The G20 communiqué released earlier this month was eagerly anticipated to see if Japan faced official criticism (for devaluing the yen) but in fact it stated commitment to “market-determined exchange rate systems” and the endorsement of monetary activism to support growth.
However, the fact that the value of the yen is under such scrutiny suggests the commitment to market-determined exchange rates is not as strong as one would think. Were the yen to fall another 10-20%, would policymakers in Europe, the US and rest of Asia remain acquiescent? It is hard to imagine so.
The reality is flexible exchange rates are tolerated, but only as long as policymakers remain comfortable with the levels. The Swiss National Bank already operates a managed exchange rate after its 2011 decision to prevent appreciation against the euro. Elsewhere, we have had informal verbal intervention from Bank of England Governor, Mervyn King, favouring a weaker pound.
Does this mean we are moving to a world in which G10 exchange rates operate once again on a managed basis? Current central bank policies could be pushing inadvertently in this direction as large scale quantitative easing in some countries creates unease elsewhere.
Moreover, with interest rates close to zero in many countries and bond yields low, the exchange rate remains a key policy variable.
Economic orthodoxy has tended to favour either freely floating exchange rates or hard pegs. But as we have seen with the debates on inflation targeting and capital controls, old orthodoxies are breaking down.
You don’t need to go back to the Bretton Woods era; major currencies were managed in the 1980s and 1990s with the Plaza and Louvre Accords, first to devalue the US dollar then to stabilise its value. It would not come as a major surprise if a similar global coordination of exchange rates were to occur in the years ahead despite today’s rhetoric in favour of freely floating currencies.