September 19, 1997
Thank you very much, indeed, Mr. Gyohten.
First of all, on behalf of the Hong Kong Monetary Authority and the Hong Kong Administration, let me welcome you all to Hong Kong. We hope that you are pleased with the facilities that we've provided, and that this seminar and the annual meetings will show how Hong Kong is performing business as usual. I'm doing the advert first.
I feel very awed by the occasion, because I'm speaking in front of my old boss, Stan Fischer. And I don't have the stature of Mr. Gyohten, I don't have the profound brilliance of Michael Mussa, a professor from the University of Chicago, nor do I have the eloquence or the insight of my old friend, Montek.
So, I was wondering why I was really invited here today. And the answer is very simple. I am providing the organ for the organ grinder and for his star performers. So, I will try to ape their performance.
Now, how do you really comment on a paper that covers such a broad subject, and with which it is difficult to disagree? Like Montek, I'm glad that Dr. Mussa has used the medical metaphor because he is, after all, our Chicago Hope--the doctor is in and Asia and the world are in very safe hands.
Thinking about this very wide coverage by Dr. Mussa on the Fund's approach to macroeconomic policy, we have to go back to the basic Polak model. And that's the monetary approach to the balance of payments.
I fully agree with Mike that the role of the Fund in Asia should be to promote international monetary cooperation, high levels of employment, and real income and exchange rate stability, and to provide temporary financial assistance to lessen the degree of disequilibrium in the balance of payments.
The corollary of this, of course, is the difficult question of surveillance and policy recommendations for adjustment. Now, the Polak model is 40 years old. Fundamentally, it has served the Fund very, very well. It's simple, it's eloquent, and it has evolved over time. But I think everybody recognizes--and Mike would probably agree--that the world has evolved, as Montek said, and we're facing a changed world that has great difficulties.
Basically, the Polak model is a flow model. It really hasn't taken into consideration the question of stocks. In particular, it looks at monetary creation, but it has not looked at the quality of bank money.
This bank-fragility problem that Montek has brought up is an area that the Fund has begun to focus on. We are beginning to slowly understand that capital flows are really portfolio shifts among several major markets involving the levels of deposit money, stock prices, real estate, and, of course, foreign exchange assets. And capital flows are shifting very rapidly between these types of debt markets, money markets, foreign exchange markets, and equity markets. These are large shifts that move according to sentiment and confidence, and create shocks in the global economy.
How do we deal with these very large stock valuations, since the exchange rate changes the asset price? And how do we include, for example, some sort of real price levels in macroeconomic policy? This is something I think Alan Greenspan and all the economics profession is struggling with: How do we incorporate this in designing the appropriate monetary policy?
Although I'm absolutely delighted that there is a perception that the flexible exchange rate is the way to go, Mike has said, and the Fund has said, very clearly, that there is no one size that fits all; there is room for a range of exchange rate regimes, including the fixed exchange rate regime in Hong Kong.
And, of course, the fundamentals support the exchange rate, not the other way around. A flexible exchange rate gives you a little bit of room to maneuver, but in very small, open economies like Hong Kong's, a fixed exchange rate is a discipline. It disciplines the public sector to maintain clear fiscal surpluses, and it disciplines the private sector, so that it does not use the variations in the exchange rate to gain competitive advantage.
So, if you are a very flexible economy like Hong Kong, with a fixed exchange regime yet an open economy, the fixed exchange regime is a very important policy instrument target, and an anchor of Hong Kong's prosperity.
I want to comment on the Polak model in relation to macroeconomic adjustment for single economies. One of the difficulties in designing a macroeconomic adjustment for a single economy is thinking that its problems are exactly the problems of all markets. This is the fallacy of composition.
What is right for one economy need not be right for the world as a whole, particularly in exchange rate adjustments, which are very standard policy features in economies that need balance of payments adjustments. It is not necessarily an advantage in that these adjustments, as we have recently seen, can lead to contagion and competitive depreciation that actually restore the old competitive equilibrium.
In a world of large flows and trade competition between the regions, there is some danger--and I think the Fund would have absolutely the right perspective to look at this problem--of what I call the ping-pong effect. If one part of the world depreciates its currency to obtain certain adjustments, this may, with some leads and lags, cause trade pressures on the other parts of the world. How do we take this into consideration?
Small economies are not in a good position to see the global effects of these changes. After all, exchange rate depreciation is an expenditure-switching policy that alters the incentive structure. Therefore, we really need to think very, very carefully about how these kinds of adjustment policies would affect the global economy.
So, basically, I come back to an issue that I think we need to be very clear about in our minds today: We live in a very different world from the original model, with very volatile, very large capital flows. Macroeconomic policies are actually the sum of micro policies, and if you don't get your micro policies right, you can't get your macro policies right.
The relatively simple elegance of models may have depended upon very strict assumptions. For example, the free market assumes that the payment system works robustly and efficiently. But the system has a very good set of rules and laws, and banking supervision. There is also transparency of information. Most of the world is not like that.
Most of the world works with a number of rigidities and imperfections. And in this imperfect world of large capital flows, it is important not only to get your macroeconomic policies right, but to get your micro policies right at the stock levels. How do you ensure that your banking systems are well-regulated and sound, and how do you detect banking fragility?
One of the difficulties, clearly, is foreseeing the problem. This is exactly what I was told by the Fund in its last World Economic Outlook--banking fragility problems or banking problems of one degree or another detected in 130 of 181 member countries of the Fund.
Clearly, this is no longer just one problem in the global economy, but something of a chronic nature that must be addressed in policies.
Coming back down to the policy level, it is not just a question of adjustment on the exchange rate side or on the fiscal side. The issue is that when stock prices drop, and other asset prices decline, this puts a huge pressure on the banking system that is the main provider of the economy's payments mechanism and credit. Very large quasi-fiscal or potential losses in the banking system result from asset deflation. Some very strong economies in the region and throughout the world have been running what appear to be very good primary fiscal surpluses when, if you add in the potential quasi-fiscal deficit in their banking systems or elsewhere, the authorities actually may be misled into thinking that they are running appropriate fiscal policies when they should have taken into consideration the adjustments in the other areas.
So, it gets down to the fact that, in this new world, you really need to look at all details.
In this aspect I think our Thai friends are not here to answer some of the questions that Mike has put.
I would like to end by saying a few words on this area. I think a lot of people did not expect the degree of shock that the whole region received. But I think one must understand that the Asian economy's fundamentals are basically very strong--all the fundamentals of a young labor force and great trade competitiveness. We may not have understood one thing: that the shock waves of capital flows are now much larger than before.
So in relative terms, the exchange rate adjustments in Asia, in relative terms, if you really think it through, have not been as large as the variations in the G-3 currencies (the U.S. dollar, the Japanese yen, and the German mark). The G-3 currencies had very large volatility recently and to some extent this had an impact on the region.
Obviously, Asian growth may need to pause, but we also need to consolidate and we will move forward. I think that we need to take into consideration all the lessons that Mr. Mussa and Montek and others have highlighted, and rethink. But--I would like to repeat this--I think the Asian growth fundamentals are still there.
As an international financial center, Hong Kong fully supports Asian regional and international monetary cooperation and stability, and we will do our utmost to contribute toward that.
We are absolutely delighted that the Fund has come here today to promote and explain its role in Asia. And I thank you all for your presence.