Jeffrey Frankel on Recession-Dating, the Plaza Accords, and Globalization

Jeffrey Frankel is a professor and economist at Harvard University and the director of the Program in International Finance and Macroeconomics at the National Bureau of Economic Research (NBER). He joins the show to discuss serving on the NBER’s Business Cycle Dating Committee, which officially declares the start and end of recessions. David and Jeff also discuss the monetary history of the Plaza Accord, an international agreement in 1985 to devalue the U.S. dollar. Jeff also shares his thoughts on globalization in the past few decades and current-day challenges facing it.

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Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Jeff, welcome to the show.

Jeff Frankel: Thank you David. Good to be with you.

Beckworth: Oh it's a treat to have you on this show. With all my guests, I begin by asking how did you get into economics?

Frankel: So, when I started college, I think probably if I had to guess what my majors were going to be would be math, which I liked for its precise answers, or history or politics. And then as soon as I took economics, I figured it was really for me, and the way I thought about it at the time is just think of maximizing. You're multiplying two things, how important a question is in practical terms, and how good the particular discipline is giving precise answers to the questions.

Frankel: So, I thought of math as infinitely precise with questions of zero practical importance, so if I can put it that way, and political science is sort of the other way around, and multiply that, the economics, kind of optimize the importance of the questions times the ability to answer them.

Beckworth: So, it kind of fell out as a byproduct of those two things then, economics?

Frankel: Yes.

Beckworth: Yeah.

Frankel: Yes.

Beckworth: Okay. I understand. Now, did you have any inspirational teachers along the way that kind of directed you down that path?

Frankel: Yeah. I mean I went to a very good small liberal arts college, Swarthmore College, and there's this one professor Bernie Saffron there who really got me interested. And then I mean I went to grad school at MIT and had an all-star ... Rudi Dornbush and Stan Fischer are my thesis advisors and a whole line of greats were there.

Beckworth: Oh fantastic. Now, how did you get into international economics? I mean, there's a wide field of areas that you could have gone into, but you choose international economics, you flourished in it. How did you know you were meant to be an international economist?

Frankel: I guess I was interested in international things long before I knew anything about economics. When I was a child, I was always interested in other countries. I supposed it started with maps, one of those people who got a thing about maps. And then beyond that, I guess I mean the news sort of kind of moves slowly, and even these days it seems to be moving very fast in the US, but still it sort of moves slowly in any one country.

Frankel: And if you kind of follow kind of what's going on in lots of different countries, each of them has their own story and the plot is always moving along rapidly somewhere. In technical terms, it's nice to have a lot of data-

Beckworth: Right, right.

Frankel: ... and it's had a series of one country only offers so much data, but if it got 195 countries or however many you can get data for, that's very powerful for answering lots of questions.

Beckworth: Nice big panel data set.

Frankel: That's right.

Beckworth: Absolutely. Now, you also served in addition to your duties as an international economist professor at Harvard, you serve on the NBER Recession Dating Committee. For our listeners who don't know, this is the committee that determines when the US officially begins a recession and exits a recession. So, how did you get into that?

Frankel: Well, I've been associated with the NBER, which is a larger organization for quite a while, and for a long time I've directed a program of international finance and macro. And so, originally it was sort of a ex-officio thing that when I took that one, it automatically sort of made me a member of the committee.

Frankel: I mean, I work for Martin Feldstein in the early '80s when he was the chairman of the council of economic advisors, and so he's on kind of my list of mentors, and I think he sort of promoted me within the NBER.

Beckworth: So, what is it like serving on that committee? I mean, you get together. Did you guys meet regularly? Do you communicate via email, some other method? How do you guys know when to get together and start talking about whether we're in a recession or not?

Frankel: So, it's different from what a lot of people assume. It's the perfect committee in a sense that most of the time it never meets.

Beckworth: Nice.

Frankel: If there's no live questions, it's been over six years since our last meeting, and during my first nine years on it we never met at all in the 1990s because that was kind of this record expansion. There's was nothing to talk about. So, we don't forecast, we don't talk about if maybe we're going into a recession. We wait until it's really clear.

Beckworth: Do you ever feel any pressure to make a decision because it can be a very political decision making process, right? People want you to state when did the recession officially begins. Did you ever feel pressure to make a statement or any kind of repercussions from making a statement?

Frankel: Well, we never feel any political pressure, and there's just never any whiff of politics inside the committee, but we do feel pressure. I mean, what often happens is people are saying ... Well, let me explain. On average, roughly it's a year after a turning point, after the beginning of a recession or the end of a recession before we make the call, and people that typically say ... Well, we get a lot of commentary, and not all of it positive.

Frankel: Half the commentary is, "You idiots. Everyone has known that we went into a recession or that we came out of a recession." So, that's on the one hand. On the other hand, we don't view our job as being fast. Lots of people try to do that. We want to be definitive, and we rather not have to change a date. This isn't just declaring that there was a recession, it's picking the exact turning point, the exact month, and that can be very tricky even after the fact given data points, different ways. And one thing we prefer not have to do is to change a date after the fact, for example because some GDP numbers which are revised, which they always are.

Frankel: So, the pressure we feel is this trade off between not waiting so long that it's completely ridiculous versus being pretty sure that we won't have to change our mind that we can be definitive about it, which is harder than you would think.

Beckworth: I'd imagine so, and what I find fascinating about it though is the dates that you have picked, you and your fellow committee members have picked, it's so widely used now. So, when you open Fred for example, you see the fruits of your labor there, right? You see those recession bars. You're the one to determine whether those recession bars went or you think of the studies that used probit models to predict recessions based on the NBER's recession periods.

