Canada’s central bank governor, Mark Carney, yesterday called for new “rules of the game” for the international monetary system and a code of conduct governing the implementation of capital controls.
But he warned that imposing punitive trade sanctions against economies that fail to adhere to IMF and G20 exchange rate principles is both counter-productive and divisive.
The Bank of Canada chief called instead for a gradual move towards a system based around “coherent macro policies” and “flexible, market-based exchange rates”.
In a major policy speech to delegates at the IDB’s annual meeting in Calgary, Carney criticised China for artificially holding down the value of its exchange rate. He warned that the implementation of capital controls and macro-prudential measures by emerging market policymakers was driving up both commodity prices and domestic demand, fuelling inflation and overheating.
“When large economies with undervalued exchange rates keep their currencies from appreciating, others feel pressured to follow,” Carney said. “Over time, macro policy becomes contorted: exchange rates more inflexible, monetary policy more hesitant and economic controls more prevalent.
“The collective impact of this behaviour risks inflation and asset bubbles in emerging economies and, over time, subpar global growth.” Carney criticised French proposals to give the IMF powers to implement punitive sanctions against countries that flout international rules. He said the suggestion, in a report commissioned by President Nicolas Sarkozy and presented at the G20 meeting in February, was unrealistic and potentially counterproductive.
“Enforcing behaviour through trade sanction is obviously extremely divisive, and runs the risk of reversing the globalization process itself,” he said.
Instead, Carney called for a gradualist approach that acknowledged the validity of short-term, stop-gap measures, such as capital controls, as countries transition towards these long-term objectives.
“Sudden capital inflows raise legitimate concerns about currency overvaluation, overheating and, conversely, the consequences of sudden stops,” he said.
“This is especially true for countries with less-developed capital markets and weak institutional infrastructures, where the capacities to absorb and benefit from large inflows are limited.”
Carney outlined proposals for a code of conduct for capital flows, based around four key principles: a clear objective to promote sustainable and effective flows of private capital between economies; recognition that capital controls should not be the first policy option; a commitment that any such controls should be temporary, targeted and transparent; and a recognition of the responsibilities of capital-exporting countries to monitor the risks run by recipients of these capital inflows.
Carney’s speech can be seen as an attempt to outline a distinct Canadian model for overhauling the global monetary policy system, in the light of increasingly divergent policy decisions in the aftermath of the global financial crisis and accommodative monetary policy in developed economies, which has resulted in a flood of liquidity to emerging markets in particular.
Carney said that Latin America would remain particularly susceptible to capital inflows, given the underweighting of emerging market assets in developed market portfolios.
He also justified the G7’s recent decision to act in concert to suppress the value of the Japanese yen, insisting that it was in line with G7 calls for flexible exchange rates without intervention.
“The circumstances were clearly exceptional,” he said. “Movements in the yen had become disorderly, volatility was excessive and there were potential adverse implications for economic and financial stability.”
The move has been criticised by some economists as undermining the moral legitimacy of the US and other G7 nations to criticise China for exchange rate intervention, while appearing to do just that over Japan.