Jacques Polak’s paper provides a stimulating introduction to the national and international economic policy problems currently facing the major industrial countries. Polak’s encyclopedic knowledge of the details of the historical development enables him to analyze penetratingly the profound change of style that has taken place in general economic policy as well as in the monetary policies of many industrial countries. Happily, he does not abstain from economic policy assessments, which bear his own unmistakable stamp. Since I myself belong to a generation whose economic outlook was shaped by the conditions of the tempestuous 1950s and the “golden” 1960s, and no less of course by the disappointments of the turbulent 1970s, I find Polak’s paper very attractive in this respect, too. But although I was exposed to, and influenced by, the pendulum swings in economic policy objectives and philosophies, in retrospect my verdict would perhaps differ slightly in some particulars.
Up to the beginning of the 1970s it was possible to speak of a “post-Keynesian basic consensus” among the leading economic policymakers in the major industrial countries, albeit with national modifications. The thinking behind this consensus reached the Federal Republic of Germany with a distinct time lag. During the successful 1950s the influential economists who built up the intellectual framework of the “social market economy” were no close admirers of Keynes. But then, under the strong influence of Karl Schiller, the ideas of Keynes and Walter Eucken, the architect of “German neo-liberalism,” were amalgamated. Anticyclical behavior was chosen as the guiding principle of German fiscal policy.
This to a large extent common platform, which (as Polak rightly notes) from the outset met with a rather skeptical response from the Bundesbank, seems to have quite disappeared. Today, any comments on fundamental or current questions of national and international economic policy first require the discussants to define where they stand. Polak’s remarks on the special features of “activist” and “non-activist” economic and monetary policies avoid any oversimplified categorization, but if his comments were to be ascribed to an “enlightened neo-Keynesian” rather than to a “pragmatic monetarist,” to use Lamfalussy’s categories, I hope that this would not be unjust.
On the basis of my own experience, I look back on the 1960s and early 1970s with less nostalgia than Polak does. I am also less optimistic than he is that, given the successes achieved to date in the field of stabilization and consolidation policy, monetary and fiscal policy can now be set to work efficiently again in the cause of demand and exchange rate management of the traditional type, even though the number of advocates of such a policy is growing. While I agree with Polak’s overall assessment in many respects, let me take up a few of the points he touched upon in which I detect certain disparities which presumably derive above all from differences in our economic and monetary policy starting points.
In assessing conditions during the 1960s and 1970s, which some advocates of an “activist” budgetary and monetary policy stance today look back upon in rather a favorable light, I would sometimes put the emphases in slightly different places. I have no wish to deny that, during the period when economic policy action was dominated by the use of economic policy tools to achieve the “magic quadrangle,” some industrial countries scored considerable successes in the field of growth and employment policies. The question which arises in this connection is, however, to what extent the economic growth that was achieved is attributable to these policies or to other factors.
Specifically, I have two comments on this question:
(1) The highly satisfactory growth and employment figures recorded in many industrial countries from the mid-1950s to the second half of the 1960s were due in substantial measure to distinctly favorable supply-side conditions. The fact that real GNP in the OECD countries was expanding during that time at an annual trend rate of 4½-5 percent was due, among other things, to the very low level of commodity and energy prices over a long period, the rapid spreading of comparative cost advantages, technology transfer in the wake of the intensification of cross-border trade and capital transactions, the release of labor from shrinking sectors with low labor productivity (such as agriculture), immigration into the more developed industrial countries, and the spreading of cost-curbing mass production to up-market consumer goods. Against this background, an OECD growth study compiled in 1970 for the period up to 1980 concluded with an optimism that is almost unthinkable today: “The risk for modern industrial countries is not that of not achieving growth.” 1
(2) It appears to me—also in the light of German experience—to be certain that the discretionary use of fiscal and monetary policy (with an expansionary “bias”) and the “fine tuning” of aggregate demand at the limits of full employment and beyond, especially in the five to seven years up to the eruption of the first oil crisis in 1973, paved the way for the later emergence of stabilization crises and impediments to growth. Inflationary expectations grew seemingly irresistibly and took on more concrete shape, struggles over income distribution increasingly affected wage and price formation, and the ballooning of public expenditure and tax ratios, the spreading of government intervention in the market, and growing market rigidities lessened the efficiency of the free market system. These signs of crisis were clearly discernible even before the two oil shocks exposed the industrial countries to quite exceptional additional pressures, and these oil price hikes themselves were not solely an exogenous factor but—apart from the hectic movements—a successful endeavor to prevent the real price from falling more sharply, as it had done until 1973.