Beckworth: Do you ever site back and say, "Wow, that's the fruits of my labor right there."?

Frankel: Well, definitely and it does have this, even though the NBER is a private non-profit organization, it does have its official status. The government doesn't have any other way of doing it, and they use it, the government uses it in their charts as well, so it does have this official status. And by the way, the fact that people use it in research is one of the reasons why we would not have to go back and revise the dates because that would wreak havoc on someone's research.

Beckworth: Yeah. Well, very interesting. Well, let's move into your main area and that is international economics. As I've mentioned at the beginning of the show, you're widely published in this area, and you lead the research program on international economics and macro at the NBER, and let's begin by talking about paper that you recently published “Globalization and Chinese Growth: The End of Trends,” and in it you get into this discussion of has globalization kind of petered out? Is its future in doubt?

Globalization and Chinese Growth

Beckworth: So, tell us about it. What did you find in this paper?

Frankel: Well, let me mention first why this paper was written. In 1995, I gave a talk in Bologna, Italy where I was asked to talk about, look at head what seemed at the time to be infinitely far in the future to the year 2020, and just think about trends, which I don't know about you, but honestly I'm not very good at forecasting early at that horizon, but it seemed to be that was so far off that it was pretty insane, and then it comes around faster than you would think, and I was asked to go back and kind of update because 2020, it's almost here. So, I mean one of the things that I didn't get a whole lot of forecast, right?

Frankel: But I did get some and one of them was, one sentence that I think was right is just because globalization has been a steady trend, for example increasing ratio of trade to GDP and so on, whatever your favorite measure is, just because it's been a very steady trend throughout the post-war period doesn't mean it's inevitable. And I referred to the fact that in the '30s, even though technological progress continued and reducing cost of trade, that political factors ... Actually, from 1914 to 1944 was a reversal and especially in the '30s of course, and so that was wars, that was tariffs, Smoot-Hawley Tariff, the retaliation, there was a lot of things. And I said it could happen again, and maybe we're now seeing it.

Frankel: It is remarkable that the last 10 years, the first time in decades when trade has not increased relative to GDP, and maybe some other measures of globalization seemed to be in abeyance as well.

Beckworth: Well, let's go back even before that. When does globalization really begin to take off? What decade would you place that in?

Frankel: Well, of course it's not the world's first experience with globalization. But if you're talking about when it had a really big impact on the economic lives of most people, that would be the 19th century. The 19th century and the second half.

Frankel: For the post-war period, the liberal trading regime, open trading regime that was established as a goal, and more and more of a reality began with Bretton Woods, and took hold in the 1950s and '60s. For the US, I guess a big increase in trade was within the '70s. I wouldn't want to pick one date as to when it started.

Beckworth: Okay. I guess it's easy as someone my age to think back and want to put a finger on it. I recall the '90s, in particular like late '90s, and I know globalization was occurring before then, but just some of the reaction to it, recall some of the WTO, IMF protests, late '90s, early 2000s. And I figured well by that point, globalization has manifested, people are feeling the disruptions it's creating, and even today we're still dealing with that.

Beckworth: So, I guess maybe to rephrase my question is there a period when globalization accelerated? Was there an inflection point where things really begin to heat up, and we see more trade relative to the size of the economy?

Frankel: Well, that's probably because I'm a little older than you. I see it as a longer term phenomenon, and repeatedly the media have said, "This is a whole new phenomenon."

Beckworth: Right.

Frankel: I mean, so I got my PhD in 1978, and certainly people have always told me, "Oh you're ina really hot field now." I mean, that goes way back to end of Bretton Woods in '73, and oil shocks, and the big increase, the concerns about competition. Back then it was really from Japan first, and then other ... We call them the NICs, newly industrializing economies, Korean and so forth, so I mean it goes way back, and it was a huge issue in the 1980s, which is before the period you were talking about.

Frankel: I mean, I know what you're talking about, certainly the anti-globalization movement. The phrase that surfaced I would say when you said it, but these were big issues. All of the competition particularly in auto, and steel, and textiles were huge issues in the '70s and the '80s, and when Bill Clinton ran for president, that was one of his issues. "We need to be smarter about our trade policy." He said.

Beckworth: Yeah, yeah. Yeah, and a little bit later in the show we're going to get to one of those periods that's related to the Plaza Accord, so definitely it's been going on for a while, and definitely as someone my age it's easy to recall certain things that lack the historical perspective they need. But as you mentioned-

Frankel: I mean, one thing that's new ... Sorry, just one thing that's of course very consistent to what you're saying is the rise of China, which really did in terms of how it impacted the US. It was the late '90s and early 2000s.

Beckworth: Yeah, yeah. But as you've mentioned, this is not the first wave of globalization. So, the late 1800s, early 1900s really was the first one, and I've seen this many times. There's a famous economist article from during that period was just very optimistic, things are looking great, and then of course World War One comes along and completely throws it off track.

Beckworth: So, one question I have then, and in this paper you bring it up and you mentioned earlier that trade actually slowed down, the growth of trade has slowed down since the crisis in 2008, and there was one responsible, it was because we're going to have more protectionism. We didn't actually have it right then, maybe we're going to see it soon, but back then we didn't see it after the crisis. So, what are the reasons for the slowdown in trade since the crisis?

