Wednesday, April 4, 2012

Jeffrey Frankel - A Proposal to Anchor Monetary Policy by the Price of the Export Commodity

“A Proposal to Anchor Monetary Policy by the Price of the Export Commodity”
Jeffrey Frankel
Ayako Saiki

The debate over monetary standards and exchange rate regimes for developing countries is as wide open as ever. On the one hand, the big selling points of floating exchange rates – monetary independence and accommodation of terms of trade shocks – have not lived up to their promise. On the other hand, proposals for credible institutional monetary commitments to nominal anchors have each run aground on their own peculiar shoals. Rigid pegs to the dollar, for example, are dangerous when the dollar appreciates relative to other export markets.
This study explores a proposal that countries specialized in the export of a particular commodity should peg their currency to that commodity. When the dollar price of the commodity on world markets falls, the dollar exchange rate of the local currency would fall in tandem. The country would thus reap the best of both worlds: the advantage of a nominal anchor for monetary policy, together with the automatic accommodation to terms of trade shocks that floating rates claim to deliver. The paper conducts a set of counter-factual experiments. For each of a list of countries specialized in particular mineral or agricultural commodities, what would have happened, over the last 30 years, if it had pegged its currency to that commodity, as compared to pegging to the dollar, yen, or mark, or as compared to whatever exchange rate policy it actually followed historically? We compute what would have happened under these scenarios to the price of the commodity in local terms, and we then simulate the implications for exports. Illustrative of the results is that some victims of financial difficulties in the late 1990s might have achieved a stimulus to exports precisely when it was most needed, without having to go through wrenching currency collapses, if they had been on regimes of pegging to their export commodity: South Africa to gold or platinum, Nigeria and Indonesia to oil, Chile to copper, Argentina to wheat, Colombia to coffee, and so on. Not all countries will benefit from a peg to their export commodity, and none will benefit in all time periods. Nonetheless, the results suggest that the proposal that some countries peg their currency to their principle export commodity deserves to take its place alongside pegs to major currencies and the other monetary regimes that countries consider.


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