Against this macroeconomic background, unlike Polak, I would not say so unambiguously that in the late 1970s and early 1980s the economic policy priorities had been shifted deliberately in favor of combating inflation and of “conservative” structural and supply-side policies. The governments in office at that time, regardless of which political party they belonged to, had no choice but to try to protect the market-economy conditions prevailing in the industrial economies from further serious erosion. In the words of a leading U.S. Keynesian (A.M. Okun), during the 1970s the “Phillips curve” became an “unidentified flying object”; administrative price and wage controls foundered either on the lack of a social consensus or because “incomes policy” very often only amounted to an attempt to stop the consequences of fundamental factors, especially inflationary influences, which was bound to fail. In particular countries (such as the United States) the system of fixed exchange rates permitted pent-up inflation to develop at times. However, in the countries where price movements had been relatively moderate at first, massive buying of the U.S. dollar had become necessary, with the result that control over domestic monetary trends was being lost.
In the view of some major central banks there was, therefore, no real alternative to the abandonment of the fixed rate system and hence to a transition to a more nationally orientated monetary policy. However, the strategy pursued from the mid-1970s onward—in fact, from as early as 1975 in a few major countries, if I may add this in amplification of Polak’s paper—of adopting pragmatically handled “monetary growth rate rules” likewise pursued the objective of persuading the general public as well as management and labor that monetary policy would not be accommodating again and that it would be important to keep the cost of fighting inflation as low as possible. At all events, the Bundesbank, which was the first central bank to announce an annual monetary target (at the end of 1974), interpreted its “experiment” along these lines from the very beginning.
As far as the currently pressing issues of international economic policy or monetary and economic policy cooperation are concerned, Polak has generally placed the focal points where I would put them too: in the eyes of world public opinion, the achievement of appropriate noninflationary economic growth has become a key economic policy problem in the industrial countries (unlike the situation as recently as the early 1970s). The outlook in this area can be lastingly improved only if the disturbing disequilibria among the industrial countries can be eliminated and, moreover, the debt problems of the Third World progressively resolved. To this end, cooperative monetary and economic policy strategies appear to be essential, although—as Polak to my mind quite rightly points out—approaches of this kind must not overlook the fact that the style of economic policy has changed during the 1980s. Unless I am much mistaken, the major countries are not on the threshold of a return to old-time religion demand management policies, to fine tuning in monetary policy, to anticyclical fiscal policy, or to a Bretton Woods system in a new guise. (But I may indeed be mistaken; swings of this kind can never be ruled out entirely.) The following points corroborate this view.
A main point of effort in economic policy today is generally deemed to be the improvement of supply-side conditions in the broadest sense. In the international arena, this should first be a matter of lessening the substantial risks which the global economic disequilibria present to investment propensity and the operation of the financial markets. Second, the fight to prevent new restrictions from being imposed on international trade and capital movements, the circumvention of the formal GATT regulations and the like must be continued. (GATT is the General Agreement on Tariffs and Trade.) Similarly, all industrial countries must strive to contain the misdirection by agricultural policy. The ambitious project of the common European internal market planned for 1992, which is being strongly promoted by Germany, might well be instrumental in reducing the numerous international impediments to competition in the shape of regulations, government-owned firms, and subsidized firms. It may be rather an overstatement for the EEC Commission to claim that the planned project might yield a growth gain equivalent to over 4–6½ percent of Community GNP for the European Community countries by the end of the 1990s, but there should be no doubt at all about the economic usefulness of this European initiative, even if particular intractable problems (such as those posed by agricultural, transportation, and communication policy), which have rarely diminished but often actually increased in the last 30 years, set bounds to enthusiasm.
Such efforts, which have an international bias from the start, must be accompanied by stronger national endeavors to put “one’s own house” in order (microeconomically speaking) in the area of structural policy. The OECD in Paris, which relied rather one-sidedly on traditional demand management for a long time, has demonstrated in a recent report the extent to which production and adjustment conditions in many sectors in the industrial countries have deteriorated, primarily as a consequence of undue government intervention. 2 The moves concerned are not simply distorting and conserving measures but also include the disproportionately rapid expansion of the public sector and social budgets, the increase in taxes and social security contributions, and—not least in Germany—the system of subsidies. However, Germany’s modest successes in the field of deregulation, in the consolidation of the public sector and social budgets, and in the promising reform schemes which are due to be implemented in 1989 and 1990 show clearly that this is an arduous path with limited room for maneuver, since social groups’ and other pressure groups’ thinking in terms of vested interests and inertia may make radical reform packages appear to be politically unattainable. In this connection, the way in which a government is formed (whether it is a coalition government or government by a majority party) is also of some significance.