Frankel: Well, I mean it's a really interesting question, and of course it's not just the trade has slowed down because world growth has slowed down as well, but it's also that trade is not even growing fast than world growth, which seemed to be like a law of nature for at least a few decades there, so it is a bit of a puzzle. And then during the great recession, that seemed to be one puzzle that trade actually fell a lot more than world output fell, and so some of the initial explanations were kind of designed to fit that fact. But now we see that it's a longer term trend, and by the way I guess even though there was not the increase in protectionism that people feared, nothing happened after the '81, '82 recession for example, let alone the really clear contrast with the Great Depression, the Smoot-Hawley Tariff.

Frankel: Nevertheless, we've now gone 15 years or longer than that, without major progress in trade globalization under the WTO at the multilateral level, and the regional trade agreements have sort of turned that stopped happening with the ... Sorry. To pull out of the EU, Brexit, and now the US pulling out of TPP, et cetera. So, I would put on the list of a period where we have not continued to have important new globalization or trade agreements, and then now of course there is a risk in the US and elsewhere of actually putting up tariff barriers if you listen to some of the political leaders.

Frankel: But as you've mentioned, there wasn't a big increase in protectionism in 2008, the way so many people have feared, so many economist have feared anyway, and I saw other explanations. I mean, one is that investment has been lower. Businesses aren't investing at the same rate, and construction relative to before the recession, and it's still down a percentage of GDP, and investment is a component of GDP that in most countries, it's pretty intensive in trade, pretty intensive in imports. So, that's one explanation.

Frankel: Another one, and all of these fall in the category of things that we sort of thought were permanent trends turned out other have been a product of two or three or four decades that maybe those decades were the exception to the rule rather than the normal one. But another one on the list is this tremendous process of lengthening the value added chain, especially with respect to China. It's so much manufacturing takes places with various inputs and intermediate products going back and forth, and back and forth, especially in sectors like automobiles and consumer electronics whether it's Asia or between US and Mexico or within Europe, lots of back and forth, and that was a process which people are aware of how big that is, but they may not realize that it basically peaked sometime early in the century, and that process of lengthening the value added chain. So, it stopped, that just ran into diminishing returns, and one aspect of that is a bit of reshoring that we've had that some companies that have moved some operations to China have been back again even though I would exaggerate the importance of that in particular.

Frankel: But a lot of stages of production have previously would have been gone back and forth across national borders. That trend is no longer in that direction, and China just generally, that would be the last of the major hypothesis or explanations that I would give you for this kind of decline in international trade that China, as people have been urging them, has started shifting from this very heavy reliance on manufacturing and exports as their source of growth, and have shifted to more emphasis on services and more emphasis on domestic demand. Probably not as much as they need to, but they are moving in that direction.

Beckworth: China is an amazing story. Three decades, 30 years or so where they grew about 10% a year. That's just mind blowing. I mean, I don't think there's any other country in history that's grown that rapidly for that long.

Frankel: I think that's right, and I agree with both the statistical fact that it is very remarkable.

Beckworth: Yeah. So, you've mentioned the mature supply chains. One of the reasons that arguably trade has slowed down since 2008 prior to the Trump election and this rise of protectionism that we see around the world right now, let's talk about that a little bit more. So, the supply chain, what it says as you've mentioned early is that any of our products like my iPhone or our car, it's assembled along many different stages in different parts of the world. And so, being that's the case, some of the pushes that President Trump has in mind would really disrupt those supply chains, wouldn't it?

Trade, Protectionism, and Impact on Supply Chains

Frankel: Absolutely, and when I say that the trend has maybe run into diminishing returns, that doesn't mean it's reversed. It's still true that many people's perceptions maybe are lagging behind a bit that when we import an automobile or a component or an auto part from Mexico or we import a smartphone from China, people don't realize how little of the value added came from that country in question, and how much came from somewhere else. A smartphone from China is mostly not American, and Korean and other components in it, and same with auto parts, and it is an efficient process.

Frankel: To simplify things a little bit, you can imagine a world we're not that far from, where there is an Asian automobile, a North American automobile, and a European automobile, and they're competitive in each case, and part of the reason they're competitive globally is that for the most labor intensive parts of the production process, the American and Canadian companies outsource those to Mexico, and the Japanese auto companies outsource those to China or Southeast Asia, and the German automobile company outsources it to Eastern Europe where labor is cheaper. And if they didn't do that, they wouldn't be competitive on world markets.

Beckworth: Yeah. So, one of the observations you get from this is that many people who maybe champion some of Trump's push to bring jobs home, to put up trade barriers fail to recognize that there are jobs in the US along the supply chain, some small part of making that phone, that car who will find their jobs gone or disrupted if this happens. I mean, because it's such a complicated global supply chain, I mean many folks around the world would be adversely affected including in the US.

Frankel: Absolutely, and I don't think it's a small thing. I think it's a big thing.

Beckworth: Right, right. Well, let's talk about then in the global economies. We're mentioning the trend has been trade has been declining, and maybe a true inflection point here with President Trump as some of his trade policies go through, but not just here, but also overseas. I mean in Europe, we see that same kind of strain of populism going, and one question I have is, and I thought about this a lot, had our response been very different to the Great Recession, and I don't want to take anything away from the Federal Reserve and the government, but let's just say for the sake of argument we could have avoided the great recession, and we have been much more aggressive had there been a mild recession as opposed to the Great Recession.

Beckworth: Let's suppose the same thing in Europe, that the ECB, the European Central Bank hadn't raised interest rates twice in 2011, hadn't raised in 2008, and have been very accommodative. I mean, on that note, let's just imagine QE3 had been done in the beginning in both places, and we have a much better outcome, would we see the same push for trade restrictions and protectionism that we do now in that counter-factual world?

