Download Yesterday Once More

"Yesterday Once More", written by Richard Carpenter and John Bettis, is a hit song by the Carpenters from their 1973 album Now & Then. Thematically the song concerns reminiscing about songs of a generation gone by. It segues into a long medley, consisting of eight covers of 1960s tunes incorporated into a faux oldies radio program. The work takes up the entire B-side of the album.

The single version of the song peaked at number 2 on the Billboard Hot 100 chart, kept from the number 1 spot by "Bad, Bad Leroy Brown" by Jim Croce.[2] It was the duo's fifth number two hit and makes them the act with the second-most number two hits on the chart behind Madonna. The song also peaked at number 1 on the easy listening chart, becoming their eighth number 1 on that chart in four years.[3] It is the Carpenters' biggest-selling record worldwide and their best-selling single in the UK, peaking at number 2.[4] Richard Carpenter stated, on a Japanese documentary, that it was his favorite of all the songs that he had written. He has performed an instrumental version at concerts.

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Good morning. As the world seems to be struggling back to its feet after the great financial crisis, I want to draw attention to an area we need to be concerned about: the conduct of monetary policy in this integrated world. A good way to describe the current environment is one of extreme monetary easing through unconventional policies. In a world where debt overhangs and the need for structural change constrain domestic demand, a sizeable portion of the effects of such policies spillover across borders, sometimes through a weaker exchange rate. More worryingly, it prompts a reaction. Such competitive easing occurs both simultaneously and sequentially, as I will argue, and both advanced economies and emerging economies engage in it. Aggregate world demand may be weaker and more distorted than it should be, and financial risks higher. To ensure stable and sustainable growth, the international rules of the game need to be revisited. Both advanced economies and emerging economies need to adapt, else I fear we are about to embark on the next leg of a wearisome cycle.

Central bankers are usually reluctant to air their concerns in public. But because the needed change has political elements to it, I take my cue from speeches by two central bankers whom I respect greatly, Ben Bernanke in his 2005 "Global Savings Glut" speech, and Jaime Caruana in his 2012 speech at Jackson Hole, both of whom have raised similar concerns to mine, although from different perspectives.

Before starting, I should disclose my interests in this era of transparency. For the last few months India has experienced large inflows of capital, not outflows, and is seen by the markets as an emerging economy that has made some of the necessary policy adjustments.1We are well buffered with substantial reserves, though no country can be de-coupled from the international system. My remarks are motivated by the desire for a more stable international system, a system that works equally for rich and poor, large and small, and not the specifics of our situation.

The macroeconomic argument for prolonged unconventional policy in industrial countries is that it has low costs, provided inflation stays quiescent. Hence it is worth pursuing, even if the benefits are uncertain. A number of economists have, however, raised concerns about financial sector risks that may build with prolonged use of unconventional policy.5Asset prices may not just revert to earlier levels on exit, but they may overshoot on the downside, and exit can cause significant collateral damage.

One reason is that leverage may increase both in the financial sector and amongst borrowers as policy stays accommodative.6One channel seems to be that a boost to asset liquidity leads lenders to believe that asset sales will backstop loan recovery, leading them to increase loan to value ratios. When liquidity tightens, though, too many lenders rely on asset sales, causing asset prices and loan recovery to plummet. Because lenders do not account for the effects of their lending on the "fire sale" price, and subsequently on lending by others, they may have an excessive incentive to build leverage.7These effects are exacerbated if, over time, lenders become reliant on asset sales for recovery, rather than on upfront project evaluation and due diligence. Another possible channel is that banks themselves become more levered, or equivalently, acquire more illiquid balance sheets, if the central bank signals it will intervene in a sustained way when times are tough because unemployment is high.8

Leverage need not be the sole reason why exit may be volatile after prolonged unconventional policy. Investment managers may fear underperforming relative to others. This means they will hold a risky asset only if it promises a risk premium (over safe assets) that makes them confident they will not underperform holding it.9A lower path of expected returns on the safe asset makes it easier for the risky asset to meet the required risk premium, and indeed draws more investment managers to buy it - the more credible the forward guidance on "low for long", the more the risk taking. However, as investment managers crowd into the risky asset, the risky asset is more finely priced so that the likelihood of possible fire sales increases if the interest rate environment turns. Every manager dumps the risky asset at that point in order to avoid being the last one holding it.

