March 28, 2005
IMF Public Communication Modes
Brad Setser is puzzled by IMF Chief Economist Ragu Rajan:
Brad Setser's Web Log: The financing of the US current account deficit: That is why I was slightly disappointed with this speech by Ragu Rajan, the IMF's chief economist. If any institution is well placed to track global reserve accumulation, it is the IMF. Yet rather than emphasizing central bank financing, Rajan goes to great lengths to minimize it.
Rajan argues that the US deficit is financed primarily by private investors:
Overall, the bulk of US assets sold to foreigners are still [sold] to the private sector. That may come as a surprise to some of you who believe that the US current account deficit is being financed by foreign central banks ... the [foreign official sector] still only amount to about one-third of the total gross inflows into the US. ... It is therefore entirely correct to say the US current account deficit is more than fully financed by foreign private investors while US private investment abroad is partially financed by foreign central bank investment in the US...
Rajan appears to be saying that (a) if foreign central banks stopped buying U.S. Treasury and other securities, (b) U.S. investors and businesses would stop investing abroad, (c) would buy those U.S. Treasury and other securities instead, and so (d) the U.S. current account would be unchanged--exchange rates wouldn't move.
Conversely, he appears to be saying that (e) if foreign private investors' taste for dollar-denominated assets were to fall, (f) there would be no change in U.S. gross investment abroad as long as central banks kept buying, but (g) there would be a substantial reduction in the U.S. current account--the value of the dollar would fall.
A model of international trade and finance that made these predictions would be a very strange model of international trade and finance indeed. The same purchases of dollar-denominated assets would have different effects on the value of the dollar depending on who was making them.
I read Ragu Rajan's speech differently. In my experience, the IMF has two public communication modes. The first mode, Communication Mode (1), is when there are serious long-run problems with economic policies (and when are there ever not serious long-run problems with economic problems?) but the short-run outlook is relatively quiet. Then the task of the IMF is to aid national Treasuries in getting their High Politicians to take the long run problems seriously. And the IMF does this through public pronouncements of: "DOOM!! DOOM!! DOOM--not tomorrow, but in the long-run, sure as the sun will set!"
The second public communication mode, Communication Mode (2), is when the IMF judges that the long run is at hand, that there is very limited time before the crunch comes, that a market panic would bring the crunch now, and that the key task is calm markets and buy time so that--perhaps--last minute policy changes to avert utter disaster can be made. Then the IMF talks about the medium-run sustainability of policies, the depth of markets, the commitments of governments to reform, and so forth.
Rajan's speech looks as if the IMF has just switched, as far as the U.S. current account deficit and the value of the dollar are concerned, from Communication Mode (1) to Communication Mode (2).
That is pretty frightening.
Posted by DeLong at March 28, 2005 07:15 PM