Frankel: Well, I mean that's a really interesting question. I'm not sure of the answer. Protectionism does tend to be a cyclical thing. It's been true in the past that it goes up in times of recession, and once again the '30s would be the most dramatic example of that. Now, of course the US anyway, I'd say we're pretty much back to full employment. I'm not sure how you feel, but we're certainly in a much higher business cycle, and I think we're pretty much there, and yet we now have a president who as you say, at least in talks, direct protection in this way, and it seems in many ways to be following through on the things that he would do during the campaign.

Frankel: I'm not sure that fits, and more broadly I always hesitate before attributing things to increases in inequality because anybody can define inequality however they want and attribute anything to it.

Beckworth: Sure.

Frankel: But nevertheless, inequality has increased sharply since the '70s and especially since the turn of the century, median family income. I mean, we got a good increase in the most recent ... Of course, we have statistics for real median family income, but it's still not above where it was in the year 2000. I think it was lower in the year 2000, and so I don't know if that explains Trump. I tend to be skeptical of that, but it certainly is an obvious thing to point to in terms of backlash against globalization.

Frankel: I think not with merit for the most part, but nevertheless I could see people's logic.

Beckworth: Right. There's definitely a disappointment feeling of we've missed out on something, and I agree. It does seem we're much closer to full employment today, but I also wonder ... So, maybe we're near full employment. I wonder, could we even be at a higher level of full employment in the sense that maybe potential GDP is lower today.

Beckworth: Our capacity to produce, to create jobs is lower today than it would have been had we have had a more robust recovery that to some extent, potential GDP has been affected by the slow anemic recovery, and to the extent that's true, which again that's a conjecture on my part, but that's true. People sense that, and they're looking for some kind of solution, and they turn to protectionism.

Frankel: Well, I mean above and beyond the fact that the Great Recession from 2007 to 2009 was easily the most severe since the '30s. Above and beyond that, we seem to be on a slower trend of growth, and I guess a number of different possible explanations for that.

Beckworth: Right.

Frankel: One of them is, a technical term is hysteresis, which I think is what you're getting at, that the magnitude of the Great Recession is attributable in some way to a financial crash. We don't have to completely figure out the specifics to think about the consequences that's had permanent effects. That's one of the hypotheses, and permanent effects via reduced investment and therefore lower capital stock, people leaving the labor force earlier and retiring early otherwise leaving the labor force, or just being out of work for a couple of years and their skills deteriorating or at least their potential employers think their skills might have deteriorated, this kind of stigma effect, those are all reasons why you could get this possible permanent effect out of a recession, and I think that's possibly something to that.

Frankel: There possibly is something to that. But I guess I can't go all the way with you.

Beckworth: Okay.

Frankel: The slowdown, I mean it does date back to the turn of the century. Growth has been on average much slower since 2000 than it was before that, or if you're looking at productivity growth, it's been slower since the '70s than it was before that, and for 50 years. And so, I want you to at least consider some of the other hypotheses-

Beckworth: Sure.

Frankel: ... that have been offered. One is secular stagnation hypothesis, another one is Robert Gordon's claim that the great technological innovations that we've had recently are nothing like the great tech watch bubble innovations that we have in the late 19th and early 20th century in terms of what they do for productivity growth.

Beckworth: Yeah. So, there's a number of alternative explanations, so I don't want to overstate my case for sure. Well, let's look at the outlook for the global economy. What do you see is the biggest threats? Is it the Eurozone Crisis re-emerging? France has an election coming up, and one of the candidates there wants France to leave the Euro, that could really potentially trigger a financial crisis. China could have problems.

Biggest threats to the Global Economy

Beckworth: Anything else you would see or worry about at nighttime as we move forward?

Frankel: Well, its shocks tends to be things that one can and can't predict. I mean, Europe for so long was kind of stable, and boring, and we look everywhere else in the world for political crises and economic crises, but Europe has had more than its share lately. Besides a scenario like you're saying, an upset in France or Italy, and a party coming to power that wants to pull them out of the EU like the British or do other kind of radical things, a higher probability event is that we have a return of the Greek crisis because it's no better than it ever was in terms of their ratio.

Frankel: The GDP is still going up, and up, and up, and the Germans still say that with fiscal austerity is the way to solve it, and really nothing has changed there, and they're going to be doing, I think it's in April for a sort of trench deployment going over the day. Now, when I say that's higher probability, I think the Greek crisis will come back whether it has spillover effects, I have no idea. There is so much uncertainty in the world today, and many of the things that our new president says and does really scare me, and I guess I'm most scared even more than probably some of the things he said he's going to do.

Frankel: Just my doubts that in the event of some unforeseen crisis whether it's political or economic, whether it originates within the US or outside that he will just not react in a sensible way.

Beckworth: Okay. Yeah. The Eurozone Crisis is an interesting one. I mean, the story, you mentioned Greece and how they effectively kicked the can down the road in terms of their debt problem, so it will be interesting to watch as well as to see what happens at home. Well, let's move onto the Plaza Accord I mentioned earlier. You have a paper on it, a recent paper titled The Plaza Accord 30 Years Later, and this takes us back to the mid '80s, and tell us what it was, the Plaza Accord, and why was it importance.