In this situation, with respect to longer-range global growth prospects, I think we have to admit without illusions that the growth successes of the first decades after the war, which were achieved under exceptionally favorable supply-side conditions, are unrepeatable today in the industrial countries. Nor do they need to be repeated. After all, economic growth is not a final goal. National prosperity is a goal; high employment is a goal; peace between the social groups of a society is a goal; and social fairness is desirable. Preservation of nature as a basis for human existence is a goal which is increasingly being recognized as a duty in the old, densely populated but still fairly prosperous industrial countries. And the figures of the real gross national product, which are often invested with almost mystical properties, reflect this at best highly imperfectly.
This is not to say that there is no reason or room for an active shaping of shorter-term economic activity. The Federal Republic of Germany, for instance, has shown in the last two years that it remains prepared to respond flexibly to unusual internal and external economic policy challenges. Monetary and fiscal policies have been steered onto an expansionary course in consideration of Germany’s surplus position, the steep appreciation of the deutsche mark, and temporary signs of cooling off in domestic business activity. In the process, we have achieved respectable economic growth rates in Germany, with rises in GNP of 2½ percent in 1986 and 1¾ percent in 1987, and are anticipating an increase of 2 percent and more in 1988. Needless to say, the short-term growth prospects for a country that is running down its real external surplus position are not particularly good. In 1986 and 1987 alike, the real foreign surplus declined by an amount equivalent to 1¼ percent of GNP, and this tendency will persist in 1988, albeit less rapidly. These trends gave rise to substantial frictional adjustment burdens for German industry, which is much more dependent on foreign trade and exposed to international competition than is, say, Japanese or U.S. industry; moreover, these burdens cannot be offset at will by domestic stimulatory measures. To be sure, in order to foster the adjustment process and promote orderly exchange rate movements, we have tolerated a marked overshooting of the annual monetary targets more than once; moreover, the medium-term deficit estimates for the public sector budget in Germany have been substantially overshot. Hence it can hardly be maintained that monetary and fiscal policy in Germany have completely forfeited their traditional instrument role. 3
By thus departing temporarily from the steadying course of its monetary and budgetary policy over the medium term, Germany is deliberately contributing to a globally coordinated adjustment strategy which Polak, if I understand him rightly, endorses: in the major surplus countries the growth rate of domestic demand should be above that of GNP, while in the deficit countries domestic demand should expand more slowly than total output. Political and institutional obstacles naturally set limits to globally coordinated adjustment strategies of this kind; it would be unrealistic to disregard them. In addition, care must be taken to ensure that the flexible, discretionary use of monetary and fiscal policy instruments does not in the longer run trigger developments which are clearly incompatible with the medium-term stabilization and consolidation goals of the countries concerned.
In this connection I should like to make an—open—remark on the comments which Polak’s paper contains about the relationship between exchange rate management and national monetary policy: for the central banks of the major industrial countries, the stabilization of nominal exchange rates has not of late been a goal “in its own right,” as it was toward the end of the Bretton Woods system; nor can it in the future become the central banks’ main function, regardless of the prevailing circumstances, to try to implement fixed targets for exchange rate movements. It is true that central banks have recently been willing to maintain orderly conditions in the foreign exchange markets, as far as possible, by means of coordinated interest rate measures and interventions, and to foster the real adjustment process; indeed, no central bank outside the United States has the option of adopting an attitude of “benign neglect” vis-à-vis exchange rates. Central banks’ most important function, however, resides in the fact that they collectively bear the ultimate responsibility for the “global rate of inflation” and that each individual major central bank is responsible for the stability of the purchasing power of its own currency. In the long run, these functions inevitably fall to the lot of monetary policy, since they cannot seriously be assigned to government incomes policy without endangering the foundations of free-market systems. This is why the monetary policies of the major industrial countries must provide a nominal anchor for economic policy decisions and thus facilitate the attainment of medium-term stabilization goals. Where the major countries are concerned, however, nominal exchange rate goals cannot form such an “anchor”; indeed, as past experience has shown, they may provide the instrument for synchronized national monetary policies which may expose the world economy to a cycle of unduly expansionary or unduly contractionary monetary influences.
