Monetary and Economic Policy Management, then and now

Kumiharu Shigehara
Deputy Secretary-General
Organisation for Economic Co-operation and Development

A key-note speech delivered at the Emile van Lennep Memorial Conference on "A Global Order for Sustainable Economic Growth" jointly organised by the Netherlands' Ministry of Finance, De Nederlandsche Bank, the University of Groningen and the Netherlands' Institute for Banking and Stockbroking Industry in Amsterdam, on 20 April 1998

I. Introduction

It is a great honour for me to accept Nout Wellink's invitation to participate in the Emile van Lennep Memorial Conference on a "Global Order for Sustainable Economic Growth". This invitation to be a key-note speaker presumably reflects the fact that, in addition to my service as a central bank economist and practitioner for 20 years, it happens that I have virtually had a "career" as an OECD economist, having worked in different positions on four different occasions.

Emile van Lennep was OECD Secretary-General during my first two periods of service there; the first one (1970-1974) included work as Head of Monetary Division in charge of servicing the Economic Policy Committee's Working Party N-3 for "the promotion of better international payments equilibrium", chaired by Otmar Emminger, then Vice-President of the Deutsche Bundesbank; and the second period of service (1980-1982) was again devoted, though not exclusively, to Working Party N-3's activities under the chairmanship of Sir Kit McMahon, then Deputy Governor of the Bank of England. Even after Emile van Lennep's departure from the OECD, I had the opportunity to communicate with him from time to time, both during my two most recent periods of service at the OECD (1987-1989 and 1992 to the present) and during my service at the Bank of Japan. He sent me his last personal letter in May 1996 to comment on my lecture at the Bundesbank's conference on monetary policy strategies (1). He recalled at that time the debates between the Americans and Europeans on US monetary policy during the 1960s when he was Chairman of the OECD Working Party N-3. His letter demonstrated his continued strong interest in monetary and economic policy debates. He was scheduled to visit the OECD to meet Secretary-General Donald Johnston and myself on 8 October 1996 which, sadly, turned out to be the day of his funeral in his home town of the Hague.

The topic I have been asked to address "Monetary and Economic Policy, then and now" -is a vast one. I shall, therefore, be highly selective, focusing essentially on a brief review of monetary, fiscal and structural policy management in a multilateral setting during the period when Emile van Lennep was associated with the OECD as Chairman of the Working Party No.3 of the Economic Policy Committee (1961-1969) and Secretary-General (1969-1984). I shall also discuss key changes in the multilateral framework for the conduct of economic policy, both macroeconomic and structural, that have occurred since then. Global natural resource management and the environment were also matters of important concern to Emile van Lennep, but I do not have time to discuss these issues here.


II. Changes in the framework of monetary and fiscal policy management
4. When Emile van Lennep was Chairman of Working Party N-3 and as he began his long tenure as Secretary-General of the OECD, fixed exchange rates were still in existence, and monetary and fiscal policy were considered by economists and policy-makers alike to be tools of demand management. Although multilateral trade liberalisation was underway through the GATT rounds, concerns with structural policies were less important. However, during his first decade as OECD Secretary-General, there were great changes in the macroeconomic policy environment. By the end of the 1970s, there had been a generalised move to flexible exchange rates among industrialised countries, and a shift in emphasis from fiscal to monetary policy as a tool of economic stabilisation. Let me quickly go over some of the macroeconomic policy developments and discussions of this period.
5. The role of fiscal policy as a tool of active demand management was examined extensively in a report published in 1968 by a group of independent experts for the OECD (2). The prevailing view in the experts' report was that over the course of the 1960s, the priority that had been accorded to balancing the budget, gave way to use of the budget to stabilise economic activity. According to the experts' consensus view, the appropriate stance of fiscal policy should depend on the state of the economy, rather than the state of the government's accounts or the government's concern about ensuring sufficient revenues each year to cover expenditures. This policy recommendation supported active use of fiscal policy with a view to maintaining reasonably full employment which had been achieved without inflation in most OECD countries by the mid-1960s.
6. By early 1970, when I had moved for the first time to the OECD from the Bank of Japan to work as a member of a project team for a monetary policy study, OECD inflation had accelerated to 5per cent, more than double the average rate in the early 1960s. At the initiative of Emile van Lennep, the OECD Secretariat prepared a report on inflation, published in December 1970. Reflecting the then prevailing view, the report discussed the possibilities for more vigorous action against inflation (3). It called for cautious demand management policies, more direct price-incomes policy, and a more positive price policy through the whole range of government activities, including trade liberalisation, domestic competition policy and other measures to ease structural problems and to even out demand pressures. In that report, no systematic effort was made to evaluate the relative importance of different policy instruments in controlling inflation. Monetary policy was considered together with fiscal policy as an instrument of demand management, and the unique rŪle of monetary policy in determining inflation and inflation expectations over time was not recognised.
7. A series of OECD Secretariat studies on the working of monetary policy were launched almost in parallel with the inflation report, but it took more time to be completed. One of the broad conclusions from these studies, culminating with the 1974 synthesis report (Shigehara and Thygesen, 1975) (4) was that, despite differences in institutions and the choice of policy instruments, monetary policy could have a significant influence on aggregate demand. Another, equally important conclusion was that the attempt to "fine tune" the real sector of the economy with monetary policy was overly ambitious and likely to lead to problems, given limited knowledge of the transmission mechanism, time-lags, and the magnitude of monetary policy effects.


8. The combination in the early 1970s of world-wide excess aggregate demand and of oil shocks led to an upsurge in inflation unprecedented in the peacetime history of OECD countries. This disrupted economic performance for several years. Furthermore, the collapse of the Bretton Woods fixed exchange rate system and the subsequent relaxation of controls on international capital flows by many OECD countries triggered substantial changes in financial markets. More liberalised international capital inflows enabled oil-importing countries to finance current account deficits by borrowing from international capital markets, where OPEC surplus funds were largely invested. One important consequence of relaxation of controls on capital flows was the greater rŪle of market forces in determining domestic financial conditions, weakening the effects of direct administrative controls on interest rates and the availability of credit. The deregulation of domestic money and capital markets was required if they were to compete with more efficient international capital markets, such as Euro-currency markets, to which domestic financial market participants were allowed increasing access.