Frankel: Right. Yeah. So, this was for a conference, the 30th anniversary of the Plaza, which was a meeting at September 22nd, 1985 that the G5 finance ministers and some representatives of central banks met at the Plaza, and agreed that the dollar, which had appreciated a lot between 1980 and '85 that it was maybe too strong and that it should come down, that they stood ready to intervene when necessary. Besides a precise meeting at the Plaza, in my paper I kind of date the key turning point back to January of that year of 1985 when James Baker became Secretary of the Treasury, and brought with him a different attitude towards the issue of the dollar than his predecessor had, and this conference was held at the Baker Center in Houston.

Beckworth: Yes. Go ahead.

Frankel: So, I mean I probably realize it sounds like ancient history for many of your listeners, but it is-

Beckworth: It's important history. Yes.

Frankel: It is important history. I think it just deserves to be remembered and studied just for no other reason because it's kind of the most important episode of international cooperation, and of activist change rate policy for the dollar that we've had since the break up of Bretton Woods. But beyond that, of course many people are asking are there parallels for today because the issue was the dollar is too strong, and is that hurting the trade deficit, hurting American exporting firms, and firms that compete with imports.

Beckworth: Yeah. It's a pretty remarkable period. So, you mentioned in the paper the dollar went up 44% in the five years leading up to 1985. So, in the first half of the decade, the dollar rose 44% pretty rapidly, and then it pretty rapidly went down.

Beckworth: From '85 to '87 it declined 40%, and then of course this affected with the lag the trade balance. It also interestingly led to the creation of the G7. We foresee the G7 really working together to get something done, and since then we've had the G7, other groups like that expanded to a bigger number of countries, but that's the beginning of the G7 there.

Beckworth: So, it does seem to have some interesting parallels for today because the US dollar, since mid 2014, has risen over 20%, and it recently went up a little bit more with the election of Trump and it's kind of tapered off now. And then there's been some people who've called for a new Plaza Accord, and one thing you bring out in the paper is it's amazing how open everyone was to international cooperation back then whereas today, it's much more everyone is looking at each other, countries view each other as currency manipulators. Anything that comes close to that, they're worried to point a finger.

Beckworth: So, one question I have, do you think it's even plausible that we could have a Plaza Accord today if there was an agreement that the dollar needed to come down in value?

Frankel: Well, I mean there are some similarities, but many differences. I mean, even before the Trump kind of turn against international cooperation per se, which I think it's fair to characterize that his attitude is that, to the extent we've had cooperation in recent years, with the G7 and the G20 have agreed not to intervene in the foreign exchange market. That's kind of been a separate trend that to intervene in a foreign exchange market is manipulation, and we've all agreed not to do it or we haven't been doing it. Certainly, the G7 countries haven't, and the G20 countries have not intervened too.

Frankel: Of course, the Chinese are intervening to keep their currency from depreciating, I'm not sure our president has gotten that message yet where he seems to okay they're doing the opposite. And to make it really clear, if China agreed to do what we keep asking them to do, which is stop intervening in a foreign exchange market, their currency would go down, not up. But then we have this, not backlash, but move against cooperation, international cooperation per se, which I just think is a huge mistake, but that does seem to be the current feeling.

Frankel: So, that's one of many reasons why it seems to me that a new Plaza Accord in the immediate future or foreseeable future is unlikely.

Beckworth: Well, just based on theoretical grounds, would you ever call for one? I mean, do you think the rise in the dollar since the mid 2014 warrants a Plaza Accord? So, put aside whether we could actually do it politically, is there an argument to be made for doing it?

Frankel: Well, I can imagine a repeat. I don't think they were finished with foreign exchange intervention for example just because we haven't been doing it for some years, but I don't think we're at the point where it would make sense. I mean, the dollar even though it's appreciated over the last couple of years as you've said, and especially since the election, but before that too in the last few years it's still well below the level of where it was in 1985. That's one point.

Frankel: Another point is in 1985, I mean you could explain the early stages of the appreciation by fundamentals such as the shift of monetary discipline under Paul Volcker, but basically by the time you got to '85, you couldn't explain that by fundamentals anymore. The last 20%, which happened between mid 1984 and February 1985 happened to go in the opposite direction of just ability any economic fundamentals any of us could come up with. This is different. I mean, I think this is explainable by fundamentals.

Frankel: And so, for intervention or some other agreement to bring it down to be either desirable or for the odds of its success to be high, it would have to be I would say be more likely to happen if it were departure from fundamentals, which I don't yet see that it's gone that far.

Beckworth: And just so our listeners understand, when you say fundamentals, I think you mean is that the Fed has been talking up interest rate hikes, it's had a few, but the market is expecting more interest rate hikes in the US, which pulls in capital whereas in Europe and in Japan and elsewhere, rates are down and they don't look to be going up anytime soon. So, that spread in interest rates is causing the dollar to rise sharply whereas what you're saying in the early '80s, that was only true up to a point, and after that you couldn't explain it by that difference.

Frankel: Yeah. It's just differentials are high on the list of what I had in mind, and they had turned around by 1985. US interest rates had started back down again, so that's part of what I had in mind. But also, there's other fundamentals that matter as well. Really fundamental fundamentals is how fast the economy is growing.

Beckworth: Right.

Frankel: And so, the US even though we haven't grown in recent years as fast as we would like, we've been growing faster than Japan or Europe, and that's why we stopped the monetary easing the Fed did, and tapered down, and then has shifted to a few increases in interest rates, and they're expected to raise interest at a more rapid rate during the rest of this year during a period when the rest of the world, as you say, has sort of moved towards monetary ease because their economies have slowed down.