A final remark should not be suppressed either: a forward-looking monetary policy, geared to stable prices over the long term, is possible in principle both with and without pre-announced monetary targets. Indeed, good monetary policy is conceivable without them, and bad monetary policy with them, as I said when they were first introduced 13 years ago. Hence, monetary targets, the benefits of which Polak seemingly rates rather low at present, have never been treated by the Bundesbank as targets in their own right, but have always been regarded literally as “intermediate targets”; however, we thought and still think these targets helpful in making clearer to the public the abstract process of stabilizing the value of paper money. We can also collaborate with central banks which attach less importance than we do to monetary indicators, as well as with central banks which set less store by monetary stability. But those who are counting on our constructive involvement in “blueprints” of international economic and monetary policy cooperation should please bear in mind: participation in cooperative international strategies—both within the EEC and worldwide—should be expected of us only if preservation of the stability of the purchasing power of money continues to be regarded as the principal contribution which monetary policy can make to the maintenance of favorable global growth conditions. This is what German monetary policymakers are prepared to do—no more, but no less; in point of fact, they feel positively under an obligation to act along these lines.
Jacques Polak has given us a fascinating and very useful review and analysis of the changes in macroeconomic policy during the past 25 years. It is especially helpful that he looks at the process of policy formation in each of Group of Five countries and does so within a common analytic framework. The result is a paper that traces the intellectual development of macroeconomic policy during the past quarter century as well as the changes in the policies themselves.
I agree completely with the key theme of Polak’s analysis. He characterizes the development of the past quarter century as a retreat from macroeconomic policy activism. This retreat has not been the result of an ideological shift but of the recognition of the limits of activist government stabilization policy. Polak presents substantial evidence dealing with the experience in all of the major countries. His conclusion is undeniable.
A recurrent theme of the analysis is the growing emphasis on monetary policy as countries recognized that incomes policy and Keynesian fiscal policy are ineffective or actually destabilizing. The combination of reduced activism and a shift to monetary policy also paralleled a change in the focus of macroeconomic policy from the discretionary stabilization of employment and economic activity to a reduction of the rate of inflation.
At one point in his paper Polak discusses the shift in macroeconomic policy in the language of Jan Tinbergen as a shift away from some instruments and suggests that this was because of a change in preferences about the instruments per se. Although this idea that policy officials could have preferences about “instruments” as well as about “targets” is familiar to economists because of the work of Hans Theil, I think Polak’s argument is not convincing. As he himself shows, the instruments of fiscal policy and of incomes policy were dropped not because of a “political aversion” to these instruments but because experience had shown them to be counterproductive.
Polak’s discussion raises a central issue in the design of monetary policy. He correctly emphasizes the distinction between targeting monetary aggregates and using the management of monetary aggregates to target nominal GNP. I wish he had said more about this important issue.
I find nominal GNP targeting a very attractive approach. While it may not be the best of all ways to guide monetary policy, I think it is preferable to traditional targeting of monetary aggregates. Its key virtue is that it provides a practical and non-arbitrary way of adjusting monetary aggregates to exogenous shifts in velocity.
Nominal GNP targeting would avoid the inflationary excesses of the type observed in the United States and elsewhere in the 1970s. It would also provide an understandable guide to what the monetary authority is doing and therefore a better basis for confidence that observed changes in interest rates or money growth rates do not represent a weakened resolve to prevent increased inflation.
There are three commonly proposed alternatives to nominal GNP targeting: pure fixed money growth; ad hoc judgment without any nominal GNP anchor; and targeting exchange rates. I think that the nominal GNP approach is better than any of these alternatives.
A fixed money growth rate does prevent secular increases in inflation but would in practice (even if not inevitably in theory) lead to excessive short-term fluctuations of real activity and of employment when changes in financial institutions and banking rules lead to shifts in the demand for money.
A policy of “using good judgment”—that is, permitting any ad hoc action—is frightening to financial markets when the decision makers are seen to have very diverse views and when the financial markets do not have great confidence in the understanding and judgment of the monetary authorities. This is an even greater problem in countries where the central bank is subject to direct political influence.
