creates challenges for the rest of world implementing EMTF policy, sustainable growth should be possible by 2015.

Source: John Makin, "Currency Wars and the Paradox of Global Thrift," American Enterprise Institute, February 25, 2013.


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