Keynes at the periphery: Currency hierarchy and challenges for economic policy in emerging economies

ABSTRACT

While the post Keynesian literature offers a rather clear concept for growth-oriented policies, it is necessary to adapt them for peripheral emerging economies. We base our analysis of an appropriate Keynesian policy mix for these countries on the concept of currency hierarchy, where the currencies of peripheral emerging economies have a lower liquidity premium than the currencies of advanced economies. The international asymmetry related to the currency hierarchy, amplified by financial globalization, imposes major constraints to the adoption of Keynesian policies for these economies. Under these conditions, we argue that domestic economic policy coordination should lay a major focus on a low policy rate and, especially, a competitive exchange rate for obtaining, at least, a balanced current account, in order to prevent capital flows boom-bust-cycles with subsequent financial crises. We conclude that it is a rather ambitious and long-term goal to climb up the currency hierarchy, especially under the current condition of financial globalization.

KEYWORDS:

• Currency hierarchy
• financial globalization
• Keynesian policies

JEL CLASSIFICATIONS:

• F3
• F4
• E6

Notes

¹The terms “peripheral emerging,” “emerging,” and “developing” will be used interchangeably as well as “center,” “advanced,” and “developed.”.

²A similar approach is developed by Kaltenbrunner (2015), but her focus is exchange rate determination, while our focus is the expected return of assets denominated in a specific currency.

³We assume for simplicity the abstract concept of homogeneity of different classes of assets for all assets in equilibrium.

⁴Liquidity in this article refers to the accessibility and convertibility of a currency.

⁵Because of limited space, in the following we restrict our analysis to monetary and exchange rate policies, even if fiscal policies are a key element in a post Keynesian approach.

⁶Kregel (2015) recommends Keynes’s postwar international system as a blueprint for reform of the international financial architecture that could address emerging market grievances more effectively than current approaches.

⁷As Skidelsky (2000) stresses, Keynes was mainly worried about England’s position as a debtor country in the international system and, hence, with the asymmetries between debtor and creditor economies in terms of the burden of balance-of-payment adjustment. In this article, we emphasize the center–periphery asymmetries of the international monetary and financial system (Ocampo, 2001).

⁸Flandreau and Sussmann (2005) show that Latin American countries, from the beginning of the creation of domestic currencies together with political independence, were confronted with the fact that the bonds they emitted at the international market contained gold clauses, giving them the characteristics of foreign-exchange-denominated debt. This is what Eichengreen and Hausmann (2005) label the “original sin”— a country’s inability to borrow abroad in its own currency.

⁹For a similar theoretical approach on the different role of national currencies at the international level, see Cohen (1998, 2004).

¹⁰Those regulations encompass both capital controls and financial prudential regulations. For more details, see Ocampo (2012).

¹¹The map is based on a data set developed at the Bank of England on stocks of cross-border capital, spanning eighteen advanced and emerging economies. Obstfeld and Taylor (2004) had also pointed out this asymmetry, but their study covers only the 1980s and 1990s.

¹²Kaltenbrunner (2015) points out that in emerging economies short-term foreign liabilities exert a latent depreciation pressure on the domestic currency that severely restricts their currencies’ ability to become international media of contractual settlement and stores of value.

¹³The main reason is that income is negatively and significantly correlated with pass-through as lower income economies have a larger portion of traded goods in the households’ consumption basket.

¹⁴Many econometric studies find that developing countries with competitive real exchange rates tend to grow faster. Gala (2008), for instance, on a panel of 58 developing countries from 1960 to 1999 and using purchasing power parity (PPP) measures detected a negative relationship between growth and overvaluation. In the same direction, Rodrik (2008), using a variety of fixed-effect panel specifications covering a maximum of 188 countries and eleven five-year periods from 1950–54 through 2000–2004, finds a systematic positive relationship between growth and undervaluation, especially in developing economies. Razmi et al. (2012), running a series of panel data regressions for a data set of a maximum of 153 countries in 1960–2004, get a positive relationship between real exchange rate undervaluation and investment growth. So we conclude from these empirical studies that the real exchange rate plays a fundamental role in the convergence of the developing economy with developed economy incomes.

¹⁵The studies of Magud and Reinhart (2006) and Magud et al. (2011) stand out in the literature to measure the effectiveness of capital controls in emerging economies. Based on the review of more than thirty studies that evaluate capital controls either on inflows or outflows around the world, they argue that to enhance this effectiveness it is necessary to take into account country-specific features in their design. They conclude that “capital controls on inflows seem to make monetary policy more independent; alter the composition of capital flow; reduce real exchange rate pressures (although the evidence is more controversial),” but “seem not to reduce the volume of net flows (and hence, the current account balance)” (Magud and Reinhart, 2006, pp. 6–7).

¹⁶Corden (1980, p. 183) points out that “The more disturbance there is on the macro-economic side, the more industrial policy is likely to become short-term oriented, to flounder around, a tool in political and economic crisis management.”

Additional information

Notes on contributors

Luiz Fernando de Paula

Luiz Fernando de Paula is a professor of economics at the University of the State of Rio de Janeiro (UERJ, Brazil) and a National Research Council (CNPq) researcher.

Barbara Fritz

Barbara Fritz is a professor of economics at the Institute for Latin American Studies at the Freie Universität Berlin.

Daniela M. Prates

Daniela M. Prates is a professor of economics at the University of Campinas (Unicamp, Brazil) and a CNPq researcher.