Polak discusses the targeting of exchange rates as an alternative guide for monetary policy. It is not clear from the text whether he is advocating this or just describing it. My own view is unambiguous: targeting the exchange rate is a bad idea that confuses a real and a nominal magnitude.
Changes in real exchange rates play an important role in guiding the international allocation of resources. For example, an increase in real energy prices requires an offsetting realignment of real exchange rates. Since Japan is very dependent on imported oil, a rise in the price of oil requires a yen depreciation. A change in technology or tastes also requires offsetting real exchange rate adjustments. The increased capability of the newly industrialized nations to produce a range of intermediate technology products and high technology products requires a relative decline in the real value of the countries whose products they displace internationally.
Shifts in national saving rates also require offsetting shifts in real exchange rates. When the United States stimulated a sharp drop in the national saving rate by increasing budget deficits significantly, the real value of the dollar rose and the resulting increase in the current account deficit permitted a major capital inflow.
Of course, shifts in the observed nominal exchange rate may reflect nothing more than changes in the underlying price levels or the expected rates of inflation. A rise in the price level induces a currency devaluation while a rise in inflation that makes a currency more risky may also cause a fall in the value of the currency. The advocates of targeting exchange rates see it as a way to control such inflation-driven changes in exchange rates.
The danger in this process however lies in using changes in monetary policy to alter the nominal exchange rate when there are real exchange rate shifts. When the United States slowed the growth of money in 1987 in an attempt to stop the decline of the dollar it caused a rise in interest rates that slowed the economy’s expansion and was a precipitating factor in the stock market decline. Earlier in the decade, there were many who advocated that the United States ease money as a way of stopping the dollar’s sharp rise. That increase in the real value of the dollar was caused by the decline in the U.S. national saving rate and the dollar rise provided the mechanism for transferring capital to the United States from the rest of the world. The primary effect of an expansionary monetary policy that stopped the nominal rise in the dollar would have been a rise in the U.S. inflation rate while the real value of the exchange rate would have remained essentially unaffected.
Polak’s discussion of this topic completely ignores a major area of national economic policy: changes in tax structure. This is perhaps natural since such structural changes are not aimed at cyclical or price level conditions but at long-term resource allocation and economic growth. But structural tax policy has been a central instrument of government policy in dealing with these longer-term goals and has recently moved to center stage in the policy debate in a number of countries.
The key distinction that must be emphasized in this context is between the traditional Keynesian use of tax changes as fiscal policy instruments aimed at changing disposable income in order to stabilize economic activity with the structural use of tax policy to change relative prices and therefore long-run resource allocation.
During the 1980s the United States reduced the top individual income tax rates from 70 percent to 50 percent and then to 28 percent. Such tax rate reductions are now being copied worldwide. The purpose of these changes is to increase the incentives for individual effort, saving, and entrepreneurship. Lower tax rates also reduce the temptation to enter into investments that are driven by tax considerations rather than by pretax real rates of return. If these tax reforms are successful, they should increase the rate of economic growth and improve the allocation of resources.
Reducing personal tax rates is only one form of targeted tax policy. Other tax changes have been aimed at increasing personal saving rates and increasing investment in plant and equipment. The recent U.S. tax reforms were advocated as a way of making investment “more efficient” by reducing inter-asset distortions in effective tax rates (for instance, between equipment and structures) but may have been counterproductive by inadvertently increasing other inter-asset distortions even more (for example, between business investment and owner-occupied housing investment and between physical capital investments and investments in training and advertising).
Structural tax policies can play another role in the international economy. As the international mobility of capital increases, countries cannot control their own real interest rates. They can however influence the mix between consumption and investment by tax rules that influence the demand for investment at any given real interest rate.
I might add in this context that my emphasis on tax policies even in this international context is on the development of good national policies and not on the international coordination of structural tax rules. What is needed in this area of economic policy as elsewhere is better national policies and not more attention to the international coordination of policies.
As we look to the future of macroeconomic policy, it will be important for governments to consider more explicitly the structure of tax rules as well as other microeconomic policies that influence the allocation of resources. The paper by Polak provides a very useful historical analysis on which to base such a discussion of the redirection of economic policy in the future.
As a practitioner who, almost by accident, happened to be one of the junior participants in the series of Group of Five and Group of Seven meetings over the last three or four years, I found Jacques Polak’s paper extremely intriguing. His very rich assessment and well-balanced, objective analysis also made the paper very persuasive. 1 particularly liked his finding about the role of fiscal policy—that at the moment it needs to be treated with a considerable dose of tender loving care to keep it in sufficiently good health for the uncertain tasks of the future. As a treasury man, I would very much like to compliment this finding.