Beckworth: Yeah.

Frankel: So, the top two fundamentals are the growth rates in the real economies and the monetary policy, and they're connected.

Beckworth: Okay. Now, what happens if the border adjusted tax comes into place? So, that's the tax where imports would be taxed, and exports would be able to sell abroad without any tax. The argument that's often given for the support of adjusted tax that President Trump and Republicans seem to like is that it would actually increase the value of the dollar pretty quickly and pretty dramatically. So, number one, is that true? Would the dollar go up under this tax, and if so, what would happen then?

Beckworth: I mean, would we be at a place where you would want to think about a Plaza Accord? Because if you put that on top of where we are today, that would be quite a big increase.

Frankel: Well, I mean you're right. At least the public economists point that's what would happen in theory, and it is I think one of a whole long list of things that are our new administration has said or done that had contributed to appreciation of the dollar, and not just administration, but Republicans in Congress that are supporting that proposal. I mean of course the big thing is that people are expecting, we're expecting, I think they're still expecting a fiscal stimulus increase in spending and tax cuts, and that the Fed would raise interest rates. I mean, that's ... But there's other things on the list as well.

Frankel: I do remember slightly that if we economists say or perceive to saying that this is a certain thing because exchange rates do have a habit of just doing whatever they want, and they don't always obey or theoretical predictions especially when there's lots of other things changing at the same time.

Beckworth: Sure.

Frankel: So, if I were to list all the reasons why the dollar might go up or down, I mean that would be on the list, but it would be not a sure thing, and it wouldn't be the most important thing on the list.

Beckworth: Okay. All right. Let's go back to the Plaza Accord for a few moments. What lessons do we get out of that? For example, does sterilized intervention work? And maybe explain what a sterilized intervention is, and then does it work?

Lessons from the Plaza Accord

Frankel: Sure. Well, I think pretty much everyone whether economic economists or policy makers agree that if you have an easier, tighter monetary policy, that's likely to have an effect on the exchange rate. If the increase of supply of the currency, then the value of the currency goes down. But there is some disagreement. If you intervene in a foreign exchange market buying, selling dollars for Euros or Yen or whatever, but you sterilize it meaning prevent that from changing the money supply, the total supply of dollars versus the supply of Euros or Yen by undertaking, offsetting operations whether that has an effect, and an awful lot of theory and many economists both in the academic world and central bankers will tell you that intervention doesn't have an effect if it's sterilized.

Frankel: Otherwise, it doesn't have an effect unless it changes money supplies. I actually think that it does. Maybe not, maybe it can't have a really permanent effect, but if it only has an effect for a few months, that's often useful. And my statistical work that I've done in the past, and looking at the Plaza, and looking at the period, the 20 years after that when we continued to intervene from time to time in the foreign exchange markets, I read the evidence as saying that it often does have an effect.

Beckworth: Okay.

Frankel: And by the way, why would we be so upset about it? One due point is why would we be so concerned of countries intervening in the foreign exchange market if we didn't think it had an effect. On the other hand, many of the people who worry so much about currency manipulation, if you press them, they're saying, "Well, we're not talking about intervention." We realize that Japan and Europe happen to intervene in the foreign exchange markets, and China is actually intervening in the opposite direction, but we are talking about the total money supply.

Beckworth: One of the other interesting insights that you brought out in this paper that I wasn't aware of is the fears of folks in Asia that the US manipulating in its currency. So, we often have politicians and observers in the US point to Japan in the '80s, China more recently, they're the manipulators, but you have this part of your paper that talks about a conspiracy theory that the US has used its advantage over time. I'm just going to read an excerpt here from page 12.

Beckworth: You put, "One of the legacies of the Plaza Accord is sort of a conspiracy theory that has continued to circulate widely in Asian. The theory is that the United States deliberately sabotaged the Japanese economy. The most common version is that the effect came via in Dachau, the strong Yen, which priced Japanese manufacturing out of world markets. The idea is that the US successfully used this weapon against Japan at the Plaza in 1985, then against in 1988, '89, and against China in the year since 2004."

Beckworth: So, is this a pretty common in view in Asia that the US is being a hypocrite, that we're actually the ones manipulating currency?

Frankel: Well, I'd say it's a common view in many parts of the world. The whole phrase currency wars was sort of coined or at least made popular by the Brazilians five or six years ago in reaction to US quantitative easing, and back when the dollar was depreciating, and their currency so strong. So, that's very widespread. They were hypocrites for saying this now.

Frankel: And then there's the particular version that yeah it's fairly widespread in Asia. The Chinese have really picked up on it, but beyond just us being hypocrites that the Plaza was a plot to do in China, and then we did the same thing to Korea, and then now we want to do it to ... Sorry. First Japan, then Korea, then China.

Beckworth: That's amazing kind of connecting those three events there. I've heard this accusations individually, but then to connect them all together into some super overarching conspiracy theory, that's pretty remarkable.

Frankel: Well, I mean there is a grain of truth to it. The US Treasury, I've had the privilege of serving in different administrations, so different parties, has pretty consistently for understandably reasons push Asian countries to open to US financial institutions, and has consistently pushed the Asian currencies to appreciate. That is true.

Beckworth: Well, it's interesting. I used to work at the US Treasury Department and International Affairs, and one of the things that we had to do I believe is twice a year was do a report on all the countries of the world that we engage with, and whether or not they manipulate their currency, and we did our best to show that they did not manipulate because of the repercussions if you did see they did manipulate. So, I was there in the early 2000s, and I remember we worked really hard to make sure that we didn't say China was manipulating its currency.

