Unprecedented Global Monetary Policy As World Trade Volume Craters

With the IMF cutting its global growth forecasts and signs of slowing evident in the dramatic contraction in World Trade Volume in the last few months, it is perhaps no surprise that the central banks of the world have embarked upon what Goldman Sachs calls an 'Unprecedented Alignment of Monetary Policy Across Countries'. Our earlier discussion of the European event risk vs global growth expectations dilemma along with last night's comments on the impact of tightening lending standards around the world also confirms that this policy globalization is still going strong and is likely to continue as gaming out the situation (as Goldman has done) left optimal CB strategy as one-in-all-in with no benefit to any from migrating away from the equilibrium of 'we all print together'. Perhaps gold (and silver's) move today (and for the last few months) reflects this sad reality that all your fiat money are belong to us, as nominal prices rise (but underperform PMs) in equities (and risky sovereigns and financials).


While the 25 year low in Baltic Dry is explained away by the simple over-supply of ships (as if that is a good thing) with little thought as to the near-record high inventories of Iron Ore and so on around the world, the reality as shown above is a world in which trade volumes are down dramatically. The 3 month rate of change has turned negative and that trend is accelerating as the 6 month average is about to turn negative - a very weak signal.

Goldman Sachs:- The 'Globalization' Of Monetary Policy

  • In this daily, we draw attention to the intensification of monetary policy coordination around the world.
  • We show that the magnitude of policy synchronization has been unprecedented since the financial crisis...
  • ...and it is still going strong in spite of some divergence across and within EM and DM central banks.

In their Daily strategy report Goldman draws attention to the intensification of monetary policy coordination around the world. We formally assess the magnitude of policy synchronization across countries and show that it has risen to unprecedented levels since the financial crisis and its aftermath. The recent trend of policy ‘globalization’ is still going strong in spite of some divergence across and within EM and DM central banks.

The Financial Crisis Prompted an Unprecedented Alignment of Monetary Policy Across Countries...

There are two basic kinds of monetary policy alignment: explicit coordination of actions (when central banks actually agree to carry out plans simultaneously) and coordination that occurs implicitly (when central banks respond to their own cycles, which are often synchronized, and the monetary impulse from others). Since the Fall of 2008, we have seen both in practice, which is not common by historical standards. We assess the magnitude of this global policy alignment with the following considerations:

Recent coordination agreements are unprecedented. In previous episodes---like at the end of the Bretton Woods system and through the late 1970s---the US did engage in coordinated actions with Japan, Germany, and other countries to fight inflation, but these pacts fell very short of recent actions. To name a couple of examples, the coordinated rate cuts by six major central banks in October 2008 were completely unprecedented (with the closest case being an isolated same-day cut announced by the Fed and the ECB in 2001); so have been measures aimed at liquidity provision, such as the exchange rate swap lines the Fed established with 14 countries back in 2008 (and as recently as in November 2011 with BoC, BoE, BoJ, ECB, and SNB).


There are tradeoffs. As with other types of international macroeconomic policies, central banks face tradeoffs when engaging in coordinated actions. A common scenario is that of a monetary expansion in one country that causes a real depreciation of the domestic currency and erodes the competitiveness of another. While this may boost domestic output temporarily, possible side effects include inflation, capital outflows, and distortions across sectors in the economy. In a context of global turmoil, and especially for open economies, the tradeoff becomes particularly cumbersome. In that case, coordination becomes the optimal strategy to alleviate funding stresses, liquidity problems, credit crunches, and similar pressures. Since many of the shocks in recent years have been large and global in nature, the tradeoff has been mostly resolved in that direction.


Academic answers are now more favorable to coordination. In fact, the broad conclusion from the early academic literature on this topic was that the gains from coordination were secondary at best (and certainly behind those from macroeconomic stabilization). But academic models eventually became more realistic, by explicitly incorporating issues like uncertainty, spillover effects, structural asymmetries, and idiosyncratic productivity shocks. The issue is often framed in the realm of game theory, where countries are pictured as players which weight the size of trade externalities, their perceived views of the world, their previous record of honoring agreements, and the advantages or disadvantages of committing to future actions. Generally speaking, factors like interdependence, coincidence in business cycles, the commonality of shocks, and heightened uncertainty, make it optimal for central banks to move farther away from inward-looking policies, especially during periods of global turmoil.


We assess global coordination trends using statistical methods. A formal yet simple way of assessing the degree of monetary policy alignment across countries is to pinpoint the components that best describe their overall behavior. We do this by running principal component analyses over policy interest rates, which allows us to measure the proportion of the variance in the data that can be explained by the first common driver, the second common driver, and so on. When the proportions attributed to the first few components are higher, it means that the underlying variable (in this case, the policy rates) are more synchronized or aligned with each another. The method also gives the weights that would be given to each country to form each component (which are often called the “loadings”). We focus our results on the proportion of variance captured by the first two components across different samples, but also look at the dispersion of those weights (measured by their standard deviation). Less dispersion means that all countries are proportionately contributing to the global trend. We ran our results for three samples: a group of six DM central banks which have recently engaged in explicitly coordinated policy actions (Canada, Euro area, Japan, Switzerland, UK and US), a broader group of DM countries (20 or less, depending on data availability), and a broad group of EM countries (25 or less, covering LatAm, Asia, CEEMEA, depending on data availability).


What we found is strong evidence that the financial crisis prompted a synchronization of monetary policy that is unprecedented at the global level. In comparison to the historical data, during the period Sep 2008-Dec 2011, the primary components have accounted for a much larger share of the variance in policy rates. The percentages are now 96%, 93%, and 86% for the G6, DM, and EM samples---which are substantially higher from their previous levels of 87%, 74%, and 75%, respectively. The proportion explained by the first component alone increased by 15, 30, and 16 percentage points, in each case. Moreover, the dispersion of the weights for this component more than halved in the recent period. Such dynamics are rarely observed in the data, and reflect the explicit and implicit policy alignment with which most central banks responded to the crisis and its aftermath. Of course, unconventional policies to provide liquidity or further ease monetary conditions, in addition to the currency swap agreements, further strengthen the fact that policy coordination has reached historical highs.

...Which Is still Strong in Spite of Some Divergence Across and Within EM and DM Central Banks

In a recent Global Economics Weekly, Kamakshya Trivedi and Stacy Carlson drew attention to the trends that followed the ‘Great Easing’ of 2008-09. As they highlighted, the normalization of policy rates that coincided with fiscal tightening is likely to turn into a renewed bout of monetary easing during the rest of 2012. In the global spectrum, this will likely be true for most economies, with the exception of countries whose commodity exposure makes them more resilient to a softening in growth, those which are reaching the limits of easing, and those which face diverging inflation expectations or higher inflation pass-through from currency depreciation.

On that side of the spectrum are countries like Colombia, whose central bank hiked unexpectedly earlier this week, while the majority of EM countries are instead closer to easing modes---especially larger economies like China and India. In turn, most DM markets are in line with the Fed’s recent extension of its conditional commitment to keep rates “exceptionally low” through late 2014, and many are likely to further expand their unconventional policies.

Our results show that the story of higher policy synchronization only partially weakens by restricting the sample to the latest period of Jul 2010-Dec 2011, which excludes the more intense segments of the crisis and the Great Recession. But the easing impulse during 2012 is likely to strengthen the alignment again. The extent to which this is true will depend on the pace and the degree of easing that countries will be able or willing to implement going forward. In the EM world, this will be visible mainly through further cuts in policy rates, but in DM, where countries are at or close to the lower bound, synchronization will probably take the form of extended liquidity support agreements or more unconventional policies.