from Follow the Money

Ken Rogoff is also confused by the US policy towards dollar pegs

June 8, 2008

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It is nice to be in good company. Ken Rogoff is as confused by US policy toward dollar pegs as I am. Rogoff:

Does it make sense for the United States Treasury Secretary, Hank Paulson, to be touring the Middle East supporting the region’s hard dollar exchange-rate pegs, while the Bush administration simultaneously blasts Asian countries for not letting their currencies appreciate faster against the dollar? Unfortunately, this blatant inconsistency stems from the US’s continuing economic and financial vulnerability rather than reflecting any compelling economic logic. Instead of promoting dollar pegs, as Mr Paulson is, the US should be supporting the International Monetary Fund’s efforts to promote the eventual de-linking of oil currencies and the dollar.

The macroeconomic logic of the US position is hard to decipher.

If the US thinks monetary flexibility would help China - and the rest of Asia -- limit inflation, why wouldn’t monetary flexibility help the Gulf do the same? The Gulf certainly has an inflation problem. Saudi inflation is now over 10%. Qatar’s inflation is just under 15%. I would bet the UAE’s inflation rate, honestly calculated, is just as high, if not higher.

The Gulf’s peg the dollar -- which is likely to depreciate in the face of the oil shock -- certainly has complicates both the Gulf’s own adjustment to higher oil prices and the broader process of global adjustment. Menzie Chinn has calculated that a 10% rise in the price of oil implies a roughly 2% real depreciation of the currencies of most oil-importing economies, including the US.

In Chinn and Johnston (1996), a 10 percentage point rise in the real price of oil induces a 2 percentage real depreciation in a typical OECD country real exchange rate.

A real depreciation in the oil-importing OECD implies an a real appreciation of the oil exporting economies. Yet so long as the Gulf pegs its currency of the oil-importing economy with the largest pre-existing current account deficit (at least among the major economies), the only way this real adjustment can happen is through inflation. In that sense, inflation isn’t a problem -- it is the way the Gulf has chosen to adjust.

Perhaps China too.

I agree with Dr. Rogoff’s critique of US policy. But I wonder if has let his colleagues at the IMF off the hook a bit too easily.

Rogoff argues that they are working behind the scenes to help the Gulf move off its dollar peg.


But in public, they continue to support the peg. The IMF’s plan for global imbalances embraces the Saudi peg. The IMF’s Article IV surveillance of individual Gulf economies has also embraced their pegs. Just look at what the IMF board said about the UAE’s peg: "Directors agreed that the current peg of the dirham to the U.S. dollar has served the U.A.E. well." Finally, the IMF has publicly argued that the Gulf should adopt a contractionary fiscal policy to try to reduce inflationary pressures rather than consider moving off the peg.

All in all, it is hard to see how the IMF’s approach differs from that of the US.

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