Being stimulated by Polak’s paper, I would like to remark briefly on the progress of national economic policy coordination, particularly in the 1980s because that decade is still with us and has seen a very dramatic change. In retrospect, the decade of the 1970s was not very pleasant for all of us. It brought the collapse of the Bretton Woods regime, two oil price crises and ensuing stagflation, and, toward the end of the decade, the rather unfortunate experience of the so-called locomotive theory. I think these experiences made policymakers less confident, because it was quite clear that the industrialized world alone could not decide the destiny of the world economy. We also suffered a sense of loss because the world economic system seemed to have lost its anchor. So monetary authorities became more cautious and more conservative in establishing and formulating their policy objectives and the means to attain them. At the same time, this situation provided the rationale for the more self-oriented policy postures in many countries that became very apparent in the early part of the 1980s.
So when the 1980s set in, the macroeconomic policies of the major countries were, I am afraid, rather disorganized. But as I said earlier, there was during the 1980s a very dramatic shift from self-oriented policy formulation to a more world-oriented stance, and, in my view, the single most important determinant of the shift was the very serious international disequilibria which became most obvious in the early 1980s. The policy coordination efforts initiated by the industrialized countries like the Group of Five or the Group of Seven were certainly a product of such developments. These series of efforts to produce better coordination among the major industrialized countries can, in my view, be broadly categorized into three different stages. Interestingly enough, these three different stages were not planned beforehand; rather I think they evolved according to a learning process.
A predominant feature of the first stage of coordination was the strong emphasis on exchange rate realignment. By September 1985 everybody was of the view that the dollar was overvalued and something had to be done to rectify the situation. The famous Plaza Accord which was agreed in September 1985 had made that point very clear, as the communiqué shows. Although we talked about lists of macro-economic policies to be pursued by the members, it was very obvious that the overwhelming thrust was on the exchange rate realignment, and how to weaken the dollar. Since the five countries agreed to make strong concerted actions in the exchange market to achieve that goal, the exercise as a whole involved the intervention and exhortation mentioned by Polak in his paper rather than coordinated action on macroeconomic policy. However, the strategy worked; the dollar depreciated very rapidly. Why? In my view, it was only because the dollar was definitely overvalued at that time. The yen’s exchange rate vis-à-vis the dollar was 240 at the time of Plaza and is, as you know, 125 yen per dollar at present—a very successful outcome of the Plaza coordination effort.
As 1986 went by, a very gradual but subtle change took place in the minds of the policy authorities and the emphasis gradually shifted from exchange rate realignment to macroeconomic policy coordination. This was the second stage of the exercise. The first reason for the shift into this second stage was, 1 think, that exchange rate realignment had been successful. But while its beneficial impact was beginning to be evident from the trade performance of the major countries, for various reasons (including a J-curve effect), progress was not rapid. Meanwhile, the rapid change in exchange rate relationships had started to exert a rather unfavorable impact on the surplus countries’ economic performance. These countries became discouraged because of this over-rapid change in exchange rates and the danger that their domestic economies might slacken. In the deficit countries too, the over-rapid change in exchange rates created a new concern about the credibility of their currency and also the credibility of the economy as a whole.
As a result, as was very clearly demonstrated at the now-famous Louvre Accord of February 1987, the major thrust was clearly shifted to macroeconomic policy coordination. As you recall, the Louvre Accord declared that the exchange rate realignment had been adequate and the priority was now more stability rather than a further change in exchange rate relationships. The ultimate purpose of this macroeconomic policy coordination, in my view, was how to shift the growth patterns of the major economies via fiscal and monetary policies.
In hindsight, these efforts proved reasonably successful if you look at the growth pattern of the major three countries. For instance, in 1987, GNP growth in the United States for the first time exceeded domestic demand growth: GNP grew at 2.9 percent while domestic demand grew at 2.5 percent. On the other hand, in the surplus countries, the Federal Republic of Germany and Japan, there was a reverse pattern of the growth. In Japan in 1987, domestic demand grew at 5.1 percent, but because of the negative contribution of net exports, GNP grew at only 3.7 percent. In Germany, domestic demand grew by 2.9 percent, but GNP grew by 1.7 percent. In other words, the shift in the growth pattern of major deficit and surplus countries was achieved. This point is probably one of the rare cases where Polak is not very accurate. He notes that it seems surprising that the coordination effort has paid domestic demand so little attention. But in fact, the importance of the relationship between domestic demand growth and the external balance has been one of the major interests of the finance ministers and the governors of the central banks in recent discussions of the Group of Five and Group of Seven. This point should be emphasized.
