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Home Publications Blogs Beat the Press Neil Irwin Has a Faulty Econ Textbook

Neil Irwin Has a Faulty Econ Textbook

Friday, 08 February 2013 05:51

He presented a quote from Mario Draghi, the President of the European Central Bank:

"'The exchange rate is not a policy target, but it is important for growth and price stability. We want to see if the appreciation is sustained, and if it alters our assessment of the risks to price stability.'"

He then added:

"And with that, the euro fell more than half a percent against the dollar—even though Draghi was really more stating a fact from Economics 101 than signaling some major new policy plans by the central bank."

Actually the exchange certainly can and often is a policy target. There are many central banks, most notably China's, that quite explicitly target their exchange rate. Other central banks have often taken steps that clearly seem to have the purpose of raising or lowering the exchange rate, as was the case with this statement.

While a central bank can opt to ignore the exchange rate, that would be a specific policy decision. It is not a basic principle from economics textbooks.

Comments (1)Add Comment
targets, goals, degrees of freedom
written by pete, February 08, 2013 1:26
Hmmm...in my macro or money and banking texts, targets were interest rates or money supply. One could add exchange rates, I suppose, as a target, but typically this would be thought of as an after effect. China, with strict captial controls, may indeed target the exchange rate, but this is so far from an open economy with a central bank that it cannot be compared to Europe, Japan, and the U.S.. Explicit examples are also currency boards, though tyically these simply fix the exchange rate, rather than targetting the exchange rate, allowing their currency to rise and fall with the dollar. This is similar to the highly successful (for a while) Bretton Woods system.

Bottom line is there is one degree of freedom, and that is the money supply. Whether this is adjusted to keep interest rates at a certain level, or simply constrained to grow at a certain rate as during the Volker era, completely ignoring interest rates, is interesting. The value of the currency will reflect monetary policy, for sure, and is certainly not independent of money growth or interest rates.

For instance, if the U.S. seeks to counter Japan's attempt at devaluation, it could try and grow its money supply (not just the base) at a rapid rate, keeping the dollar from appreciating by fostering domestic inflation. This of course, would exacerbate inequality, since the rents from this inflation would go, as usual, to capita.

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Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.