Perhaps most vulnerable to the increased risk-taking in this integrated world are countries across the border. When monetary policy in large countries is extremely and unconventionally accommodative, capital flows into recipient countries tend to increase local leverage; this is not just due to the direct effect of cross-border banking flows but also the indirect effect, as the appreciating exchange rate and rising asset prices, especially of real estate, make it seem that borrowers have more equity than they really have.11

Exchange rate flexibility in recipient countries in these circumstances sometimes exacerbates booms rather than equilibrates. Indeed, in the recent episode of emerging market volatility after the Fed started discussing taper in May 2013, countries that allowed the real exchange rate to appreciate the most during the prior period of quantitative easing suffered the greatest adverse impact to financial conditions.12Countries that undertake textbook policies of financial sector liberalization are not immune to the inflows - indeed, their deeper markets may draw more flows in, and these liquid markets may be where selling takes place when conditions in advanced economies turn.13

Macro-prudential measures have little traction against the deluge of inflows - Spain had a housing boom despite its countercyclical provisioning. Recipient countries should adjust, of course, but credit and flows mask the magnitude and timing of needed adjustment. For instance, higher collections from property taxes on new houses, sales taxes on new sales, capital gains taxes on financial asset sales, and income taxes on a more prosperous financial sector may suggest a country's fiscal house is in order, even while low risk premia on sovereign debt add to the sense of calm. At the same time, an appreciating nominal exchange rate may also keep down inflation.

Ideally, recipient countries would wish for stable capital inflows, and not flows pushed in by unconventional policy. Once unconventional policies are in place, however, they do recognize the problems stemming from prolonged easy money, and thus the need for source countries to exit. But when source countries move to exit unconventional policies, some recipient countries are leveraged, imbalanced, and vulnerable to capital outflows. Given that investment managers anticipate the consequences of the future policy path, even a measured pace of exit may cause severe market turbulence and collateral damage.14Indeed, the more transparent and well-communicated the exit is, the more certain the foreign investment managers may be of changed conditions, and the more rapid their exit from risky positions.

Recipient countries are not being irrational when they protest both the initiation of unconventional policy as well as an exit whose pace is driven solely by conditions in the source country. Having become more vulnerable because of leverage and crowding, recipient countries may call for an exit whose pace and timing is responsive, at least in part, to conditions they face.

Hence, my call is for more coordination in monetary policy because I think it would be an immense improvement over the current international non-system. International monetary policy coordination, of course, is unpopular among central bankers, and I therefore have to say why I reiterate the call and what I mean by it.

I do not mean that central bankers sit around a table and make policy collectively, nor do I mean that they call each other regularly and coordinate actions. In its strong form, I propose that large country central banks, both in advanced countries and emerging markets, internalize more of the spillovers from their policies in their mandate, and are forced by new conventions on the "rules of the game" to avoid unconventional policies with large adverse spillovers and questionable domestic benefits.15Given the difficulties of operationalizing the strong form, I suggest that, at the very least, central banks reinterpret their domestic mandate to take into account other country reactions over time (and not just the immediate feedback effects), and thus become more sensitive to spillovers. This weak "coordination" could be supplemented with a re-examination of global safety nets.

Two factors have led to a rethinking of the doctrine. First, domestic constraints including political imperatives of bringing unemployment down and the economic constraint of the zero lower bound may lead monetary policy to be set at levels different from the unconstrained domestic optimal. Dysfunctional domestic politics could also contribute in moving monetary policy further from the unconstrained optimal. In other words, the central bank, responding to a variety of political pressures and weaknesses, may stray away from even the constrained optimal - towards third best policies rather than second best policies. Second, cross-border capital flows can lead to a more dramatic transmission of policies, driven by agency (and other) considerations that do not necessarily relate to economic conditions in the recipient countries. e24fc04721