After making reasonable progress in macroeconomic policy coordination, we seem to be in the third stage now, when the emphasis is on structural measures. The ultimate purpose of these measures is how to secure lasting adjustment. As I noted, reasonable progress was made on exchange rate realignment and macroeconomic policy measures. Nevertheless, there has been a strong and persistent concern that these changes may not be sustainable unless more fundamental shifts take place. I believe this is the reason that we now pay considerable attention to this new stage of coordination.
In Japan, structural measures imply both public and private initiatives. I think this is the case in every country. Public initiatives in Japan have so far involved deregulation, privatization, subsidy cuts and market opening, reductions in working hours, and the abolition of tax incentives for savings. But it should be stressed that in our structural reform, private initiative is extremely important. Major industrial restructuring by market mechanisms is, I believe, taking place. Some industries, like coal mining, ship-building and some steel, aluminum and textiles, are really dying now. And other industries that are import competitive or export oriented are reallocating their production facilities offshore. This will certainly contribute to the lasting change in the trade pattern. In addition, in view of very strong domestic demand growth, many industries are shifting their major market from overseas to domestic markets.
But this third stage, as I said, has just started and I am not sure how much we can really achieve in it. But having said that, of the four policy objectives described in Polak’s paper, I think the three goals of high growth, low inflation, and low unemployment still remain very valid. However, I believe that the balance of payments equivalent objective has changed somewhat. Under the Bretton Woods regime, the burden of adjustment fell mostly on the deficit countries, because if a deficit continued, the country had to sacrifice growth and employment. But now it seems to me that the burden of adjustment is falling more on the surplus countries. If a surplus persists, the country must suffer from rising protectionism in export markets and from international condemnation.
In conclusion, I think it is very important for all of us to realize that because of the very much greater international flows of capital, goods, and services, there has been a tremendous increase in interdependence among the major economies. As you know, various markets are also becoming more and more globalized. Therefore, policy objectives must now be pursued in an internationally harmonious way. This very important point is now recognized by the policy authorities in the major countries. I mentioned that we are now in the third stage of coordination. I do not know whether we will have a fourth stage. But I think that probably in the near future the major countries will make an effort to combine the three stages in a better way. I am sure that exchange rates will continue to have a significant role, as will macro-economic policies and structural reforms.
I can go a long way along the lines indicated by Jacques Polak in his interesting paper on the broad policy changes over the last thirty to forty years.
First and foremost, it is clear that a change in priorities has occurred, with price stability becoming more important than full employment. I think, however, that the change has been a gradual process, developing through the tatter part of the 1970s as a consequence of the combination of stagnation and high levels of inflation, and cannot easily be connected with the transition to conservative governments in the major countries.
The attitude toward economic policy has also undergone a substantial evolution. This is basically for three reasons. First the mechanistic view of policymaking has had to be abandoned. We were brought up with post-Keynesian thinking which taught that economic instruments were mutually independent and had a one-way impact. The latter characteristic meant that the economy was assumed not to react to the type of instrument used, nor to the intention of the politicians using it. This has proved to be an erroneous proposition, which the political system—and also professional economists—have found hard to learn.
The central issue is the role of credibility and expectations in the use of instruments. The use of exchange rate changes and the accommodation of inflation, for example, both create serious questions of attitude later on. Economic policy management is much more difficult than has been assumed.
Second, it was also expected that econometric models would become more and more reliable in forecasting economic developments. They have not, and this has been a great disappointment. I do not, of course, expect reliable forecasts of exogenous shocks, of which there have been many, but it was expected that endogenous developments in growth, inflation, key currency exchange rates, and so on could be forecast more reliably. Because they are not, it is not at all always clear whether economic policy should be changed and, if so, how much. Furthermore, explanations of economic performance have a tendency to degenerate into loose casuistic judgments instead of careful analysis. One consequence of this uncertainty is that the level of ambition in policymaking has been severely reduced.
Third—and connected with the second point—is the uncertainty in the interpretation of important events, particularly in the international sphere. I refer to the endeavors to move from the level of discussions and information in international relations to what could be called the coordination of policymaking.
