Poland Revisited

Paul Krugman, Matthew Yglesias, and Matthew O'Brien have recently seized upon presidential candidate Mitt Romney's comments to correctly note the Polish economy's relative strength over the past 5 years is largely attributable to a currency depreciation.  It is a topic that I have discussed briefly here and would like to point out a few things.

Matthew O'Brien claims Poland's comparative success was largely driven by rising exports as the zloty devalued.  He then links to a report with the below chart, which does show a initial growth in net exports as the zloty depreciated, helping Poland weather the worst of the late 2008-09 global nadir.  But a second look at the data shows that exports as a percentage of GDP actually decreased sharply in late 2008-09 and have still yet to recovery to pre-crisis levels, even with a significantly devalued zloty.

Instead of increasing exports, the devaluation initially helped improve the health of the Polish economy by limiting the amount of imports thus improving the terms of the current account.  But since 2009 this effect has largely fluctuated without much of an underlying trend.  This is not to say that the Polish boosting net exports was an unimportant part of the devaluation.  But it does suggest that the traditional devaluation as a means to boost exports channel only explains a small portion of Poland's continued growth.  A larger and more sustainable portion of the growth in Poland has increasingly attributable to domestic consumption and investment, which particularly strengthened moving into 2010.

The next question is how has Poland managed to maintain strong growth as the world around them has largely stagnated?  Marcus Nunes suggests that the devaluation in zloty helped to maintain NGDP growth on trend, thus laying the foundation for a stable macro economic environment, even in the midst of worst global crisis since the great depression.

It is a view I largely subscribe to as well but would also like to point out the importance of market forces in determining monetary policy.  The National Bank of Poland denounced the depreciation and at later stages actively tried to strengthen the Zloty.  Suggesting that if the Poland had reserve currency status, a la the United States, their fate would have been much different, as the large capital inflows would have put forcible appreciation pressure on the Zloty, requiring internal devaluation instead of currency depreciation as a means to combat the slump.  Instead, the swift, market forced devaluation helped to keep nominal income growing largely on trend.  This example is a reminder to all central banks, which are often too slow to quickly respond to rapidly changing market conditions, that if you want to take forcible action, it is best to announce the proper target and allow the markets to do the heavy lifting for you.

The NGDP Effect of Devaluation or Why Exports Don't Matter

Lars Christensen effectively argues that during a currency devaluation, the primary transmission mechanism for monetary policy has little to do with restoring competitiveness, but instead works through the money supply on one hand and velocity on the other.  In equation form, MV=PY=NGDP.   The purpose therefore of the currency devaluation in a depressed economy is not to increase competitiveness in order to boost exports (although he concedes that it is one effect of the devaluation) but to increase nominal spending through the expansion of the money supply and increased velocity.   Lars provides the concise example of Argentina, who abandoned its dollar peg in 2002, resulting in a rapid increase in the money supply, velocity, therefore boosting NGDP and consequently real GDP.

While Argentina provides an informative example of the benefits of devaluation on an economy in stagnation, I thought it would be important to look at a country that used monetary policy to avoid crisis all together.   Poland, as shown by Marcus Nunes last February, provides a unique example of the use of monetary policy to stabilize the broad economy in a time of international economic malaise.  Under normal circumstances, Poland’s continued economic expansion would be of little note, but the world economies since 2007 have been anything but normal.  What makes Poland remarkable is that outside of a minor decrease in RGDP growth in late Q4 2008 (-0.4%), the economy has continued to expand at the same level as it did prior to Lehman’s demise.   A close examination of Poland reveals that competitiveness plays little importance in the transmission mechanism for monetary policy in maintaining Poland's impressive rise....