Frankel: Right, and there has been more consistency than you might imagine over time in what the US Treasury ... Every US Treasury since 1988, which is when that law dates from, has basically been in the same position that some congressmen are really angry at some Asian countries. I mean, the focus is sort of moved from Japan to Korea to China, but the primary focus, but all of them, and treasuries had to walk a fine line between. If we just say nothing, then congress will get angry and pass harmful protection legislation, and my personal view, and I know not all economists agree on this, but I think the charges of manipulation are kind of misplaced.

Beckworth: Yeah. So, one thing that's always bothered me with accusations of currency manipulation, there's always kind of this ... Not always, but often there's this story being told along with it that, "Look, it's a race to the bottom. Beggar thy neighbor. One country can devaluate, but we all can't devaluate." And I think that misses a broader point or maybe more fundamental point, and the objective itself may not be to devaluate the currency. Their objective may be to raise domestic demand, and in the paper you talked about worked on Barry Eichengreen on the Great Depression where a number of countries did initially get some kind of little bump out of being the first ones to go off gold, but that wasn't really the ultimate most important effect.

Beckworth: The most important effect was to create more money and more domestic demand in their economies. So, I mean, in the case of the US, the QE you mentioned Brazil kind of as currency manipulators, my sense is that wasn't the Feds objective. The Feds objective was to stimulate demand, right? To get the economy going again, and I just sense there's some confusion between currency manipulator versus an honest attempt to raise domestic demand. Your thoughts?

Frankel: Well, I think you're completely right. So, to just sort of go over it again that in the 1930s, Roosevelt took the dollar off of gold, and then other tries, France and Britain, one by one pretty much everybody went off of gold and devalued, and the common view at the time was this was part of Roosevelt not wanting to cooperate. There's a Kindleberger review that Britain had stopped being the global hegemon because it had lost power in the longer creditor, but a debtor. And if the US wasn't ready to assume the role of kind of leading the global orchestra or of coordination, and there's a lot of truth to that when it comes to trade policy or whatever.

Frankel: But a dominant view, and the reason why the Bretton Woods Agreement in 1944 that the Allies decided to have exchange rates afterwards because they thought this had been really destructive, these competitive evaluations, which is really the same thing as currency wars, and that has been kind of the dominant view. Barry Eichengreen, as you point out has this revisionist view, which I find kind of persuasive that yeah, it's true that evaluations cancel each other out in terms of competitiveness against each other, but you devalue against gold, you increase the price of gold in terms of local currency, which has the effect of increases the global money supply, and that allows interest rates to be low, and that's exactly what you want. And some version of that I think has also been true in the last 10 years that each country has had easier monetary policies, which they responded with different timing, but major countries probably all adopted this quantitative easing or in other ways more expansionary monetary policies, and that was desirable.

Frankel: Now, the agreement that I mentioned before, the G7 and G20 countries sort of made not manipulate the currencies. It's a slew, kind of artificial thing. I do think that major motivation for the Fed, and we give quantitative easier was to simulate domestic demand, as you say, not to depreciate the currency. But they're smart, the governors. They were aware that this was likely to happen and that would contribute to it, so it's a little bit artificial of what the status quo is that you're allowed to do it to stimulate domestic demand, but you're not allowed to do it to depreciate the currency.

Frankel: It's really getting to the motives, and since they presumably know that it's likely to depreciate the currency, how can they eliminate that knowledge? But broadly, I agree with you and that really is why a lot of the talk about currency manipulation or currency wars I think is kind of misguided, because of course each country, if their economy is weak, should respond with easier monetary policy.

Beckworth: Right. And along those lines, let's segue into the last part of our program, and that's something that's near and dear to my heart, and that's nominal GDP targeting, and that is where the Federal Reserve or any central bank would aim to keep current dollar spending or nominal spending on a particular target of path, and this is something I've advocated, and it's something you have as well. You've written a number of interesting pieces on it, and you've also taken it a step further by applying it to developing economies. So, first tell me what is your interest in nominal GDP targeting?

Nominal GDP Targeting

Frankel: My career goes back far enough that I was there for the heyday of monetarism. And so, the first paper I wrote about it was in that context, which to remind your listeners Milton Friedman believed in rules rather than discretion, and he also believed that the best rule was via steady growth rate for the money supply because money was stable. Demand for money was stable.

Frankel: And he won these major victories that Paul Volcker in the US, and the Bundesbank Bank in Germany, and the Bank of Japan, and the Bank of England all kind of switched formally to monetarism in the early 1980s. So, many of us could the see the argument for more rules and less discretion, but thought that monetarism was very vulnerable to big fluctuations and the demand for money and velocity, and that nominal GDP targeting would be a way to get around that. I mean, that was a remarkably common viewpoint among top macro economists at the time, and remarkable that no country ever did it.

Frankel: Even when the Europeans were thinking of what would be the guiding principles for the new European Central Bank, they didn't even consider nominal GDP targeting.

Beckworth: Interesting.

Frankel: Yeah, it is interesting. But as you say, you can quite rightly say within I don't know, seven or eight years ago, that the topic got revived and give you a lot of credit for that, and some others especially on the new world of blogging and reviving it. And so, in the last 10 or 20 years, the status quo has been the rule for the money supply, the status quo has been inflation targeting, but some of the same argument applies that even one wants to give up some discretion and set a rule, it makes a big difference what the rule is.