The most illustrious cases are the Bonn Agreement of 1978, the Plaza Agreement of 1985, the Louvre Accord of 1987, and the Japanese expansion of 1987. In each case a really wide range of interpretations is possible—one extreme being that there was hardly any impact of the agreement, the other that it was of major importance. I am most inclined to the view that the impact has been very limited. This means that the level of ambition on coordination of international policymaking must be low.
I have been assigned to say something from a small country point of view but this presupposes that there are basic differences between big and small countries. It is certainly true that small countries do not have much influence in international negotiations, but if policy coordination is of limited importance—if it is, so to speak, one of the empty boxes—the problem does not deserve much comment. As regards the basic issues of policymaking, I do not think that conditions differ among big and small countries.
The balance of payments constraint was important for the United States in the late 1960s and is again now, as it has been for the United Kingdom and France very often and even for the Federal Republic of Germany in the late 1970s. Inflation has been a constraint for all countries—Japan, the United States, the United Kingdom, France, and Germany. Small countries have had the same problems and the same experiences with instruments that are not independent and with one instrument having an impact on several variables. In this respect 1 have never been over-fascinated by Tinbergen’s propositions. I tend to believe that economic laws do not distinguish between big and small countries.
I am not entirely happy about the philosophy in Polak’s paper in one respect. He argues that policy objectives were earlier directed at real magnitudes but are now rather concentrated on nominal goals. I do not find this convincing. When forecasts or objectives are put before parliaments there is always a distinction between real and nominal magnitudes, and as price stability has become more important—which is rightly pointed out in Polak’s paper—this really means that the distinction is taken more seriously than before. I agree—for reasons I have mentioned earlier—that ambitions have had to be scaled back but the awareness of real versus nominal targets has definitely not.
Furthermore, I am inclined to argue that fiscal and monetary policies are used more actively than before, although I would agree they are not used for fine tuning. Experience over the last ten years suggests that it gives the wrong impression to argue that less importance has been given to these two instruments. In both big and small countries fiscal policy has been used to adjust the overall savings rate—a basic Keynesian proposition—and monetary policy has emancipated itself from being tied conventionally to nominal interest rates instead of real rates. I would not maintain that results have been entirely satisfactory but I think that the learning process has had some useful results which should not be overlooked.
In that respect, I am more optimistic than Polak but perhaps not on the issue of reconciling price stability with full employment, on which I wrote a book almost thirty years ago and on which I do not think that we have come much closer to a solution.
To sum up, I agree that there has been a shift of priorities in economic policy. I do not attach much importance to international policy coordination. I do not agree that the distinction between real and nominal targets has much weight and I do not think that fiscal and monetary policies can be said to be used less than in previous periods.
The author wants to acknowledge with thanks the assistance he has received from staff members in the European, Asian, and Western Hemisphere Departments of the Fund in the description and analysis of the policies of major countries, as well as from staff members in the Research Department. However, the facts and interpretations as presented in this paper are solely the author’s responsibility.
OECD Economic Outlook 41 (June 1987), p. 4. As the note to the chart shows, the quotation marks around the second “better” are in the original. They presumably serve to convey the notion that “better” does not necessarily mean better.
‘Throughout this paper the analysis is restricted to the five largest countries (the United States, japan, the Federal Republic of Germany, France, and the United Kingdom).
The formal requirement of equality in numbers of targets and instruments should not be pushed too far in this case: neither the targets nor the instruments mentioned are fully independent inter se.
Among the main industrial countries there was indeed a strong tendency not to consider adjustment of the exchange rate as an available policy option at all. A very carefully drafted 1964 statement by the Deputies of the Group of Ten listed six categories of instruments of economic policy (not including exchange rate policy) to counteract a tendency toward a sustained deficit or surplus in the balance of payments, namely “budgetary and fiscal policies, incomes policies, monetary policies, other measures relating to international capital transactions, commercial policies, and selective policies directed to particular sectors of the economy.” Then, in the next paragraph, the possibility of use of the exchange rate was allowed, but only as a constraint: “Such instruments must be employed with proper regard for obligations in the held of international trade and for the IMF obligation to maintain stable exchange parities which are subject to change only in cases of fundamental disequilibrium.” (Group of Ten Deputies, 1964, p. 5).
On this phase of economic policy modification, see Polak (1962), pp. 165–67.