What combination of fiscal and monetary policy creates optimal conditions for currency intervention? To date, the Plaza Accord remains more pertinent than ever in identifying a successful example of currency policy coordination in which major financial leaders gathered to help decline the value of the dollar, thus stabilizing the international economy. The Plaza Accord receives mixed feelings as Japan and the German mark faced problems when the U.S. dollar depreciated to stable levels but then continued to fall. The mark and yen became misaligned in the opposite directions that they were before the accord. This post will explore the ways in which the success of the Plaza Accord outweighed the potential costs given the current circumstance and how a permanent agreement might shape the foreign exchange market.
The first important note to make is the fact that each potential financial crisis is an independent event. Historical success does not prove that such monetary and fiscal action will work in the future. At a recent conference marking the 30th anniversary of the Plaza Accord at the Baker Institute, University of California, Berkeley economist Barry Eichengreen made some valid points on how a lack of prior agreement internally amongst all stakeholders — both within individual countries and between the involved nations — could make such decisions on foreign exchange inopportune.
It appears that a prior agreement is rather impossible given that the entire point of such a meeting is to alleviate a potential crisis before it occurs. In 1985, Congress was rapidly considering protectionist policies. Textbook large open economy models suggest such policies merely raise real exchange rates rather than impact trade balance. Inevitably, investment falls as well. This would not solve the issue of potential economic instability. As former Secretary of the Treasury James A. Baker, III, said in his keynote address at the conference, (see the 8:55 mark in the video), such an agreement would not have happened and the counterfactual results could have been much more devastating to the economies involved.
This same type of counterfactual exploration leads into Eichengreen’s next point: what might have happened to price stability and employment if the Plaza Accord agreement were not enacted? While it is difficult to truly know what might have happened, the decision to enact international agreements provides similar results compared more domestic policies even if they were delayed. While a focus on domestic economic factors might have provided a more immediate short term solution for domestic employment and economic stability, the long term outcome in terms of any type of monetary or fiscal policy is just as ambiguous in predicting results as the Plaza Accord agreement a reminder given by Harvard University economist Jeffrey Frankel during the Baker Institute conference (see the 1:55:40 mark here).
Finally, the divergent economies actually made for the most opportune period of time for Germany, the U.S. and Japan to agree on such a proposition. Baker Institute fellow in international economics Russell Green and co-authors extrapolated that the U.S., Germany and Japan were perched to loosen economic policy. These factors are not consistent with the Taylor Rule. This inconsistency explains why we generally emphasize that intervention is only effective when consistent with monetary policy, and that this alignment does not always coincide with political or other factors driving coordination.
In closing, we see that the U.S. dollar continues to be strong in comparison to many other currencies, but each instance where coordinated intervention might be a plausible solution should be considered on an individual basis. A permanent agreement on currency management — regardless of objective — remains a difficult aspiration, as seen most recently with news of a potential agreement to not devalue currencies amongst the U.S. and 11 Pacific countries. In this same manner, it is important to view the success of the Plaza Accord as a singular event and to proceed cautiously in using it as an example for over-arching policy.
Sawyer Knight is a Rice University junior majoring in economics.