Frankel: You don't want to be vulnerable to shocks, and the problem with setting a money rule is that it was vulnerable to velocity shocks or money demand shocks, and in my view the big problem with inflation targeting institution that it's subject to supply shocks. And in smaller countries, it's vulnerable in terms of trade shocks, and so that's what led me to this particular angle of saying that the case for nominal GDP targeting applies in particular to small countries, developing countries, commodity exporting countries because they're the ones that experience much bigger supply shocks whether it's changes in productivity growth or natural disasters or political unrest or whatever, and especially in terms of trade growth.

Beckworth: Jeff, one of the questions I have then and going back to the history since you were there, and you were a part of this literature and this discussion in '80s when nominal GDP targeting first came up is why did it ... Kind of go to the sidelines, why did inflation targeting emerge? We know this story. New Zealand adopts inflation targeting first, and then some others. Canada, UK, and this talked about the idea of nominal GDP targeting you just mentioned is prominent among top macro economists, it never took hold.

Beckworth: So, do you have any explanation for that? Why is it inflation targeting emerged and not nominal GDP targeting?

Frankel: Well, I've always thought it was a puzzle, and I don't really know the answer. I think that when it comes down to it, central banks and for reasons that are partly or even largely defensible don't want to be nailed down too much to a target, and especially if it's a target that they can't meet, which they're really afraid of being held responsible to hit a target that they can't hit. Now to my mind, that always has said, that's more of a reason for nominal GDP targeting versus inflation targeting but monetary policy has, in theory at least, has more control over nominal GDP than it does on the breakdown of nominal GDP between inflation and real growth, which I think is right.

Frankel: But I think that I've been too, maybe many of us have been too literal at thinking that inflation targeting meant commitment to get to an inflation rate that you were really going to hit within some target range. A huge number of countries are officially targeting inflation, and almost none are hitting their targets.

Beckworth: Right.

Frankel: And maybe they received a little bit of an embarrassment for that if it comes up, but it isn't what we originally imagined, which if you say, originating in New Zealand, our original story. I don't know if this is just fantasy for the part of us monetary economists, but the original story was the governor for the Bank of New Zealand commits to an inflation rate, and then if he misses it, he's fired. Well, that was never even true in New Zealand.

Frankel: That was the precise way it worked, and it certainly not true elsewhere. So, maybe the governor of the Bank of England has to make a trip to Parliament where he explains the reasons for missing the inflation target, but it's not really that damaging to his reputation or whatever. So, I guess it's because it's related to the whole debate about rules versus discretion, and the recognition that if a rule is too tight or at least the belief that if you commit too tightly to a rule, you're likely to miss it and that central bankers are just really worried about being held responsible about hitting a nominal GDP target.

Beckworth: Yeah. That is an interesting rule they have in New Zealand that the head of the central bank there will lose his or her job, but though it's never actually been done, so it's not a really binding one.

Frankel: Are you sure it's actually the rule? I think it was a proposed rule early on. I'm not sure that they even actually adopted it as part of a rule. You'd be more likely be held-

Beckworth: Well, I heard a talk about that last year at a conference, and to be honest I haven't looked it up myself, but what the speaker said was that the rule was written in such a way that you can always find wiggle room around it, and therefore it's not really a truly binding constraint.

Frankel: I see.

Beckworth: So, that's my understanding of that bit at least. But with that said, you mentioned one of the big challenges with inflation targeting is supply shocks, and I think man, we've really seen that if we step back in an honest and assess what inflation targeting has done, and I've looked particularly to the European Central Bank. It raised interest rates twice in 2011, why did it do that? Because it saw inflation going up, but the inflation was going up because of the commodity price shocks, not because demand was falling.

Beckworth: If anything, demand was weak at that period. 2008, the ECB also raised its policy interest rate, and the Fed was during between April and October of 2008, the Fed was very reluctant to ease. It sat on 2% during that time because it was concerned about inflation. In retrospect, we know that inflation went up because of commodity price shocks.

Beckworth: So, there is real time confusion. What's driving inflation? Is it demand shock or supply shock? And I think life would be a lot easier for monetary officials if they did go to a nominal GDP target.

Frankel: Well, I think your description of what happened with the ECB is right. I mean, I wouldn't say the oil shock was the only reason, but it was a big part of it, and it is remarkable to actually move interest rates in what we think is the wrong direction at the time when the economies are going into recession, which is what they did. But by the way, you've illustrated perfectly why I think this is especially a good idea for developing countries because they do demonstrably suffer-

Beckworth: Sure.

Frankel: ... from much bigger terms of freak shocks than the advance economies.

Beckworth: Yeah. And it's also interesting as you point out that these inflation targets have been undershot for years, so the Federal Reserve ... Now, their target began in 2012, but effectively they've been aiming around 2%, and they haven't hit that since before the crisis. Since 2008, the average inflation rate for core PCE deflator, which is their preferred targets, have been about one and a half percent, and so it kind of defeats the whole idea of a flexible inflation target, which you hit on average you would hit 2%.

Beckworth: So, it's been interesting to watch, and hopefully your work for developing countries and for the advanced economies will get some recognition, and maybe push us closer to a nominal GDP target. But until then, we'll just have to keep on working and pushing that idea. Well, Jeff, thank you so much for coming on this show. Our time is up.

Beckworth: Our guest today has been Jeffrey Frankel. Jeff, thank you for coming on.

Frankel: Thank you.

About Macro Musings

Hosted by Senior Research Fellow David Beckworth, the Macro Musings podcast pulls back the curtain on the important macroeconomic issues of the past, present, and future.